Here's the basics for simplicity, with examples.
Beginning of Year (BOY) Inventory: What *YOU* paid for the product in your physical possession on Jan 1 of the tax year. This amount *MUST* be the same of the End of Year inventory in the prior year. If this is your first year of business or the first year your business reports inventory, then your BOY inventory "MUST" be zero. If you had no inventory the prior year then there's no other possible way that your current tax year being reported can have more than zero on Jan 1 of the tax year.
End of Year (EOY) Inventory: The *YOU* paid for the product in your physical possession on Dec 31 of the tax year.
Cost of Goods Sold (COGS): What *YOU* paid for the inventory that you actually sold during the tax year. It flat out does not matter in what tax year you purchased that inventory either. You could have purchased it 50 years ago. But what you paid for that inventory is not deductible on your tax return until the tax year you actually sell it.
When reporting inventory, every box *must* have a digit in it, even if that digit is a zero. You can't just leave it blank.
Now for a few examples.
Example 1:
BOY Inventory: $0
COGS: $7000
EOY Inventory: $5000
The above shows that on Jan 1st I had no inventory in my physical possession. It shows that I purchased a total of $12,000 in inventory during the tax year, and of that purchased inventory I sold $7000 worth of it during that same tax year, thus leaving me with $5000 of inventory on Dec 31 of the tax year. The COGS amount of $7000 will be deducted from my gross taxable business income received.
Example 2:
BOY Inventory: $5000
EOY Inventory: $4000
COGS: $7000
The above shows that on Jan 1 I had $5000 of inventory in my physical possession. Take note that the BOY balance is the same as the EOY balance in example 1, indicating that example 2 is probably my 2nd year of business carrying inventory. The BOY inventory of Jan 1st ***MUST*** match the EOY inventory of Dec 31st of the prior year. If it does not, then you'll have some 'splainin' to do with the IRS when they audit you. So if 2018 was your first year of business or the first year your business carried inventory, then the BOY balance ***MUST*** be zero.
Now during the year I purchased an additional $6000 of inventory, bringing the total for the tax year to $11,000. Of that, I sold $7000 of my inventory leaving me with an EOY balance of $4000. The $7000 reported as sold during the tax year (in the COGS box) will be deducted from my taxable business income for the year.
I know this math seems back-aswards. But that's how the IRS does it and how they want to see it on your return. It takes a bit of mental effort to understand it. But once you work it through "the IRS way" a few times, it'll click and start to make sense.
Now for some additional explanations of three other things asked for in the COGS section. Labor Costs, Materials & Supplies, and Other Costs to Prepare for Sales.
Labor Costs: If you have W-2 employees that you pay to do this stuff, then you have already deducted the wages you pay them for this, elsewhere on your tax return. You will *not* claim what you paid them here in the COGS section then, as that would be double-dipping. If you have a sub-contractor you paid for this and you did "NOT" claim what you paid that sub-contractor elsewhere on your tax return, then you would claim that labor cost here.
Materials and Supplies: If you are actually using inventory you purchase to build, assemble or create a finished product for sale, this category is for those things that don't necessarily become "a material part of" the finished product you sell. Instead, they are "consumed" during your manufacturing process and/or during your process of "preparing for sales". For example, if your business manufactures mirrors, one of the last things you will do in your manufacturing process is to clean the mirrors with something like Windex before you package them. The Windex does not become "a material part of" your finished mirror. Instead, it is "consumed" during the final cleaning phase of your production process. So what you pay for all that Windex is reported in COGS as a Materials & Supplies expense. Other examples of this would be rags, sand paper, nails, screws, and the such.
Other Costs to Prepare for Sales: This would be for things like the packing materials and boxes or display cases you put the mirrors in, prior to selling them. Things like this are not "a material part of" the product sold. Nor are they "consumed" during your manufacturing process. But you do have to pay for those boxes, display cases and packing materials that the customer is most likely just going to throw away once they get that mirror home and take it out of the box or display case.
