I cannot give advice, but there is a wealth of information online on this subject.
IRS Publication 538 (see pp. 13-15) explains the two methods.
If you are a small business taxpayer (defined in the pub), you can choose not to keep an inventory, but you must still use a method of accounting for inventory that clearly reflects income. A small business taxpayer can account for inventory by
- (a) treating the inventory as non-incidental materials and supplies, or
- (b) conforming to its treatment of inventory in an applicable financial statement (as defined in section 451(b)(3)).
If it does not have an applicable financial statement, it can use the method of accounting used in its books and records prepared according to its accounting procedures.
The value of your inventory is a major factor in figuring your taxable income. The method you use to value the inventory is very important. The following methods, described below, are those generally available for valuing inventory.
• Cost.
• Lower of cost or market.
• Retail.
Cost Method
To properly value your inventory at cost, you must include all direct and indirect costs associated with it. The following rules apply.
• For merchandise on hand at the beginning of the tax year, cost means the ending inventory price of the goods.
• For merchandise purchased during the year, cost means the invoice price minus appropriate discounts plus transportation or other charges incurred in acquiring the goods
Lower of Cost or Market Method
Under the lower of cost or market method, compare the market value of each item on hand on the inventory date with its cost and use the lower of the two as its inventory value. This method applies to the following.
• Goods purchased and on hand.
• The basic elements of cost (direct materials, direct labor, and certain indirect costs) of goods being manufactured and finished goods on hand.
This method does not apply to the following. They must be inventoried at cost.
• Goods on hand or being manufactured for delivery at a fixed price on a firm sales contract (that is, not legally subject to cancellation by either you or the buyer).
• Goods accounted for under the LIFO method.
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