See if this helps clarify things.
BOY = Beginning of Year
EOY = End of Year
COGS = Cost of Goods Sold
When dealing with inventory, your BOY inventory balance must match your prior year EOY balance. If it does not, then you will have some explaining to do do the IRS. There is absolutely no reason for the BOY inventory balance to not match the prior year's EOY balance. None what-so-ever.
Keeping this mind, in your first year of business (or first year dealing with inventory) your BOY balance must be zero. No exceptions. It doesn't matter if you actually purchased that inventory years ago either. If in the prior year you were not in business or did not report inventory, there is absolutely no possible way you can have an inventory balance greater than zero in that first year of dealing with inventory.
Also, understand that inventory is not a deductible business expense until the tax year you actually sell that inventory. There are no exceptions. So with all this, here's a few examples. Example 1 shows the first year of dealing with inventory. Example 2 shows the 2nd year of dealing with inventory.
Example 1:
BOY Inventory balance = $0 (What *you* paid for that inventory)
COGS = $5000 (What *you* paid for that inventory)
EOY Inventory balance - $2000 (What *you* paid for that inventory)
The above indicates that on Jan 1 of the tax year you had no inventory. Then during that tax year you sold $5000 of your inventory and ended the year with $2000 of inventory. Therefore with simple math one can see that you purchased a total of $7000 of inventory during the tax year, and in that same tax year you sold $5000 of that inventory. That $5000 is deductible.
Example 2:
BOY Inventory balance = $2000 Take special note that this balance matches the prior year's EOY inventory balance, exactly.
COGS = $4000 This is what I paid for the inventory that I actually sold during the tax year. It *does* *not* *matter* in what tax year I paid for it either.
EOY inventory balance - $3000 This is what I paid for the inventory I had left over on Dec 31 of the tax year. Again, it does not matter in what tax year I paid for that inventory either.
With the above, we can see that I started the tax year with $2000 of inventory. With some simple math we can see that an additional $7000 of inventory was purchased during the tax year, bringing my total inventory for the year to $9000. Of that, I sold $4000 of inventory leaving me with $3000 of inventory on Dec 31 of the tax year. The $3000 I paid for the inventory I sold, is deductible from my taxable business income now.
