rhonda5838
Level 2

Cost of Goods with inventory

I make bath & body products and carry an inventory that includes my ingredients & products I made but have not sold.  I entered my beginning inventory and ending inventory.  My question is regarding the next page which list cost of purchases, material and supplies, and other costs to prepare for sales.  I am confused what these 3 represent.  I have my receipts for the year that I purchased for the following reasons:

 

Ingredient that become the product (example: oils, butters, fragrances etc.)

Jars, bottles, labels (product packaging)

Boxes, bubble mailers etc. (for shipping)

 

Which one of the above expenses goes on the line for cost of purchases, material and supplies and other costs to prepare for sales?

 

If someone can please answer my question and help me understand where I am to report each individual purchase expense, I would be grateful.

 

Thanks, in advance!

Rhonda

LudwigVan_fan
Level 7

Business & farm

Hi:  In my opinion, purchases would be the ingredients.  Materials would be the jars, etc. and the shipping materials.

 

Here is a link for a printable/readable version of Instructions for Sch C.

 

https://www.irs.gov/pub/irs-pdf/i1040sc.pdf

 

That should help answer your question(s) and perhaps help you with other expenses in regards to Sch C.

**Disclaimer: Effort has been made to offer correct information; but due to the discussion forum limitations, the poster disclaims any legal responsibility for the accuracy of the poster's response**

View solution in original post

rhonda5838
Level 2

Business & farm

Thanks so much for your help I truly appreciate it.  God Bless!

Carl
Level 15

Business & farm

To (hopefully) help  you better understand.

- Those items and materials that become "a part of" the product you sell, are inventory. That would probably be the oils, butters, fragrances etc. along with the Jars, bottles, labels.

-Those items that are consumed in the process of manufacturing your product could be either supplies or materials.

-Those items that are used to "prepare for sales" would include things like bubble wrap, shipping boxes, address labels, ink, etc. (also, display boxes and related materials used to display products in a store, if you actually have a store front.)

One area where folks really mess up big time, is with inventory tracking in that first year. They don't quite understand yet, that what they paid for the inventory is not deductible until the tax year they actually sell that inventory, regardless of what year they may have purchased and paid for it.

Beginning of Year (BOY) inventory balance - What *you* paid for the product you sell, that was in your physical possession on Jan 1 on the tax year. Note that in the first year of business, or the first year of dealing with inventory, the BOY Inventory balance *must* be ZERO.  It flat out *does* *not* *matter* if the inventory was paid for years ago either. This is because your BOY Inventory balance "MUST" match exactly, your prior year's EOY Inventory balance. So if this is your first year dealing with inventory, the Beginning of Year Inventory Balance *MUST* be ZERO so that it matches the fact that you had no inventory on Dec 31 of the prior tax year. There are no exceptions.

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 year you paid for that inventory either.

End of Year (EOY) Inventory Balance - What "you" paid for the inventory in your physical possession on Dec 31 of the tax year.

 

rhonda5838
Level 2

Business & farm

Thanks so much for helping to give me more of an understanding in regards to the BOY and EOY inventory.

 

rhonda5838
Level 2

Business & farm

I was able to fill out the BOY and EOY inventory but when it took me to the next page (cost of your goods page) it was here that I needed clarified.   My question is regarding this page which list COST OF PURCHASES, MATERIALS AND SUPPLIES, and OTHER COSTS TO PREPARE FOR SALES.  I am confused what these 3 categories represent. I have my receipts for the year that I purchased for the following reasons:

 

Ingredient that become the product (example: oils, butters, fragrances etc.)

Jars, bottles, labels (product packaging)

Boxes, bubble mailers etc. (for shipping)

 

Which one of the above expenses goes on the line for Cost Of Purchases, Material & Supplies, and Other Costs To Prepare For Sales? 

Just to clarify what you said I am to put my ingredients (oils, butters, fragrances and the jars, labels etc. on the Material & supplies line and my boxes, bubble mailer etc. on Other Costs To Prepare For Sales line.   

What would I put on the COST OF PURCHASES LINE?  Everything else on this page was self explanatory it was just those 3 lines that I was not sure of.  I just want to fill everything in correctly and would hate to make any mistakes.  If you could guide me on what goes where on these 3 lines I would be forever grateful.  Thanks again!

Carl
Level 15

Business & farm

The particular lack of clarity that you are seeking to have clarified is not something one figures out through osmosis, when you don't have a full understanding of just how the math works. This lack of understanding is also exacerbated by reading to much into the information or question. So your experience is nothing new.

Basically, anything that permanently leaves the store once it's paid for, is reported somewhere in the inventory section. Regardless of where you enter the expense in that section,it gets deducted from your gross business income (with the exception of "inventory removed for personal use")

Additionally, if you have already reported the expense elsewhere in the program (such as claiming your boxes and bubble wrap as "supplies") then you can not claim it again in any other section.  So just be aware of and understand that.

Cost of Purchases: What you paid for the product you actually sold during the tax year. This would include oils, butters, fragrances, etc. and "could" include the jars, bottles and labels if the cost of these items can be broken down into the same units for each sale.

For example, if you sell your product at a fixed cost for each 10oz bottle, that 10oz has a fixed (somewhat) cost, the 10oz bottle or jar has a fixed cost, and the labeling on that jar or bottle has a fixed cost. (fixed cost to you, that is) So if you add up those fixed costs for one unit, it comes to $5 per unit. So if you ship out 12 jars, that's $60. If you ship out 6 jars then obviously it's $30.  In this scenario, this would be what I would clarify as "the product actually sold"

Labor Cost: Most likely, you would have $0 here. If you have employees, your labor costs are already taken care of in the section where you deal with the employee wages that you pay.

Materials and Supplies: This generally is used for those things that are not a part of the finished product, but are "consumed" in the manufacturing, shipping, and/or selling process. I don't see that you have anything that is consumed during the manufacturing process. But only you would know that for sure. As an example, if you manufacture mirrors, one thing you're going to do somewhere in the process, is clean that mirror with Windex; probably just before putting it in the shipping box. The cost of that Windex is a "materials and supplies" cost, because it's not part of the product being sold, and it's an undeniable fact that it is "consumed" during your manufacturing/shipping/selling process.

Other Costs to prepare for sales: This would include everything else, such as boxes, bubble wrap, address labels, and even postage. Anything that is not "a material part of" the actual product being sold, yet is utilized in the process of selling it, or preparing it for sale.

 

In the end, regardless of where you enter a valid expense in any of the above categories, the math is the same. It gets subtracted from your gross business income and is not included in the taxable business income. That's all the IRS cares about. When they have to process more than 400,000,000 returns every year, and do it in less than 90 days every year, it's not like they have the time to get nit-picky on everything.

 

rhonda5838
Level 2

Business & farm

I really want to thank you so much for breaking down so thoroughly each individual section.  I have asked this question the previous year and did not receive the valuable information you gave.  I thought last year I understood but now I am upset that unfortunately I did not.  Now that I understand what goes where I am forever grateful. 

 

Based on the inventory equation

COGS=Beginning Inventory + purchases – Ending Inventory.

 

Example:

$2,682 (BOY) + $10,630.00 (YTD PURCHASES) - $5,510.00 (EOY) = $7,802 (COGS)

 

My only question is that everything entered on this page regardless of which of the 3 categories I use should be for the $7,802.00 (COGS) and NOT $10,630.00 (YTD PURCHASES)?

 

Once I get this last answer, I will have a complete understanding of the inventory process and be able to fill out my taxes with confidence.

 

Thanks again!

Carl
Level 15

Business & farm

The way the IRS has us do this is rather weird. But it's done this way since you can only deduct from your taxable business income, what you paid for inventory you "actually sold" in that tax year. Overall, this is really simple *ONCE* you wrap your head around it. It's the process of wrapping your head around it that's not so simple for some.

I like to compare it to riding a bike. Can you remember when you were learning to ride a bike? I'm sure there were many, many times where you said "I'll never get the hang of this!" But now, It's extremely difficult (if not impossible) to truly recall that feeling of frustration and emotional state, as we take the training wheels off our own child's bike and watch them fall over time after time after time. We just can't remember what it was like to "not" be able to ride a bike. This inventory tracking is the same thing. Once you "get it", then you've "got it", for life.

Here's how this works, with two examples. The first example is the 1st of of business, with the 2nd example being the 2nd year.

YEAR 1
BOY Inventory Balance $0

COGS - $1000

EOY Inventory Balance $5000

The above indicates that I started the year with nothing. During the year I purhcased a total of $6000 of inventory. During that same year I sold $1000 of that inventory, leaving me with $5000 left on Dec 31 of the tax year.  That $1000 is what I get to deduct from my taxable business income.

YEAR 2

BOY Inventory Balance $5000

COGS - $1000

EOY Inventory Balance $13000

The above shows I started the year with $5000 of inventory. Note that it matches exactly, my prior year's EOY Inventory Balance. If this does not match, then I've got some explaining to do to the IRS. There is *NOTHING* I could tell the IRS that they would buy into, which they would except for my 2nd year BOY not matching exactly my 1st YEAR EOY balance.

Above also shows that I purchased an additional $9000 of inventory during the year, bringing my year's total inventory to $14,000. Of that I sold $1000 of the inventory, leaving me with an EOY balance of $13000.

The $1000 of inventory I actually sold in the 2nd year, is all I get to deduct from my taxable business income.

 

Now of all the "categories" you have in the inventory section, only three matter for inventory tracking.No more. No less.

1) Beginning of Year inventory balance.

2) Cost of Goods Sold (COGS)

3) End of year inventory balance.

All the other categories (cost preparing for sales, etc, etc, etc,) are deductible expenses, but they have "NOTHING" what-so-ever to do with the inventory balance.

rhonda5838
Level 2

Business & farm

For the very first time I actually understand the second page and what it represents.  I can not thank you enough for explaining in detail like you did.  I hope this post can help others in a similar situation like myself who manufactures their own products and how to properly enter their information.   You are a true ASSET to TurboTax for your valuable service.  God Bless!!

Carl
Level 15

Business & farm

Like riding a bike. Once you know, you never forget and in short time, you can't remember what it was like "not" to know. 🙂