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.
