Looking to understand how I properly account for inventory purchased on credit
The fact it was purchased on credit is irrelevant really. If you purchased $5000 of inventory and paid for it with a credit card on Dec 31 of the tax year, then it was purchased and paid for in that same tax year. Period.
Many folks (myself included) find COGS/Inventory to be a bit confusing when first starting to use it. But once you "get it", it's really simple. Just take a little (very little) brain power to get things to "click". Let's start with some definition of terms.
BOY Inventory Balance - Stands for Beginning of Year Inventory Balance. This is what "you" paid for the inventory in your possession on Jan 1 of the tax year. It does not matter in what tax year you purchased that inventory either. If the first year of business, or the first year dealing with COGS, the BOY Inventory Balance *MUST* be zero. No exceptions. (Explained later, after these definition of terms.)
COGS - Stands for Cost of Goods Sold. This is what "you" paid for the inventory you actually sold during the tax year. Again, it does not matter in what tax year that inventory was purchased either.
EOY Inventory Balance - Stands for End-of-Year Inventory Balance. This is what "you" paid for the inventory in your possession on Dec 31 of the tax year. Again, it does not matter in what year that inventory balance was purchased either.
If the first year of business, or first year dealing with COGS/Inventory, The BOY Inventory Balance has to be zero. This is because your BOY Inventory Balance *must* match your prior year's EOY Inventory Balance. Since the business did not exist, or you did not have inventory the prior year, the only way your BOY Inventory Balance can match the prior year's EOY Inventory balance, is if the BOY Inventory Balance is zero. Period. If those do not match, then you will have some 'splain' to do to the IRS, and rest assured there is no acceptable explanation for this to the IRS, other than admitting you messed up, paying any back taxes that may be due along with interest, possible fines, and late fees.
Here are two examples that show how this works. The first scenario covers the first year of business or first year of dealing with COGS. The second scenario covers the 2nd year.
Scenario 1:
Started business in 2020 selling widgets. I already have a number of widgets I've acquired over the last two years before I started my business, and I paid a total of $500 for those widgets over the prior two years. I also have the receipts to prove it, if audited. In 2020 I sold a total of $700 worth widgets and purchased $1000 of widgets. So here's my entries in COGS for the 2020 tax year.
BOY Inventory Balance = $0
COGS - $700
EOY Inventory Balance = $800
The above shows my BOY balance of $0 since that's the only possible way to match the 2019 EOY balance (as the business did not exist in 2019) The total amount of inventory acquired in 2020 (from what I had on hand and what I purchased in 2020) was $1500. I sold $700 worth of it (shown in COGS above) which leaves me an EOY balance of $800. The $700 in COGS is what will be deducted from my 2020 business income and I won't pay taxes on it.
For the 2021 tax year:
BOY Inventory Balance = $800 (matches the 2020 EOY balance as required)
COGS = $1000
EOY Inventory Balance = $1000
By 2021 BOY matches my prior year EOY as it should. During the year I purchased an additional $1,200 of inventory which gives me a total inventory of $2,000. I also sold $1000 of that inventory (as shown in COGS) which leaves me with an EOY balance of $1000. The $1000 COGS will be deducted from the total business income so I don't pay taxes on it.
Now there are other categories in the COGS section I didn't cover here. For example, there's a category for "Inventory removed for personal use" Basically, this is for the obvious. But the main thing is, it allows you to account for inventory and not throw things out of balance between on year's EOY balance and the next year's BOY balance.
