Discussion:Accounting for Inventory Under Cash Basis
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Cross Accounting (talk|edits) said: | 25 May 2005 |
| Recently one of my clients has been audited. He sells toys at a toy store as an S Corporation. His sales have been under one million and he has elected to use the cash basis. In these first couple years he has been adding inventories and expensing 100% of the inventory purchases as costs of goods sold.
The auditor keeps asking for an inventory amount. While the auditor has not yet made a change, I am sensing he is going to try and back out $200,000 worth of inventory from an expense to inventory as an asset. It has been my impression that as long as sales are under $1,000,000 then cash basis expensing can be used even on inventory items. Can anyone lend me a hand to help me show the auditor this in the code or in a regulation? Thanks, Cross Accounting | |
| 25 May 2005 | |
Hi, I believe you still need to have inventory even if you are allowed to use cash method. The inventoriable items are deductible in the year in which they are actually consumed and used (or sold), or in the year in which the taxpayer actually pays for the items, which ever is later.
Hope this will help. Jack Chen, CPA | |
| 25 May 2005 | |
| You must use an inventory method. I would take current inventory at LCM and work with the Revenue Agent. | |
KittyForTax (talk|edits) said: | 27 May 2005 |
| Even though your client is allowed to use the cash basis for and is not required to carry an AR or AP for tax purposes he can only expense the item that have actually been sold and therefore must maintain an inventory to come up with an accurate figure. The only way he can not have an inventory is if he sells on a party plan and therefore does not buy until the order is received and therefore does not have any inventory. Kitty McDowell E.A. | |
Cross Accounting (talk|edits) said: | 13 June 2005 |
| The 1.162-3 code seems too broad. Are you sure this is for cash basis instead of accrual basis. This extends beyond inventory to supplies. As an example, I had a contractor buy $40,000 worth of cord for the Super Bowl in December of '04 that was consumed by his own company one month later. I can't write-off the $40,000 in supplies?
1. Are you guys sure 1.162-3 applies for cash basis? It looks awfully accrually. So everyone here still thinks I was too aggressive in expensing inventory upon purchase? I guess all my Mary Kay and Tupperware people are going to have to start carrying inventory again? 2. While I'm starting to lose my confidence in inventory expensing, what do you guys and gals think about the expensing on the cord above? I'm still inclined to take it as a $40,000 expense (Company revenue $540,000), but it might be more out of stubborness than code even though I want to follow the code. 3. Where is the destinction bewtween consumed vs. resold in 1.162-3 "Cost of Materials". Thanks everyone for your valuable input. I really enjoyed and dreaded reading 1.162-3. I guess I just want a little more confirmation before I go and switch my thinking around here. Sincerely, Cross Accounting. | |
| 23 December 2005 | |
| Rev. Proc. 2001-10
This revenue procedure modifies and supersedes Rev. Proc. 2000- 22, 2000-20I.R.B. 1008, and provides that the Commissioner of Internal Revenue will exercise his discretion to except a qualifying taxpayer with average annual gross receipts of $1,000,000 or less from the requirements to use an accrual method of accounting under section 446 of the Internal Revenue Code and to account for inventories under section 471. Section 471 provides that whenever, in the opinion of the Secretary, the useof inventories is necessary to clearly determine the income of the taxpayer,inventories must be taken by the taxpayer. Section 1.471-1 requires a taxpayerto account for inventories when the production, purchase, or sale of merchandiseis an income-producing factor in the taxpayer's business. | |
| 23 December 2005 | |
| I would write off the cord since in is not a income-producing factor. | |
Michael P Kelly, CPA (talk|edits) said: | 4 January 2006 |
| I think the following will answer your question, from the IRS tax topics number 408:
"Be aware that Revenue Procedure 2001–10 & Revenue Procedure 2002–28 specifically state when you can deduct the costs for the inventoriable items that are being treated as materials and supplies that are not incidental within the meaning of Treasury Regulation 1.162–3. In the case of a cash method taxpayer, the cost for these items cannot be deducted until the year in which (1) you sell the items or (2) you pay for them, whichever is later." So basically the exemption from inventory afforded by the 2 Rev Proc's is a lot of BS, because you must still account for your inventory. You cannot deduct the expense until you sell the merchandise. Michael | |
| 5 January 2006 | |
| If the business has the same mark up on the product, then just reduce gross sales by the mark up percentage to arrive at the sales cost and thus avoid cost of sales data. Enter that number on Purchases line on schedule C. This is a simple way for clients that don't keep decent records for beginning and ending inventories. | |
| 21 February 2006 | |
| DEDUCTION FOR INVENTORY IS AN EXPENSE WHEN THE ITEMS ARE PAID FOR AS PER ANY OTHER CASH BASIS EXPENDITURE PROVIDING THE COMPANY SALES ARE LESS THAT A MILLION DOLLARS. | |
| 21 February 2006 | |
| DAVEG, can you specifically support your response? 2002-28 is what I've used to explain to cash clients the requirement for ending/beg inventory counts for reduction or change to COGS. | |
| 21 February 2006 | |
| This is in some way a judgement call, but look at §1.471-2 (2): It(the valuation of inventory) must clearly reflect income. Valuing at $0 (expensing) or cost of what is actually on hand are two different methods of valuation.
If sales are below $1M and there is approximately $200K of inventory floating around, I would have a hard time justifying that this method clearly reflects income. I can't find where it says that cash basis taxpayers must keep record of inventories, but I clearly remember I was taught to do exactly that using a hybrid system. | |
DR BRISKET (talk|edits) said: | 21 February 2006 |
| I was taught in a small merchandising business to use accrual accounting through cost of goods sold, and cash basis for all other disbursements if the business is indeed cash basis. This means all inventory purchases should be booked through accounts payable rather than from cash disbursements. This is particularly true at year end if delivery is taken on a truck load of goods, and is included in a physical year end inventory count. Merchandise purchases must be adjusted for beginning and year end inventory counts. I suspect the reason your S-Corp client was audited was for not showing inventory on his balance sheet in a merchandising business. | |
| 24 September 2006 | |
| This is interesting discussion on cash basis accounting.
I have a related question concerning a company with less than 1 Mil sales. It's business concept is selling covered call options and registering the premiums as revenue. The short position on the call is supported by ownership of the stock that is purchased by the LLC's funds. Can the LLC expense the cost of purchasing the stock at the time the disbursement is made? Due to the nature of the business, ownership of the stock is less than 1 year. | |
| 23 October 2007 | |
| Let's change the discussion a little to a cash basis artist. 263A does not apply to creative expense. So are all of the materials and supplies that an artist uses to create items a cash basis expense? If not, I would like to know how preparers would apply it to an artist. The only approach that I could see would be to have the artist list created pieces that he has for sale. Then to ask for the materials cost to create them. This approach leaves a lot of discretion up to the artist (who is creative prone, not record keeping prone). They would have to list pieces as well as calculate how much of each material went into each product (besider their labor of course). If the artist does some custom furniture work as well as floor and wall products, they would have a lot of demonstration products to get their product out in front of the public and to get known. The actual buyer might want something a little different that would be custom ordered. Any help on this subject is appreciated. | |
TheTinCook (talk|edits) said: | 23 October 2007 |
| It's been adressed on your post in this other thread. Artits can deduct all expense in current year? | |
| 23 October 2007 | |
| I brought this up once in the accounting forum, and now that it's up again, I have an excuse... Eligible businesses (like the toy store way above) that choose not to maintain inventories must still treat merchandise on hand at the end of the tax year in the same manner as materials or supplies. Ok, materials and supplies treatment: Reg. 1.162-3 essentially requires that expense be matched with use. The cost of supplies on hand at end of year are totaled, carried forward, and deducted in the year the supplies are used. Sounds like accrual to me; what labor is exactly being saved here if you applied this to small business "inventory".! This is one of those things you find in practice that are like a pebble in your shoe. Someone thought to put this 1 mil. inventory exception in there, but for what practical purpose, I have not been able to determine. Is it perhaps a valuation method issue you can skip? But I would have to disagree with the posters above who say that you can merely expense all goods held for sale in a small cash basis business like this. P.S. for instance, concretely, would you skip all COGS calculation on the return, and place all "matched inventory" costs under supplies? Seems like this says you could. But why would you? | |
