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Old 03-07-2016, 08:50 PM   #1
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How to resolve inventory claimed as expenses

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Let me begin by stating that I do have an accountant and have already seeked her advice, but was told that she is backed up for tax season and wont be able to reply promptly. Until then, I'm hoping for opinions on this issue:

It seems many, myself included, have mistakenly been under the impression that we could simply write off unused materials as expenses in the year we purchased them. In my case, I run a sewing business and built up a stock of fabrics for customers to choose from, and believed I was handling it correctly by expensing those purchases the same year. I never had actual finished goods at year end, just the unused fabric, but I have build up quite a stash of it and expensed it all the year I bought it.

Now, however, it has come to my attention that these should have been inventoried and expensed when sold. How have others handled resolving this issue to correctly account for inventory when much of that inventory has been expensed in previous years?

I'm wondering if the following would be acceptable:
Since I've already paid taxes on the fabric I have on hand, could I begin my inventory this year at $0, and value finished goods based *only* on the cost of the material *purchased this year*, so as not to double expense the material I've bought previously that was already deducted? And then value all inventory purchased this year but not used/sold at cost?

Example #1:
I make an item using $10 of material I bought this year. At the end of the year, if unsold, I value that item at $10

Example #2:
I make an item using $5 of material I bought this year, and $5 of material I bought last year but *expensed last year*. At the end of the year, if unsold, I value that item at only $5

Can anyone who has been in this situation please provide information on how they began correctly tracking inventory when they were previously mistakenly expensing unused material the year they bought it?

Last edited by melissa; 03-07-2016 at 09:32 PM..
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Old 03-11-2016, 05:52 PM   #2
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How much are we talking about in material inventory that has previously been written off? $100, $1000, $!0,000, $100,000, $1Million?
If the amount is substantial then amended returns may be appropriate, to the extent allowed by the statute of limitations.
If the amount is not material then using the zero basis for any of the material used in the production of a product would be appropriate.
You and your accounting/tax professional should establish a "cost accounting" system AND an inventory "method". These are not only defined in Generally Accepted Accounting Principals, but are also spelled out in the tax code. At certain income levels the tax code, as written by Congress, requires the "full absorption method" of determining Cost of Goods Sold (COGS).
Beginning inventory plus
Purchases in the year plus labor and overhead equals
Goods available for sale less ending inventory equals COGS

Gross receipts less
COGS equals
Gross income (for tax purposes)

These are both accounting and tax formulas. The tax formulas are a matter of statute in the tax code.
Again, there are allowances in the tax code for simpler ways to determine COGS and inventory but the depend upon lower income levels. Have this conversation with your Tax professional.
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