Does my business have to track inventory, or can I just expense what I buy when I buy it?

Does the tax law make you count what you hold?

Except as provided in paragraph (b) of this section, inventories at the beginning and end of each taxable year are necessary, in order to reflect taxable income correctly, in every case in which the production, purchase, or sale of merchandise is an income-producing factor. (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Taxpayers subject to U.S. federal income tax that produce, purchase or sell merchandise, accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).)

“Except as provided in paragraph (b) of this section, in order to reflect taxable income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor.”

Paragraph (a) of this section (the general need for inventories) shall not apply to a taxpayer, other than a tax shelter prohibited from using the cash receipts and disbursements method under section 448(a)(3), in any taxable year if the taxpayer both meets the gross receipts test described in paragraph (b)(2) and uses as its method of accounting for inventory a method described in paragraph (b)(3). (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Taxpayers meeting the section 448(c) gross receipts test, other than a tax shelter prohibited from using the cash method under section 448(a)(3), accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).)

“Paragraph (a) of this section shall not apply to a taxpayer, other than a tax shelter prohibited from using the cash receipts and disbursements method of accounting (cash method) under section 448(a)(3), in any taxable year if the taxpayer meets the gross receipts test described in paragraph (b)(2) of this section, and uses as a method of accounting for its inventory a method that is described in paragraph (b)(3) of this section.”

Partly established. Established: the federal tax rules that determine whether a business must account for inventories (S01, S03); any size-based or small-business relief (S03); the measure on which that relief is tested (S03); whether relying on that relief depends on an election or other step the business must take (S03). Missing: the period over which the measure is applied; when that step has to be taken.

The facts about your own business that decide it

See Except as provided in paragraph (b) of this section, inventories at the beginning and end of each taxable year are necessary, in order to reflect taxable income correctly, in every case in which the production, purchase, or sale of merchandise is an income-producing factor.

See Paragraph (a) of this section (the general need for inventories) shall not apply to a taxpayer, other than a tax shelter prohibited from using the cash receipts and disbursements method under section 448(a)(3), in any taxable year if the taxpayer both meets the gross receipts test described in paragraph (b)(2) and uses as its method of accounting for inventory a method described in paragraph (b)(3).

A taxpayer that is eligible to use, and that chooses to use, the paragraph (b) exemption may account for its inventory either by using a method that treats its inventory as non-incidental materials and supplies (the section 471(c) NIMS inventory method) described in paragraph (b)(4), or by using for each item the method reflected in the taxpayer's applicable financial statement (the AFS section 471(c) inventory method) or, if the taxpayer has no AFS for the taxable year, the books and records of the taxpayer prepared in accordance with its accounting procedures (the non-AFS section 471(c) inventory method). (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Taxpayers meeting the section 448(c) gross receipts test, other than a tax shelter prohibited from using the cash method under section 448(a)(3), accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).)

“A taxpayer eligible to use, and that chooses to use, the exemption described in paragraph (b) of this section may account for its inventory by either: (i) Using a method that treats its inventory as non-incidental materials and supplies (section 471(c) NIMS inventory method), as described in paragraph (b)(4) of this section; or (ii) Using the method for each item that is reflected in the taxpayer’s applicable financial statement (AFS) (AFS section 471(c) inventory method); or, if the taxpayer does not have an AFS for the taxable year, the books and records of the taxpayer prepared in accordance with the taxpayer’s accounting procedures, as defined in paragraph (b)(6)(ii) of this section (nonAFS section 471(c) inventory method).”

Partly established. Established: whether goods are held for sale (S01); the accounting method in use (S03, S05); the size measure the rules apply (S03). Missing: any election the relief depends on.

If you are let off, which method are you actually on?

See Paragraph (a) of this section (the general need for inventories) shall not apply to a taxpayer, other than a tax shelter prohibited from using the cash receipts and disbursements method under section 448(a)(3), in any taxable year if the taxpayer both meets the gross receipts test described in paragraph (b)(2) and uses as its method of accounting for inventory a method described in paragraph (b)(3).

See A taxpayer that is eligible to use, and that chooses to use, the paragraph (b) exemption may account for its inventory either by using a method that treats its inventory as non-incidental materials and supplies (the section 471(c) NIMS inventory method) described in paragraph (b)(4), or by using for each item the method reflected in the taxpayer's applicable financial statement (the AFS section 471(c) inventory method) or, if the taxpayer has no AFS for the taxable year, the books and records of the taxpayer prepared in accordance with its accounting procedures (the non-AFS section 471(c) inventory method).

The non-AFS section 471(c) inventory method is the method of accounting used for inventory in the taxpayer's books and records that properly reflect its business activities for non-tax purposes and are prepared in accordance with the taxpayer's accounting procedures. (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Taxpayers meeting the section 448(c) gross receipts test, other than a tax shelter prohibited from using the cash method under section 448(a)(3) without an AFS for the taxable year, accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).)

“The non-AFS section 471(c) inventory method is the method of accounting used for inventory in the taxpayer’s books and records that properly reflect its business activities for non-tax purposes and are prepared in accordance with the taxpayer’s accounting procedures.”

If an item of income or expense is not treated consistently from year to year, that treatment may not clearly reflect income, notwithstanding the application of this section. (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Taxpayers subject to U.S. federal income tax, accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).)

“If an item of income or expense is not treated consistently from year to year, that treatment may not clearly reflect income, notwithstanding the application of this section.”

Expensing as you buy still comes with conditions

See The non-AFS section 471(c) inventory method is the method of accounting used for inventory in the taxpayer's books and records that properly reflect its business activities for non-tax purposes and are prepared in accordance with the taxpayer's accounting procedures.

See If an item of income or expense is not treated consistently from year to year, that treatment may not clearly reflect income, notwithstanding the application of this section.

In the regulation's Example 1, a taxpayer whose bookkeeping software treats all costs paid during the year as presently deductible, but whose employees take a physical inventory count that the taxpayer uses as part of its books and records to capitalize and allocate costs, may not expense all of its costs paid during 2019 because its books and records do not accurately reflect the inventory records used for non-tax purposes in its regular business activity, and instead must use the year-end physical inventory count to determine how its capitalized costs are allocated and recovered. (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Taxpayer using the overall cash method and the non-AFS section 471(c) inventory method, in the regulation's example, accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).; Stated by the regulation as an example illustrating the rule; an example, not itself a separate requirement.)

“E may not expense all of its costs paid during the 2019 taxable year because its books and records do not accurately reflect the inventory records used for non-tax purposes in its regular business activity. Instead, E must use the physical inventory count taken at the end of 2019 to determine how its capitalized costs are allocated and recovered.”

In the regulation's Example 6, where the partnership's employees take regular physical counts but its books-and-records method of accounting for inventory does not allocate costs between ending inventory and cost of goods sold and instead expenses the cost of inventory in the year it was paid for, the partnership may recover as deductions in 2020 the $550,000 of inventory costs it acquired and paid for in that year. (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Partnership using the overall cash method and the non-AFS section 471(c) inventory method, in the regulation's example, accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).; Stated by the regulation as an example illustrating the rule; an example, not itself a separate requirement.)

“H’s employees take regular physical counts of the inventory on the shop floor and in the storeroom, however H’s method of accounting for inventory for its books and records does not allocate costs between ending inventory and cost of goods sold, and instead expenses the cost of the inventory in the year it was paid for. Prior to December 2020, H acquires and pays for $500,000 of beer, wine, and liquor. In addition, on December 1, 2020, H acquires $50,000 in beer and wine, and pays for this beer and wine on December 20, 2020. H may recover as deductions in 2020 the $550,000 of inventory costs.”

Partly established. Established: a method consistent with how the business actually keeps its books (S05, S06, S08); records supporting the treatment (S06, S08). Missing: that method applied consistently across periods.

The underlying rule: goods you bought to sell are an asset until they sell

Inventory consists of goods (products, merchandise) waiting to be sold to customers, and, for a manufacturer, also its raw materials and work-in-process that will become finished goods. (jurisdiction: United States, entity_scope: companies that hold inventory (retailers, distributors, manufacturers))

“Inventory consists of goods (products, merchandise) waiting to be sold to customers as well as a manufacturer’s raw materials and work-in-process that will become finished goods.”

Inventory is recorded and reported on the company’s balance sheet at its cost. (jurisdiction: United States, entity_scope: companies that hold inventory (retailers, distributors, manufacturers))

“Inventory is recorded and reported on a company’s balance sheet at its cost.”

The sale of an inventory item is the event on which that item’s cost is removed from inventory and reported on the income statement as cost of goods sold. (jurisdiction: United States, entity_scope: companies that hold inventory (retailers, distributors, manufacturers))

“When an inventory item is sold, the item’s cost is removed from inventory and the cost is reported on the company’s income statement as the cost of goods sold .”

Recording inventory on a cost basis ordinarily achieves the objective of properly matching costs with revenues, cost being the amount chargeable against the revenues of future periods; however, in certain circumstances cost may not be the amount properly so chargeable. (jurisdiction: United States, entity_scope: Nongovernmental entities applying U.S. GAAP that hold inventory, accounting_basis: U.S. GAAP (FASB Accounting Standards Codification), effective_from: Public business entities: fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. All other entities: fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. Earlier application permitted as of the beginning of an interim or annual reporting period.)

“The cost basis of recording inventory ordinarily achieves the objective of a proper matching of costs and revenues. However, under certain circumstances cost may not be the amount properly chargeable against the revenues of future periods.”

Partly established. Established: the treatment under the applicable accounting framework of goods held for sale, their cost carried as an asset until the goods are sold (S31); that cost recognised then against the related revenue (S12, S14); the presentation that follows (S11, S17, S31). Missing: what charging those purchases to the period in which they are bought does to the reported result; what charging those purchases to the period in which they are bought does to the margin in a period in which the level of goods held moves; what the inventory treatment then obliges the business to maintain, being a record of the goods held, their counting, their valuation and the flow of their cost into cost of sales.

Required authority: authoritative professional or accounting standard. Highest achieved: high quality professional secondary reference.

Why the cost waits for the sale

See Inventory is recorded and reported on the company’s balance sheet at its cost.

See The sale of an inventory item is the event on which that item’s cost is removed from inventory and reported on the income statement as cost of goods sold.

See Recording inventory on a cost basis ordinarily achieves the objective of properly matching costs with revenues, cost being the amount chargeable against the revenues of future periods; however, in certain circumstances cost may not be the amount properly so chargeable.

Expenses are costs matched with revenues on the income statement — Cost of Goods Sold being an expense caused by Sales — and under the accrual basis of accounting that matching is not based on the date the expenses are paid. (jurisdiction: United States, entity_scope: companies that hold inventory (retailers, distributors, manufacturers), accounting_basis: accrual)

“Costs that are matched with revenues on the income statement. For example, Cost of Goods Sold is an expense caused by Sales. Insurance Expense, Wages Expense, Advertising Expense, Interest Expense are expenses matched with the period of time in the heading of the income statement. Under the accrual basis of accounting, the matching is NOT based on the date that the expenses are paid.”

Partly established. Established: the default principle that goods held for resale are carried as an asset until sold (S31); their cost recognised at that point (S12). Missing: what that matching exists to prevent.

Required authority: authoritative professional or accounting standard. Highest achieved: high quality professional secondary reference.

What each treatment does to the profit you report

See Expenses are costs matched with revenues on the income statement — Cost of Goods Sold being an expense caused by Sales — and under the accrual basis of accounting that matching is not based on the date the expenses are paid.

Under the periodic system the Inventory account is updated only periodically (such as on the last day of the accounting year); goods purchased during the year are recorded in temporary Purchases accounts, and at year end the cost of ending inventory is calculated, the Inventory balance adjusted to it, and cost of goods sold calculated at the same time. (jurisdiction: United States, entity_scope: companies that hold inventory (retailers, distributors, manufacturers))

“The periodic system indicates that the Inventory account will be updated periodically, such as on the last day of the accounting year. Throughout the year, the goods purchased will be recorded in temporary general ledger accounts entitled Purchases. At the end of the year, the cost of the ending inventory will be calculated. The Inventory account balance will be adjusted to this amount. At this time, the cost of goods sold is also calculated.”

Under the periodic system the Inventory account is normally adjusted only at year end, so during the year it shows only the cost of inventory as of the end of the previous year. (jurisdiction: United States, entity_scope: companies using the periodic inventory system)

“The Inventory account is normally adjusted only at the end of the year. During the year the Inventory account will show only the cost of inventory as of the end of the previous year.”

Cost of goods sold is likely the largest expense reported on the income statement, and subtracting it from sales leaves the company’s gross profit. (jurisdiction: United States, entity_scope: companies that hold inventory (retailers, distributors, manufacturers))

“Cost of goods sold is likely the largest expense reported on the income statement. When the cost of goods sold is subtracted from sales , the remainder is the company’s gross profit .”

Not established from an authoritative source.

Required authority: authoritative professional or accounting standard. Highest achieved: high quality professional secondary reference, primary regulator or government.

What counts as inventory, and what is just a supply

See Inventory consists of goods (products, merchandise) waiting to be sold to customers, and, for a manufacturer, also its raw materials and work-in-process that will become finished goods.

For purposes of Sec. 1.162-3, materials and supplies means tangible property that is used or consumed in the taxpayer's operations, that is not inventory, and that additionally answers to one of the descriptions set out in paragraphs (c)(1)(i) through (v); property that is inventory is therefore outside this definition. (jurisdiction: United States - federal income tax (26 CFR Chapter I, Internal Revenue Service, Department of the Treasury), entity_scope: Taxpayers applying section 162(a) or section 212 and the regulations under those sections, accounting_basis: U.S. federal income tax (methods of accounting under sections 446 and 481), effective_from: 2014-01-01, conditions: Section applies generally to amounts paid or incurred in taxable years beginning on or after January 1, 2014; under paragraph (j)(2) a taxpayer may choose to apply the section to taxable years beginning on or after January 1, 2012)

“(c) Definitions—(1) Materials and supplies. For purposes of this section, materials and supplies means tangible property that is used or consumed in the taxpayer’s operations that is not inventory and that—”

The section cross-refers to section 263A and its regulations, which require taxpayers to capitalize the direct and allocable indirect costs, including the cost of materials and supplies, of property produced by the taxpayer and of property acquired for resale, and to Sec. 1.263(a)-3, which requires capitalization of amounts paid to improve tangible property. (jurisdiction: United States - federal income tax (26 CFR Chapter I, Internal Revenue Service, Department of the Treasury), entity_scope: Taxpayers applying section 162(a) or section 212 and the regulations under those sections, accounting_basis: U.S. federal income tax (methods of accounting under sections 446 and 481), effective_from: 2014-01-01, conditions: Section applies generally to amounts paid or incurred in taxable years beginning on or after January 1, 2014; under paragraph (j)(2) a taxpayer may choose to apply the section to taxable years beginning on or after January 1, 2012)

“For example, see § 1.263(a)–3, which requires taxpayers to capitalize amounts paid to improve tangible property and section 263A and the regulations under section 263A, which require taxpayers to capitalize the direct and allocable indirect costs, including the cost of materials and supplies, of property produced by the taxpayer and property acquired for resale.”

The section cross-refers to Sec. 1.471-1, which requires taxpayers to include certain materials and supplies in inventory. (jurisdiction: United States - federal income tax (26 CFR Chapter I, Internal Revenue Service, Department of the Treasury), entity_scope: Taxpayers applying section 162(a) or section 212 and the regulations under those sections, accounting_basis: U.S. federal income tax (methods of accounting under sections 446 and 481), effective_from: 2014-01-01, conditions: Section applies generally to amounts paid or incurred in taxable years beginning on or after January 1, 2014; under paragraph (j)(2) a taxpayer may choose to apply the section to taxable years beginning on or after January 1, 2012)

“See also § 1.471–1, which requires taxpayers to include in inventory certain materials and supplies.”

Required authority: authoritative professional or accounting standard. Highest achieved: high quality professional secondary reference, primary regulator or government.

Drawing the line: resale goods, parts that go into the product, job materials, supplies

See For purposes of Sec. 1.162-3, materials and supplies means tangible property that is used or consumed in the taxpayer's operations, that is not inventory, and that additionally answers to one of the descriptions set out in paragraphs (c)(1)(i) through (v); property that is inventory is therefore outside this definition.

See The section cross-refers to section 263A and its regulations, which require taxpayers to capitalize the direct and allocable indirect costs, including the cost of materials and supplies, of property produced by the taxpayer and of property acquired for resale, and to Sec. 1.263(a)-3, which requires capitalization of amounts paid to improve tangible property.

One description qualifying tangible property as materials and supplies is that it is a component acquired to maintain, repair, or improve a unit of tangible property owned, leased, or serviced by the taxpayer, and that is not acquired as part of any single unit of tangible property; the unit of tangible property need not be owned by the taxpayer, since property leased or merely serviced by the taxpayer is included. (jurisdiction: United States - federal income tax (26 CFR Chapter I, Internal Revenue Service, Department of the Treasury), entity_scope: Taxpayers applying section 162(a) or section 212 and the regulations under those sections, accounting_basis: U.S. federal income tax (methods of accounting under sections 446 and 481), effective_from: 2014-01-01, conditions: Section applies generally to amounts paid or incurred in taxable years beginning on or after January 1, 2014; under paragraph (j)(2) a taxpayer may choose to apply the section to taxable years beginning on or after January 1, 2012)

“(i) Is a component acquired to maintain, repair, or improve a unit of tangible property (as determined under § 1.263(a)–3(e)) owned, leased, or serviced by the taxpayer and that is not acquired as part of any single unit of tangible property;”

Partly established. Established: goods held for resale and components that become part of what is sold distinguished from supplies consumed in operations (S19). Missing: goods held for resale and components that become part of what is sold distinguished from materials installed while performing a service.

Required authority: authoritative professional or accounting standard. Highest achieved: high quality professional secondary reference, primary regulator or government.

The cases people put in the wrong box

Inventory treated as non-incidental materials and supplies is used or consumed in the taxpayer's business in the taxable year in which the taxpayer provides the inventory to its customer. (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Taxpayers meeting the section 448(c) gross receipts test, other than a tax shelter prohibited from using the cash method under section 448(a)(3) that uses the section 471(c) NIMS inventory method, accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).)

“Inventory treated as nonincidental materials and supplies is used or consumed in the taxpayer’s business in the taxable year in which the taxpayer provides the inventory to its customer.”

In the stated example, toner cartridges bought in a single box costing more than $200 are still materials and supplies under paragraph (c)(1)(iv), because the $200 test is applied to the allocable cost of each unit of property ($50 each) rather than to the cost of the bulk purchase. (jurisdiction: United States - federal income tax (26 CFR Chapter I, Internal Revenue Service, Department of the Treasury), entity_scope: Illustrative example - H, which provides consulting services to its customers and paid $500 for one box of 10 toner cartridges to use as needed for its printers, accounting_basis: U.S. federal income tax (methods of accounting under sections 446 and 481), effective_from: 2014-01-01, conditions: Section applies generally to amounts paid or incurred in taxable years beginning on or after January 1, 2014; under paragraph (j)(2) a taxpayer may choose to apply the section to taxable years beginning on or after January 1, 2012; Stated in an example in paragraph (h); the examples illustrate only the application of this section and, unless otherwise stated, do not address treatment under other provisions of the Code; Assumes each toner cartridge is a unit of property under Sec. 1.263(a)-3(e))

“The toner cartridges are materials and supplies under paragraph (c)(1)(iv) of this section because even though purchased in one box costing more than $200, the allocable cost of each unit of property equals $50.”

Partly established. Established: materials consumed on service or installation jobs (S22); bulk purchases consumed internally (S26). Missing: goods bought against a specific customer order; goods held but not owned.

Required authority: authoritative professional or accounting standard. Highest achieved: primary regulator or government.

Goods sitting in your building that are not yours

Not established from an authoritative source.

Relief on the return is not relief on your financial statements

Nothing in section 471(c) has any effect on the application of any other provision of law that would otherwise apply, and no inference is to be drawn from section 471(c) with respect to the application of any such provision. (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Taxpayers meeting the section 448(c) gross receipts test, other than a tax shelter prohibited from using the cash method under section 448(a)(3), accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).)

“Nothing in section 471(c) shall have any effect on the application of any other provision of law that would otherwise apply, and no inference shall be drawn from section 471(c) with respect to the application of any such provision.”

Inventory measured using any method other than LIFO or the retail inventory method - the paragraph gives FIFO and average cost as examples - must be measured at the lower of cost and net realizable value. (jurisdiction: United States, entity_scope: Nongovernmental entities applying U.S. GAAP that hold inventory, accounting_basis: U.S. GAAP (FASB Accounting Standards Codification), effective_from: Public business entities: fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. All other entities: fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. Earlier application permitted as of the beginning of an interim or annual reporting period., conditions: Inventory measured using any method other than LIFO or the retail inventory method)

“Inventory measured using any method other than LIFO or the retail inventory method (for example, inventory measured using first-in, first-out (FIFO) or average cost) shall be measured at the lower of cost and net realizable value.”

The Board noted that Topic 330 requires disclosures about the basis for stating inventories, losses from the subsequent measurement of inventory, goods stated above cost, stating inventories at sales prices, losses on firm purchase commitments, and significant estimates applicable to inventory. (jurisdiction: United States, entity_scope: Nongovernmental entities applying U.S. GAAP that hold inventory, accounting_basis: U.S. GAAP (FASB Accounting Standards Codification))

“The Board noted that Topic 330 requires disclosures about the basis for stating inventories, losses from the application of lower of cost or market (amended in this Update to refer to losses from the subsequent measurement of inventory), goods stated above cost, stating inventories at sales prices, losses on firm purchase commitments, and significant estimates applicable to inventory.”

The recorded cost of goods still in inventory at the end of the accounting year is reported as a current asset on the balance sheet. (jurisdiction: United States, entity_scope: companies that hold inventory (retailers, distributors, manufacturers))

“The recorded cost for the goods remaining in inventory at the end of the accounting year is reported as a current asset on the company’s balance sheet.”

A manufacturer must disclose in its financial statements the cost of its work-in-process as well as the cost of finished goods and materials on hand. (jurisdiction: United States, entity_scope: manufacturers)

“A manufacturer must disclose in its financial statements the cost of its work-in-process as well as the cost of finished goods and materials on hand.”

Not established from an authoritative source.

Required authority: authoritative professional or accounting standard. Highest achieved: high quality professional secondary reference.

What a lender, investor or franchisor still expects to see

See Nothing in section 471(c) has any effect on the application of any other provision of law that would otherwise apply, and no inference is to be drawn from section 471(c) with respect to the application of any such provision.

See Inventory measured using any method other than LIFO or the retail inventory method - the paragraph gives FIFO and average cost as examples - must be measured at the lower of cost and net realizable value.

See The Board noted that Topic 330 requires disclosures about the basis for stating inventories, losses from the subsequent measurement of inventory, goods stated above cost, stating inventories at sales prices, losses on firm purchase commitments, and significant estimates applicable to inventory.

See A manufacturer must disclose in its financial statements the cost of its work-in-process as well as the cost of finished goods and materials on hand.

Not established from an authoritative source.

Required authority: authoritative professional or accounting standard. Highest achieved: high quality professional secondary reference.

What carrying inventory obliges you to do afterwards

Because costs for the same product purchased during the year may differ, when that occurs the company must decide which costs should be matched with its sales and which costs should remain in inventory. (jurisdiction: United States, entity_scope: companies that hold inventory (retailers, distributors, manufacturers), conditions: applies when the company’s costs differ for the same products purchased during the accounting year)

“It is common for a company to experience rising costs for the goods it purchases. As a result, the company’s costs may be different for the same products purchased during its accounting year. When this occurs, the company must decide which costs should be matched with its sales and which costs should remain in inventory.”

Inventory items are recorded at their cost, cost being defined as all costs necessary to get the goods in place and ready for sale. (jurisdiction: United States, entity_scope: companies that hold inventory (retailers, distributors, manufacturers))

“Inventory items are recorded at their cost. Cost is defined as all costs necessary to get the goods in place and ready for sale.”

The costs of goods in inventory do not have to flow the way the goods physically flowed — goods can flow first in, first out while costs flow last in, first out — which is why accountants call the cost flows cost flow assumptions. (jurisdiction: United States, entity_scope: companies that hold inventory (retailers, distributors, manufacturers))

“However, the costs of the goods in inventory do not have to flow the way the goods flowed. This means the bookstore can sell the oldest copy of its three copies from inventory but remove the cost of its most recently purchased copy. In other words, the goods can flow using first in, first out while the costs flow using last in, first out. This is why accountants refer to the cost flows as cost flow assumptions .”

Even where the company’s computers keep track of inventory, the computer quantities must be verified by physically counting the goods at least once per year. (jurisdiction: United States, entity_scope: companies that hold inventory (retailers, distributors, manufacturers))

“(Even if the company’s computers keep track of inventory, the computer quantities must be verified by physically counting the goods at least once per year.)”

Partly established. Established: counting (S36); valuation (S29, S34); a cost flow into cost of sales (S12, S15, S33, S35). Missing: a record of goods held falling due once a business is in the inventory regime.

Required authority: authoritative professional or accounting standard. Highest achieved: high quality professional secondary reference.

Signs you are on the wrong treatment

See Under the periodic system the Inventory account is normally adjusted only at year end, so during the year it shows only the cost of inventory as of the end of the previous year.

See Cost of goods sold is likely the largest expense reported on the income statement, and subtracting it from sales leaves the company’s gross profit.

Under the periodic inventory system the general ledger accounts do not show the cost of the current inventory or the cost of goods sold. (jurisdiction: United States, entity_scope: companies using the periodic inventory system)

“There is no way to tell from the general ledger accounts the cost of the current inventory or the cost of goods sold.”

A company that uses the periodic inventory system and physically counts its inventory only once per year must estimate the cost of its inventory at the end of each interim accounting period for its interim financial statements. (jurisdiction: United States, entity_scope: companies using the periodic inventory system that count inventory only once per year, conditions: company uses the periodic inventory system; inventory is physically counted only once per year; interim financial statements are prepared)

“If a company uses the periodic inventory system and physically counts its inventory only once per year, it must estimate the cost of its inventory at the end of each interim accounting period for its interim financial statements.”

Not established from an authoritative source.

Required authority: authoritative professional or accounting standard. Highest achieved: high quality professional secondary reference.

Moving from one treatment to the other

A change in the method of treating inventory under paragraph (b) is a change in method of accounting under sections 446 and 481 and the accompanying regulations, and a taxpayer changing its method of accounting under paragraph (b) may do so only with the consent of the Commissioner as required under section 446(e) and § 1.446–1. (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Taxpayers meeting the section 448(c) gross receipts test, other than a tax shelter prohibited from using the cash method under section 448(a)(3), accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).)

“A change in the method of treating inventory under this paragraph (b) is a change in method of accounting under sections 446 and 481 and the accompanying regulations. A taxpayer changing its method of accounting under paragraph (b) of this section may do so only with the consent of the Commissioner as required under section 446(e) and § 1.446–1.”

Certain changes in method of accounting made under paragraph (b) may be made under the procedures to obtain the automatic consent of the Commissioner to change a method of accounting, and in certain situations special terms and conditions may apply. (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Taxpayers meeting the section 448(c) gross receipts test, other than a tax shelter prohibited from using the cash method under section 448(a)(3), accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).)

“Certain changes in method of accounting made under paragraph (b) of this section may be made under the procedures to obtain the automatic consent of the Commissioner to change a method of accounting. See Revenue Procedure 2015–13 (2015–5 IRB 419) (or successor) (see § 601.601(d)(2) of this chapter)). In certain situations, special terms and conditions may apply.”

Any change in method of accounting made pursuant to §471(c) shall be treated, for purposes of section 481, as initiated by the taxpayer and made with the consent of the Secretary. (jurisdiction: United States (federal), entity_scope: taxpayers making a change in method of accounting pursuant to §471(c), accounting_basis: U.S. federal income tax, effective_from: taxable years beginning after Dec. 31, 2017, conditions: applies to changes in method of accounting made pursuant to subsection (c); the deemed treatment is for purposes of section 481)

“Any change in method of accounting made pursuant to this subsection shall be treated for purposes of section 481 as initiated by the taxpayer and made with the consent of the Secretary.”

Nothing in section 471(c) affects the requirement under section 446(e) that a taxpayer secure the consent of the Commissioner before changing its method of accounting. (jurisdiction: United States — federal income tax (Internal Revenue Code and Treasury regulations), entity_scope: Taxpayers subject to U.S. federal income tax, accounting_basis: U.S. federal income tax accounting (methods of accounting under section 446), effective_from: 2021-01-05, conditions: This section applies for taxable years beginning on or after January 5, 2021; a taxpayer may apply this section for a taxable year beginning after December 31, 2017 and before January 5, 2021 provided it follows all the applicable rules of the section for that year and all subsequent taxable years (§ 1.471–1(c)).)

“Similarly, nothing in section 471(c) affects the requirement under section 446(e) that a taxpayer secure the consent of the Commissioner before changing its method of accounting.”

Partly established. Established: what is required to change between expensing purchases and accounting for inventories (S39, S42); whether a formal accounting-method change procedure applies (S39, S40). Missing: from when the new treatment operates.

Why switching is not just recoding an account

See A change in the method of treating inventory under paragraph (b) is a change in method of accounting under sections 446 and 481 and the accompanying regulations, and a taxpayer changing its method of accounting under paragraph (b) may do so only with the consent of the Commissioner as required under section 446(e) and § 1.446–1.

See Certain changes in method of accounting made under paragraph (b) may be made under the procedures to obtain the automatic consent of the Commissioner to change a method of accounting, and in certain situations special terms and conditions may apply.

See Any change in method of accounting made pursuant to §471(c) shall be treated, for purposes of section 481, as initiated by the taxpayer and made with the consent of the Secretary.

See Nothing in section 471(c) affects the requirement under section 446(e) that a taxpayer secure the consent of the Commissioner before changing its method of accounting.

Partly established. Established: that moving between the regimes is not a coding change (S39); what has to be established before the change takes effect (S39, S40, S42). Missing: what has possibly to be filed before the change takes effect.