COGS / Inventory Assets ?

@phurabe 

My questions are:
1. Does it matter that I'm using COGS for Cost of Inventory? Are the two more or less interchangeable?  Yes, it matters and, no, they are not interchangeable.  The reason is that you could easily offset all of your taxable income by just buying more inventory and recording it as COGS.  That's why COGS is an expense at the time of the sale, not at the time of purchase.  Businesses, where the sale of inventory is an income-producing factor, are required to use accrual basis accounting.  Having said that, there is a provision in the tax law that allows you to account for inventory as non-incidental materials and supplies (thereby allowing you to be on cash basis) but you should consult with a CPA and/or tax attorney if you want to go that route.  There is no consensus on that provision.  In any case, you should not record the purchase of inventory as COGS.  

 
2. If it matters, and I should switch to Cost of Inventory, do I have to record the COGS as well??  You record the purchase of inventory to an inventory asset account and the subsequent sale of the inventory does two things: 1) it reduces inventory by the cost of the product sold and 2) it increases the cost of goods sold by the same amount.

3. How do I record my current assets? Quickbooks doesn't allow me to add inventory items, or to reconcile the inventory asset account.  When you buy inventory, assign the cost to an Inventory other current asset account.  You don't need to use QB to track specific inventory items unless you want to.  If your website tracks it, you can use QB solely to track the value of your inventory, not the individual items.   

3. I use a cash basis method. Should I switch to accrural?  See #1 above.  In order to have inventory on your balance sheet, you need to be on accrual accounting.   This is a discussion to be had with your CPA/tax attorney.  IMO, accrual accounting provides a better picture of your business performance and it clearly reflects income which the IRS likes to see.  If you switch from cash to accrual, you need to file Form 3115 (Application for Change in Accounting Method). 

Thank you so much for the thorough response! I have a few more clarifying questions... I tried finding more information on this process but if you could help walk me through it that would be amazing.

"You record the purchase of inventory to an inventory asset account and the subsequent sale of the inventory does two things: 1) it reduces inventory by the cost of the product sold and 2) it increases the cost of goods sold by the same amount."
Say I spend $10 on a tshirt today. In quickbooks, I record that withdraw as an inventory asset. Tomorrow, that tshirt sells for $20, and after all is said and done with taxes and fees, my merchant deposits $21.60 into my bank. I categorize that deposit into my "Etsy Bank" account, create a journal entry logging the $20 sale, $1.60 tax, $5 shipping, and -$5 merchant fee. At what point am I telling quickbooks to take $10 from the inventory asset account and move it to the COGS account?

Now say that tshirt doesn't sell this year. My inventory asset account will still say $10, but the tshirt is worth $20. Shouldn't my balance sheet show what the inventory assets are worth, and not just what I paid for them?

Thank you so much for the thorough response! I have a few more clarifying questions. I tried finding more information on this process but if you could help walk me through it that would be amazing...

"You record the purchase of inventory to an inventory asset account and the subsequent sale of the inventory does two things: 1) it reduces inventory by the cost of the product sold and 2) it increases the cost of goods sold by the same amount."
Say I spend $10 on a tshirt today. In quickbooks, I record that withdraw as an inventory asset. Tomorrow, that tshirt sells for $20, and after all is said and done with taxes and fees, my merchant deposits $21.60 into my bank. I categorize that deposit into my "Etsy Bank" account, create a journal entry logging the $20 sale, $1.60 tax, $5 shipping, and -$5 merchant fee. At what point am I telling quickbooks to take $10 from the inventory asset account and move it to the COGS account?

Now say that tshirt doesn't sell this year. My inventory asset account will still say $10, but the tshirt is worth $20. Shouldn't my balance sheet show what the inventory assets are worth, and not just what I paid for them?

@phurabe 

Good questions.

At what point am I telling quickbooks to take $10 from the inventory asset account and move it to the COGS account?

If you don't use QB to track your inventory, you will need to make an adjusting journal entry at the end of each month to reduce inventory and book COGS (or more frequently if you want to track your net income by day or week).  Your financial reports (P&L and balance sheet) will only be accurate as of the day you make the adjusting entry in QB.  When you buy inventory and assign it to your inventory asset account, it will keep increasing until you adjust it down to your actual inventory value from your website.  So, let's say at the beginning of January you have $150K in inventory.  During the month, you purchase $50K and on January 31, QB shows that you have $200K in inventory.  Obviously, this is not your actual inventory because you sold some during the month.  If your website shows your inventory is $160K, you will need to make a journal entry that reduces your inventory and books the COGS expense.  To make the journal entry, go to New > Journal Entry.  Then, you want to credit (reduce) your inventory by the amount of the difference between the inventory in QB and your actual inventory.  In this case, it's $40K ($200K in QB - $160K actual).  So, credit inventory for $40K and debit COGS for $40K.  You now have the correct inventory value and COGS for the month of January.  Most POS systems create this entry automatically if/when the data is transferred into QB from the POS system.

Shouldn't my balance sheet show what the inventory assets are worth, and not just what I paid for them?

No.  Your inventory is always recorded at cost.  Retail prices are irrelevant until you sell inventory at that price which then is recorded as income. 

Makes sense! 

Whats the best way to adjust my 2022 reports before filing taxes this year? The inventory asset account is at 0, but I have about $50k in goods (spent, not retail value!)

Should I "undo" every purchase I mistakenly assigned as COGS in 2022, reassign it to an asset account, and then create 12 journal entries debiting and crediting the COGS and asset accounts (I only need 12 for month-to-month)?

An issue with this is that some of the inventory I sold in 2022 was purchased in 2021, so the asset account would be thrown off. Can I retroactively adjust the asset account to reflect my inventory at the end of 2021? Or make an adjustment for the end of 2022? If so, how? Ive already tried to reconcile the asset account to reflect the current inventory but to no avail.

Thank you again.

@phurabe 

Make sure you talk to your CPA on this because all of this discussion is predicated on the fact that you will be switching from cash to the accrual method of accounting because you carry inventory.  If your CPA is fine with you staying on cash basis, then all of this discussion is essentially moot.  The Tax Cuts and Jobs Act of 2017 (TCJA) introduced some uncertainty into the Tax Code as to whether it is necessary for businesses that meet the definition of a Small Business Taxpayer (you do) and purchase inventory, to be on the accrual method.  I have reviewed that section of the Tax Code many times and it appears that, if you track inventory, you need to be on the accrual method.  However, your CPA should have the final say on that.  

"An issue with this is that some of the inventory I sold in 2022 was purchased in 2021, so the asset account would be thrown off. Can I retroactively adjust the asset account to reflect my inventory at the end of 2021? Or make an adjustment for the end of 2022?"

Since you have presumably filed your 2021 tax return, you should not make any adjustments to 2021.  If you have been recording all purchases to COGS, then you have overstated your expenses in the past and understated your income.  2022 is the year where you will have to make it up.  Discuss this with your CPA because they may suggest amending your 2021 return, in which case, you will make a 2021 year-end adjustment.

"What's the best way to adjust my 2022 reports before filing taxes this year? The inventory asset account is at 0, but I have about $50k in goods (spent, not retail value!)  Should I "undo" every purchase I mistakenly assigned as COGS in 2022, reassign it to an asset account, and then create 12 journal entries debiting and crediting the COGS and asset accounts (I only need 12 for month-to-month)?"

That's unnecessary unless you want to see your monthly business performance.  Otherwise, you can make a year-end (date it 12-31) adjusting journal entry to increase your inventory and lower your COGS.  You're lowering your COGS expense because you have been overstating it in the past.  The journal entry should be - debit inventory asset $50K and credit COGS $50K.