The end of the year is flying up fast. For most Amazon sellers, December 31st is also the end of the fiscal year. And that means it’s time to get your books cleaned up for tax time. One vital tax task is valuing your current inventory.
This post will walk Amazon sellers through the simplest way to value you inventory for tax time.
What to Know Before Valuing your Amazon Inventory
Here at Seller Accountant we often talk about the importance of using accrual accounting to obtain a clear picture of your business’s financial health. And one thing that you need in order to use this accounting method is your inventory value on the last day of your business year. (For most businesses, that day is 12/31.)
As an operations person, it’s likely that you are accustomed to counting your inventory by unit. But, for tax purposes, you need to assess your inventory’s dollar value. This post will walk you through how to do that, and then address some common pitfalls when it comes to valuing inventory on your income taxes.
Pro Tip: Don’t wait until December 31st to track your inventory. Value inventory several times per year to stay on top of your business’s books and make counting and valuing inventory simpler during the hectic tax season. This will also ensure you catch any small inventory valuation issues before they become big issues!
How to Value Your Inventory
Let’s dig in.
Step 1: Determine Where Your Inventory is Located
- In FBA – Amazon has built their world famous logistics system around keeping close track of inventory, so if your inventory is somewhere in Amazon’s vast network of warehouses, you’ll be able to easily find that in Seller Central. Below is a screenshot of the FBA report you want to pull called Inventory Reconciliation. Here’s a quick video of me explaining how to do this.
- In Other Warehouses or 3PLs – Perhaps you don’t only sell on Amazon. Or perhaps you don’t send all of your inventory into Amazon at once, and instead keep some at your own warehouse or in a 3PL. In this case, you’ll need to determine the value of inventory you currently hold outside of FBA.
- In Transit – This is one of the trickier aspects of managing and valuing inventory. In this case, perhaps you’ve paid for, or paid a deposit on, a shipment from your manufacturer, but are not in possession of your inventory yet. If you have money tied up in this inventory, it’s still vital that you value it for tax purposes.
Step 2: Assign a dollar value to your unit counts
Now that you know how many units you currently have in your inventory, the next step is to assign those units a dollar amount. Do this by multiplying your value per unit for each SKU to the actual quantity of items in the FBA and warehouse reports.
For example, say you count 1,000 of Widget X in your warehouses/FBA, and Widget X is worth $20. You would assign a value of $20,000 to Widget X on your balance sheet. You would continue to assign values to all of your current inventory until you have an inventory total. Then note this number on your balance sheet.
Step 3: Determine How Much You’ve Paid for Inventory
Again, there are three possibilities here:
- You’ve paid in full – In this simplest case, you have fully paid for the inventory that you now own and have in your possession.
- You’ve not paid or have only partially paid – In this case, you have the inventory in your possession but haven’t paid for it yet (or have only partially paid for it.)
- You’ve made a deposit – You’ve made a deposit on inventory, but those items are not in your possession yet.
Step 4: Value Your Inventory
In accrual accounting, every time you purchase inventory that you will sell, you immediately put those dollars into your inventory account as an asset on your balance sheet.
Each month, as you actually sell the units, you expense those units by removing the dollars from your inventory category and placing them in Cost of Goods Sold (COGS).
This is also when you need to reconcile, or double check, that you actually own the amount of inventory that your business’s bookkeeping says that you own. As anybody who has ever dealt with inventory can attest, this should be easy. Sell an item, subtract that item from inventory. But mistakes can and do happen. Perhaps you counted that you received 100 units when you really only received 99, or another unit “walked away” from the warehouse. These small mistakes and errors can add up at tax time.
That said, for the very reasons I mentioned above, it is unlikely that you will ever see your inventory count exactly match what your books say. You may lose units, or perhaps the estimated value of your units is off by a few percentage points. In fact, it is vanishingly rare to see a seller’s unit count match the exact inventory value on their balance sheet, no matter how tight their ship. The good news is that if the numbers are close, we can simply process a small inventory adjustment to correct the balance sheet.
But what if the error is bigger? Perhaps you’re balance sheet is off by a few thousand dollars? That’s common, too, and we’re here to help.
Troubleshooting Common Inventory Valuation Issues
Here are some common examples of inventory valuation issues and how to correct them.
Problem: Your Balance Sheet Shows More Inventory than the Hard Year-End Inventory Count
If your accounting system is showing more inventory than you actually counted in FBA, your warehouses and in transit, then there are two possible reasons why:
- You forgot to count some inventory – Perhaps you forgot to count a warehouse, or a portion of your inventory is currently in transit in FBA’s system or from your supplier and simply didn’t get counted.
- You haven’t been expensing enough each month – In this case, perhaps the amount you are entering for COGS is incorrect. (Example: Where you should have been entering $20/unit you were accidentally entering $10/unit.)
Common Solution: If the error is small and you don’t suspect a serious issue with your underlying system, then you can simply process an inventory adjustment on the date of the count that lowers the balance sheet inventory amount down to the verified level of the count. When possible, it is important to attach the “count” spreadsheet to the adjusting entry to serve as documentation of this change. This covers your tracks in case of an audit or an evaluation of your books by a lender, potential buyer, etc.
Problem: Inventory Count Shows More Inventory than the Balance Sheet
If the inventory count shows you actually own more inventory than what is listed on your balance sheet, then you have either failed to account for some inventory on your balance sheet, or you have been over-expensing throughout the year. (Example: Where you should have been expensing COGS at $10/unit you were accidentally expensing it at $20/unit.)
Common Solution: Again, if the error is small and you don’t suspect a serious issue with your underlying system, you can process an inventory adjustment on the date of the count that increases the Balance Sheet inventory number up to the verified level of the count. When possible, it is important to attach the “count” spreadsheet to the adjusting entry to serve as documentation of this change in case of an audit or an evaluation of your books by a lender, potential buyer, etc.
Small adjustments like these are very common and a run of the mill experience when running an inventory-based business. But if the difference is large, then you may need to take more drastic measures.
What if you are detecting a large difference between your inventory count and balance sheet?
For example, say you count your inventory and compare it to the value on your balance sheet at the end of the year and that number is too large to be handled by a small adjustment. This means that there is a problem somewhere in your inventory system, whether it’s with your count or (more likely) with the way you are accounting for and handling inventory in your business’s books.
In this case, it’s vital that you work with your accounting team to investigate and discover the underlying issue with your inventory system. That’s one reason we created Seller Accountant. We not only help sellers troubleshoot and put out fires, but we then help them implement sustainable systems to they never face that particular problem again.