Armed with knowledge of the costs for inventory, purchases and goods sold, you can The direct relationship of ending inventory to income means that your. Relationship between cost of goods sold and inventory given by equation: Beginning inventory + Purchases = Costs of goods available for sale – Ending. + Beginning inventory + Purchases + Freight in and freight out - Purchase returns + Direct labor + Factory overhead = Cost of goods available for sale - Ending.
What Is the Relationship Between the Valuation of Inventory & Income? | Your Business
Share on Facebook A merchandising business must put a value on inventory at the beginning and end of each year as part of the process to generate its annual income. To get correct values, you need to identify what items you have in inventory and the value of each item. Armed with knowledge of the costs for inventory, purchases and goods sold, you can calculate your taxable income and your tax bill. Income Calculate gross profit by subtracting the cost of goods sold from net sales revenues.
Net sales are total sales minus allowances, discounts and returns. COGS equals beginning inventory plus inventory purchases minus ending inventory.
Sales, Cost of Goods Sold and Gross Profit
As the value of ending inventory falls, COGS rises and gross profit decreases. A lower gross profit translates into lower taxable income, taxes and net income. Taxable income is directly related to the value of ending inventory and inversely related to beginning inventory.
Identifying Costs You need to identify the cost of your goods on hand and the ones you sell to figure the value of your inventory. The Internal Revenue Service gives you three choices. Shane specializes in sportswear and other outdoor gear and requires a good supply of inventory to sell during the holiday seasons.
Cost of Goods Sold (COGS)
Shane is finishing his year-end accounting and calculated the following inventory numbers: This information will not only help Shane plan out purchasing for the next year, it will also help him evaluate his costs. For instance, Shane can list the costs for each of his product categories and compare them with the sales. This comparison will give him the selling margin for each product, so Shane can analyze which products he is paying too much for and which products he is making the most money on.
The COGS definition state that only inventory sold in the current period should be included. Both have drastically different implications on the calculation. The first unit purchased is also the first unit sold. Going back to our example, Shane purchases merchandise in January and then again in June.
The last unit purchased is the first unit sold. Thus, Shane would sell his June inventory before his January inventory. It also makes a difference what type of inventory system is used to count the purchases and sales. Most companies use one of two methods: If Shane used this, he would periodically count his inventory during the year, maybe at the end of each quarter.
If Shane only takes an inventory count every three months he might not see problems with the inventory or catch shrinkage as it happens over time.FIFO Inventory Method
As soon as something is purchased, it is recorded in the system. As soon as something is sold, it is removed from the system keeping a real time count of inventory. Using a perpetual system, Shane would be able to keep more accurate records of his merchandise and produce an income statement at any point during the period.