Tax implications of unsold inventory
You might be tempted to think that unsold inventory is not a big deal when it comes to the success of your business. After all, it’s just boxes of stuff sitting on a shelf, so what harm can it do? In reality, stuff sitting on a shelf can have a significant impact on your bottom line. That’s because, for tax purposes, unsold inventory is considered an asset and one that you have to pay taxes for.
Impact of unsold inventory on taxable income
The total impact that unsold inventory can have on a business’ taxable income will depend on the method used to calculate taxes. More often than not, businesses will use the cost of goods sold (COGS) method to calculate their taxes. The cost of goods sold is deductible from a business’ revenue, and it includes the costs involved in producing or purchasing products that have been sold during a specific timeframe.
Calculation of cost of goods sold and its relation to taxes
When a business is faced with unsold inventory, then this inventory will not contribute to the calculation of COGS. Consequently, taxable income could be higher since the costs of producing or purchasing these unsold items will not be deducted.
This is how the cost of goods sold is calculated:
COGS = Beginning inventory + net purchases – ending inventory
Understating or overstating your COGS could lead to irregularities in your tax calculations. Overstating your ending inventory means you’ll be understating COGS, meaning you’ll end up with a higher taxable income and, consequently, higher taxes to pay.
Equally, understating your ending inventory means you’ll be overstating your COGS, resulting in a lower taxable income and lower taxes. It’s crucial that you calculate your COGS correctly to ensure that your tax balance reflects the realities in your warehouse inventory management.