Accurately reporting the value of your inventory is an important part of filing your business taxes. If you report it wrong, you may end up having to file an amended tax return, with possible penalties and interest due on the new amount, or you may short yourself on a portion of your legitimate business expenses. There are a number of accounting methods you can choose, but last in first out (LIFO), and first in first out (FIFO), are two that are commonly used.
Determine the value of your inventory as of the end of the prior accounting period. If you have a new business, you won’t have a value for your inventory -- write zero dollars for the value.
Count all of your inventory. Before you can calculate the value of what you have in stock, you have to know how many items you have in stock. Each type of item needs to be counted individually.
Use the value of your most recently purchased inventory to calculate the total value. The amount used to figure this amount is your cost, not the price for which you sell the item. Using the most recent purchase -- the last in item -- helps you during times of inflation by keeping the value of your inventory high, even if you purchased some of your stock for a lower price. This results in a lower income to be reported on taxes and helps to minimize your tax liability for the year.
Multiply the cost per item times the number of items in inventory, then add this number to your starting value to get the total inventory value of that item. Do this for each item in stock, then add all the values together to get the grand total of your inventory. This is the number you report to the IRS.
Determine the value of your inventory as of the end of the last accounting period. If your business is new and this is your first accounting period, the number will be zero.
Count all of your inventory items. You must count each type of item separately, so that you can use these numbers later to calculate your total inventory value.
Determine the value of the oldest item you have in stock. Use your actual cost and not the item’s resale value for this figure. Using the oldest cost keeps the overall value of your inventory as low as possible when the purchase costs rise. This gives you a relatively high net income and a low cost of goods sold when compared to the LIFO method.
Multiply the total number of each inventory item by the FIFO value, then add it to the starting value. Do this for each inventory item. Add everything together to get the total value of your inventory and enter it in the appropriate place on your tax reporting forms.
You can choose to use whatever inventory method is most appropriate for your business, and you are allowed to change methods if you wish.