Deductions of Supplies to Make Products Vs. Inventory
If you are starting up a business where you turn out a product, you need to be able to prove what you spent, how it was used and how it applies to the business. Not all expenses are a considered a supply, so you need to know the difference. Keep an inventory list of what you made and what remains after sales at the end of the year, and you have a good record to satisfy Internal Revenue Service questions.
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What is a Debit and What is a Credit?
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It is easy to understand the difference between a debit and a credit if you fold a sheet of paper in half and make a column on the left side of a sheet and call it debit; call the right side credit. Put any expense incurred in business on the left side. Any inventory at the actual price it costs to make and any money made from the sale of inventory become credits.
How to Define Supply vs. Inventory
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Refine the debit side by taking out intangible expenses that don't directly apply to the cost of making your product and leave only the cost of actual supplies. On the credit side remove the money made from actual sale of the item. What is left is supply and inventory.
When manufacturing begins, the first finished product becomes inventory. It has left the area of supply and has not yet been sold. It is now called merchandise inventory. On the balance sheet, it is no longer a debit and is now listed as an asset credit. However, it is only reported at the amount it took to make the product, not the sale price.
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How Important are Profit and Loss Statements
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Purchased actual supplies are business tangibles and must be enumerated and counted. When you purchase supplies that will be used in any facet of your business, you are held accountable. These supplies go on a profit and loss sheet that proves what you purchased. This sheet proves your assets and equity as well as your liabilities on any given date.
Who Needs the Profit and Loss Statements?
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Your accountant needs your P&L statement to know how to properly file your taxes. If you are audited by the government, the IRS will want a copy. You will also find that by keeping outstanding records, you can increase your profit line by seeing where you can decrease expenses.
What if My Hobby Becomes a Business?
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According to the IRS, if you sell items you made for a hobby, you may be required to report the income to the government. It is a matter of how much you made, whether you depend upon that income, if you make a profit most years and if you are trying to improve your productivity. The occasional sale of a bird house may not be considered a business, but if you regularly take your inventory to swap meets, you need the same profit and loss sheet that a manufacturer needs. Even if you don't make a profit of supplies vs. inventory, you still need to be able to prove it.
Start-up Costs are Deductible but not as Supplies
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Keep a complete record of every penny spent in starting a manufacturing business and have a receipt to back up every claim. Remember that there are hidden costs such as fees for business licenses, joining a guild or even a group to help support your business. Miles driven, advertising, phone bills from a dedicated business phone line, education expenses and consultations are all deductible. You may deduct up to $5,000 of these types of expenses in the first year but if there are additional costs, amortize them over the next five years of business.
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