Inventory Calculations

I am a small business owner who makes handcrafted jewelry. I am doing inventory and have 3 questions:

1. I have a lot of gemstones that I tumbled from raw - I have been 'valuing' them when I make creations between $3 to $5 per stone.  Is this the amount I use per stone when figuring my inventory? For example, 50 stones at $5 for a total of $250.

2.  I have several finished creations that have not yet sold.  How do I figure the costs of these creations in inventory?  Supplies and materials only? Supplies, materials, labor and profit?  For example, supplies and materials are $5, labor (myself) is $15; retail price for creation is $45.  Do I only use the $5 or do I use the $45 (retail price)?

3. I have many stones that were given to me. I put a value on them on what it would cost me to REPLACE them, for example, $5 per stone. If I had 25 stones at $5 for a total of $125 - can I claim them in my inventory even though I did not 'buy' them myself?

Thanks in advance.

Did you have the Schedule C form in front of you when you asked those questions? If not, take a look at one now:

http://www.irs.gov/pub/irs-pdf/f1040sc.pdf

And the instructions:

http://www.irs.gov/pub/irs-pdf/i1040sc.pdf

I'm guessing the inventory question has to do with part III cost of Goods sold.

LeaMae:

1. I have a lot of gemstones that I tumbled from raw - I have been 'valuing' them when I make creations between $3 to $5 per stone.  Is this the amount I use per stone when figuring my inventory? For example, 50 stones at $5 for a total of $250.

You are probably using the cash method of accounting. If you aren't, you probably should be because it's simple and limits your risk of an audit (my opinion, anyway).

That means you have to value your gemstones at cost, which is what you paid for them during the tax year that you bought them.

LeaMae:

2.  I have several finished creations that have not yet sold.  How do I figure the costs of these creations in inventory?  Supplies and materials only? Supplies, materials, labor and profit?  For example, supplies and materials are $5, labor (myself) is $15; retail price for creation is $45.  Do I only use the $5 or do I use the $45 (retail price)?

The cost of supplies and materials only (line 38).

You don't include the cost or value of your own labor or profit in that section.

LeaMae:

3. I have many stones that were given to me. I put a value on them on what it would cost me to REPLACE them, for example, $5 per stone. If I had 25 stones at $5 for a total of $125 - can I claim them in my inventory even though I did not 'buy' them myself?

No.

Your cost for the stones is zero so you don't include them in the inventory.

Please read the instructions carefully and look for other business related publications on the IRS website.

If this is your first year in business, I suggest you have a tax pro prepare your returns the first time so you have the proper format to follow in future years if you want to do it yourself.

Watch this thread for Taxagent to explain it further or correct me if I got something wrong. 

You need to figure inventory cost in order to compute your cost of goods sold. I'll assume you are a sole proprietor and use the cash method of accounting. You only include in that cost amounts you actually spent on the materials that go into the items you make. Stones that were given to you and thus you didn't pay for have a cost of zero. There are several methods of inventory accounting that are generally accepted. Which one is best for you depends on the details of your business, and I don't have all the details here to advise you on that. This is something you might wish to discuss with a CPA who handles tax issues. It's an important decision because you need to determine which method to use on the first return you file for the business. If you want to change the method later, you must get consent from the IRS to do it. For more information on the rules for inventories, see IRS publication 538.

Ok - I think I have a rough idea on this inventory.  I DO plan to have a tax professional prepare my taxes this first year and that is why I am trying to gather the inventory before approaching a professional.  I want to have some sort of system in place.

I have done a Schedule C in years gone by but then I was a independant contractor.  This time around I am a single member LLC so I have other factors to consider in - like inventory and depreciation - both that confuse quite a bit.  I understand inventory - I am just not sure how to assign values to various things hence my original thread. I know to assign items that have receipts for actual purchases; I am not sure about assigning value to those items (like prepping raw gemstones to finished polished gemstones - a process which took several months and dollars) - for the moment, I will go with the $3 to $5 per stone price unless I am told differently.

Thanks.

LeaMae:

I am not sure about assigning value to those items (like prepping raw gemstones to finished polished gemstones - a process which took several months and dollars) - for the moment, I will go with the $3 to $5 per stone price unless I am told differently

You probably will be told differently because you are including your labor in the cost of the gems and you don't do that.

You mention that the "process" took several months and dollars. The months you spent polishing the stones don't factor into the cost of goods sold (unless you paid somebody to do it - and that opens up another issue of payroll taxes) but the dollars might.

What dollars did it take?

Depreciation takes some effort to figure out, especially since there are several option (straight line, MACRS, etc).

Basically, if you buy a piece of equipment, depreciation allows you to spread the cost over a period of years so you can take a partial deduction each year. The following link is to the IRS Overview of Depreciation. At the bottom of the article is a link to publication 946.

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/A-Brief-Overview-of-Depreciation

For more information on Cost of Goods Sold, read publication 538. It has a section on Inventories:

http://www.irs.gov/publications/p538/index.html

LeaMae:

I have done a Schedule C in years gone by but then I was a independant contractor.  This time around I am a single member LLC so I have other factors to consider in...

For federal income tax purposes, a single member LLC is regarded as a sole propriertorship. So, your federal income tax return will be no different here than it would be if you were operating a sole proprietorship.

LeaMae:

...like inventory and depreciation...

Those are things that determined by the details of the business you do (in this case making and selling jewelry) rather than the fact that you are organized as a LLC.

LeaMae:

I know to assign items that have receipts for actual purchases; I am not sure about assigning value to those items (like prepping raw gemstones to finished polished gemstones - a process which took several months and dollars) - for the moment, I will go with the $3 to $5 per stone price unless I am told differently.

Once again, you will only include the cost of things that you paid out money for. Your own time in making the goods is not something that goes into the cost of goods sold. Your profit on the sales is what compensates you for your time in making the items — and of course that's the bottom line on the Schedule C.

Depreciation is a way of deducting what you paid for items used in your business (other than inventory) that have a useful life of more than one year. Instead of deducting the entire cost in the year you buy the item, you instead spread out the cost over several years. The details of how you do the depreciation depend on the item you bought. If you qualify, you may take the entire cost in the year of the purchase under IRC § 179. This is all explained in IRS Publication 946.

LeaMae:

Ok - I think I have a rough idea on this inventory.  I DO plan to have a tax professional prepare my taxes this first year and that is why I am trying to gather the inventory before approaching a professional.  I want to have some sort of system in place.

That's a good idea. You might find IRS Publication 583 helpful. It covers a lot of tax issues related to starting a business, including recordkeeping.