Retailers sell goods purchased from various vendors. Most goods purchased for resale, or used to make items for resale must be treated as inventory until such time as goods purchase or manufactured are sold. In general the purchase price of inventory and other cost relating to the manufacturing process cannot be taken as a deduction against income until the merchandise is sold. Once the merchandise is sold then the costs incurred from purchasing, shipping, assembling etc. the item can be expensed as Cost of Goods Sold (COGS).
In addition Uniform Capitalization (UNICAP) rules require capitalizing indirect costs allocatable to the production of real or tangible personal property to that property – so the cost of inventory will include not only the cost of materials and labor to produce it, but also will included costs such as depreciation of equipment used in the manufacturing process as well.
Some vendors give an allowance that is to cover the estimated cost of defective merchandise with no obligation to return the defective merchandise nor let the vendor know how much was defective. If this is the case, then these allowances do not have to be included in income as they are fixed and NOT related to actual amount of defective merchandise NOR proof of defects NOR require the return of the defective merchandise. This allowance is treated as a trade discount, a simple reduction in the Cost of Goods from the vendor.
In addition since this allowance is not related to the defective merchandise specifically, the allowance reduces the cost of all of the goods from the vendor not just the defective merchandise.
Finally when valuing the subnormal goods received, these items should be valued at the bone fide selling price less the cost of direct disposal (if any). They are neither scrap nor spoilage, which normally must be depreciated under UNICAP.
As always, small business services and taxation are our business. If you have any questions about UNICAP rules, trade discounts or valuing inventory, or if you need other help Please give Art & Business Consulting a call. We would love to engage you as a client.
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