In late 2018, the United States government announced the new Excise Tax for products purchased from China. Many distributors and manufacturers raced out and purchased extra merchandise to avoid the Excise Tax for as long as possible. By purchasing excess inventory, they thought they would be saving money because they would have the inventory in the United States before the tax would take effect.
Many people bought additional inventory. But maybe they would have saved money by keeping the products in China and paying the Excise Tax when they actually needed or could sell it.
Managing inventory is one of the reasons many people call their CPAs before making significant purchases of any kind. It seems logical to expect that a lower cost on inventory will yield a higher profit when the inventory is sold. No question: it’s essential to keep the manufacturing inputs and loaded (with the expenses to maintain, store, and move the inventory) Cost of Goods Sold figure as low as possible. It helps profits. But in the accountant’s world, there are other considerations.
Thinking about inventory correctly
There’s inventory, and there are costs associated with inventory. We remind people as they look at their financial statements that inventory is on the balance sheet, not on the income statement. Inventory is an asset. If a company has ordered products or parts from China and cannot sell them right away, they have now taken on extra inventory. The inventory figure goes up, which might be okay if the stock can be sold right away. Revenue increases! However, the money spent on the inventory reduces cash, another balance sheet asset.
The extra inventory does not mean lower taxes from a reduced income because of additional costs—not until the inventory is sold. It’s particularly hard to understand until we look at what happens if a company buys extra stock. Below are some costs they could be paying for that additional product.
- More units ordered from overseas require added time and resources to remove them from the ship.
- Increased imports mean new holding charges at the docks if the product cannot be received right away.
- Whether it’s finished goods or parts, these larger shipments will require bigger holding containers. (Space is expensive, whether it’s in a ship, on a dock, or at a warehouse.)
- The larger holding containers need bigger transport vehicles (i.e., rail cars or trucks), which cost more.
Companies that purchase more extensive inventories face larger warehouse spaces, additional buildings, and more movement of the stock around the warehouse or from one storage area to another.
It’s helpful to ask: Would the Excise Tax be more or less than all the added costs enumerated above?
Inventory, Goldilocks, and Cash Flow
Inventory is expensive to carry, but we can’t expense it as a “cost of goods sold ” until the item is actually sold.
On the other hand, you cannot sell what you do not have.
Many businesses struggle to attain the Goldilocks “just right” level of inventory. Every situation is different. If the company can sell the inventory, then, buying more may be the correct decision. If they have to borrow money to acquire it, or if they can’t sell it, the financial statements will be affected. We need to say it here: Cash flow is always an issue. Always.
Generally Accepted Accounting Principles (GAAP)
We recommend that all businesses be compliant with the Generally Accepted Accounting Principles (GAAP) Guidelines on inventory and, well, everything. We often send our CPAs and accountants to courses to keep up-to-date with the current administration’s tax laws. The domestic political climate and international relations are continually changing. We make sure we’re on top of all of it!
In general, we encourage our clients to have a strategic discussion with their CPA (hopefully us) before they make any big purchases of any kind. Whether it’s inventory, equipment, a building, or even a company car (link to Lease vs. Purchase blog)—the financial statements will be affected.
Artificial Intelligence (AI) and Accounting
We are often asked about AI. We remind our clients and prospects that accounting is not always black and white. It’s very gray, and quite frankly, that’s why people should not rely on Artificial Intelligence to do their accounting.
In summary: With the whiplash speed of change in the global political climate, correctly accounting for inventory has become a pressing issue. We stay current, so our clients can be “just right” on their inventory, their financial statements, and their cash flow.
For over 30 years, Maria has served clients in a variety of areas including financial statement audits, reviews and compilations as well as business and individual taxation. Maria excels working with clients in the real estate, and healthcare industries, along with employee benefit plans.
You can reach Maria at 714-569-1000