Surviving an I.R.S. audit - What Is Included in the Cost of Finished Good besides your best guess?
September 28, 2010
In the previous post, we focused on using your inventory record to document your cost of Finished Goods for the IRS. So what can be included in the cost of Finished Goods and what can't?
To keep this really simple, Finished Goods = cost of materials and employee labor that go DIRECTLY into the work.
If you use jump rings, a tube of paint, a roll of canvas, pounds of clay, or sheets of metal, anything that you use DIRECTLY in your work, is included in your Finished Goods.
To figure out how much your raw materials cost, you can look at your receipts for purchases or write it on the materials themselves. For example, when I buy metal, I write the total cost on the sheet of metal with a magic marker. Buy some clay? Write how much it cost per pound on the outside of the package. Canvas? Write down the price per yard.
A sheet of sterling silver. I wrote the
price of the sterling sheet metal when
I bought it.
Write it down when you buy your materials so you won't have to look it up later. If the jump rings cost you $3 for 20, then they cost you 15 cents each.
There are lots of ways to track your materials. Keep it simple and use the same method all the time. Write your cost of materials in your Inventory Record for each piece.
Employee labor is also part of your finished goods. Just keep an index card on your bench or in your studio for each work in progress. Write down the employee's labor and your labor separately. The index card on the left shows my labor ("HB") and 2 employees for a work in progress.
The IRS requires that the artist's labor (as a sole proprietor) does NOT go into Finished Goods, but I keep a record anyway. I want to know how many hours I have invested in each piece. Don't you? How else can you plan new work or figure out if you are charging a reasonable retail price?
Your Inventory Record SHOULD INCLUDE the cost of materials and employee labor in each artwork. You need this information at the end of the year. By the end of the year, the sum of Finished Goods for all finished work adds to your inventory.
NOW IT IS TIME TO SELL! This will be the post for next time when we change FINISHED GOODS into Cost of Goods Sold (without magic).
Stay tuned to ASK Harriete! Learn the standards you need to survive an I.R.S. audit.
Campbell's Soup Multi-Can Earrings
© 2001 Harriete Estel Berman
What are my materials costs?
Materials: 2 sterling silver posts,
2 sterling silver jump rings, sterling
silver wire, recycled tin cans.
PS If you don't have Inventory Records or if you don't consider your art or craft a business, then the IRS will not allow you to deduct your expenses.
If you intend to deduct expenses, then somehow, some way, you really need to track the cost of materials and employee labor in your FINISHED GOODS to meet the expectations of the I.R.S.
This information is essential every year when you file your taxes.
This post was updated on January 21, 2022.