Surviving the I.R.S. - Cost of Goods Sold, Are you ready? Watch my head explode!

My appointment with the IRS required that I bring my Cost of Goods Sold and Inventory records.

Visualize this written on I.R.S. stationary...

Cost of Goods Sold (and I quote directly from the Information Document Request)
"Physical inventory sheets for both beginning and ending inventory for the year. Copies of the Federal Income tax returns for the year before and the year after the return being examined (copy of your inventory list, logbook, invoices, or any documentation you have that records your inventory.)

Canceled checks, receipts, journal or summaries of goods purchased for resale and all other records for labor, materials and supplies, and any other cost incurred to raise or produce goods for sale."

Does that sound scary? There was more....but we will discuss this in another post... the point is:
Are your Inventory Records good enough for the I.R.S.?

IF the I.R.S. wants it, you've got to have it!

To be honest, I am permanently confused about the Cost of Goods Sold and Finished Goods...I feel like one of those bobblehead dolls. Yeah, I understand this for about a minute, then get confused again.  But I do know how to keep records, simple records, but records of everything. The IRS requires records and that's what you need to survive an IRS audit.

THE QUESTION IS: "How do you figure your Cost of Goods Sold?"

First, you need your Inventory Record of everything you made. This has been discussed in many posts on ASK Harriete.

Use your Inventory Records to figure a value for FINISHED GOODS.
FINISHED GOODS is accountant speak. (All accountants live on a different planet than artists.)

Finished Goods equals the cost of any materials that go directly into your completed work plus the cost of your employee's manufacturing labor (but not your own labor).

FINISHED GOODS is the dollar cost of the work that you finish and the amount that you add to your Inventory for each finished piece. 

GET IN A GOOD HABIT.
As soon as you finish an artwork or item, add the costs to your Inventory Record.

FIGURE OUT YOUR MATERIALS COST (and employee labor). Write down every jump ring, bead, or sheet of paper. Estimate (as best you can) the cost for the clay, paint, or metal. It might be by the pound, by the ounce, by the inch, or by the yard.

WRITE IT DOWN
Write down the cost of your materials and employee labor in your Inventory Record. This is the monetary value of Finished Goods for each piece.

AT THE END OF THE YEAR, the sum of all the Finished Goods is how much you have increased your Inventory during the year.

Finished Goods is not your retail price. Repeat this mantra.
Finished Goods is not your retail price.  NOD YOUR HEAD, like a bobblehead doll.
Finished Goods is not your retail price. It is your materials cost (plus your employee labor.)

Finished Goods DOES NOT INCLUDE your overhead labor or overhead expenses.
Finished Goods DOES NOT INCLUDE your profit.
Finished Goods DOES NOT INCLUDE your labor.

This is my head exploding.  Ask Harriete

This post was updated on January 21, 2022.