Page 36 - Small Business Taxes

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The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.
Inventory at beginning of year . . . . . . . . . . . . . . . . . . $37,845 profit by net receipts. The resulting percentage measures
Plus: Purchases . . . . . . . . . . . . . . . . . . . $285,900 the average spread between the merchandise cost of
Minus: Items withdrawn for personal use . . . 2,650 283,250 goods sold and the selling price.
Goods available for sale . . . . . . . . . . . . . . . . . . . . . $321,095
Minus: Inventory at end of year . . . . . . . . . . . . . . . . . 32,955 Next, compare this percentage to your markup policy.
Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . $288,140 Little or no difference between these two percentages
shows that your gross profit figure is accurate. A large dif-
ference between these percentages may show that you
Items To Check did not accurately figure sales, purchases, inventory, or
other items of cost. You should determine the reason for
Consider the following items before figuring your gross the difference.
profit. Example. Joe Able operates a retail business. On the
average, he marks up his merchandise so that he will real-
Gross receipts. At the end of each business day, make ize a gross profit of 33 /3% on its sales. The net receipts
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sure your records balance with your actual cash and (gross receipts minus returns and allowances) shown on
credit receipts for the day. You may find it helpful to use his income statement are $300,000. His cost of goods
cash registers to keep track of receipts. You should also sold is $200,000. This results in a gross profit of $100,000
use a proper invoicing system and keep a separate bank ($300,000 − $200,000). To test the accuracy of this year's
account for your business. results, Joe divides gross profit ($100,000) by net receipts
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Sales tax collected. Check to make sure your records ($300,000). The resulting 33 /3% confirms his markup per-
centage of 33 /3%.
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show the correct sales tax collected.
If you collect state and local sales taxes imposed on
you as the seller of goods or services from the buyer, you Additions to Gross Profit
must include the amount collected in gross receipts.
If you are required to collect state and local taxes im- If your business has income from a source other than its
posed on the buyer and turn them over to state or local regular business operations, enter the income on line 6 of
governments, you generally do not include these amounts Schedule C and add it to gross profit. The result is gross
in income. business income. Some examples include income from
Inventory at beginning of year. Compare this figure an interest-bearing checking account, income from scrap
with last year's ending inventory. The two amounts should sales, income from certain fuel tax credits and refunds,
usually be the same. and amounts recovered from bad debts.

Purchases. If you take any inventory items for your per-
sonal use (use them yourself, provide them to your family,
or give them as personal gifts, etc.), be sure to remove
them from the cost of goods sold. For details on how to 8.
adjust cost of goods sold, see Merchandise withdrawn
from sale in chapter 6.
Inventory at end of year. Check to make sure your pro- Business Expenses
cedures for taking inventory are adequate. These proce-
dures should ensure all items have been included in in-
ventory and proper pricing techniques have been used. Introduction
Use inventory forms and adding machine tapes as the You can deduct the costs of operating your business.
only evidence for your inventory. Inventory forms are These costs are known as business expenses. These are
available at office supply stores. These forms have col- costs you do not have to capitalize or include in the cost of
umns for recording the description, quantity, unit price, goods sold but can deduct in the current year.
and value of each inventory item. Each page has space to To be deductible, a business expense must be both or-
record who made the physical count, who priced the dinary and necessary. An ordinary expense is one that is
items, who made the extensions, and who proofread the common and accepted in your field of business. A neces-
calculations. These forms will help you confirm that the to- sary expense is one that is helpful and appropriate for
tal inventory is accurate. They will also provide you with a your business. An expense does not have to be indispen-
permanent record to support its validity. sable to be considered necessary.
Inventories are discussed in chapter 2. For more information about the general rules for de-
ducting business expenses, see chapter 1 of Pub. 535.
Testing Gross Profit Accuracy If you have an expense that is partly for business
! and partly personal, separate the personal part
If you are in a retail or wholesale business, you can check CAUTION from the business part. The personal part is not
the accuracy of your gross profit figure. First, divide gross deductible.

Page 30 Chapter 8 Business Expenses