WHOLESALE & MANUFACTURING INDUSTRY UPDATE

Have you addressed the issue of slow-moving inventory lately? Does your company have a program in place to identify and dispose of such items? If issues relating to slow-moving inventory are addressed now, before the end of the year, you may be able to accelerate your tax deductions, in addition to cleaning up your warehouse and making space available that can be used for more profitable purposes.

Before we discuss the tax savings, here are a few key points to remember when addressing slow-moving inventory:

• Slow-moving inventory needs to be identified. To accomplish this, you should have an inventory analysis report that lists each inventory item according to the total cost value sold in the last year, from largest value sold to the smallest. This report should also list the cost value of each item you currently are holding in inventory. From this information, it’s easy to see which items at the bottom of the list are not contributing to sales. When analyzing inventory this way, many companies are often surprised to learn that less than 1% of their sales are generated with inventory that comprises as much as 5-10% of their total inventory holdings. Often a significant percentage of inventory holdings is not generating any sales!

• A decision needs to be made on which slow-moving items to discontinue and which should be kept. This decision should be analyzed in conjunction with the sales staff. There may be good reasons for continuing to hold certain inventory items, even though they are not contributing to sales.

• Implement a plan for disposition. Offer the discontinued items for sale at discounted prices if necessary. If sales efforts are unsuccessful, try returning the merchandise to your supplier. If that effort fails, consider selling the items for scrap or donating them to charity.

In order to turn dead stock inventory into a tax deduction, there are a few technical rules you need to follow. Inventory generally must be valued at your cost, and you do not benefit from a tax deduction until the item is sold. There are certain instances, however, when unsold inventory can be valued at less than cost, or even written off completely without being sold.

• Lower of Cost or Market - For taxpayers using the lower of cost or market method of inventory valuation, each inventory item should be valued at cost or “market” - whichever is lower. “Market” generally means the current bid price (i.e., replacement cost). Regulations allow inventory to be valued based on a net realizable value lower than the replacement cost if the merchandise was actually offered for sale prior to year end at a price lower than its replacement cost. In this situation, inventory should be valued at the selling price less direct costs of disposition. The IRS can challenge this value by looking to actual sales of such merchandise both before and after year end.

• Subnormal Goods - There is another rule that applies just to valuing “subnormal goods.” “Subnormal goods” are any goods that are unsaleable at normal prices or unsaleable in the normal way because of damage, imperfections, shop wear, changes of style, odd or broken lots or other similar causes, including second-hand goods taken in exchange. “Subnormal goods” should always be valued at net realizable value, regardless of whether the taxpayer uses the cost method or the lower of cost or market method for valuing regular inventory. For “subnormal goods,” net realizable value is based on bona fide selling prices less direct costs of disposition. This must be based on actual offers to sell the “subnormal goods” for up to 30 days after year end.

• Obsolete Goods - Obsolete or unsaleable inventory does not actually have to be offered for sale at a price lower than cost in order to prove net realizable value, since such merchandise presumably has no value. These items can be valued at the net realizable value, which often is scrap or salvage value.

Kim Gregoris, CPA, MS (Tax)
Principal