united-states, taxes, accountingIn a small (hobby stage) business, how should I account for waste?
I’m buying my raw materials (fine lumber and other stuff) under a sales tax exemption (state of Texas, Travis county 8.25% total rate.) So I have to account for how it’s used (sales are taxable, disposed of is not taxable, other uses become taxable.)
I’m trying to do accrual accounting, where I take material off the inventory account at cost and move it to finished goods.
However, there is a sizable amount of unusable product that I dispose of. Maybe 25% at worst. (Obviously I’m motivated to reduce that!)
To simplify finished goods inventory, I’m using an internal transfer price that assumes no waste in making the product.
To balance the books, I intend to take inventory periodically and create a “plug” entry:
Book Value of Raw Materials - Internal COGS - Plug = Value of actual inventory
The plug would be waste.
Suppose I purchased $1000 in lumber to make 20 products, then my internal COGS is $50 each; COGS being cost of goods sold. Now suppose the lumber is used up, and there are only 15 finished, salable products. My Inventory account had $1000 in it. I drew down $750 while using up all the raw materials, so my plug would be $250.
$1000 - $750 - $250 = 0
My state sales tax would be based on revenue from in-state sales of finished goods plus lumber removed from (sales tax-free) inventory for other uses. So my accounting setup helps answer the question: what is my sales tax base. But I would also put the Waste entry into my COGS account.
I expect to reach $3000 in sales this quarter for the first time, so I’m trying to do this right before filing taxes.
Is this a good way of accounting for my inventory and waste? What are some problems with it and ways to do it better?
Any cost incurred in production of a product must be matched with the revenue from it as closely as possible. Therefore typically waste gets factored in the COGS. That way your COGS would represent your true costs and shows you how you can increase profit by decreasing waste.
So your waste “plug” entry would be part of the COGS account.
Imagine a carpenter requires 9 feet of a 2x4 for a product. His supplier only sells 10 foot 2x4 so he buys them. For each product he has 1 foot left over which he cannot use in a product and assuming he cannot make money selling them as scrap. He would therefore assume that each product uses 1pc of 10 foot 2x4 in his books and that would be in his COGS. That 1 foot was waste is typically an operational measure and not an accounting measure unless it is assigned a salvage value afaik.
how it’s used (sales are taxable, disposed of is not taxable, other uses become taxable.)
What they mean by disposed of here may not be referring to material waste as part of production but disposing of inventory without revenue such as a write off.
There is more here. http://www.accounting4management.com/scrap_and_waste.htm. http://www.dummies.com/how-to/content/cost-accounting-for-waste.html http://www.accountingtools.com/questions-and-answers/what-is-a-disposal-account.html You can also verify exactly what they meant by disposed of with the county or state sales tax administration.
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