Valuing Inventories on Tax Year

An inventory is necessary to clearly show income when the production, purchase or sale of merchandise is an income-producing factor. If the taxpayer must account for an inventory in his or her business, he or she must use an accrual method of accounting for his or her purchases and sales. 
To figure taxable income, the taxpayer must value his or her inventory at the beginning and end of each tax year. To determine the value, the taxpayer needs a method for identifying the items in his or her inventory and a method for valuing these items. The rules for valuing inventory are not the same for all businesses. 
The method the taxpayer uses must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. The taxpayer is inventory practices must be consistent from year to year.
The value of your inventory is a major factor in figuring your taxable income. The method you use to value the inventory is very important. Generally there are two methods for valuing inventory. These methods are cost or lower of cost or market.

• COST METHOD. To properly value your inventory using the cost method, you must include all direct and indirect costs associated with it.
• LOWER OF COST OR MARKET METHOD. Under the lower of cost or market method, compare the market value of each item on hand on the inventory date with its cost and use the lower value as its inventory value.