Internet retail and inventory management
Most internet retailers have to deal with at least some level of inventory and it can be quite a pain. For instance, intuitively you might think that you can just track your sales and figure out the cost of goods sold by calculating how much you paid for the merchandise (including shipping, of course).
For the IRS, however, this isn’t good enough - first of all, it doesn’t account for “shrinkage” of your inventory - the fact that your inventory will shrink over time because of returned products, theft, misplacing inventory, etc. For this reason when your inventory level hits a significant level (usually greater than $100K) you need to use this formula for calculating cost of goods sold:
Beginning of period inventory - End of period inventory + Purchases made
Note that on an accrual basis the inventory levels at the beginning and end of the period should include all inventory orders in transit.
As you can imagine this can cause quite a few problems if you either have a bad count or are dealing with a lot of purchase orders (placed by you to suppliers or with you from customers). My advice - come up with a meticulous process for counting your inventory and document every step of the purchase order process to be able to iron out all of the inevitable wrinkles later.
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