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Here’s the situation: Beginning Inventory and Ending

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Here’s the situation:Beginning Inventory and...
Here’s the situation:Beginning Inventory and Ending Inventory have been very significantly understated for years. As a result, Purchases have been forced to be significantly overstated for years. COGS have been estimated and are reasonably accurate. The goal is to fix the Inventory amount moving forward (which would also fix the Purchases amount).Re-balancing out the COGS/Inventory will not work because the Inventory has been so very significantly understated for years, that there simply isn’t enough room to rebalance it out (i.e. lowering COGS and increasing Ending Inventory to re-balance) using the existing numbers. Inventory has been listed way too low to do that and it needs to be stated significantly higher (3x-4x higher!).The two key areas to fix the Inventory amount on is the Balance Sheet (Schedule L) and the 1125-A Form (COGS).The business is a 1120-S and is going to be transferred via an Estate to a Seattle couple automatically for $0. How can the couple fix the incorrect Inventory amount in these two key areas moving forward on the 1120-S?
Submitted: 11 months ago.Category: Tax
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9/11/2017
Tax Professional: taxmanrog, Certified Public Accountant (CPA) replied 11 months ago
taxmanrog
taxmanrog, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 1,206
Experience: Licensed CPA, MA, MST with 31 years' experience. Teach Accounting and Tax courses at Masters level.
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Hello again!

I don't know why you can't accept my answer from before. It is 100% correct. Even if the reason the inventory is incorrect is because of prior year errors, the errors affected COGS. The ONLY way you will be able to correct this is by adjusting COGS. I don't understand why you refuse to believe this.

Even if you do nothing this year (this is an option, as you did not control the company for the last year) and you correct the ending inventory at the end of 2017, the COGS will be the balancing figure.

Even if you do not like the answer, it is the correct one. I could pull out one of my forensic accounting manuals to show you this is correct, but based on the fee you proposed, it would take too much time.

This is the correct answer. Correct the ending inventory and offset it with the COGS.

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Tax Professional: PDtax, Certified Public Accountant (CPA) replied 11 months ago
PDtax
PDtax, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 5,122
Experience: 35 years tax experience, including four years at a Big 4 firm.
Verified

I'mCustomer A different expert. I'd like to try and assist.

What is the problem with fixing the end of year inventory now and living with the prior year timing differences? All it really does is clean up prior year errors you had nothing to do with. And the balance sheet will be accurate for the first time. And retained earnings will be accurate too.

I guess I don't see the value in getting caught up in the prior year multiple errors. You have been told accurate advice already. My take is that I don't see the cause for prior year concern.

Thanks for asking at just answer. Positive feedback is appreciated. I'mCustomer

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Customer reply replied 11 months ago
I understand what you are saying but it will not work in this case because Inventory is listed way too low to be able to offset COGS. COGS cannot possibly be adjusted enough to fix this issue. Let me give you an example why. For example, let’s say Beginning Inventory is listed at $10K. However, actual inventory is really $80K. Because there is such a big difference, there isn’t enough room to offset it with the COGS.Here’s an example:- Beginning Inventory: $10K
- Purchases: $50K
- COGS: $50K
- Ending Inventory: $10KIf I change Ending Inventory to $80K, that means COGS would actually become negative -$20K.This is what I am trying to explain. I cannot correct ending inventory and offset it with the COGS because Inventory is listed EXTREMELY LOW. If I try to offset with COGS, then the COGS would be extremely NEGATIVE. That's how big the difference is.
Tax Professional: PDtax, Certified Public Accountant (CPA) replied 11 months ago

Got it. The problem is you are trying to fix through cost of goods sold. That's not necessary.

Make the income adjustment you believe you need which is to the 1/1/16 inventory. Treat it as other income on the face of the 1120. That will increase the income to what you believe is the historical understatement. On the other income sheet, describe the adjustment as 1/1/16 beginning inventory understatement, which will support a new, higher 1/1/16 inventory and report the income.

Your 1/1/16 inventory will then be correct, and you can safely report your 2016 activity with the first normalized cost of good sold section.

Thanks again for your persistence in asking, but it was your last description that kicked in for the correcting response. Please rate when satisfied, and a bonus would be appreciated. I'mCustomer

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Customer reply replied 11 months ago
Thank you for understanding the issue. So, you are essentially saying, whatever the understatement in the Inventory is, treat that difference as “Other Income” and adjust Beginning Inventory accordingly, correct? If so, that raises a few issues:1. Since this method raises income, I would essentially be paying tax for increasing my inventory. Paying tax for increasing my inventory doesn’t make sense to me? Especially since the increase would be so big.2. On the 1125-A, the Ending Inventory from 12/31/15 and the Beginning Inventory from 1/1/16 wouldn’t match up. Would I attach another explanation to 1125-A explaining the adjustment?3. How would the adjustment be done on the Schedule L (Balance Sheet)? Something would need to balance out the big jump in inventory on the Balance Sheet. Inventory increases are typically balanced out by either (a) Decrease in Cash or (b) Increase in Accounts Payable. Neither of which apply here.4. Finally, wouldn’t making all of these changes/adjustments and attaching explanations cause a potential audit and other unnecessary issues? Is it a big deal to just leave Inventory low the way it is and use a higher Purchases amount to balance things out. So although Inventory will be listed too low and Purchases will be listed too high, COGS will still be accurate. In the end, it all balances out and the tax liability doesn’t change. The Purchases number just becomes higher then it should be because Inventory is lower then it should be - but COGS would be accurate and the tax liability wouldn’t change either way.5. I see the 4 issues above with the method you have described. The other method (fixing through COGS) obviously won’t work at all. Is there another method that simply allows me to refigure the Inventory amount? There must be another method out there besides these 2 methods? For example, Line F on the 1125-A states “Was there any change in determining quantities, cost, or valuations between opening and closing inventory?” - Would this solve the issue? What other methods are there for for fixing Inventory understatement?I would REALLY appreciate it if you would address all 5 points above. This should be my final follow-up on this question. Thank you in advance for your time. I really value your responses and look forward to reading the next one.
Tax Professional: PDtax, Certified Public Accountant (CPA) replied 11 months ago

Sorry, but I can't address all of this and the original question for the price posted.

Please accept and rate my response, and post these new issues to a new question. Ask for me, and I will respond.

Positive feedback and a bonus are appreciated.

Customer/p>
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Tax Professional: PDtax, Certified Public Accountant (CPA) replied 11 months ago

Hi again.Customerhere.

I was prompted to follow up. Please advise.

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Customer reply replied 11 months ago
Hello - Since the first two exchanges were me just clarifying the actual question, I would appreciate a response to my last message without having to open up a new question. I don't believe its fair to open up a new question when the first two exchanges were just needed for clarity purposes. I hope your will cooperate so we can successfully finish this question and I can rate you, otherwise my only option will be to close this out poorly & refund. I assure you there will be no more questions except which were in my last message. Thanks in advance and I hope we can resolve this.
Tax Professional: PDtax, Certified Public Accountant (CPA) replied 11 months ago

Your follow-up indicates you don't believe my response. The additional time will be needed to defend what I already reported, and expand into audit risk, tax consequences, and your desire for a nontaxable alternative.

I will opt out.

Customer/p>
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