 that the you know the iris might question you about purchases if you take any inventory items for your personal use use them yourself provide them to your family or give them as personal gifts etc be sure to remove them from cost of goods sold for details on how to adjust cost of goods sold see merchandise withdrawal from sale in chapter six so in other words if you're dipping into your own stash of inventory then you have to properly account for that is is in essence a withdrawal type of situation inventory at the end of the year check to make sure your procedures for taking inventory are accurate so notice when you're tracking inventory you might be using a perpetual inventory system or a periodic inventory system in other words a periodic inventory system is one where you do a physical count periodically and make the adjustment reducing inventory and recording cost of goods sold on that periodic basis based on the physical count either weekly nightly or yearly monthly if you were to do a perpetual inventory system the system will be reducing the inventory and recorded the related cost of goods sold at every sale which more sophisticated software would be able to do but you still need to do a physical count counting out counting out counting to make sure the system is working properly and to make sure your ending inventory is accurate and make sure it ties out to reality the physical count accounting for shrinkage and spoilage and that kind of stuff use inventory forms and adding machine tapes as the only evidence for your inventory so inventory forms are available at office supply stores these forms have columns for recording the description quantity unit price and value of inventory items so you could track your inventory you might use different methods of inventory tracking first in first out well first in first out that's me last and first out weighted average specific identification so on each page has space to record who made the physical count who priced the items who made the extent of the extensions and who proof read the calculations these forms will help you confirm that the total inventory is accurate they will also provide you with a permanent record to support its validity inventories are discussed in chapter 2 so testing gross profit for accuracy if you are in a retail or wholesale business you can check the accuracy of your gross profit figure first divide gross profit by net receipts the resulting percent measures the average spread between merchant merchandise cost of good sold and the selling price next compare this percent to your markup policy so in other words if you're trying to trying to say does this gross profit calculation look reasonable well if you can kind of think about the relationship the ratios between the gross profit and your and your sales and think about is that is that similar to the ratio that I usually have for my markup of my inventory so if I just buy and sell inventory what is the markup of the inventory you would expect to have a similar kind of relationship to the totals at the end of the year because the sales are a result of simply selling inventory and the the cost of good sold represents the cost of the inventory so you would expect to have a similar relationship now if you have a more complex business where you have you know other income or you're marking up and down the inventory all the time the prices and costs are fluctuating all the time then that's going to be a little bit more difficult to do like a like a double check or comparison but clearly you can look at these ratios and get a general idea if if they're similar to your markup ratios to get an idea if the gross profit looks reasonable so next compare this percent to your markup policy little or no difference between these two percents show that your gross profit figure is accurate a large difference between these percentages may show that you did not accurately figure sales purchases inventory or other items of costs you should determine the reason for the difference now you can also imagine that the IRS on their side of things might look at similar ratios from similar industries so they're going to say well you're in this particular industry I've they've got evidence on the market average for those industries if your ratio looks widely different than the market average you would think that that might be something that would be like a red flag to the IRS I'm not saying that's exactly how they do their auditing process but just if you were just to use ratio analysis then then you would you know you would think that would be a reasonable way if you were trying to figure out if someone's making an accurate return to kind of look at things right so so you might think of it from that perspective as well obviously it should it should reflect a reasonable analysis of your markup and if you have a competitive business then you would think that would be somewhere in the range of other type of businesses you know around you at least in in your location so example Joe Abel operates a retail business on the on the average he marks up his merchandise so that he will realize a gross profit of 300 I'm sorry 33 and one-third percent on its sales so the net receipts gross receipts minus returns and allowances so showing on his income statement are 300,000 so his cost of good sold is 200,000 this results in a gross profit of 100,000 so sales minus cost of good sold he's making 100,000 he's selling for 300,000 the cost of good sold the cost of the inventory that was sold is 200,000 therefore the gross profit not the net income the gross profits 100,000 to test the accuracy of this year's results Joe divides gross profit 100,000 by net receipts that's the sales 300,000 the revenue side the result is 33 and one-third which confirms his markup percent so in this example it's perfect is it's exact which would mean that he didn't like make any variance in his markup percents through the entire year and he sold everything constant through the whole year so you can see it's not a perfect kind of system but it can give you a general example so additions to gross profit if your business has income from a source other than its regular business operations enter the income online six of schedule c and add it to gross profit the result is gross business income some examples include income from an interest bearing checking account income from scrap sales income from certain fuel tax credits and refunds and amounts recovered from bad debt