 Income tax 2021-2022, testing gross profit accuracy. Get ready to get refunds to the max diving into income tax 2021-2022. Most of this information can be found in publication 334, tax guide for small business 2021 tax year looking at the tax formula line 1, income having a supplemental schedule that would feed into it basically an income statement, income and expenses then included, expenses basically being deductions, the net then flowing in to line 1 income of the income tax formula, as well as page 1 as we see here of the form 1040, which we would basically have the schedule C flowing into the schedule 1, which would flow into line 8 of the first page of the form 1040. This is the schedule C, basically an income statement. So we're testing gross profit for accuracy. We've got to make sure that gross profit is sufficiently gross. Is it gross enough for us to turn in to the IRS and accurate enough? So here we go. So this is kind of like a little check figure that you can use a little technique. So if you are in a retail or wholesale business, meaning you're purchasing the inventory and simply basically marking up that inventory, then you're going to have an idea of what your markup is for the inventory. So you can check the accuracy of your gross profit figure. First, divide gross profit by the net receipts. So you're going to take the gross for profits and divide it by the net receipts. The resulting percentage measures the average spread between the merchandise cost of goods sold and the selling price. Next, compare this percent to your markup policy. Little or no difference between these two percentages shows that your gross profit figure is accurate. So this is a nice little technique or calculation to determine whether your gross profit looks appropriate or not. And you can also think that if someone else was trying to kind of review your financial statements, such as an auditor, they may use a technique like this as well. If there's a big difference, then you would want to be able to explain that to yourself. Why was there a difference? So 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 reasons for the difference. So obviously you want to determine the reasons for that difference for a couple of different reasons. One, you want to say where's the error just for your own bookkeeping purposes because you would think it would be a reasonable number. And notice it's still just an estimate because your markup might not be consistent for the whole year. You could have different products and so on and so forth. So this is just a measure or a check type of number that may not be exact, but it could be a rough estimate to get an idea. And again, too, it might be used by someone like an auditor to help determine whether or not your calculation for gross profit and your calculations for the financial accounts in general, your schedule C, cost of goods and sales look appropriate, look reasonable, look correct. So example, we'll pull up the calculator for our example. We've got Joe Abel operates a retail business. On the average, he marks up his merchandise so that he will realize a gross profit of 33 and one third on its sales. So one third is one divided by three. So in decimal format 0.33333 on forever. So for example, if we sold something for $100, we bought something. I'm sorry, we bought it for $100. That's the cost. How much would we sell it for $100 times? We're going to say 0.33333, one third, 33333333. That's going to give us the $33.33 about. So we can calculate that also by doing it this way. We could say, well, if we had 100%, which would be whatever we sold it for 100% of that, plus the 33.333 markup. So plus the 0.33333 on forever. That would be the 1.33333 times the cost $100. That gives us our 133.33. Okay, so that's this general markup policy. The net gross receipts minus returns and allowances showing on his income statement is $300. His cost of goods sold is $200. This results in gross profit of the $100,000, $300,000 minus the $200,000. So there's the gross profit. To test the accuracy of this year's results, Joe divides the gross profit, the $100,000, by net receipts, the $300,000. The result is 33.33 confirms his markup percent. Now, it's not always going to be exactly that amount because you could imagine multiple different products and having multiple markup percents. Maybe he tries different markup percents. He changes his price. He changes his profit margins and so on. But as a general rule, people generally have a good idea of how much they're marking up their items for to generate revenue. And then you can get a reasonable calculation. If it's way off, if you do this calculation and it's way off, then you're going to say, well, something funny is happening here and you want to look into it. And of course, if it's way off and you can't explain it in an audit who does a similar calculation and is trying to figure why it's way off, then that's going to be a problem as well. So you want to be able to double check that to some degree. So additions to gross profit. If your business has income from a source other than its regular business operations, enter the income on line 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 debts.