 Income tax 2022-2023, cost of goods sold and gross profit, tax software example, let's do some wealth preservation with some tax preparation. Here we are in our example form 1040 populated with LISERT tax software. You don't need tax software to follow along, but it's a great tool to run scenarios with. You can also get access to the form 1040 related forms and schedules at the IRS website, irs.gov, irs.gov, starting point. We have the single filer Mr. Anderson has a Schedule C income business flowing through to line eight. Let's look at that flow through. It's on the Schedule C. Support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website broken out by category further broken out by course, each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Profit or loss from business in essence and income statement, income minus the expenses, the 100,000 in essence net income flowing to Schedule 1. There it is on Schedule 1, flowing to the form 1040. There it is on the form 1040 line eight. We also note there's going to be self employment tax, which is flowing from the Schedule C. Once again, net income 100,000 flows to the Schedule SE, where we calculate Social Security and Medicare. There's the self employment tax 14129 that flows to the Schedule 2. There's the 14129 Schedule 2, which flows to the form 1040 page two, not the income tax, but the self employment tax down here. We know that half of that is going to be basically an above the line deduction. So from the Schedule C, we've got the net income that's being calculated with the Schedule SE self employment. And that's going to be the 14129. Then half of that, the 7065 is an above the line deduction, which flows into the Schedule 1 page number two. There's the 7065, which flows on over to the form 1040 page one at the 7065. There's our AGI 92935 standard deduction is just the standard deduction would be the same if we have a business or no business Schedule C or not. In other words, qualified business income deduction were reliant on the software at this point to calculate here. That gives us the taxable income 63,988. Two calculates the federal income tax, 9692 in this case, and then the self employment tax 14129 for a total of the 23821. Then we're saying that there was a payments of 30,000 that were made, giving us the 6179. Now we're focused, of course, on the Schedule C, so we're back on over to page one, looking at the Schedule C and let's jump on over to that Schedule C. Now note that if you're in a type of business that doesn't have the any inventory, then it's going to be a lot easier in some ways because you don't have to deal with the cost of goods sold calculation. So you've got income up top on online one. You've got the returns and allowances that's typically also going to be there if you have like inventory that was returned for the basically the net sales. And then you've got the cost of goods sold and the cost of goods sold is the expense related to the selling of the inventory gives us that gross profit. So this gross profit subtotal is where our focus is. Again, if you don't have any inventory, these numbers will most likely be the same and your income will flow down here to your gross income and then you'll just subtract your other expenses. Note that when we think about these other expenses down here, advertising, car, utilities and whatnot, these aren't, it's not like the cost of goods sold is completely different in nature from these other expenses. The general idea of the business expenses is that in an income tax system, we want to be taxing the net income, not the gross income. We want to be allowing deductions for those items that were consumed in order to generate the revenue. And when we think about the cost of goods sold, the thing that has been consumed is the inventory. So we took the asset of inventory, it was consumed because we gave it away in order to generate the revenue related to it. The reason it's so important to have up top here is because the cost of goods sold is such a relevant component, such a big number generally to those kinds of businesses that sell inventory that warrants it having its own spot and also because it's one of those areas that we need to kind of do an accrual component to. We have to track the inventory oftentimes if we're doing the inventory for bookkeeping purposes. So we might need another sub-calculation of the inventory to support this number. So the sub-calculation is on page two. So in order to get this number on line four, we'd have to go to page two and basically enter the cost of goods sold calculation here. Now note in practice, you might be getting just an income statement from a client, right? Because you might not have the full balance sheet and income statement double entry accounting system. Hopefully you do. Hopefully they're using software or something like a QuickBooks which forces the double entry accounting system to be used. You'll have a balance sheet and an income statement. But if you're just filling out the schedule C with just an income statement, then you may not have the balance sheet with the double entry accounting system and you may just already have the number of cost of goods sold from what's being reported on the income statement. So then you'll be forced to kind of like back into this cost of goods sold calculation here, which is kind of a method of the periodic cost of goods sold inventory kind of calculation method of cost of goods sold. But the books might be done on like a perpetual inventory type of method. So in other words, when you're doing the schedule C, you might first just try to enter the income statement in such a way that you're going to get the net income that ties out to what's on the income statement. Once you've done that, then I would do incremental adjustments that are going to deviate from what was given to you by the client as the income statement, including calculating the cost of goods sold and then also doing any other kind of differences such as the mileage method versus the whatever expense they had on the books for expenses and adding like the home office and stuff so that you can do each change incrementally. And so if you mess up, you don't have to go through the whole thing again. So in other words, if I go back to the schedule C and I say, okay, if I was trying to data input this information, and I'm going to say the cost of goods sold, I don't know the, I don't want to get into the calculation, but I just know on the income statement they gave me, if I just know the cost of goods sold was, let's say it was $70,000, I'm just going to put that on the purchases here. So if I go back on over, now it's calculating that $70,000. If that's what's being shown on the income statement, I can use that to at least keep on going forward and see if I can get to the proper net income number even though page two is not correct because all I have is the $70,000. I just made this work to give me the $70,000 so I can then go back in and kind of figure out the cost of goods sold calculation. Now when you actually do this calculation of the cost of goods sold, it's the standard cost of goods sold accounting formula, which would be beginning inventory plus purchases equals the goods available for sale minus the ending inventory gives you the cost of goods sold. If they just purchase goods and then sell them, mark them up and sell them, it's fairly straightforward. It gets a little bit more complex when you have to deal with someone that's a manufacturing company that's making things. So let's just do it like a standard. This first number right here is going to be the inventory at the beginning of the year. If they were in business last year, that number should be the same in most cases as whatever it was last year. So if I said, okay, this needs to be whatever it was last year, let's imagine it was $10,000 last year at the ending inventory. That means the beginning inventory, so last year's inventory at the end should match the beginning inventory for the current year, you would think. And then the purchases might be the thing that you actually don't know because you could go into accounting software and try to figure all the purchases. But if they've been accounting for it on like a whatever, a perpetual or a periodic system, then they've been recording the purchases kind of as they have gone. So you might, if you just have the financial statements, you might not know exactly what the purchases are. So you might back into the purchases number. So then I can say, okay, the cost of labor, this would be if it was a construction company or a company, I'm sorry, that is constructing or manufacturing something, creating the inventory instead of just buying and marketing it up like a merchandising company, same with the materials and other costs to get to the total increases. This in other words is going to be the beginning balance plus the purchases. And then you've got the ending inventory. Now the ending inventory is a balance sheet item. So if you're just looking at like an income statement and you try to data input the income statement, you're not going to have that number, but the client likely will have, you might have a balance sheet and they'll likely have the ending balance sheet number. If they're tracking their inventory properly. So that number is would also be basically known. Let's say the ending number is 7,000, let's say. So ending number is 7,000. So then you can, if you just bought the inventory, you may be able to back into, in essence, the purchasing number if you know what the cost of goods sold is. So in other words, if I do my good old cost of goods sold formula here, and I'm like, okay, they gave me an income statement. I'm going to format this thing, right click format, and I'm going to make it currency, boom, boom, boom. And let's get rid of the decimals and I'm just going to say that cost of goods formula is going to be beginning inventory, I might spell this wrong, I'll abbreviate it. Beginning inventory plus purchases equals inventory available, available, available for sale less ending inventory gives me the cost of goods sold. That's the general formula. It's a little bit more complicated if they manufacture because then you have to work in process and the materials and the labor and the overhead and that stuff. But generally let's say we have this and we're going to say the beginning inventory I said was 10,000. So we're going to say 10,000 up top. And then the purchases we don't know here. So I'm going to say then the inventory available for sale is the sum of these two, just adding those up. And then the ending inventory we said was 7,000. So the cost of goods sold should be equal to this minus this, right? And I'm going to say, let's say the cost of goods sold, we know because the cost of goods sold would be on the income statement. And what did I say that was? I said it was 70,000 I think, 70,000 I said was the cost of goods sold. So given that information, I need to back into the purchasing number so you could do that. So the formula would basically be if I write it this way, 10,000, 10,000 plus X minus 7,000 is going to equal the 70,000. And then we can basically do our algebra and figure it out. Another nice thing down here, notice if I, you can use like a tool just in Excel, I'll just show you that comes up. I think it's kind of neat tool called goal seek. So if I see, if I do this now, I come up to 3,000 because this is the unknown. So I want to change this number to get that to be 70,000. So let's put an underline here. So whenever you have that situation, I don't need to be on any sale. I'm going to say that that cost of goods sold needs to be 70,000. So I'm just going to say, I'm going to go to my data tab and I can go to what if analysis, what if? And then I can say goal seek. And I'm going to say that I want this so to be equal to, I'm just going to hard code type in 70,000. I want you to do that by changing this so. And so, so notice it's not connecting to anything, it's just going to do trial and error. So it's kind of like algebra from a trial and error. As you say trial and error, eh? Stam point and let's go boom. And then it kind of plugs that in there, bam. And then you can, then you can double check it and say, does that make sense? Because if I had 10,000, if I had 10,000, and then I purchased that, it should sum up to the 77,000. That's the amount available for sale. Notice that it doesn't mean I ever had $77,000 worth of inventory at any given time. In this case, it just means that if I didn't sell any of the inventory and I just had my purchases plus the beginning inventory, that's how much I would have had. If I didn't sell anything for the whole year is given the purchases. The ending inventory is what I still have. Notice we are talking about dollars instead of units of inventory. So you have that conversion problem of units to dollars where you might have to use flow assumptions. You know, when you're doing an inventory system like weighted average, first, first and first out, last and first out and whatever. But here, we're basically trying to say, hey, they've already done all that stuff. What I'm trying to do is just back into the purchases number because basically I already have the cost of goods sold, possibly, and I'm trying to fill out this second page of the tax return and I've got all the numbers except possibly the purchases number would be that kind of scenario. So then I can go back on over here and say, okay, there's my 10,000. I'm going to say the purchases were 67,000. And then let's see if it calculates it properly. So that gets me back to my 70,000. So I'm going to say, okay. And then if I go to the page one of the schedule, see now I can populate the 70,000. So like I said, you could, you already know what the cost of goods sold is sometimes because you have it on the income statement, but you still need to fill out that second sheet, which is basically a cost to get sold on a periodic inventory system that's supposed to summarize the entire year. So you might have, so sometimes that becomes a little bit of an issue to populate. Now the returns and allowances is also a kind of a strange one because note that if I'm talking about selling inventory, then if they return the inventory to me, then it kind of negates the sale. Let's say I sold inventory last year in 2021 and I recorded it as revenue. But this year, they returned the inventory. So now what do I do? Should I go back to last year in 2021 and amend the return? Because I didn't really get revenue because they returned the inventory, which means they negated the sale. No, usually we want to fix it going forward. Well, how are we going to fix it going forward? Should I reduce the sales number in the current year by the sale that didn't really happen last year because they returned it this year? And usually the answer is no because we don't like reducing the sales number. That should only go up. And because you'd have a matching problem if you did do that because this number only includes this year's revenue, not last year's revenue. That's why we often use this sales returns and allowances, which is similar to a bad debt kind of calculation. But instead of recording it down here as an expense, we're going to record it up here as a contra sales number. So the point is it's still basically kind of like acting as an expense. It's negating the sale of last year. All of them would have the same impact on net income. In other words, net income would have the same impact. If I decreased the sales number, let's say by 5,000 because they've returned something, or if I left the sales number the same and I recorded a contra sales amount of returns and allowances, or if I recorded an expense of like bad debt, the net income would basically remain the same. But if it's a return, we typically will have this contra sales number. So let's say 5,000 was returned, for example. So if I go back on over, now we've got 120,000 minus the 5,000 gives us the 115,000. That in essence is net sales. Not net income. Net income is down here. After all expenses, you might call it your net sales. And then you've got your cost of goods sold, gives you the gross profit. This is just another sub-total down along the way. Remember, just from an accounting standpoint, you can think of the income statement. The most easy income statement is like a single-step income statement where you would just combine all the expenses into one category, income minus expenses. This is just basically a multiple-step income statement with a couple pit stops along the road. So now you got 120,000 minus the 5,000, which you could think of as kind of as equivalent to an expense, but they're putting it up here as a contra income account, minus 5,000 gets us to the 115,000. So that's like a pit stop, a sub-total along the way to get down the net income, minus the cost of goods sold, which is there because it's such an important sub-total, 70,000, and that gets us to the 45,000. And then we're gonna take all the other expenses, which are just 20,000 minus the 20,000 gets us down to the 25,000, which is of course the net income. So it's just a couple pit stops along the road, couple sub-totals before we get down to the bottom line. It's always basically decreasing, right? We're going from our gross income minus all those basically kind of expenses or contra sales accounts to get down to that bottom line. Now also note it's kind of useful to think about this gross profit relationship as compared to the sales, because that relationship then will give you an idea of your markup, your standard markups and whatnot. And that's like some basic kind of ratio analysis. So if you're selling all the same inventory, you can kind of compare your gross profit and your cost of goods sold to, in essence, the sales price. I'll compare it to this number here. So let's say we took the seven, so that's gonna be the 45,000 divided by the 115,000. So you come out to 39.13% if I move the decimal two places over. So you can kind of compare that to what your standard markup is to see if that makes sense. You can also kind of compare it to the markup for the industry, which is one way if someone was trying to see if your numbers look reasonable that they might do. So in other words, you could also take the 70,000 of the cost of goods sold divided by the 115,000. And so you could say the cost of goods sold is taking up, I moved to decimal, two places over about 61%. So for every dollar being sold, you know, 61% or so is going into the cost of the thing that was sold and the rest is going then to profit. So that's a common kind of ratio analysis. And if you were trying to judge the validity of the income statement in comparison to other industries, you might compare, say, ratios like that to other industries. It's also a common benchmarking thing when you're trying to improve. So that's going to be that. So just note that obviously inventory throws a pretty more substantial wrench into the system. Bet system, betting system. That you're gonna be setting up for taxes. And also if you're helping people out with bookkeeping or something like that in terms of how they're gonna be tracking inventory can get a little bit confusing.