1. About

This article explains how to track your COGS using the purchase based COGS method. You can also view this video to understand more.

If you’re not sure if this is the right method for you, first check out our article How to choose your COGS tracking method in Finaloop.

When you choose purchase based COGS:

Inventory-related purchases are categorized directly into the relevant P&L account under Cost of Goods Sold (COGS).
No changes are made to the balance sheet during the year.
We make a year-end adjustment to your balance sheet so that the inventory closing balance at year end is correct for filing your tax return.

You can also check out our step by step walkthrough to learn more.

2. When to use purchase based COGS?

The purchase based COGS method is a great choice if you're a brand that:

sells all products through dropshipping and vendor invoices are issued on or very close to the date of the customer order, or when payments to vendors are made on or very close to that date.; or
doesn’t hold, on average, more than $3,000 of inventory each month.

3. Setting up purchase based COGS

As a one-time task, we’ll need you to enter your inventory closing balance (c/b) from the previous financial year. This becomes your Finaloop opening balance (o/b) and ensures consistency year over year. You can get this value from your previous year’s balance sheet or from your tax return, if it was already filed.

Here's an example

12/31/2023 Closing balance (previous books) $2,500

01/01/2024 Opening balance (Finaloop) $2,500

>To set your Finaloop opening balance:

From the menu pane, navigate to Inventory>Settings>Opening Balance tab.
Enter the inventory balance from the previous year.
Activate the checkbox if you are sure that you qualify for the “Exception for Small Business Taxpayers” - see the section Exception for small business taxpayers in this article.
That’s it. We'll automatically update your COGS in your P&L each time you purchase inventory. The opening balance you added in Step 2 will be the balance shown as inventory in your balance sheet until we make an adjustment for any unsold inventory at the end of the year. To see an example of what your financials will actually look like under purchase based COGS, see the section in this article Purchase-based COGS in the P&L and Balance Sheet.

NOTE: Use the on-screen FAQs if you need more help with finding your inventory balance There’s also a summary in this article - see the section Inventory methods and categories in this article.

4. Tracking inventory purchases

To view / track inventory transactions, navigate to the Purchases screen on the side menu pane (Inventory>Purchases tab). If relevant, you can also track inventory-related payroll transactions.

The screen has three sections.

Filters (#1)

Filter options:

Time period: e.g, today, last month, last quarter etc.
Date range: from and to
Status: in process, in transit, received
Search: enter text or a value

Inventory totals (#2)

Global totals

Total purchases

Category totals

On your screen, you’ll only see the relevant categories for your business.

Dropshipping
Finished products
Shipping & freight-in
Supplies & materials
Packaging materials
Production costs
Consignment
Custom fees & services
Dead inventory
Other inventory indirect costs
Production labor costs
Duties & tax
Inventory insurance
Pallet costs
Shipping surcharge
Vendor fees
Product donations
Product giveaways

Drill down details

Click the category to filter by the purchases for each category.

You can see the inventory categories on the Purchases tab when you click the link Learn about purchase categories just below the inventory totals.

Transaction details (#3)

Here you can drill into each transaction and see and update further details, such as:

Shipping date
Purchase received date
Split the purchase into 2 or more transactions or shipments and update the status of each shipment
View the transaction source(e.g., bank/ credit card transaction or bill)
Upload attachments.

5. Which transactions are shown as purchases?

The list of purchases you see in the Purchases tab of your inventory screen are your inventory-related transactions from your banks or credit cards or from any bills in Finaloop.

Transactions

Shown in the purchases screen with the icon below. These are transactions from your bank accounts or credit cards that were categorized into an inventory-related account (see the list above of all the inventory categories), either automatically by us or by you.

Bills

The Purchases tab may also have inventory-related purchases from vendor bills. These may have been synced automatically if you are using Settle or Bill.com for your vendor bills, or you may have added them manually in our Bills screen.

6. Missing or uncategorized inventory transactions

You can manually edit or add transactions if you have uncategorized inventory transactions, or if transactions are in the wrong category.

>To categorize or change the inventory category:

From the menu pane, navigate to Transactions to recategorize specific transactions.
From the menu pane, navigate to Vendors>Bills to add any missing inventory Bills.

7. Adding a historical purchase

If you purchased inventory before your books started in Finaloop, you can also add historical purchases to create opening balances for in-process and in-transit inventory.

For example, you paid for a purchase in December 2023, your books in Finaloop start on Jan 1, 2024, and you only received the purchase in February 2024.

If you received a purchase before your start date with Finaloop, there is no need to add a historical purchase.

To add a historical purchase:

Navigate to the Purchases screen on the side menu pane (Inventory>Purchases tab).
Click Actions > Add a historical payment.
Enter the details in the form:
Click Save.

8. Exception for small business taxpayers

As a general tax rule from the IRS, if you earn income by selling inventory, COGS must be deducted based on an accrual basis. With certain exceptions, this rule applies whether you file taxes on a cash basis or an accrual basis.

In other words, even if you file your tax return on a cash basis, your COGS deduction would generally be calculated based on the COGS related to inventory you actually sold, and not what you purchased.

In recent years, tax laws were changed to allow for exceptions for certain inventory-based businesses. One of these exceptions allows you to deduct COGS based on purchases (pure cash basis) if you meet certain conditions, including:

You made a special tax election to report inventory on a cash-basis, and
You don't actively record the value of your inventory (although inventory count is OK).

To prevent any issues in qualifying for this exception, please confirm with your CPA if an election was made to report inventory on a cash basis under Treas. Reg. §1.471-1(b). If yes, choose the purchase based COGS to record COGS each month and mark the check box on the Opening Balance tab.

If no election was made, we’ll make sure to make any necessary adjustments at year-end by reducing your COGS by costs related to unsold inventory to get your numbers tax-ready.

IMPORTANT: If your CPA confirms that the IRS has approved your exemption, activate the exemption checkbox when you set your opening balance - see the section Set up purchase-based COGS in this article

9. COGS in the P&L and Balance Sheet

Here’s an example of how COGS are recorded in the P&L and Balance Sheet using the purchase based method, unless you apply the IRS exemption.

When inventory-related items are purchased- COGS in the P&L are increased.
At year end, the inventory line in the Balance Sheet and the COGS in the P&L are adjusted to produce a closing balance using this formula:.

Opening balance + inventory purchased - inventory sold = closing balance.

Here's an example:

Date	What happened	P&L Impact (COGS $)	Balance Sheet Impact (Inventory $)
Opening balance			$2,500
January 10	Purchased 2,000 units @ $1	+$2,000	No change
March 22	Sold 1,000 units	No change	No change
September 27	Purchased 2,000 units @ $1	+$2,000	No change
December 31	Year end adjustment	-$3,000 of unsold units	+3,000 of unsold units
Closing balance		$1,000	$5,500

10. Year-end adjustments

At the year end, we’ll ask you for the balance of unsold inventory (in the above example, it’s $5,500) .

We then make the necessary adjustment for tax purposes so that the value of COGS is the value of inventory actually sold, ensuring that you don’t overstate the value of COGS in your tax returns.

There’s an exception to this general approach for small business taxpayers - see the section Exception for small business taxpayers in this article.