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Discounted GC for inventory purchases

Discussion in 'Taxes' started by Devon, Jan 2, 2018.

  1. Devon

    Devon New Member

    Hey everyone! I started reselling on a bit larger scale this year, and plan on filing my reselling profits as self-employed income on a Schedule C.
    I will use the

    My question is as follows: how do I calculate inventory procurement paid for with GC bought at a discount?

    Example: buy a $1000 gift card for $950
    Use the GC for $1000 of good from te store
    Sell at 1100.

    Did I pay $950 for the goods?(cost of gc) and sell for $1100?

    Or did I pay $950 for "goods"(gc) and "sell" the GC to the merchant for $1000, then purchase goods for $1000 and sell for $1100, making COGS $1950 and revenue $2100?

    Or did I pay $1000 for the goods, sell for $1100 and report the discount as "other income" (line 6)

    In all cases I am reporting $150 profit, I'm just not sure about the correct method
  2. Matt

    Matt Administrator Staff Member

    It is down to the $950 COGS (Indirect) vs $1000 COGS with $50 'going somewhere' (Direct)

    The essence of this question is whether you are following the Direct or Indirect method of accounting. Both methods are allowable under IFRS and US-GAAP, but both groups recommend that Direct is used in order to provide clarity for shareholders (A sweeping statement which was designed with in larger companies in mind..)

    The $1950 COGS is not proper because using the gift card to buy inventory is not selling the gift card for profit (or loss).

    The reason that Direct is preferred is that it is easier for an independent auditor or analyst to review the return/books and ascertain why profitability is what it is, so if you were to compare two businesses in parallel, but only one used discounted gift cards you would find that reason sooner, and it would support the P/L.

    So, the question is if you followed the best practice, and enter $1000 and $50 as separate items, where do they go? Personally, I would look to reach the netted out $950 via section 3 (line 42) of the Schedule C, where COGS is calculated. I would use this section to bring up $950 to Page 1 of the Schedule C (line 4). Ultimately, that line 4 would be $950, thus you would not make use of line 6 other income.

    How I net out the line 42 would really come from the method of accounting used in the books of the business, and I would seek to have a consistent approach to this, but the goal would be to faithfully represent the profit and loss of the business with the accounting being a supporting document. As such, if the accounting did break out all gift card purchases and subsequent inventory purchases as credits/debits to a 'gift card account' and you could see a clear tracking of the discount, then I would use the Direct method. If the reseller had just netted out these discounts and applied them to COGS, then I would find myself more inclined to want to not break out the discount on the tax return, and use the Indirect method.
  3. El Ingeniero

    El Ingeniero Level 2 Member

    Let's say you buy a $100 face value gift card for $90. You now have an asset worth $100, an expense of $90, and a profit of $10 (not yet realized).
  4. Matt

    Matt Administrator Staff Member

    This is an acceptable way to look at things from a business persons perspective, and I get what you are saying. Knowledge like this is enough to run a business the right way, and many people don't get that.

    From an accounting perspective it isn't correct, but that is because Accounting is often silly....

    Remember, Assets go on the Balance Sheet and must have a Liability to balance them immediately.
    Income and Expense go on the Income Statement, and from then you reach profit and loss.

    You can't pair the Asset with the Expense, and you can't call the $10 profit per se.
    1. Your example misses a liability.
    2. The expense is correct.
    3. The profit is incorrect, because instead it should be considered either a discount or income, and profit is determined at the sale of inventory level.
    (I spent a couple of hundred hours of study/continuing education last quarter on balance sheets and income statements and banging my head against a wall)
  5. El Ingeniero

    El Ingeniero Level 2 Member

    So what would be the liability in this case? Let's say I buy $100 of inventory with a $100 bill: from 30,000 feet it looks like I've exchanged one asset (cash on hand) for another (inventory). Unless I borrowed the $100 bill, I'm not sure where the liability lies, unless cash on hand is a special class of assets that we can borrow against.

    Regarding profit and income, I see I've conflated profit with income. D'oh. But probably it's simpler to treat income from buying discounted gift cards and income from selling inventory separately, rather than tracking the discount from gift cards for each inventory item. I'd do the same for credit card rewards, just record it it as income.

    When I was reselling, I bought discounted gift cards all the time, but I made inventory decisions as if I was paying straight cash out of my wallet. Made my life simpler and gave me an extra margin of safety.
  6. Matt

    Matt Administrator Staff Member

    Technically, the liability between the cash and inventory step is in the form of Accounts Payable as an intermediary. It is convoluted, but it would go:

    Cash (no change)
    Inventory up $100 (asset)
    AP up $100 (liability)

    Then when the AP is due:

    Cash down $100
    AP down $100
    New liability created for $100 to offset the Inventory Up.

    So you'd end up with the cash>inventory swap, but it should (in theory) pass through this phase in many cases, because a lot of inventory is not bought with cash, rather it is bought using a credit card or by using negotiated credit terms from a wholesaler.

    You could argue that if you really did pay cash this wouldn't apply, but the counter to that would be that physical process of removing cash from your checking into your wallet would also generate an Asset/Liability pair (Petty Cash or Cash On Hand being carved out from 'Cash at Bank), and even using a debit card would go through this process, even if it were at a very high speed.

    A lot of convolution, nothing really wrong with your approach to it, but if you make it first 'as complicated as possible' it helps ensure that when you are later taking shortcuts that they are correctly interpreting the flow of money.
  7. El Ingeniero

    El Ingeniero Level 2 Member

    You're right about accounting being silly sometimes ....
  8. Devon

    Devon New Member

    @Matt wow thanks for the detailed post! I just read through it quickly, but having very little accounting experience I have to go through again.
    @El Ingeniero there are several methods of valuing a quarter's closing inventory. Iinm the most commonly used is the price paid, in that method the $100 gc would be valued at $90. Though you say you dont like that method because of safety and simplicity of life.
  9. Devon

    Devon New Member

    "As such, if the accounting did break out all gift card purchases and subsequent inventory purchases as credits/debits to a 'gift card account' and you could see a clear tracking of the discount, then I would use the Direct method"

    If we had a fixed asset account for gift cards, would it get complicated keeping track of value used? Because when i spend the $1000 its really only 950 credit to the gc account. And not every time you buy gc is the discount the same. Unless you would make a new account for each gc, though im pretty sure thats not in keedping with best practices.

    Also, if im sitting on gc at the end of the year, is that included in closong inventory? That would mean that gc is inventory, which its not because i am not in the gift card reselling business
  10. Matt

    Matt Administrator Staff Member

    I think the most proper way to do it is to have two accounts, GC purchase and GC discount. You then match these two accounts with the transaction to credit card:

    $1000 GC Account
    -$50 GC Discount Account

    Total = $950, which balances with $950 credit card line item.

    You then start accruing a running balance in the two new accounts. You use the GC purchase account to pay for inventory, thus lowering it, and you have the GC discount as a running balance that at the end of the year you can look at to make adjusting entries to account for the discounts taken.

    It does get complicated, I once thought to make each vendor an account (EG Dell GC is one account, and so forth) but it is too hard to track. Using two accounts in total for all cards is easier.

    It is a lot easier if you can spend the GC balance to zero, and also if you don't have an Inventory. The latter is hard, but the former should be achievable.
  11. El Ingeniero

    El Ingeniero Level 2 Member

    Suppose you bought many GC at varying discounts, then used them to buy lots of different items as onesies/twosies.

    1) If each gift card is valued in your accounting system at the price paid, won't know what your total gift card buying power is without keeping a separate spreadsheet. If you lump all of your gift cards types into a single asset, you won't know how much you can spend with gift cards at TJ Maxx versus Nordstrom Rack versus Home Depot without keeping a separate spreadsheet.

    If you value gift cards at their purchase price, then use multiple gift cards to buy a bunch of items, with a balance left on one of the gift cards, you will then have to do some math to figure out the effective discount on your entire purchase. Then you have the issue of figuring out what the gift card with the remaining balance is worth.

    All of this extra hassle goes away when you value the gift card asset at face value, and take the difference between face value and purchase price as income.

    2) Same thing for cash back. Each portal offers a different percentage depending on the store and the date. CC cash back varies on the card, and the store category. Tracking all that item by item is a hassle. So much simpler to just take it as income when you get an ACH or a statement credit.

    3) As a reseller, I never want to make a deal dependent on discounted GC + CC CB + portal CB + store rewards + whatever else. The percentages are usually too small to make a huge difference, but if I can make the deal work on a cash out of pocket basis, and I deploy the MS toolkit then I have an additional cushion.

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