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Irs Publication 926 - Additional Material Prev  Up  Next   Home   More Online Publications
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Irs 7. Irs   Figuring Gross Profit Table of Contents Introduction Items To Check Testing Gross Profit AccuracyExample. Irs Additions to Gross Profit Introduction After you have figured the gross receipts from your business (chapter 5) and the cost of goods sold (chapter 6), you are ready to figure your gross profit. Irs You must determine gross profit before you can deduct any business expenses. Irs These expenses are discussed in chapter 8. Irs If you are filing Schedule C-EZ, your gross profit is your gross receipts plus certain other amounts, explained later under Additions to Gross Profit. Irs Businesses that sell products. Irs   If you are filing Schedule C, figure your gross profit by first figuring your net receipts. Irs Figure net receipts (line 3) on Schedule C by subtracting any returns and allowances (line 2) from gross receipts (line 1). Irs Returns and allowances include cash or credit refunds you make to customers, rebates, and other allowances off the actual sales price. Irs   Next, subtract the cost of goods sold (line 4) from net receipts (line 3). Irs The result is the gross profit from your business. Irs Businesses that sell services. Irs   You do not have to figure the cost of goods sold if the sale of merchandise is not an income-producing factor for your business. Irs Your gross profit is the same as your net receipts (gross receipts minus any refunds, rebates, or other allowances). Irs Most professions and businesses that sell services rather than products can figure gross profit directly from net receipts in this way. Irs Illustration. Irs   This illustration of the gross profit section of the income statement of a retail business shows how gross profit is figured. Irs Income Statement Year Ended December 31, 2013 Gross receipts $400,000 Minus: Returns and allowances 14,940 Net receipts $385,060 Minus: Cost of goods sold 288,140 Gross profit $96,920   The cost of goods sold for this business is figured as follows: Inventory at beginning of year $37,845 Plus: Purchases $285,900   Minus: Items withdrawn for personal use 2,650 283,250 Goods available for sale $321,095 Minus: Inventory at end of year 32,955 Cost of goods sold $288,140 Items To Check Consider the following items before figuring your gross profit. Irs Gross receipts. Irs   At the end of each business day, make sure your records balance with your actual cash and credit receipts for the day. Irs You may find it helpful to use cash registers to keep track of receipts. Irs You should also use a proper invoicing system and keep a separate bank account for your business. Irs Sales tax collected. Irs   Check to make sure your records show the correct sales tax collected. Irs   If you collect state and local sales taxes imposed on you as the seller of goods or services from the buyer, you must include the amount collected in gross receipts. Irs   If you are required to collect state and local taxes imposed on the buyer and turn them over to state or local governments, you generally do not include these amounts in income. Irs Inventory at beginning of year. Irs   Compare this figure with last year's ending inventory. Irs The two amounts should usually be the same. Irs Purchases. Irs   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. Irs ) be sure to remove them from the cost of goods sold. Irs For details on how to adjust cost of goods sold, see Merchandise withdrawn from sale in chapter 6. Irs Inventory at end of year. Irs   Check to make sure your procedures for taking inventory are adequate. Irs These procedures should ensure all items have been included in inventory and proper pricing techniques have been used. Irs   Use inventory forms and adding machine tapes as the only evidence for your inventory. Irs Inventory forms are available at office supply stores. Irs These forms have columns for recording the description, quantity, unit price, and value of each inventory item. Irs Each page has space to record who made the physical count, who priced the items, who made the extensions, and who proofread the calculations. Irs These forms will help satisfy you that the total inventory is accurate. Irs They will also provide you with a permanent record to support its validity. Irs   Inventories are discussed in chapter 2. Irs Testing Gross Profit Accuracy If you are in a retail or wholesale business, you can check the accuracy of your gross profit figure. Irs First, divide gross profit by net receipts. Irs The resulting percentage measures the average spread between the merchandise cost of goods sold and the selling price. Irs Next, compare this percentage to your markup policy. Irs Little or no difference between these two percentages shows that your gross profit figure is accurate. Irs A large difference between these percentages may show that you did not accurately figure sales, purchases, inventory, or other items of cost. Irs You should determine the reason for the difference. Irs Example. Irs   Joe Able operates a retail business. Irs On the average, he marks up his merchandise so that he will realize a gross profit of 331/3% on its sales. Irs The net receipts (gross receipts minus returns and allowances) shown on his income statement is $300,000. Irs His cost of goods sold is $200,000. Irs This results in a gross profit of $100,000 ($300,000 − $200,000). Irs To test the accuracy of this year's results, Joe divides gross profit ($100,000) by net receipts ($300,000). Irs The resulting 331/3% confirms his markup percentage of 331/3%. Irs Additions to Gross Profit If your business has income from a source other than its regular business operations, enter the income on line 6 of Schedule C and add it to gross profit. Irs The result is gross business income. Irs If you use Schedule C-EZ, include the income on line 1 of the schedule. Irs 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. Irs Prev  Up  Next   Home   More Online Publications