Year-end inventory value is the lower of what the goods cost you or what they are realistically worth now, counted physically, valued at landed cost, and adjusted for anything damaged, obsolete, or unsellable. That sentence contains four separate jobs, and skipping any one of them produces a number that misstates both your balance sheet and your taxable income. Here is how to do each in order.
Step 1: Count what you actually have, everywhere
A physical count is the foundation. System quantities drift from reality through shrinkage, damage, miscounts, and returns processed incorrectly. Sellers who have not counted in a year are often several percent off on their fastest-moving items.
For a product business selling across channels, inventory sits in more places than the warehouse:
- Your own warehouse or storage unit
- Third-party fulfillment centers, including marketplace fulfillment networks
- Goods in transit that you already own
- Units held at a prep center or 3PL awaiting inbound
- Customer returns received but not yet restocked
Goods in transit is the one most often missed. Ownership transfers according to the shipping terms on the purchase order. Under FOB origin terms you own the container the moment it leaves the supplier’s dock, which means a shipment on the water at December 31 is your inventory and belongs in the count. Under FOB destination you do not own it until it arrives. Check the terms rather than assuming.
Step 2: Value each unit at landed cost
Landed cost is everything required to get the unit to a sellable state and location. Supplier invoice price, inbound freight, duty and tariffs, customs brokerage, insurance in transit, and prep or labeling.
Costs that do not belong in inventory value: outbound shipping to customers, marketplace fees, advertising, storage fees at the fulfillment center, and general overhead. Those are period expenses.
A worked example
Say you imported 2,000 units of a single item:
- Supplier invoice: $9.40 per unit, so $18,800
- Ocean freight for the shipment: $3,100
- Duty at 7.5 percent of invoice value: $1,410
- Customs brokerage and port fees: $540
- Prep and labeling at $0.35 per unit: $700
Total landed cost is $24,550 across 2,000 units, which is $12.28 per unit. The supplier invoice alone would have suggested $9.40, understating the value of each unit by $2.88, which is 23 percent.
If 700 units remain at year-end, inventory value is 700 times $12.28, or $8,596. Valuing the same 700 units at invoice cost gives $6,580. The $2,016 difference reduces reported inventory and increases reported cost of goods sold, which lowers taxable income in a way that is not supportable.
Step 3: Apply a costing method consistently
When units of the same item were bought at different costs, you need a rule for which cost applies to what sold.
FIFO assumes the oldest units sold first, so remaining inventory carries the most recent costs. It matches physical flow for most product businesses and is the most common choice.
Weighted average blends all costs into a single average per unit. It is simpler when you receive frequent shipments at fluctuating costs, and it smooths the effect of a single expensive container.
Specific identification tracks each unit individually. Practical only for high-value, low-volume goods.
The method matters less than consistency. Changing methods between years changes reported profit without anything in the business changing, and a change generally requires filing for approval rather than simply switching. The rules on accounting methods and inventories are set out in IRS Publication 538, and this is a decision to make with a CPA rather than alone.
Step 4: Write down what will not sell at cost
Inventory is carried at the lower of cost or market value. Units that cannot be sold for what they cost you have to come down to what they can realistically fetch.
Work through the aged report and sort into categories:
- Damaged or defective, unsellable in any condition: write down to zero
- Obsolete, superseded or seasonal and past its window: write down to realistic liquidation value
- Slow moving, still sellable but at a discount: write down to expected net selling price less the cost of selling it
- Current: carry at cost
A practical trigger is 365 days without a sale. Anything sitting that long is a write-down candidate and should be examined rather than rolled forward at full cost for another year.
Continuing the example
Of the 700 remaining units, suppose 120 came back as customer returns with damaged packaging and can only move as open-box at $6 each, against a landed cost of $12.28.
Those 120 units come down from $1,474 to $720, a write-down of $754. Total inventory value becomes 580 units at $12.28 plus 120 units at $6, which is $7,122 and $720, so $7,842.
Step 5: Reconcile to the general ledger and document it
The counted, valued, adjusted figure has to agree with the inventory asset account on the balance sheet. Where it does not, the difference is shrinkage, and shrinkage is an expense that belongs in the current year.
Keep the working papers. Count sheets with dates and who counted, the landed cost calculation for each item, the aging report, and the reasoning behind each write-down. If the number is ever questioned, contemporaneous documentation is the difference between an adjustment and a dispute.
Why this gets harder across multiple channels
A seller on one channel with one warehouse can do this with a spreadsheet and an afternoon. A seller across Amazon, Shopify, Walmart, TikTok Shop, and eBay has the same units moving through several fulfillment networks with different reporting formats and different lag times, and reconciling five sources to one ledger by hand at year-end is where the afternoon becomes a fortnight.
This is the gap the ecommerce accounting category addresses. Platforms including ConnectBooks, Webgility, and Synder handle multi-channel inventory and cost of goods tracking so the year-end exercise becomes verification rather than reconstruction. The tool is not the point, though. The discipline is: count everything, value it at landed cost, write down what will not sell, and keep the paper.
A note on timing
Do the count as close to your year-end date as you can manage, and avoid counting during a period of heavy movement. Sellers with a December 31 year-end who count in the middle of the holiday shipping rush get a number that is wrong on arrival.
If a count on the exact date is impossible, count on a nearby date and roll the quantity forward or backward using documented receipts and shipments. That is acceptable practice provided the roll is supported by records.