Inventory accounting for a product business comes down to four decisions: whether you are on accrual, how you value each unit, what you include in cost, and how often you reconcile the count to the ledger. Get those four right and the rest is arithmetic. The questions below are the ones product businesses ask, with the IRS and marketplace sources named where a rule or a figure comes from. This is general information, not tax advice; confirm your own position with a CPA.
Do I have to use accrual accounting if I hold inventory?
Usually, yes. IRS Publication 538 states that if an inventory is necessary to account for your income, you must use an accrual method for purchases and sales. There is a small business taxpayer exception for businesses with average annual gross receipts of $26 million or less over the prior three years (indexed for inflation) that are not tax shelters. Even where the exception applies for tax filing, accrual books are what lenders, buyers and your own margin analysis need, so most product businesses run accrual for management purposes regardless.
What is the difference between inventory and COGS?
Inventory is an asset on the balance sheet: units you own, valued at cost, wherever they sit. Cost of goods sold is an expense on the P&L: the cost of the units that sold this period. When you buy stock, inventory goes up and cash goes down; nothing hits the P&L. When a unit sells, its cost moves from inventory to COGS. Expensing purchases when you pay the supplier is the single most common error in product-business books, and it makes profit swing with purchase timing rather than with sales.
Should I use FIFO, weighted average, or something else?
FIFO (first in, first out) is the most common choice for ecommerce because it matches physical flow and produces a current inventory value on the balance sheet. Weighted average smooths cost changes and is simpler when many receipts land at different prices. LIFO exists for tax but is rare in small ecommerce and has restrictions. Pick one, document it, and apply it consistently; Publication 538 requires consistency year to year, and changing methods generally requires IRS consent.
What goes into the cost of a unit?
Landed cost: the supplier price plus inbound freight, duties, insurance and any prep or labeling required to make the unit saleable, allocated per unit. A shipment of 5,000 units at $4.20 with $3,500 freight and $1,200 duties has a landed cost of $5.14 per unit, not $4.20. Marketplace fulfillment and storage fees are not inventory cost; they are selling expenses recognized when incurred.
How do I account for inventory sitting in FBA or a 3PL?
It is still your inventory, at your landed cost, until it sells. Location does not change ownership. Include it in the count and on the balance sheet. Amazon’s FBA inventory reports give you units by SKU and by condition; reconcile those to your ledger monthly. Units Amazon reports as lost or damaged come off inventory as an adjustment, and the reimbursement Amazon pays is other income, not sales revenue.
What about inventory in transit?
Ownership usually transfers at the point defined by your shipping terms. If terms are FOB origin, the goods are yours (and on your balance sheet) once they leave the supplier. If FOB destination, they are yours on arrival. Most sellers importing on FOB origin terms carry in-transit inventory as a separate line so the count and the ledger stay reconcilable.
How do I handle returns?
A customer return reverses the sale and, if the unit is resaleable, puts it back into inventory at cost. If it is not resaleable, it comes out as a write-off. Marketplace returns processing fees are selling expenses. The practical problem is timing: refunds and the physical return arrive on different dates and in different reports, so a monthly reconciliation of refunds issued against units returned is the only way to keep the count honest.
When do I write inventory down?
When its net realizable value drops below cost: aged stock you will have to discount, discontinued SKUs, damaged units. Book the write-down in the period you identify it, not when you liquidate. Marketplace aged-inventory surcharges are a useful trigger; if a unit is old enough to attract one, it is old enough to review for a write-down.
How often should I count?
A full physical count at least annually, and cycle counts on high-value or fast-moving SKUs monthly. For stock at FBA, the marketplace’s own inventory report is your count; reconcile it to the ledger every month. Any variance between count and ledger gets booked as an adjustment with a note explaining the cause. Unexplained shrink that recurs is a process problem, not an accounting one.
What is inventory turnover and what is a good number?
COGS divided by average inventory for the period. It tells you how many times a year you sell through your stock. A good number is category-specific: the Census Bureau’s June 2026 Manufacturing and Trade Inventories and Sales report shows clothing stores holding 2.14 months of inventory against sales and general merchandise stores holding 1.24, which on a sales basis is roughly 5.6 and 9.7 turns a year respectively. Compute yours per SKU, not just company-wide, because a blended number hides the slow movers.
Can software do this for me?
The mechanical parts, yes: pulling settlements, applying a costing method per unit, posting COGS at the sale, reconciling to the deposit, tracking units across locations. Tools built for marketplace sellers do this; ConnectBooks, for example, syncs Amazon, Shopify, Walmart, TikTok Shop and eBay into QuickBooks or Xero with automated COGS and real-time inventory tracking. What software cannot do is decide your costing method, judge whether a SKU needs a write-down, or sign the return. Those stay with you and your accountant.
How does the 1099-K fit in?
The IRS says Form 1099-K reports gross payments processed by marketplaces and payment apps, with a reporting threshold of over $20,000 in more than 200 transactions, though forms may be issued below that. Gross payments exceed your net sales by fees and refunds, so the 1099-K total will be larger than revenue on your books. Keep a reconciliation from 1099-K gross to net sales; it is the first thing an examiner or a buyer asks for.
Where do I go for the rules?
Publication 538 for accounting periods and methods, including the inventory and accrual rules. The marketplace’s own seller documentation for fee schedules and inventory reports; Amazon’s settlement report reference lists the fields you will reconcile from. The SBA’s business management guidance for the general framework. And a CPA who has seen a settlement file before, for everything specific to you.
