Inventory at year-end: the count that moves your tax bill

Closing inventory is income. Goods you bought but have not sold are an asset, not an expense, and they only reduce profit in the year they leave. So the arithmetic runs the direction most owners find backwards: the more stock sitting on the shelf on the last day of your fiscal year, the higher the profit your return reports and the higher the tax on it.

The identity behind that is one line. Opening inventory plus purchases minus closing inventory equals cost of goods sold. Closing inventory is subtracted from the expense side, so every dollar you add to it takes a dollar off cost of goods sold and puts a dollar on profit.

A truckload bought on December 28 buys you an asset, not a deduction

This is where the December spending spree goes wrong. Rent, wages and repairs are gone when you pay for them, and they reduce the year’s income. Stock is not gone. It moved from the bank account to the warehouse, and the deduction waits there until the goods sell. For a registrant the GST/HST on the purchase is generally recoverable as an input tax credit, which is real cash on a real timetable — but the income-tax side of that invoice does nothing for the year you bought it in. The reverse holds too: a year that ends with the shelves unusually bare reports a smaller profit than the sales alone suggest.

What “cost” means before anything gets valued

The price on the supplier’s invoice is a starting point, not the cost. For a reseller, the cost of goods generally includes what it took to get them to your door — freight-in, customs duty, brokerage, and taxes you cannot recover. Those are costs of the goods, so they sit in inventory with the goods and come out when the goods sell. Tax you claim back as an input tax credit is not part of cost at all.

For a manufacturer the question runs deeper, because the goods did not arrive finished. Cost generally takes in the raw materials, the direct labour that converted them, and the share of production overhead attributable to what was made. Which overhead attaches and which stays a period expense is where manufacturers’ numbers most often go soft. Selling costs and general administration are generally not inventory costs; they belong to the year, not to the pallet.

None of this is bookkeeping neatness. Two importers with identical invoices report different profits if one expenses freight and duty while the other carries them in unsold inventory — and the one that expensed them took the deduction a year early.

Lower of cost and fair market value, applied the same way every year

For tax, inventory is generally valued at the lower of cost and fair market value — or at fair market value throughout, if that basis is applied consistently. There are two constraints in that sentence and the second one does most of the work. Whichever basis you are on, you stay on it.

The same discipline applies to how you assign cost to identical units bought at different prices. First-in-first-out, or an average: a convention you choose once and keep, and not every convention that appears in a management report is accepted for tax. Consistency is what makes one year’s gross margin comparable to the last one’s, and it is the first thing a reviewer tests — a basis selected fresh each year to suit that year’s profit reads as exactly what it is.

A write-down is a statement of fact, so it needs facts

Lower of cost and fair market value is what permits a write-down on stock that is genuinely obsolete or impaired. It does not permit a cushion. The test is what the goods are worth now — not what you would prefer the profit to be.

What makes one hold up is unglamorous: how long the item has sat without a sale, what the market currently pays for it, the replacement model that superseded it, the supplier’s own markdown, the liquidator’s offer, the damage report. Goods scrapped rather than marked down produce their own evidence — a dated disposal record, with a name on it and a description of what left the building. And the honest half: a write-down moves a deduction, it does not create one. Next year opens with a lower inventory figure, so the profit you took off this year comes back on next year unless the goods really do sell for what you wrote them down to.

A worked example: C$400,000 on the shelf, C$40,000 of it dead

Illustrative, round numbers, December 31 year-end.

A distributor opens 2026 with C$350,000 of inventory and buys C$1,200,000 during the year, landed. The system says C$400,000 remains at December 31, and the count confirms it is all physically there. Cost of goods sold is C$350,000 plus C$1,200,000 less C$400,000, or C$1,150,000.

The count turns up something the system could not: C$40,000 of it, at cost, is a superseded model. Nothing has sold in eighteen months, the manufacturer’s replacement sits beside it at a lower price, and a liquidator has offered C$10,000 for the lot. Carried at C$10,000 instead of C$40,000, closing inventory becomes C$370,000, cost of goods sold becomes C$1,180,000, and 2026’s profit is C$30,000 lower. At 9% federal on active business income within the first C$500,000 for an eligible CCPC, that is C$2,700 of federal tax deferred, with the province’s rate on top of it.

Then 2027 opens at C$370,000 rather than C$400,000, so C$30,000 of cost that would have run through 2027 has already run through 2026 and 2027’s profit is C$30,000 higher, all else equal. If the liquidator takes the lot, the goods leave at roughly what they were carried at and nothing further happens. If the lot instead clears at its old cost in March, 2027 reports C$40,000 of revenue against C$10,000 of carrying value, the C$30,000 comes straight back, and the write-down file now holds a valuation the sales ledger contradicts.

The count is the evidence, not just the number

An inventory figure is an assertion about one specific day, and the count is the only proof of it. Six things make one defensible:

• The date, and its relationship to the year-end date if the count happened on another day.
• The method — a full physical count, cycle counts rolled forward, or a perpetual system tested by sample. Say which.
• Signatures. Who counted, who checked, on the sheets themselves.
• Cut-off. Goods received on the 30th but invoiced in January, and goods shipped on the 31st but invoiced in January, land on the wrong side unless someone draws the line.
• Ownership. Stock out on consignment with a customer is generally still yours; stock in your warehouse on consignment from a supplier generally is not. Goods in transit follow the shipping terms.
• The variance between the count and the system, explained rather than plugged.

Keep the sheets, the variance notes and the write-down support for the period the CRA sets for business records; a count nobody can produce later is, for review purposes, an estimate.

A sloppy count is wrong twice

Closing inventory this year is opening inventory next year — one number appearing in two returns, with opposite signs. Overstate December 31 by C$40,000 because pallets scrapped in October were never taken out of the system, and 2026 reports C$40,000 of profit that was never earned and pays tax on it, while 2027 reports C$40,000 too little.

Over two years it washes out, which is the argument for not fixing it. It does not wash out in cash: you funded a year’s tax early on income that did not exist. And if the CRA adjusts the later year — the one that came up short — the offsetting correction to the earlier one is not automatic. It has to be claimed, and that year has to still be open. One bad count is therefore two wrong returns with a cash cost in between, which is why the count is fixed by the year-end date with no window after it.

What Cadence does

We tie the count to the year-end close instead of to whenever the file reaches us — the date, the method, the cut-off and the sign-off, so the number in the return is one somebody actually observed. Landed costs get built into the cost of the goods rather than parked in operating expenses, which for manufacturers, importers and distributors is where the distortion starts. Write-downs get supported before they are claimed, because an unsupported one costs more than it saves. Where the store, the processors and the inventory records can be integrated, that reconciliation runs monthly inside bookkeeping rather than once a year under pressure, which is why the fit for online sellers and retailers depends on the systems underneath. If your records and your shelves have not agreed in a while, that is worth an hour with someone who can look at both.