Recording mandatory and optional inventory adjustments

Mandatory inventory adjustments are required when a year results in a net loss instead of income. If this occurs, you’re required to add the value of your purchased inventory to your income at Fair Market Value. You’ll need to add the lesser of the value of purchased inventory or the amount of the loss to the income.

Optional inventory adjustments can be used to increase your net income to take advantage of non-refundable tax credits. They can also be used to average out your income and avoid higher taxes the following year if you expect next year's income to fall in a higher income tax bracket. 

For example:

Imagine you’ve had a net loss of $20,000 for the fiscal year:

1. If you’ve purchased inventory valued at $15,000, you’re required to make a mandatory inventory adjustment and add the entire $15,000 to your income, resulting in a net loss of only $5,000.00 for that year. The mandatory inventory adjustment must be deducted from next year's net income.
2. If you’ve purchased inventory valued at $43,000, you’re required to make a mandatory inventory adjustment and add $20,000 to your income, resulting in a break-even income and expense statement for that year. You can also make an optional inventory adjustment of up to $23,000. Both the mandatory and optional inventory amounts must be deducted from the next year's net income.
3. If you’ve purchased inventory valued at $10,000 and your total inventory is valued at $45,000, you’re required to make a mandatory inventory adjustment and add $10,000 to your income, resulting in a net loss of $10,000 for that year. You can then make an optional inventory adjustment of up to $35,000. Both the mandatory and optional inventory amounts must be deducted from next year’s net income.

For more information, visit the CRA Interpretation Bulletin IT-526

Last updated on June 30, 2014 by FCC AgExpert