A year-end inventory number is only useful if it can be defended twice: once to your own books, and once to anyone who later asks how the number was produced. The starting point is not a spreadsheet. If a business carries inventory, it should do a physical count at or near year-end and investigate differences against its records (s1). That investigation — not the count alone — is what turns a shelf total into a closing figure for cost of goods sold and taxable income. Valuation affects both cost of goods sold and taxable income (s1), so a sloppy count does not stay a warehouse problem. It becomes a tax problem.
One myth needs removing before any procedure starts. Buying inventory at year-end does not lower current-year profit, because inventory is an asset until it sells (s3). A December stock purchase may be sensible for January sales, cash flow, or supplier pricing. It is not a deduction strategy. Treat it as a buying decision, judged on buying merits, and keep it separate from the count.
The count procedure
The procedure below is the operational core of this guide. It is a recommended working method for producing a count a reviewer can follow — count sheets, differences, and adjustments in one trail — rather than a rule imposed by the Canada Revenue Agency.
- Pick the count window and freeze movements. Count at or near year-end (s1). Stop receiving, shipping, and internal transfers during the count, or log every movement that cannot wait on a single cut-off sheet. A count taken while stock moves is two half-counts of different inventories.
- Prepare the floor before counting. Tidy and label every location, separate damaged and unsellable stock into a marked area, and set aside customer-owned or consignment goods so they are not counted as yours. Print count sheets by location, not by product, so counters record what is physically there instead of what the system expects.
- Count in pairs, blind. One person counts, one records, and neither sees the book quantity during the count. Blind counting is slower. It is also the difference between verifying stock and transcribing a system.
- Set a recount trigger in advance. Decide before the count what size of difference forces an immediate recount of that location — for example, any high-value line, or any line where the count and the record disagree at all. Recount while the team is still on the floor, not a week later from memory.
- Handle goods in transit deliberately. In-transit inventory counts if you have paid for it and legal title has transferred (s3). List inbound shipments separately, with the title evidence, instead of guessing them into the shelf count or leaving them out entirely.
- Investigate every material difference. The count is not finished when the counting stops. Differences against records must be investigated (s1): receiving errors, unrecorded damage, mis-picks, theft, and simple keying mistakes each leave a different pattern, and the pattern decides the fix.
- Price the counted quantities, then lock the file. Apply your costing method (below) to the verified quantities, file the count sheets, recount notes, and adjustment reasons together, and make no silent changes afterwards. Any later correction gets its own dated note.
What success looks like: every location has a signed count sheet, every material difference has a written explanation or a recount, in-transit stock is listed with its title basis, and the final quantity file can be re-priced by someone else and produce the same total.
Value it the Canadian way
Canadian costing starts with a short permitted list. Common costing methods in Canada are first in, first out (FIFO) and weighted average cost, applied consistently (s1). FIFO is one of three permitted methods (s2), the third being specific identification — the method that tracks the actual cost of each distinct item, suited to low-volume, high-value stock where items are not interchangeable. One method is ruled out entirely: last in, first out (LIFO) is not permitted in Canada (s2).
| Method | How cost flows | Best fit | Watch-out |
|---|---|---|---|
| FIFO | Oldest costs leave first; closing stock carries the newest costs | Perishable, dated, or fast-turning stock where physical flow matches cost flow | Closing value moves quickly when supplier prices are rising |
| Weighted average | All units in a line share one averaged cost | High-volume, interchangeable units bought at varying prices | Averages hide a single badly priced purchase inside a line |
| Specific identification | Each item carries its own actual cost | Distinct, high-value items that are tracked individually | Record-keeping cost is unjustifiable for interchangeable low-value units |
| LIFO | Newest costs leave first | None in Canada | Not permitted in Canada (s2) — do not adopt it from a US guide |
Consistency is not a preference here. The named methods are applied consistently (s1), which means the method chosen this year is the method the books keep using, and a change is a considered, documented decision — not a year-end lever pulled because one method gives a nicer profit figure this December.
Cost itself is wider than the invoice. Landed cost includes the supplier price plus inbound freight, customs duties, and brokerage (s3). Costing from the supplier invoice alone understates inventory and overstates cost of goods sold. If freight and duties sit in expense accounts while stock sits on the shelf, the year-end figure is wrong in both directions at once. Build the landed cost per line before the count is priced, not as an adjustment afterwards.
Shrinkage: name it, size it, watch the trend
Shrinkage is what is missing from the count — stock the records say should be there and the shelves say is not. Track it explicitly: a small amount is normal, and a growing amount is a problem (s4). That distinction is the whole decision framework. A stable, small shrinkage figure, investigated and explained, is a cost of handling physical goods. A figure that grows year over year, or concentrates in one location or one product line, is a signal — of a receiving error, a recording gap, damage going unlogged, or theft — and the response is to find the pattern before adjusting the books and moving on.
Record shrinkage as its own line in the count file: quantity missing, cost value, location, and the explanation the investigation produced. An unexplained adjustment teaches nothing and cannot be compared with next year's count. A labelled one can.
Write-downs: document the condition, the reason, and the estimate
Damaged, obsolete, or unsellable stock does not belong on the books at full cost. Write down damaged, obsolete or unsellable inventory to net realisable value, because valuation affects cost of goods sold and taxable income (s1). Inventory that has spoiled, become obsolete or is unsaleable can be written down to net realizable value under the Income Tax Act (s2).
The write-down lives or dies on its support. The CRA requires the write-down to be supportable: the condition, the reason for the decline, and the basis for the net realizable value estimate (s2). In practice that is a short record per item or group: what the stock is, what happened to it (damage, expiry, a discontinued line, a market that moved), what it can realistically still be sold for, and how that figure was arrived at — a clearance price, a parts value, a quote, or zero for stock with no buyer at any price. Photographs of damaged stock, taken during the count, are cheap support. A bare journal entry in March is not.
Closing the books on inventory
Four final checks close the file. First, the priced count, the shrinkage line, and the write-down schedule agree with each other — no item appears in two places, and no damaged item is both written down and counted at full cost. Second, the costing method on the closing schedule is the method the business used last year, or the change is documented. Third, landed cost — price, freight, duties, brokerage (s3) — is inside the unit costs, not stranded in expenses. Fourth, the records are kept: the CRA generally expects records to be kept for six years from the end of the last tax year they relate to (s4), and the count file is exactly the kind of record that expectation covers.
Do those four, and inventory stops being the softest number in the year-end file. It becomes what it should have been all along: a counted quantity, priced by a stated method, with its losses named.
— Sterling Cole, Money Writer — Earning Desk