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What Is Inventory Accounting And Why Do It?

October 20, 2023
Bill Kimball

Inventory accounting can be a time-intensive, frustrating process for retail businesses – especially small or independent teams. You can work out the average cost by simply dividing the overall cost of products for sale by the total number in the inventory. Sticking to a specific method for inventory valuation is critical for consistent, accurate and legally acceptable financial statements. Add any newly purchased inventory throughout the accounting period. All inventory sold will be listed under the COGS account in your income statement at the end of each business year. The value of any unsold, on-hand inventory at the end of an accounting period. Let’s take a look at a few scenarios of how you would journal entries for inventory transactions.

inventory bookkeeping

But it can lose its value fast if it gets old, out of date, damaged, or the market price for that type of product drops. Let’s look at some of the ways you can keep tabs on your inventory and accurately represent it all on your balance sheet. Sometimes you have a single freight or duty invoice that covers multiple shipments that were all sent together. Because this is complex, there are not many software platforms that handle it well, if at all. This means that you’re best building your own custom spreadsheet, if not using a system that fully supports landed costs. Use your spreadsheet to work out a “freight and duty” cost for every item in each delivery, as it comes in, and then add this to the net cost price of the item to get your landed cost. Even though you have bought $50 of stock, at the end of the month you are $75 down on the previous month (opening balance $100 – closing balance $25).

Improve Record Accuracy

Also, the company usually does not maintain other records showing the exact number of units that should be on hand. Although periodic inventory procedure reduces record-keeping, it also reduces control over inventory items. Firms assume any items not included in the physical count of inventory at the end of the period have been sold. Thus, they mistakenly assume items that have been stolen have been sold and include their cost in cost of goods sold. Inventory includes the raw materials used by manufacturers in production or the resale goods distributors and retailers acquire to sell to their customers. Proper accounting of inventory is important for small businesses.

To ensure accuracy and efficiency, sales order processing, profit and loss tracking, and asset management need to function from a single software platform. When you sell the $100 product for cash, you would record a bookkeeping entry for a cash transaction and credit the sales revenue account for the sale. This transaction transfers the $100 from expenses to revenue, which finishes the inventory bookkeeping process for the item.

inventory bookkeeping

She was a university professor of finance and has written extensively in this area. Adjust your inventory instantly when stock gets damaged or lost.

Ensure that all employees responsible for inventory control and accounting entries are knowledgeable about the products and items inventoried. This accounting method ensures an accurate representation of the value of all assets, company-wide. Instead of tying up money in slow-moving stock, you can keep it as cash and use it for more productive things like paying down debt or improving the business. Inventory accounting helps you figure out the value and costs of your inventory. That’s important for things like setting prices, getting insured, budgeting, working out taxes, and selling your business. Inventory is the items that your business has bought with the intention of reselling to customers.

After all, your inventory is your most valuable asset within your business. Set reorder levels and get alerts before the stock level dips below your minimum. If you select preferred vendors for specific items, you can send purchase orders instantly. Organize your inventory with vital information like SKU, product image, vendor details, cost, and stock on hand. Complete inventory tracking from monitoring stock levels to replenishing them. The LIFO approach works on the assumption that the most recent products added to your inventory are the first ones to be sold first.

Capture Complete Product Details

Computerization makes it economical for many retail stores to use perpetual inventory procedure even for goods of low unit value, such as groceries. Ccountants must have accurate merchandise inventory figures to calculate cost of goods sold. Accountants use two basic methods for determining the amount of merchandise inventory—perpetual inventory procedure and periodic inventory procedure. The main advantage of inventory accounting is to have an accurate representation of the company’s financial health. However, there are some additional advantages to keeping track of the value of items through their respective production stages. Namely, inventory accounting allows businesses to assess where they may be able to increase profit margins on a product at a particular place in that product’s cycle.

And this leaves the final inventory figure to be included as a company asset. When an item is ready to be sold, transfer it from Finished Goods Inventory to Cost of Goods Sold to shift it from inventory to expenses. Debit your Finished Goods Inventory account, and credit your Work-in-process Inventory account. Before we dive into accounting for inventory, let’s briefly recap what inventory is and how it works.

When you make a sale, you reduce your asset and increase your cost of sale, which transfers the inventory value from the Balance Sheet onto your Profit and Loss report or Income Statement. Whether this is done when the sale happens, or at month’s end when you run a stock take depends on which inventory accounting method you use, which we will look at in the next chapter. With this technique, you still receive the inventory so it reflects in your sales channels, but you give it a zero value to prevent accounting transactions from being made. When you do a stock take, the items show in stock, but your Balance Sheet is not affected. Similarly, when you make a sale, no accounting transactions are made since the asset has no value.

  • Inventory is an asset and it is recorded on the university’s balance sheet.
  • The next day, you make 50 more clocks, though the cost goes down to just $6 each.
  • You’ll just need to stipulate which one is being used when submitting financial records and accounts.
  • When the sales report is sent back from the retailer at the end of the month, inventory corrections are then made.
  • To help keep track of inventory, you need to learn how to record inventory journal entries.
  • It’s possible that the FIFO system can lead businesses to under or overestimate the value of inventory in the future, due to market changes down the line.

The LIFO method uses the most recent inventory value for the cost of sale transaction when the sale is made. If the cost price of a product is increasing over time, then LIFO will result in the lowest profit , since the most recent costs will be higher than the oldest costs. The difference between perpetual and periodic inventory procedures is the frequency with which the Merchandise Inventory account is updated to reflect what is physically on hand. Average Cost (or weighted-average) inventory accounting method is totally different to the previous two. As the name suggests, COGS refers to the amount it cost a business to produce the products it sold, including everything that went into it – materials, labor, tools used, etc. But without factoring in costs not directly tied to the production process – like shipping, advertising and sales force costs, etc. On-hand inventory isn’t simply stock that hasn’t sold yet – it’s a business asset, and must legally be treated as such.

What Is Inventory Accounting And Why Do It?

An accounting journal is a detailed record of the financial transactions of the business. The transactions are listed in chronological order, by amount, accounts that are affected and in what direction those accounts are affected. Since the ending inventory of the one period is the beginning inventory for the next period, management already knows the cost of the beginning inventory. Companies record purchases, purchase discounts, purchase returns and allowances, and transportation-in throughout the period. Therefore, management needs to determine only the cost of the ending inventory at the end of the period in order to calculate cost of goods sold. Subtract leftover, unsold inventory at the end of the accounting period.

This chapter covers the basics of inventory accounting for greater understanding of inventory management as a whole. But it is highly recommended to seek the services of a professional accountant and/or bookkeeper when it comes to submitting any financial documents. If you sell products at your business, you likely have some form of inventory. Knowing how much inventory you have on hand, as well as how much you need to have in stock, is a crucial part of running your business.

inventory bookkeeping

At the end of the accounting period, you exclude this figure from management reports. Note that reducing overheads will increase your short term profit, since you are adding value to your assets and deferring the build cost into a later Cost of Sale transaction.

Adjusting The General Ledger Inventory Balance

This can be seen most prominently in products that require exceptional time or expense in secondary stages of production. Items such as pharmaceuticals, machinery, and technology are three products that require large amounts of expense after their initial designing. Properly tracking inventory costs will tell you the true margin on each product line you sell. Inventory includes raw materials that you use to make products. Choosing the best inventory management software for your business is like choosing the best car for your high school-age child. You’ll need to carefully do your research, test drive a couple of top contenders, then choose an option that is reliable and easy to use.

Establishing A Sales Operating Account Current Fund, Gndept

We need to assign an actual value to the unsold inventory figure (i.e. how much this company asset is worth in monetary terms). Cost of goods sold is a core element of measuring a retail business’s profitability and inventory value. When you sell to a customer, you’re getting rid of inventory. Then, credit your Accounts Payable account to show that you owe $1,000. Depending on your transactions and books, your accounts may look or be called something different. Suspend receiving and shipping operations during physical inventory. The time period for making these calculations needs to be the same.

When preparing monthly or quarterly income statements, the amount of revenue is recorded at the top of the income statement. When you sell goods, you recognize the reduction in inventory as well.

Inventory accounting is all about how a business would show the stock it holds in its financial records – balance sheets, profit & loss (P&L) reports, etc. This is typically more complex than it sounds as inventory is often a ‘live figure’ that’s constantly changing as sales are made and more stock purchased. On the other hand, periodic inventory relies on a physical inventory count to determine cost of goods sold and end inventory amounts.