First, a brief introduction to accounting concepts around inventory

When dealing with inventory, there are two transactions that occur for each product:

1. Purchasing the item for resale, or the items needed to manufacture the product
2. Selling the product to a customer (sales)

Inventory affects the following accounts:

• Cost of Goods Sold: Money spent on items for resale, or supplies for manufacturing.  Cost of goods sold is recorded on the Profit and Loss statement as an exepense.
• Inventory: The value of the items currently in stock, equal to the total purchase price of those items
• Income: Inventory sales should have at least one account which is used when selling the item
• Cash/Bank/Receivables/Payables: Inventory is bought and sold using money, often with credit offered when between businesses

Tracking inventory is commonly done in one of two ways:

1. Periodic inventory tracking, in which the inventory account value is only adjusted from time to time (annually or quarterly, depending on when accurate reports are needed or wanted).
   
2. Continuous inventory tracking, in which the inventory account value is adjusted on every purchase and sale

The easy way: Periodic Inventory Tracking

The advantage of periodic inventory tracking is that it’s a lot less work than continuous inventory tracking.  The disadvantage is that you don’t have a precise count of all your stock.

• When setting up your business, create an account Inventory with a type Other Assets
• When purchasing goods and supplies for resale, or which are used to create a product for sale, create a Bill and enter Cost of Goods Sold as the Expense Account.  Since normally the ‘Expense Account’ field only shows expense accounts, either type ‘Cost’ or click ‘Show All Accounts…’ to reveal the account.
• When completing a sale, enter an Income record and use Sales Revenue as the Income Account.
• Annually do a tally of the cost of all inventory and record an Adjustment and calculate the difference between the counted value of inventory and the inventory value on the balance sheet. Create an Adjustment and enter a credit of this calculated difference on Cost of Goods Sold and a Debit of this amount on Inventory.  The number may be negative if inventory values have decreased since the last count.

The meticulous way: Continuous Inventory Tracking

The advantage of continuous inventory tracking is that you always have a precise value for your inventory; however, this comes at the cost of extra effort.

• When setting up your business, create an account Inventory with a type Other Assets
• When purchasing goods for resale, or supplies which are used to create a product for sale, create a Bill and enter Inventory as the Expense Account.  Since normally the ‘Expense Account’ field only shows expense accounts, either type ‘Inv’ or click ‘Show All Accounts…’ to reveal the account.
• When completing a sale, enter an Income record and use Sales Revenue as the Income Account.
• After completing a sale, also calculate the price of the good sold, or the materials used to produce the good.  Create an Adjustment with a credit to Inventory and a debit to Cost of Goods Sold of this calculated price.

Time-saver: Setting Up and Using “Items”

The ‘Items’ link on the navigation takes you to a page where you can set up what we call ‘Items.’  An item is a product or service which has a preset price, tax rate, and income/expense accounts.  They act as a kind of “short cut” when entering bills and invoices since by selecting the item the account, price, and tax rate are automatically filled in.

If your business buys or sells the same things over and over, adding Items may save some time.  Also, in the future it will be possible to generate a report showing the total quantity of each item bought or sold in a given time period, which would help with verifying inventory counts.

Using a Third-Party Inventory Management System

If inventory management is important to your business, purchasing a third-party inventory system or point-of-sale system with inventory management features might be a great time-saver for you.

If you are using a third-party inventory system, you can periodically update your balance sheet by following the instructions for “How to do Periodic Inventory Tracking” above, except that instead of manually counting inventory, you print out the current inventory total from your inventory management software.  Since this is relatively easy, you could do this on a monthly or even weekly basis to keep your balance sheet current.

Closing Remarks

Even though Clarity Accounting does not contain specific support for inventory tracking, because it is a general accounting system you can still perform inventory tracking the ‘old fashioned way’ as described above.  In the future we may add specialized support for inventory and cost of sales; if this interests you please vote for it.

Tags: accounting, cost of goods, cost of goods sold, cost of inventory, goods for resale, inventory, inventory tracking, items, online accounting software, sales, time saver, tracking sales

This entry was posted on Tuesday, September 23rd, 2008 at 4:58 pm by Dobes and is filed under Accounts Set Up, Bookkeeping, Small Business Accounting Basics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.