Accounting for inventory
Learning about inventory is essential for any business that sells products because you need to buy to sell goods and have a count of the items you hold in your business; if not, you might run or overstock the goods.
Inventory means that the goods are bought for sale or used in manufacturing the products. It stays as the current assets in the balance sheet of a company. Too much
Inventory account
| 2 Dec $ Purchases 400 | 2 Jan $ Sales 400 |
Inventory can create cash flow problems because you have used too much to buy the merchandise. In the above illustration, you might think it is easy to account for the sale items you have in your stock, but when making the sale, you need to have profit, so the sales figure is more than the cost of the store.
When preparing the profit and loss account, the cost of goods sold taken away from the sales gives you the gross profit. When the cost of goods sold is calculated to deduct from the sales, the additional expenses incurred in buying the inventory are added to the cost of goods sold.
There are four accounts involved in the inventory
- Purchase
- Sales
- Returns inwards
- Returns outwards
Let us assume a business buys a book for $100, and the shipping cost for that is $5.00 and recorded in the inventory account. In addition, when the business sells the book, the amount will be $105, which will remove from the inventory account.
Inventory is generally categorized as raw materials, work in progress, and finished goods; raw materials are unprocessed goods used to produce a good.
Cost of goods sold
Cost of goods sold to customers and reported on the profit and loss accounts when the income revenue is reported. Total revenue from the price of goods sold gives you the gross profit for a certain period.
Accounting Transactions
When preparing monthly or quarterly income statements, the amount of revenue is recorded at the top of the income statement. The cost of goods sold is then subtracted to show a gross profit. When you sell goods, you recognize the inventory reduction as well. If your accounting method shows a $20,000 COGS and your prior inventory level was $100,000, your new inventory balance would be $80,000. When you acquire new inventory, you add the acquisition costs to the value of the stock.
Purchases of inventory
The necessary accounting entries are shown below when a company purchases inventory, makes an immediate cash payment, or buys on credit terms.
When you make an immediate payment for your inventory credited to the bank shows a decrease in an asset.
Credit purchase.
Purchases
| $ | $ |
| 10th Dec Creditor 800 |
Creditor
| $ | $ |
| 10th Dec Purchases 800 |
In this case, the liability increases because the purchase is credited to the creditor’s accounts.
Sales of inventory
In March, the company sells inventory for cash; therefore, the accounting entry will be as follows.
Cash sales
| $ | $ |
| 1st Mar Bank 650 |
Bank
| $ | $ |
| 1st Mar Sales 650 |
Credit sales
| $ | $ |
| 1st Mar Debtor 650 |
Debtor
| $ | $ |
| 1st Mar Sales 650 |
In cash sales, the immediate payment occurs, so an asset increase- bank balance.
However, payment is received later; therefore, an asset increased that is the debtor as we debit the debtor.
Then there will be inventory returns outwards and inwards, so the accounting entries are made in the asset account.
Quiz
Why is it necessary to maintain accounts for inventory?
It can create cash flow problems.
When you sell your inventory and forget to invoice them to collect the money from customers will run out of money.
You might go out of stock.
You will not know the number of goods in your hands if you do not have proper accounting.
Possibility of overstocking
Accounting is essential to know the amount of stock in the store that prevents you from purchasing.
Open to fraudulent activities.
Regular counts are necessary to keep everything under control without getting yourself in trouble.