Inventory - How To Record Inventory The Right Way
If you sell a physical product on Amazon, Shopify or your own website, you probably have wondered if you have been recording all your inventory costs the correct way.
In this article, we will talk about the difference between cost of goods sold, inventory, raw material and the process used to record them.
What is inventory?
“Inventory” is the term for the products you sell. An inventory (or inventory asset) account is a balance sheet account which records the inventory as an asset for your company. These inventory assets are usually expected to sell within a year.
If you make or assemble your inventory (products), there are three stages for making the inventory:
1) Raw materials (the most basic parts and components that you use to make the final product)
2) Work-in-progress (after you start mixing all the raw materials, before you finish the final product)
3) Finished goods (the product that is ready to sell)
For example, if you own a protein bar company, your raw materials are almonds, blueberries, quinoa, etc. Once you mix all the raw materials (almonds, blueberries, etc.) together, these mixed raw materials are called work-in-progress. Once you have cooled down the mixed materials, cut them into smaller pieces and packaged them as protein bars, now you have the finished goods and are ready to sell them.
Products in each stage are part of the total inventory, an asset for your company which you record on your balance sheet. An inventory account shows you when the product (or its raw materials) were purchased, but it doesn’t tell you when the product will be sold. As the business owner, you need to record all the inventory as an asset on the balance sheet when you first purchase it – none of these expenses should be on your income statement.
What is Cost of Goods Sold?
Cost of goods sold is an income statement account. It is the cost of all the products you sold during a specific period of time – for example, during the current month.
Let’s use the example of the protein bar company again. Every time you sell a protein bar, the cost of that product is recorded under cost of goods sold. With each protein bar you sell, it increases the cost of goods sold for the current month and lowers the inventory with the same cost.
Cost of goods sold tells you how much it costs you to sell the product, and the cost shows on the Income statement. In contrast, if you bought inventory to store and will sell them in the future months, the cost should be recorded under inventory asset account on the balance sheet.
Here is a handy flow chart:
You should always record the dollar value spent on inventory in this sequence: 1) raw material 2) inventory 3) cost of goods sold.
You buy raw material and make it into finished goods: both costs are on balance sheet. Once you sell the inventory, you record the cost of that inventory under Cost of Goods Sold, which is an income statement account.
This is the process of how you record inventory cost. Did you make it through the flow chart okay? Recording complete information on inventory in your accounting system can get complicated. Hopefully this article has provided you with some clarity!
