Products to be sold are called inventory. As a bookkeeper, you use two accounts — Purchases and Inventory — to track inventory for your business. Here's a closer look at what the Purchases and Inventory accounts mean:
Purchases: Where you record the actual purchase of goods to be sold. This account is used to calculate the Cost of Goods Sold, which is an item on the income statement.
Inventory: Where you track the value of inventory on hand. This value is shown on the balance sheet as an asset in a line item called Inventory.
Companies track physical inventory on hand using one of two methods:
Periodic inventory: Conducting a physical count of the inventory in the stores and in the warehouse. This count can be done daily, monthly, yearly, or for any other period that best matches your business needs. (Many stores close for all or part of a day when they must count inventory.)
Perpetual inventory: Adjusting inventory counts as each sale is made. In order to use this method, you must manage your inventory using a computerized accounting system that’s tied into your point of sale (usually cash registers).
Even if you use a perpetual inventory method, it’s a good idea to periodically do a physical count of inventory to be sure those numbers match what’s in your computer system. Because theft, damage, and loss of inventory aren’t automatically entered in your computer system, the losses don’t show up until you do a physical count of the inventory you have on hand.
When preparing your income statement at the end of an accounting period (whether that period is for a month, a quarter, or a year), you need to calculate the Cost of Goods Sold in order to calculate the profit made.
In order to calculate the Cost of Goods Sold, you must first find out how many items of inventory were sold. You start with the amount of inventory on hand at the beginning of the month (called Beginning Inventory), as recorded in the Inventory account, and add the amount of purchases, as recorded in the Purchases account, to find the Goods Available for Sale. Then you subtract the Inventory on hand at the end of the month, which is determined by counting remaining inventory.
Here’s how you calculate the number of goods sold:
Beginning Inventory + Purchases = Goods available for sale – Ending inventory = Items sold
After you determine the number of goods sold, you compare that number to the actual number of items sold by the company during that accounting period, which is based on sales figures collected through the month. If the numbers don’t match, you have a problem. The mistake may be in the inventory count, or items may be unaccounted for because they’ve been misplaced or damaged and discarded. In the worst-case scenario, you may have a problem with theft by customers or employees. These differences are usually tracked within the accounting system in a line item called Inventory Shrinkage.
