Introduction to accounting for inventory

It's really important to understand how your inventory is being accounted for, because the value of your inventory directly impacts on your profit.

The profit you make is your sales revenue less your cost of sales, and the cost of your goods sold will make up the majority of your cost of sales.

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Profit is only recorded when you sell items.

When you buy inventory from a vendor, you increase your inventory asset value and increase your vendor debt - resulting in no net change to the balance sheet or your profitability. Similarly if you buy inventory for cash, you are increasing your inventory asset value and decreasing your cash asset value, which also does not result in a net change to the balance sheet or profitability.

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Profit comes in when goods are shipped.

Shipping an item reduces your inventory asset value and increases your cost of goods sold, which is shown on your income statement.

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The timing of the cost of sales entry is dependent on your method of inventory accounting.

Periodic and perpetual inventory accounting

By default, Brightpearl uses a method of inventory accounting called perpetual (or cost of sales) inventory accounting.

With cost of sales inventory accounting, accounting journals are created for every receipt or shipment of inventory, which updates asset account codes and COGS account codes on a continual basis. Most merchants use this method as it provides a near-real-time view on COGS and therefore profitability of sales.

  • Accounting entries are made with every unit brought into the system and taken out of the system
  • You have an immediate view of current assets
  • You have an immediate view of your cost of sales, and therefore your profit

With periodic accounting, accounting journals are not made when inventory is received or shipped; instead, a cost of goods sold journal will need to be entered manually for each period in order to get useful profit figures.

To calculate your periodic inventory values, you would take the difference between opening and closing stock, taking into consideration any purchases.

  • Individual inventory transactions generate no accounting
  • A journal must be manually posted to calculate the cost of goods
  • There is no visibility of assets or profit until this task is done

Learn more about the differences between perpetual and periodic accounting here.

Assigning costs to units

With cost of sales accounting, the cost is assigned to each individual unit. The unit will carry a cost throughout its time in Brightpearl.

Process Cost value comes from
Receiving goods The price of the items on the purchase order
Shipping goods The cost of existing inventory

Learn more about accounting for goods in and accounting for goods out.

First in first out (FIFO) valuation

Brightpearl uses the first in first out (FIFO) method of inventory valuation, which means when a unit is shipped, the cost of the oldest unit in stock is used for the accounting (regardless of which physical item is shipped).

Learn more about FIFO valuation here.

Manual inventory adjustments

When adjusting inventory using a manual correction, the accounting entry will affect your inventory assets code as well as an inventory adjustments code, selected under Settings > Company > Accounting: accounts (nominal codes)

Writing inventory off debits the code and adding inventory in credits the code.  The code is generally in the 5XXX range as inventory write offs reduce profits while adding inventory increases it.

Learn more about manual inventory adjustments here.

Which inventory actions result in journal transactions?

When cost of sales accounting is activated in Brightpearl, accounting journals for inventory will be created at the following times:

For goods out (sales):

  • Shipping items on a sale (cost of sales)

Read more about accounting for goods out.

For goods in (purchases and sales credits):

  • Receiving items on a purchase
  • Receiving inventory on a sales credit (returns)
    • Add into the warehouse
    • Place in quarantine
    • Write-off

Read more about accounting for goods in.

For inventory quantity and price corrections:

  • Adding or removing stock items
  • Making an inventory price correction
  • Unreceiving items on a purchase order
  • Receiving the purchase invoice with a price correction

Read more about accounting for inventory corrections.

The following processes will never create any accounting entries:

  • Transferring items between warehouses
  • Moving items between warehouse locations

Non-stock tracked products

Non-stock tracked products don't hold an asset value and so do not contribute to the cost of goods sold when they are included on sales.

However, if included on purchase orders, invoicing the purchase order will post their value directly to a cost of sales cost (as defined on the product record).

Dropshipping

When fulfilling orders via a dropshipped purchase order, you are never taking possession of the goods and therefore they will not affect your asset balance.

However you still need to record the cost of the sale. The item acts a non-stock tracked item and the cost is posted directly to a cost of sales code, as defined on the product record, upon the purchase order being invoiced.

Accounting (nominal) codes

When items are added or removed from stock, journals are usually created using the account codes from the product record.

Perhaps some of your inventory is classed as asset type A, and some as asset type B. Multiple asset types could also be reflected by multiple cost of sales codes (which are also assigned to a product record).

Video

A broad overview of the accounting implications of inventory management in Brightpearl.

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