Inventory & COGS Insights

Inventory And COGS - Complete Controller


Companies involved in manufacturing and selling physical goods must record them as assets in their books and expenses at the time of their sale. Manufacturing companies usually deal with three inventories: materials, work in process, and finished goods. Retailers only have to deal with one inventory, which is merchandise. In all cases, a company has to sell inventories to make profits. Before it is sold, it serves as an asset for the company. However, after merchandise is sold, the cost covers an expense called the Cost of Goods Sold (COGS). The cost is then transferred from a balance sheet to an income statement via journal entry in bookkeeping terms.ADP. Payroll – HR – Benefits

Companies maintain a significant amount of inventory to manage their day-to-day operations. However, it is an important asset that needs to be monitored closely. Storing too much inventory can cause issues related to decreasing cash flows, storage costs, and losses if the item turns archaic. Similarly, too little of it can result in lost sales and customers.

Indirect costs or overhead costs that cover depreciation, factory maintenance, cost of factory management, electricity, etc., are allocated to inventory, depending on the production levels. Overheads are frequently assigned based on direct labor hours or the number of machine hours.

Cost of Goods Sold

Cost of Goods Sold represents the cost of goods or merchandise sold to customers. Unlike inventory, which is mentioned on the balance sheet, the cost of goods is reported on the income statement. All costs to get the merchandise into the inventory and then ready for sale are included in the goods’ cost. The cost of acquiring it from the supplier, shipping costs, and all other costs are included. Direct materials, labor, and overhead costs are also included in the goods sold.CorpNet. Start A New Business Now

For services, the cost of goods would account for labor, payrolls, and benefits. All of the direct costs associated with the production of the product are the cost of goods. It is essential to highlight that goods not sold during the year and still in inventory would not be included in calculating the COGS. Only the goods that were sold are included.

Cost Flow Assumptions

There are three methods that the IRS accepts to move the cost from the balance sheet to the income statement. The accepted methods are FIFO (First In, First Out), LIFO (Last In, First Out), and Average Cost. They are what the names suggest. First out means that goods that arrive first should be removed at an original cost. It doesn’t matter if the cost of goods sold has increased for the new batch. You would have to record at an actual price. Each cash flow assumption can be used in both systems mentioned below.

Periodic Inventory System

Under the periodic system, the inventory account amount is not updated at the time of purchase. The account is only updated at the end of the year. It means the account would show the cost of last year’s stock for the whole year.Complete Controller. America’s Bookkeeping Experts

All the purchases related to merchandise are recorded in either one or more purchase accounts. At the time of year-end, the purchase accounts are closed, and the stock account is matched with the cost of merchandise at hand. Under the periodic system, the cost of goods sold does not exist in the account to record merchandise sales. It is calculated as beginning stock + new purchases – ending stock. You could not figure it out while looking at a general ledger account.

Perpetual Inventory System

Under a perpetual system, the stock account is continuously updated. The cost of merchandise purchased from the suppliers is added to the account, while what is sold to the customers is constantly being reduced from the account. There is no room for purchase accounts under this system.

The cost of goods sold account is debited at the sale, precisely for the merchandise’s cost. There must be two recorded journal entries for the sale of any merchandise. Sales and accounts receivable are recorded as one entry, while the other caters to reducing inventory and increasing the cost of goods sold.

FIFO, LIFO, and Average cash flow assumptions are combined with either perpetual or periodic systems to account for the stock’s cost at hand. It is up to you to choose any one of them at your convenience.

Download A Free Financial ToolkitAbout Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual bookkeeping, providing service to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud platform where their QuickBooks™️ file, critical financial documents, and back-office tools are hosted in an efficient SSO environment. Complete Controller’s team of certified US-based accounting professionals provide bookkeeping, record storage, performance reporting, and controller services including training, cash-flow management, budgeting and forecasting, process and controls advisement, and bill-pay. With flat-rate service plans, Complete Controller is the most cost-effective expert accounting solution for business, family-office, trusts, and households of any size or complexity. ADP. Payroll – HR – Benefits