Purchasing Inventory and Cost of Goods Sold (COGS)
One
of the most important functions of a retail or
manufacturing business is the purchase of inventory.
Without inventory, there are no sales.
To
understand inventory, you must also look at cost of
goods sold. These two are like the ends of a
teeter-totter. In theory, when goods are purchased
for manufacture or resale, they go into inventory.
When they are sold, they are taken out of inventory
and plunked into cost of goods sold (COGS).
Therefore, at the end of every period, the balance
in the inventory account represents the cost of the
items left in inventory. The amount in cost of goods
sold represents the cost of those items that appear
in the revenue line. (For an in-depth look at
valuation of inventory.)
There
are two main systems for managing the accounting of
inventory: the perpetual inventory system and the
periodic inventory system. The larger the company,
the more likely it is to use the perpetual inventory
system.
The
perpetual inventory system adjusts the inventory
every time an inventory transaction occurs. Doing so
allows the inventory and COGS accounts to be
accurate at any point in time.
When
inventory is purchased, the entry to account for the
purchase is as follows:
DR Inventory
$4,750.00
DR Retail sales taxes
recoverable
332.50
CR Cash (or Accounts
payable)
$5,082.50
Obviously,
you would credit the bank account if you purchased
the inventory with cash and the accounts payable
account if you purchased it on credit.
When
inventory is sold, the entry would be as follows:
DR COGS
$4,750.00
CR Inventory
$4,750.00
This
action places the sold goods onto the income
statement where those costs belong.
A
periodic inventory system is easier to account for
and manage. All inventory purchases are posted to
the COGS account until the end of the year, when the
inventory is counted and an adjustment is made. The
entry for the purchase of inventory would then be as
follows:
DR COGS
$4,750.00
DR Retail sales taxes
recoverable
332.50
CR Cash (or Accounts
payable)
$5,082.50
At the
end of the period (usually the year, but sometimes
the month), the actual inventory on hand is counted
and the cost calculated. The adjustment to actual is
then made through the
COGS
account, which then makes both
accounts correct. For example, if actual inventory
on hand at the end of the year was $52,450, and your
books reflected the inventory total from last year
of $41,231, the entry to correct both the inventory
and the cost of goods sold
account would be as
follows:
DR Inventory
$11,219.00
CR COGS
$11,219.00
Purchasing
Inventory and Cost of Goods Sold (COGS)
