The bookends of inventory accounting are your buy price and your sell price. They can both change a lot. If your supplier starts charging more, or you sell a bunch of product on discount, your margin will drop quickly. There are a couple of different ways to link your buy price and sell price.
Under the first in, first out (FIFO) method, items are assumed to be sold in the order they’re bought. This doesn’t have to happen literally. You can sell them in any order you like. But from an accounting perspective, you imagine that it all happens in sequence.
When a new item comes in, you note what it costs and place it in a queue to be sold. When that sale happens, you record the price. Now you have a buy and sell price for each single item of stock.
Rather than tracking the purchase and sale price for each individual item of inventory, you can use averages. For each product line, work out:
1. average buy price: divide the money you paid over the year by the number of products you got.
2. average sell price: divide total revenue for the year by number of sales made.
While it’s a simpler method for doing annual accounts, AVCO doesn’t work well when there are big price fluctuations. It can also cause confusion if a manufacturer introduces a new version of a product. You could end up with two inventory items that have the same name but very different prices.
Not all inventory valuation methods are equal. And nor are they always possible. It may depend on the inventory management system you have in place.
1. Periodic inventory system:
Under the traditional periodic inventory system, businesses physically count their stock at the end of an accounting period. The stock count is reconciled against purchase and sales records. If required, adjustments are made to match the two.
2. Perpetual inventory system:
Perpetual inventory systems – also known as dynamic inventory systems – are an automated alternative to the manual stocktake.
When you order stock, your software adds the count to your inventory. And when you sell an item, it does the subtraction. This type of software is often sold as an app that can plug into your point of sale (or invoicing) systems and your accounting software.
It’s not always enough to know what you paid for a product, and what you sold it for. Some businesses have to spend a lot on inventory while they have it. These costs typically include things like storage and insurance but there may be others. Dangerous goods, for example, may require you to take expensive health and safety precautions.
Quickmas perpetual inventory management system keeps track of inventory balances continuously, with updates made automatically whenever a product is received or sold. Purchases and returns are immediately recorded in the inventory account. As long as there is no theft or damage, the inventory account balance should be accurate. The cost of goods sold account is also updated continuously as each sale is made. Perpetual inventory systems use digital technology to track inventory in real time using updates sent electronically to central databases.
Beside using this dynamic inventory management system you can take a periodic physically count stock and reconcile with the Quickmas perpetual inventory statement.