TECH TOPIC:
Items & Cost of Goods Sold (COGS) in QuickBooks
Part 2

For businesses that sell products, keeping track of inventory and your cost of goods sold (COGS) is vital. If you're not careful, inventory valuation and COGS may not reflect your true business progress.

In Part 2 of this series, we'll now discuss the problems you may encounter when using Items. If you haven't read Part 1, you may want to read it now to refresh your memory of the use of "Items" in QuickBooks.

Contents

Valuing Inventory Items
When Inventory Costs Are Recorded As COGS
Adjusting Inventory & Cost of Goods Sold
Summary of Items & Cost of Goods Sold

Valuing Inventory Items

Key Concept: QuickBooks tracks the average cost of unsold Inventory Items.

Every time you purchase an Inventory Item, QuickBooks recalculates the average amount you've paid for the items in stock regardless of the amount you enter in the 'Cost' field when you set up your Inventory Item.

This average value is used every time you make a sale or adjust inventory valuation. Whenever you make a sale, this average value is what is recorded in your Cost of Goods.

Let's use an example using our brooms from Part 1:

You purchase two brooms for $10.00 each from ACME Vending for resale. The average price of the brooms is now $10.00. Three months later you purchase two more brooms except this time they cost $12.00 each. You make no sales between your two purchases. Your average cost per broom now is $11.00.

Total Cost		Avg Cost
20		44
+ 24		÷ 4
44		11

Using the same example except this time, you sell one broom between your purchases.

Total Cost		Avg Cost
20		34
- 10		÷ 3
+ 24
		11.33
34

Notice that the average cost ($11.33 in this case) is calculated from the quantity you have on hand, not on your total purchases.

Is this a problem? It depends. Many small businesses operate using QuickBooks' average cost valuation method. It's a reasonable method of tracking your true costs of inventory without burdening the small business owner with using the Last In, First Out (LIFO) or First In, First Out (FIFO) methods.

That is something you and your accountant should discuss when setting up your business' accounting methods.

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When Inventory Costs Are Recorded As COGS

Key Concept: Non-Inventory & Service Items are recorded in the selected accounts at the time of purchase. This may not correspond to when the sale is made.

Remember in Part 1 we said that at every sale, the cost value of the Inventory Item is transferred from your inventory asset account to the Cost of Goods Sold (COGS)\ account. The amount recorded is explained in Valuing Inventory Items on this page.

When you purchase or sell Non-Inventory or Service Items, this is not the case. QuickBooks' Non-Inventory or Service Items are intended to be used for items that you don't stock or buy for a specific customer or purpose. This usually means a short time frame between the time you purchase the part and the time you resell it.

Provided you checked the "This item is purchased for and sold to a specific customer:job" box, QuickBooks records Non-Inventory and Service Items purchases in your Cost of Goods or Outside Services accounts when you purchase them. Otherwise, all purchase and sales transactions are recorded in the account selected in the Non-Inventory or Service Item dialog box.

This can present a problem when a significant period of time lapses between the time you purchase a Non-Inventory Item or a Service Item and the time you finally resell them. You will have already recorded the Cost of Goods Sold without a corresponding sale.

Adjusting Inventory & Cost of Goods Sold

You can easily fix this using journal entries. Use the Make Journal Entry menu item. Credit the cost of the Non-Inventory or Service Item(s) to the Cost of Goods Sold account and debit your Inventory Asset account as shown in the figure below.

When you do resell the Non-Inventory Item or invoice for the Service, make another journal entry to reverse these entries; e.g., debit the cost of the Non-Inventory Item or Service from your Cost of Goods Sold account and credit the Inventory Assets account.

Check with your accountant to determine if and when you should make these journal entries.

If you're prone to forget to make the reversing journal entry to correct your Cost of Goods Sold, I recommend making a To Do List entry due at the end of each month as a reminder. If it is not required, you can reset your To Do task for the next month.

If you find you have to make a significant number of these entries, I highly recommend that you consider converting the Non-Inventory Item to an Inventory Item and let QuickBooks do the accounting for you.

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Summary of Items & Cost of Goods Sold

In Part 1 we learned the difference between Inventory, Non-Inventory and Service Items in QuickBooks. In order for your accounting to conform to well-understood principles, the recognition of Cost of Goods should be closely related, time-wise, to the time of sale.

In this part, we learned that QuickBooks keeps track of the average value of Inventory Items. For Non-Inventory and Service Items, QuickBooks makes no attempt at keeping track of valuation.

We also learned that QuickBooks recognizes the value of your Cost of Goods (Services) at the time of puchase for Non-Inventory and Service Items. Inventory items are recorded in your Cost of Goods Sold account at the time of sale at the average valuation of your Item.

The shortcomings of Non-Inventory and Service Items can be corrected by using journal entries, if necessary. If you need to do this frequently, you should consider making that Item an Inventory Item.

02 June 2002

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