Inventory items are tracked items that you sell to your customers. These items can also be used as parts to build inventory assemblies with.
When creating your Inventory items, you should opt to make them “double-sided.” This means that when you purchase an item, the appropriate expense/COGS account will reflect this item on your Income Statement. When you sell that item, the appropriate income account is affected and will reflect on your Profit & Loss statement.
Keep in mind that the cost of Inventory you purchase will NOT be booked to the Income Statement until that Inventory is sold to a customer. This is called accrual based accounting, and it serves to match revenues with the corresponding expenses in the same accounting period.
So how does QuickBooks know how to calculate the cost since it has no way of knowing which particular item of the 50 items you have in stock has sold? It doesn’t. QuickBooks uses the average price method of expensing Inventory. This means that QuickBooks calculates the average cost of the multiple Inventory items purchased up to the point when the item was sold to the customer.
This average cost calculation OVERRIDES any cost you manually assign to an Inventory item when you create it. Your manual entered cost will automatically populate a Vendor Bill upon choosing that item in the Bill. This cost can be changed on the Bill if you have a special price from your vendor.
The same concept is in effect on the other side of the Inventory item – the Selling Price. The amount you enter as the selling price will populate for that Inventory item when you use it on a Customer Invoice. (Unless your customer has a customized price, which you may choose as well).
It is very important to make sure you have the correct expense, income, and asset accounts tied to each Inventory item. Maintain your Inventory regularly and attentively, and make sure that your Inventory items NEVER fall into a negative availability status. This will adversely affect the cost calculations that QuickBooks performs for those items and will result in an erroneous Income Statement.
Note: AccuraBooks is a bookkeeping firm only, so please consult with your C.P.A. for verification and clarification about the contents of this article.