Accounting for Inventory Management – Best Practices for Retailers
Inventory accounting helps businesses properly value and record inventory, which is vital for financial reporting and tax compliance purposes. Furthermore, inventory accounting helps reduce waste by decreasing slow-moving products or detecting incorrect shipments early.
Utilising an appropriate valuation method (FIFO, LIFO or weighted average) ensures that inventory costs are consistently recorded for comparability purposes.
1. Set Valuation Method
As your primary current asset, inventory valuation is essential to understanding Cost of Goods Sold and profitability for your business. Selecting an effective valuation method suited to your production process allows you to minimize expenses while keeping enough stocks available to meet demand volume requirements.
The most widely utilized methods of inventory valuation include First In, First Out (FIFO), Last In, First Out (LIFO), Specific Identification and Weighted Average – each has its own set of advantages and drawbacks.
FIFO is a widely used inventory cost accounting method because it closely mimics reality: older units of each stock-keeping unit (SKU) typically sell before newer ones under ideal conditions. Furthermore, this approach makes calculating ending inventory easy and gives an accurate view of your balance sheet costs. Unfortunately, however, many accounting regulators disfavour its use due to high-cost inventories being moved over to cost of goods sold and thus decreasing reported profits of businesses using it.
2. Record Purchases
Once inventory arrives, it’s important to quickly record its cost in your books. Depending on your inventory accounting method, this may require an initial journal entry debiting inventory account for purchase price and crediting accounts payable for payment made directly to suppliers.
Once the inventory is sold, it is necessary to calculate the landed cost of goods sold and record that expense in a Cost of Goods Sold (COGS) account. You can do this using various techniques, including first in first out (FIFO), last in first out (LIFO), or weighted average accounting methods.
Tracking product sales, expenses and gross profit over time allows for better decision-making. Regular physical counts should also be conducted to reconcile inventory held in your warehouse with records kept. Many online point of sale and inventory management software solutions make this easy, with several allowing you to set reorder points automatically that alert when it’s time for more inventory orders to come in.
3. Track Production Costs
Accurate inventory bookkeeping is critical to the profitability of any company. Armed with accurate COGS information, businesses can better assess their stock inventory on hand, avoid overstocking or stockouts and optimize reorder points more effectively.
Businesses looking to accurately track inventory costs must first select an efficient production method. Process costing, for instance, requires assigning a total unit cost per completed product and those remaining in work-in-process inventory at the end of a period; this calculation takes into account direct materials costs as well as manufacturing overhead and variable production expenses associated with each finished good produced.
Other popular inventory accounting methods include specific identification, first-in, first-out (FIFO), and LIFO. Specific identification matches each inventory item sold back to its initial purchase price for maximum precision; however, this method requires significant costing complexities and tracking for consistent performance. Selecting an inventory management solution that suits both your business needs and accounting software implementation can lead to improved inventory management.
4. Keep Track of Excess Inventory
Excess inventory can be an ongoing problem for retailers, tying up capital and preventing you from investing back into your business. This leads to four costs: storage space costs, service charges (taxes and insurance on stock), risk costs associated with stock, and lost sales revenue. There are a few steps you can take to manage excess inventory:
An effective strategy for managing excess inventory is regular inventory reconciliation. This enables you to keep an eye on how products move through production as well as monitor seasonal shifts in customer demand.
Inventory management systems that offer reports for “dusty” or aging inventory can help businesses that use the FIFO inventory costing method ensure new stock sells prior to older stock that has expired or gone bad.
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