Cost of Goods Sold and Inventory in QuickBooks

If you are having issues with your inventory or cost of goods sold accounts in QuickBooks, you should know that lots of people do!  Inventory in QuickBooks is a complicated and sensitive system.  I’d venture to say that the majority of QuickBooks users are not accountants, and inventory itself is a complex accounting process.

The first thing you must understand is that when you use inventory items in QuickBooks, you must purchase the item on a bill or check in QuickBooks from the vendor in order to receive the items and populate the inventory in QuickBooks.  Inventory adjustments are for adjusting discrepancies, not for regularly populating the inventory.

When you purchase inventory, the cost of it is recorded in the Inventory Asset account.  When the item is sold to a customer, a cost of goods sold is created and the inventroy asset amount is reduced.

If your cost of goods sold is over-stated, a good place to start is to drill down on your cost of goods sold from the Profit and Loss report.  Carefully review the items that were sold,  and loook for items that are posting a cost above what it should be.  You can also run a report on Profitability by product or sales by item and notice any items that appear to cost more than what they are being sold by.

Many people are not clear on how QuickBooks handles inventory and items and may make a mistake setting up their items as a result.  Here are 2 scenarios I have noticed:

Jim purchases rubber tubing from his vendor in a roll of 500 feet and sells it by the foot.  He sets up the item and enters the cost as $500 – the cost for the entire roll – he enters the sales price as $5 – the price he sells it to the customer per foot.  Every time Jim sells one foot for $5, a cost is recorded in the cost of goods sold account for $500.  Can you see the problem?  To rectify this, you must keep in mind to always set up the costs and unit measures for items in their smallest unit measure.  The cost here should have been entered in the same denomination as the sales- by the foot $1.  In order to create purchase orders and such by the roll – you can use the multiple unit measure feature which allows you to specifiy – I purchase this in a 500′ roll and sell it by the foot.  (you need Premier Edition I beleive for this feature) However, the item itself is still set up in the smallest unit measure – by the foot as far as cost is concerned.

Now – here is the problem that sometimes happens with multiple unit measure: The multiple unit measure is set up in reverse.  I admit, the multiple unit measure concept is a little tricky.  I once had a client set up a multiple unit measure that caused a $50000 over-statement on one sale for the cost of goods sold!  That happened because he purchased a product in Kilos and sold it in drams.  Well, there are over 500 drams in a kilo and instead of setting up the unit measure as 500 drams in a kilo, it was accidentally set up as 500 kilos in a dram.  So, for each dram that was sold, the cost of 500 kilos was recorded!

Also, keep in mind that QuickBooks uses the Average cost method of calculating cost of goods sold.  So, if you find an item that has been in use that had an incorrect cost, you must discontinue using that item and set up a completely new one.  Otherwise, it will take forever for the cost of that item to balance to its original.

I recommend anyone using inventory in QuickBooks who is not an advanced user with accounting training consult with a Pro-Advisor who is experienced with inventory management in QuickBooks when setting up the system and for periodic review.

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