A Complete Guide on Inventory Accounting: Methods and Best Software Options

QuickBooks Accounting software was built by Intuit as an easy-to-use accounting solution for small- and medium-sized businesses. It allows you to organize your accounting data on the cloud while tracking sales and creating, generating, and transferring invoices.

With QuickBooks, you can connect your bank account to automatically categorize and import transactions. It’s also designed so you can take photos of receipts and file them away while on-the-go using QuickBooks mobile.

Although QuickBooks has many useful features, it works best with other Intuit products, and syncing up your data from outside sources isn’t always simple.

Another popular accounting software solution used by small businesses is Freshbooks, which offers many of the same invoicing and transaction-tracking features as QuickBooks.

Many of Freshbooks’ features cater to the needs of freelancers, with an emphasis on client billing and time-tracking. On the other hand, when it comes to product billing, there are far more powerful alternatives that offer you deeper insight and better analytics.

With a 30-day free trial and a range of affordable pricing plans, Xero is an accounting option for businesses looking for their first accounting software that need a low-priced option that’s easy to learn how to use.

With over 800 apps listed on the Xero app marketplace, there is likely an integration available for any other software application you use in your business accounting processes.

While it’s a fair solution for self-employed freelancers and small businesses, Xero isn’t set up to meet the needs of larger organizations. As such, if you expect to see a large amount of growth in the future, you may be better off choosing accounting software that can adapt to the needs of larger enterprises.

Pabbly has built a suite of six business process automation tools that are intended to bring automation usually associated with large corporations and high-tech industries to a larger audience.

Pabbly subscription billing takes the hassle out of collecting recurring payments from your customers, helping to streamline accounting for any subscription-based revenue model.

Although it’s one of the better subscription-billing tools on the market, keep in mind that Pabbly isn’t an all-in-one accounting solution like some of the products on this list. That means that if your business relies on income from multiple sources, rather than subscriptions alone, you may want to consider more general-purpose accounting software.

If you’re looking for free accounting software to help you keep track of your income and expenses and organize transaction records into categories for accounting, Wave might be the solution you’re looking for.

In addition to unlimited income and expense tracking for as many business partners and bank accounts as you need, Wave also offers a simple invoicing tool that connects seamlessly to an online payment processing system.

With a basic fee of €0.25 per transaction plus a 1.4% surcharge for European issued cards and a 2.9% charge for those issued outside Europe (excluding VAT), Wave might not be the cheapest option for accepting online payments. But neither is it the most expensive and many businesses choose to process payments with Wave for the convenience of using a single service for payment processing and accounting.

When it comes to accounting for inventory purchases, Zoho Books was one of the first software products to integrate inventory and purchase order management into a single unified solution for small businesses.

Although it’s one of the most affordable end-to-end accounting solutions out there, Zoho’s functionality does top out for businesses over a certain size, and its usage is limited to ten users even for premium subscribers.

AccountEdge is another small business accounting software solution that provides a suite of tools to help users keep track of their incoming and outgoing transactions.

An especially useful feature is the Data Auditor which helps you to make sure your business data is correct, protected, and balanced.

One downside to using AccountEdge is that it’s only available as a desktop application. This makes it less useful for on-the-go accounting than other options that have powerful mobile apps with a range of features.

Branding itself as an all-in-one “business assistant”, OneUp’s range of business intelligence tools ensures it is a powerful platform for small companies that need more from their accounting software.

With AI-powered forecasting, integrated Customer Relationship Management (CRM), and a host of automation options, OneUp is indeed a smart platform for small business users.

Of course, OneUp might be overkill if you only need basic accounting functionality, and at around $9 per user, per month depending on the plan, you might prefer to consider a free alternative instead.

Whether your small business has a full-time accountant, or you’re a business-of-one and do your own tax and invoicing, FreeAgent’s small business accounting software dashboard is easy to use.

With features to help with invoicing, expenses, payroll, and banking, FreeAgent isn’t just for freelancers either.

Admittedly, FreeAgent is geared towards UK-based businesses, though, so its usefulness outside of the United Kingdom is limited. That being said, the company does have plans to expand internationally and is definitely one to watch in the small business accounting software space.

Using the periodic method, inventory accounting doesn’t occur when a sale happens. A sale stores the revenue and tax transactions, and shows as 100% profit on your Income Statement. At month (or year) end, an inventory update is run, a value is assigned, and this is then compared to the previous month’s inventory value.

The “Opening stock value” and “Closing stock value” are assigned into accounts, which, factoring any purchases you may have made during the period, gives you a cost of sale, which is subtracted from the revenue to give you your gross profit.

Let’s look at an example of this in action:

Inventory at start of month: $100

Purchases made during month: $50

Inventory at end of month: $25

Even though you have bought $50 of stock, at the end of the month you are $75 down on the previous month (opening balance $100 – closing balance $25). This means the total spend on products contributing to sales in the month is $125 ($50 purchases + $75 inventory shipped).

With periodic accounting, the purchase value is added directly to the Profit and Loss report or Income Statement when you buy the stock, and the inventory adjustment is added at the end of the month. You can only get an accurate profit report once a month, after all of the calculations are made.

A stock valuation should follow a full stock take to take into account any gift sales, free samples, damage or theft. Any loss of inventory due to damage or theft won’t be discovered until the count is done, and by that time it won’t be easy to determine where and when it happened. However, because you don’t have to account for the cost of inventory for each and every sale, the periodic accounting method is simpler and easier to work with if you are running separate software systems for accounting and inventory management.

With the Cost of Sales accounting method, an entry is made on your Income Statement or Profit and Loss report (P&L) for every single sale that contains inventory. Your asset value on the Balance Sheet is decreased, and your Cost of Sale on the P&L is increased, based on the actual value of the items that have been shipped. When you buy more inventory, the purchase value is added into your assets (Balance Sheet), not into the P&L, as it would be with Periodic accounting.

Let’s see an example of this in action:

Opening inventory value: $100

Purchases made: $50 (no change to P&L)

Sale #1: $40

Cost of Sale #1: $25

Immediately we can see a gross profit for the sale made: $40 – $25 = $15.

Sales revenue during month: $200

Total cost of sale: $125

Gross profit: $75

If we continue to make 5 similar sales in the month, we have a sales revenue of $200 and a cost of sale of $125, giving the same gross profit as the periodic accounting method, but without the need for stock valuation.

We can also see the profitability in real-time. But what about the closing inventory value?

In this example, we open with $100, add $50 directly into the assets with the purchase order, and then subtract $25 for each of the 5 sales made, leaving $25 at the end of the period.

Inventory at start of month: $100

Inventory purchased: $50

Inventory sold: $125

Inventory at end of month: $25

Closing inventory value: $100 + $50 – (5 x $25) = $25

When you receive goods into stock, it is essential that you enter the most accurate cost value available. The software platform should account for any slight discrepancies if the actual value is given on the purchase invoice. Receiving inventory later is different. To benefit from Cost of Sale accounting; purchasing, inventory and accounting processes need to be tightly integrated, and ideally all operate within the same software platform. Through a single configuration, accurate data can be accessed in real-time, since transactions are automated and opportunities for error are reduced.

These days, few companies are still tracking and managing their inventory with a pen and paper. And while rudimentary spreadsheets are still a common sight in smaller businesses, for any organization that operates a warehouse, you can almost guarantee that some kind of inventory management software is in use.

What’s more, your inventory management system also includes any applications you use in your order fulfillment processes. For example, your e-commerce platform at one end, and your distributor’s shipping management app at the other.

To optimize your inventory management for efficiency and automation, you need accounting software that integrates with both e-commerce platforms and order fulfillment solutions, not to mention payment networks, point of sale systems, business intelligence, and reporting tools.

With over sixty custom integrations available in the Brightpearl app store, and Brightpearl itself representing a holistic Retail Operating System you can be sure that everything syncs seamlessly.

Among the most important features of good accounting software for inventory is the ability for it to account for sales tax.

Depending on which tax jurisdictions you sell in, you will need to pay different amounts of sales tax on different products.

When setting up Brightpearl, you can configure it for whichever regimes you operate within, taking the hassle out of paying tax in different countries and helping you to keep on top of all relevant sales taxes.

There are many advantages of using a multifunctional operating system for managing your inventory accounting. One is that it allows you to collect varied accounting and inventory data to generate actionable insights that have value to other departments besides accounting.

For example, Brightpearl helps you calculate customer lifetime value, average order value, profit margin, and more. By incorporating inventory data into your business intelligence strategy, you can generate performance reports by sales channels, products, customers, advertising platforms, and marketing campaigns.

This method uses the cost of your oldest inventory when the sale is made. Even though the actual item shipped to the customer may not be the same physical item that was first delivered, the value assigned to it must be correct. The FIFO method requires that each delivery of product is recorded separately with the date and price.

The LIFO method uses the most recent inventory value for the cost of sale transaction when the sale is made. If the cost price of a product is increasing over time, then LIFO will result in the lowest profit (and lowest tax), since the most recent costs will be higher than the oldest costs.

If your system does not track each delivery of inventory separately, then you need to apply a single cost to each item when you value the inventory (either for cost of sale transactions or for a month end periodic stock valuation). This single cost value averages out the price paid for the items currently in stock.

As we’ve seen, the value of inventory is the price that you pay your vendor, excluding tax and shipping. But what if you manufacture your own products? If you assemble finished products from components, then there will be a cost incurred during the assembly process. You need to make sure you don’t count this twice in your accounting!

If your build cost per item is significant, consider including the cost of manufacture into your product cost price, as seen in this example:

Component A: $10

Component B: $13

Assembly: 1 hour @ $20 per hour

Total cost: $33

It will then appear on your Income Statement when the item is sold, giving more accurate profitability reports. If the assembly is completed by full-time employees on payroll, then you will need to remove their rate of $20/hour from the “Wages” overhead code on your Income Statement, and add it into “Inventory / Assets” each time you build one of these items. You’ll still record the payment of wages at the time of the build, so your cash reporting will also be correct. Similarly, if you outsource your manufacturing, you’ll need to transfer the correct amount from the Income Statement “Manufacturing” code into your “Inventory / Assets” code.

Note that reducing overheads will increase your short term profit, since you are adding value to your assets and deferring the build cost into a later Cost of Sale transaction.

When you spend a significant amount of money on freight and duty to get goods delivered to you, the effective cost of products is higher than the net cost price that you pay your vendor. The “landed cost” includes the extra charges, but how do you account for this? If you receive a mix of goods in a single shipment, then working out the effective shipping cost for each item may be difficult: do you split the shipping cost across your products by weight, by volume or by item cost price?

Sometimes you have a single freight or duty invoice that covers multiple shipments that were all sent together. Because this is complex, there are not many software platforms that handle it well, if at all. This means that you’re best building your own custom spreadsheet, if not using a system that fully supports landed costs. Use your spreadsheet to work out a “freight and duty” cost for every item in each delivery, as it comes in, and then add this to the net cost price of the item to get your landed cost.

Since you’re already accounting for the freight and duty via the freight company invoice, you should not amend the asset value of the inventory in your accounting software unless you also amend the accounting entries for the freight and duty invoices. This is usually more complex than it’s worth. To calculate profit margins using landed cost, compare your net sales price with your landed cost price in Excel, or create an extra price list for “landed cost” in your product management system and use the margin reports there.

Alternatively, the simplest way of accounting for landed costs is to use a system, like Brightpearl that supports this, giving you access to your true cost across products and purchases. Your system should enable you to split the costs based on item weight, volume and value and update all of the necessary accounting transactions at the same time.

• Receive the inventory into your system at the price that you expect to pay, and make sure that any accounting transactions are made against a dedicated account code.
• You can see this in the following example scenario:
• Your regular inventory is received into “1001 – Inventory” (assuming you’re using a Cost of Sales accounting method).
• When you receive consignment inventory, receive it into “1002 – Consignment Inventory”.
• At the end of the accounting period, you exclude this figure from management reports.
• The balancing side of the double-entry accounting transaction would be against an account code “2050 – Inventory received, not invoiced”.
• As sales are made from the consignment inventory, cost of sales accounting transactions will be made using the price you’re expecting to pay, removing value (credit) from “Consignment Inventory” and adding it to “Cost of Sales” (debit).
• From there, a report is sent to the distributor detailing everything sold. In return, they invoice you.
• To balance these transactions, the invoice is recorded against the original account code: “2050 – Inventory received, not invoiced”.

With this technique, you still receive the inventory so it reflects in your sales channels, but you give it a zero value to prevent accounting transactions from being made. When you do a stock take, the items show in stock, but your Balance Sheet is not affected. Similarly, when you make a sale, no accounting transactions are made since the asset has no value. If you’re using Periodic Accounting, don’t include the consignment inventory in the stock valuation at the end of the period.

When you receive the purchase invoice for items sold, you need to allocate it directly to a COGS code (in the Expenses/Purchases section of your Chart of Accounts), even if you are using Cost of Sales accounting.

The second process is simpler – you don’t see the cost component of a sale (for profit reporting) until you have received the purchase invoice. With the first method, you see a provisional cost of sale every time an item is shipped, but the actual value is not known until the supplier’s purchase invoice is received.

For either method, it’s handy to receive the inventory into a dedicated “location”. This could be a virtual aisle or a virtual warehouse, if you have a multi-warehouse system. This makes it easier to filter reports to separate owned inventory from consignment inventory.

When you sell goods to a customer and generate an invoice, it may be entered into your accounting system immediately but the goods may not ship until the following day or later. If so, you need to decide whether you want the cost of sale transaction to be dated as per the sales invoice date or the date of shipment. If you decide the sales invoice date and the shipment date need to be the same, your profit reports will be easier to understand, since the cost and the revenue are in the same period. Even though the asset will have been removed from the Balance Sheet, an inventory report on that date will show items in stock, since their shipment is still pending.

The value of inventory from a stock take should reconcile with your asset value on the Balance Sheet, so if you choose to back-date your shipments, you’ll need to make adjustments for “inventory in stock on invoiced sales”.

It’s rare that a purchase invoice is received into your system on the same day that the inventory is received. Similarly, you don’t always ship goods to a customer on the same day that you invoice them. These timing differences will cause discrepancies in your accounting unless you put methods in place to factor for them.

If you’re using Cost of Sales accounting, then the point at which you receive inventory is the point at which you increase your asset value. If the purchase invoice has not yet been received, you need to account for the liability another way. You are holding stock for which you have not yet been invoiced (or paid for), so a liability account should be used. This shows show on your Income Statement – perhaps within the code: “2050 – Inventory received, not invoiced”.

Your accounting journal should look something like this:

Debit Credit Inventory / Asset: $100

Inventory received not invoiced: $100

When the invoice arrives, you assign it to this code and the liability is transferred to your Creditors (Accounts Payable), as seen here:

Debit Credit Inventory received not invoiced: $100

Accounts Payable: $100

If you’re using Periodic Accounting, an inventory transaction is not processed when goods arrive since inventory is counted at the end of the period rather than on every sale. When a purchase invoice is received, the invoice value is recorded into a “Purchases” P&L code, as shown below:

Debit Credit Purchases: $100

Accounts Payable: $100

With the Cost of Sales accounting method, if you sell goods to a customer before receiving the purchase invoice that reflects the actual cost value, how do you calculate the cost of sale transaction? Use the provisional cost as recorded when the goods were received.

When the purchase invoice is later reconciled against the purchase order, make any corrections. If your accounting system is not integrated with your inventory management system, then you’ll lose this detail. Depending on the inventory management platform you use, you may get the provisional cost of sale figure or the corrected cost of sale figures.

Generally, however, this isn’t a major issue unless your cost prices are changing significantly and regularly. The important thing is to make sure that your goods-in process records inventory at the most realistic cost price possible.