Inventory Accounting Basic Principals
Do you understand your inventory transactions?
When you purchase an item to be resold, technically you are creating an expense (money has been paid out of your business), but because your purpose is to resale the item, it then becomes an Asset and is added to your Inventory.
Inventory is accounted for on your balance sheet (raising your Assets), not your P&L. Regular expenses, like rent and internet are accounted for on your Profit and Loss Statement (P&L).
When you purchase an item for inventory the following basic steps need to be followed:
You need to add that item to your inventory tracking software, including the cost that was paid for the item and the sales price at which you expect to resell it for. Some Inventory Tracking Systems allow you to do this by creating a Purchase Order for that item.
You need to match the 'expense' of the item to the inventory item, therefore not letting the money become an actual expense on the P&L. This is another reason I advise an Inventory Tracking System and a Bookkeeping System, making this more streamlined.
Once the item is sold, the following transactions need to be followed:
When your item is sold, the item gets removed from Inventory (lowering your assets).
The money you earned from the item becomes Income, or Sales of Product Income (raising your income).
Because you had a cost in the item initially, the cost will also be offset by Cost of Goods Sold (moving the item from inventory to sold, therefore raising expenses).
The net of the Sales of Product Income and Cost of Goods Sold is your actual Profit amount on that item.
You purchased a camera for $100. (Inventory)
You sold the camera for $150. (Sales of Product Income)
The original Cost of Goods Sold was $100. (Original purchase amount)
Net Profit of the camera is $50.
If you find all of this to be a bit complicated and are questioning if you are tracking your inventory accurately, let's chat, I can help!