Bookkeeping Entries for Inventory Transactions

What You Need to Know About Inventory Transactions

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If your business manufactures products instead of offering services, you'll need to keep accounting records of your inventory transactions. Some companies buy finished goods at wholesale prices and resell them at retail. Others manufacture products.

The first type of inventory transaction you'd make would involve buying raw materials inventory, or the materials you use to make your products. You'll have to have a basic understanding of the inventory cycle and double-entry accounting methods to make the proper entries.

Double-Entry Accounting

Double-entry accounting is the process of recording transactions twice when they occur. A debit entry is made to one account, and a credit entry is made to another. A chart of accounts can help you decide which entry to make.

A chart of accounts lists each account type, and the entries you need to take to either increase or decrease each account.

The Inventory Cycle

The inventory cycle for a company is composed of three phases: ordering (or administrative) phase, production phase, and finished goods and delivery phase. The ordering phase is the amount of time it takes to order and receive raw materials.

The production phase is the work in progress phase. The last phase is the time it takes the finished goods to be packaged and delivered to the customer. The inventory cycle is measured as a number of days.

For example, the inventory cycle for your company could be 12 days in the ordering phase, 35 days as work in progress, and 20 days in finished goods and delivery.

A Transaction Overview

During a manufacturing process, after the inventory leaves the raw materials phase, it is transferred to work-in-process inventory and recorded in the corresponding account by the company bookkeeper (second entry in the table below).

The last phase of the production process is finished goods. The last entry in the table below shows a bookkeeping journal entry to record the inventory as it leaves work-in-process and moves to finished goods, ready for sale.

Usually, a bookkeeper will be entering this information in the general ledger's inventory journals for all of the products that you manufacture (if you don't have a bookkeeper, generally the owner makes the entries).

Bookkeeping

An accounting journal is a detailed record of the financial transactions of the business. The transactions are listed in chronological order, by amount, accounts that are affected and in what direction those accounts are affected.

Depending on the size and complexity of the business, a reference number can be assigned to each transaction, and a note may be attached explaining the transaction.

Inventory Bookkeeping
  Debit Credit
Raw Materials Inventory $100.00  
Accounts Payable   $100.00
  Debit Credit
Work in Process Inventory $100.00  
Raw Material Inventory   $100.00
  Debit Credit
Finished Goods Inventory $100.00  
Work in Process Inventory   $100.00

If you buy $100 in raw materials to manufacture your product, you would debit your raw materials inventory and credit your accounts payable. Once that $100 of raw material is moved to the work-in-process phase, the work-in-process inventory account is debited and the raw material inventory account is credited.

When the work is completed, the $100 is debited to the finished goods inventory account.

Transaction Upon Selling

When an item is ready to be sold, it is transferred from finished goods inventory to sell as a product. You credit the finished goods inventory, and debit cost of goods sold. This action transfers the goods from inventory to expenses.

When you sell the $100 product for cash, you would record a bookkeeping entry for a cash transaction and credit the sales revenue account for the sale. This transaction transfers the $100 from expenses to revenue, which finishes the inventory bookkeeping process for the item.

Cost of Goods Sold Journal and Cash Journal
  Debit Credit
Cost of Goods Sold $100.00  
Finished Goods Inventory   $100.00
  Debit Credit
Cash $100.00  
Sales   $100.00