Accounting for Inventory
Journal entries accounting for the sale of product are slightly more complicated than selling services. When you buy product you do not incur an expense. You only incur an expense when you sell it.
When you buy product you actually convert one asset, cash, for another asset, inventory. So assume you purchase 50 bottles of supplement for a cost of $10/bottle. The journal entry will be:
|Dec. 31, 20x1||Inventory||500|
|Purchased 50 bottles of inventory at $10 each for cash.|
What do we have (Dr.)? Inventory. How did we get the money (Cr.)? By reducing the cash account. (Cash is normally a debit; to reduce cash we credit the cash account.)
Now assume we sell one bottle of supplement for $19.00 (a 90% markup). Our journal entry is:
|Dec. 31, 20x1||Cash||19|
|Sold one bottle of supplement for cash.|
But that is not the end of it. We must also record the drop in our inventory, which has gone down by one bottle, so our next journal entry is.
|Dec. 31, 20x1||Cost of goods sold expense||10|
|Record drop in inventory from the sale of one bottle.|
Notice our profits are $9 (19.00-10.00) but our cash has gone up by $19 because we have already paid for the inventory we sold.
In practice, most accounting systems are not sophisticated enough to do this level of inventory control, although bar coding is becoming more accessible to small businesses. Normally what a business will do is wait to the end of the accounting cycle and then do a physical count of the inventory, and then work out the cost of goods sold from this formula:
Beginning inventory + Purchases – Ending inventory = Cost of goods sold
Using the example above and assuming we only sell one bottle of supplement on the last day of our accounting period:
Beginning inventory(0) + Purchases(500.)–Ending inventory(490)=Cost of goods sold(10)
Unfortunately things seldom work out this smoothly! Assume over the accounting period that your receptionist, Mary, “borrows” one bottle because she is not feeling well and figures “that is the least the clinic can do to keep her on the job.” And Slippery Sam, one of your patients, steals a bottle when Mary is out of the office. Now there are only 47 bottles on the shelf and the cost of goods sold has gone up to $30.
Beginning inventory(0) + Purchases(500.)–Ending inventory(470)=Cost of goods sold(30)
You are now showing a loss of $11 from your supplement sales (Sales 19 – Cost of goods sold 30) although you cash has still gone up by $19. (Remember we have already paid cash for the inventory.)
This simple example shows the added complexity to you operations from selling supplements and also illustrates the hidden costs of doing so. It also illustrates why you should try to avoid selling supplements “at cost” to anyone!