When recording journal entries for the cost of goods sold, accountants work in tandem with manufacturing or operations to ensure they’re booking the correct costs. Support from production personnel is essential to back-up journal entries and remain compliant with U.S. GAAP. These points and those below are part of the inventory cost recordation process.
What is Cost of Goods Sold?
The inventory cycle is made up of three phases. These include the ordering phase, the production process, and the finished goods and delivery phase. Many of the transactions associated with the manufacturing and shipping of inventory held for sale are classified as COGS, or Cost of Goods Sold. While an expense, these costs are displayed directly beneath sales on the income statement so that users of the financial statement can make determinations about gross margin and profitability. Businesses with these inventory valuation costs listed on the income statement include retailers of consumer or specific products such as shoes, clothing, vehicles, and beverages.
The inventory account on the balance sheet lists the value of inventory and is considered a separate line item relative to the expense recognized on the profit and loss statement. Inventory cost assumptions, such as LIFO and FIFO, are important for recording inventory costs. Accounting policies and U.S. GAAP dictate the appropriateness of the inventory costing method, given the nature of the business and accounting best practices. These methods include the periodic inventory system and perpetual inventory system,
Costs Included in Cost of Goods Sold
There is a simple formula associated with calculating the inventory cost: Beginning inventory plus inventory purchases minus ending inventory equals COGS. If a company makes inventory at a production facility, then the cost of goods manufactured plays a role in determining cost. Expenses such as direct labor cost, direct materials, and overhead costs factor into the equation. Production departments work with purchasing and purchase orders to order the raw materials used in COGM. Accounting personnel must track these costs to ensure accurate financial reporting at the end of the period.
Recording Cost of Goods Sold
When recording the journal entry for the cost of inventory, posting to the appropriate accounting period is critical to remain consistent with the matching principle. Typically Excel spreadsheets are used to track the current period inventory costs. I should use this spreadsheet to support the journal entry and tie it back to general ledger accounts, such as work-in-progress inventory accounts. There should also be a tie-out between production tracking records and the accounting inventory cost spreadsheets.
Knowing the difference between a regular expense and the cost of goods sold is of the utmost importance when preparing journal entries with double-entry accounting. A company policy is typically in place, dictating dollar thresholds, rules, and the circumstances under which costs can be added to COGS. For example, freight-in charges may be added to COGS, but only if specific criteria are met. Knowing the rules will help ensure auditors and business owners alike agree with the costs recorded for inventory.
In summary, when preparing a journal entry for inventory costs, accountants must select the correct expense account and support to justify the entry. These entries must be done with care to remain in compliance with U.S. GAAP and prevent misstatement of the financial statements. Line items such as inventory and accounts receivable are under constant review by auditors at the end of the accounting period, making accuracy a priority.