Every year your inventory valuation has to be recorded in your balance sheet. This implies two main choices:
- the way you compute the cost of your stored items (Standard vs. Average vs. Real Price);
- the way you record the inventory value into your books (periodic vs. Perpetual).
Costing Method
- Standard Price
Operation Unit Cost Qty On Hand Delta Value Inventory Value $10 0 $0 Receive 8 Products at $10 $10 8 +8*$10 $80 Receive 4 Products at $16 $10 12 +4*$10 $120 Deliver 10 Products $10 2 -10*$10$20 Receive 2 Products at $9 $10 4 +2*$10 $40 Standard Price means you estimate the cost price based on direct materials, direct labor and manufacturing overhead at the end of a specific period (usually once a year). You enter this cost price in the product form.
- Average Price
Operation Unit Cost Qty On Hand Delta Value Inventory Value $0 0 $0 Receive 8 Products at $10 $10 8 +8*$10 $80 Receive 4 Products at $16 $12 12 +4*$16 $144 Deliver 10 Products $12 2 -10*$12$24 Receive 2 Products at $6 $9 4 +2*$6 $36 The Average Price method recomputes the cost price as a receipt order has been processed, based on prices defined in tied purchase orders: FORMULA (see here attached)
The average cost does not change when products leave the warehouse.
From an accounting point of view, this method is mainly justified in case of huge purchase price variations and is quite unusual due to its operational complexity. Your actually need a software like Vorlik to easily keep this cost up-to-date.
This method is dedicated to advanced users. It requires well established business processes because the order in which you process receipt orders matters in the cost computation.
- FIFO
Operation Unit Cost Qty On Hand Delta Value Inventory Value $0 0 $0 Receive 8 Products at $10 $10 8 +8*$10 $80 Receive 4 Products at $16 $12 12 +4*$16 $144 Deliver 10 Products $16 2 -8*$10-2*$16$32 Receive 2 Products at $6 $11 4 +2*$6 $44 For Real Price (FIFO, LIFO, FEFO, etc), the costing is further refined by the removal strategy set on the warehouse location or product’s internal category. The default strategy is FIFO. With such method, your inventory value is computed from the real cost of your stored products (cfr. Quantitative Valuation) and not from the cost price shown in the product form. Whenever you ship items, the cost price is reset to the cost of the last item(s) shipped. This cost price is used to value any product not received from a purchase order (e.g. inventory adjustments).
FIFO is advised if you manage all your workflow into Vorlik (Sales, Purchases, Inventory). It suits any kind of users.
- LIFO (not accepted in IFRS)
Operation Unit Cost Qty On Hand Delta Value Inventory Value $0 0 $0 Receive 8 Products at $10 $10 8 +8*$10 $80 Receive 4 Products at $16 $12 12 +4*$16 $144 Deliver 10 Products $10 2 -4*$16-6*$10$20 Receive 2 Products at $6 $8 4 +2*$6 $32 For Real Price (FIFO, LIFO, FEFO, etc), the costing is further refined by the removal strategy set on the warehouse location or product’s internal category. The default strategy is FIFO. With such method, your inventory value is computed from the real cost of your stored products (cfr. Quantitative Valuation) and not from the cost price shown in the product form. Whenever you ship items, the cost price is reset to the cost of the last item(s) shipped. This cost price is used to value any product not received from a purchase order (e.g. inventory adjustments).
LIFO is not permitted outside the United States.
Vorlik allows any method. The default one is Standard Price. To change it, check Use a ‘Fixed’, ‘Real’ or ‘Average’ price costing method in Purchase settings. Then set the costing method from products’ internal categories. Categories show up in the Inventory tab of the product form.
Whatever the method is, Vorlik provides a full inventory valuation in (i.e. current quantity in stock * cost price).
Periodic Inventory Valuation
In a periodic inventory valuation, goods reception and outgoing shipments have no direct impact in the accounting. At the end of the month or year, the accountant posts one journal entry representing the value of the physical inventory.
This is the default configuration in Vorlik and it works out-of-the-box. Check following operations and find out how Vorlik is managing the accounting postings.
- Vendor Bill
Debit Credit Assets: Inventory 50 Assets: Deferred Tax Assets 4.68 Liabilities: Accounts Payable 54.68 - Configuration:
- Purchased Goods: defined on the product or on the internal category of related product (Expense Account field)
- Deferred Tax Assets: defined on the tax used on the purchase order line
- Accounts Payable: defined on the vendor related to the bill
- Goods Receptions
- No Journal Entry
- Customer Invoice
Debit Credit Revenues: Sold Goods 100 Liabilities: Deferred Tax Liabilities 9 Assets: Accounts Receivable 109 - Configuration:
- Revenues: defined on the product or on the internal category of related product (Income Account field)
- Deferred Tax Liabilities: defined on the tax used on the invoice line
- Accounts Receivable: defined on the customer (Receivable Account)
The fiscal position used on the invoice may have a rule that replaces the Income Account or the tax defined on the product by another one.
- Customer Shipping
- No Journal Entry
- Manufacturing Orders
- No Journal Entry
At the end of the month/year, your company does a physical inventory or just relies on the inventory in Vorlik to value the stock into your books.
Then you need to break down the purchase balance into both the inventory and the cost of goods sold using the following formula:
Cost of goods sold (COGS) = Starting inventory value + Purchases – Closing inventory value
To update the stock valuation in your books, record such an entry:
| Debit | Credit | |
|---|---|---|
| Assets: Inventory (closing value) | X | |
| Expenses: Cost of Good Sold | X | |
| Expenses: Purchased Goods | X | |
| Assets: Inventory (starting value) | X |
Perpetual Inventory Valuation
In a perpetual inventory valuation, goods receptions and outgoing shipments are posted in your books in real time. The books are therefore always up-to-date. This mode is dedicated to expert accountants and advanced users only. As opposed to periodic valuation, it requires some extra configuration & testing.
Let’s take the case of a reseller.
Configuration:
- Accounts Receivable/Payable: defined on the partner (Accounting tab)
- Deferred Tax Assets/Liabilities: defined on the tax used on the invoice line
- Revenues: defined on the product category as a default, or specifically to a specific product.
- Expenses: this is where you should set the “Cost of Goods Sold” account. Defined on the product category as a default value, or specifically on the product form.
- Goods Received Not Purchased: to set as Stock Input Account in product’s internal category
- Goods Issued Not Invoiced: to set as Stock Output Account in product’s internal category
- Inventory: to set as Stock Valuation Account in product’s internal category
- Price Difference: to set in product’s internal category or in product form as a specific replacement value