Part 1
The account inventory asset is where the total value of your companies inventory is held. This account shows up on the balance sheet.
But what you have to understand is that the account inventory asset, by itself really has no value. All the account does is display the total of the inventory sub-accounts. When you double click on inventory asset on the balance sheet to get a detail account listing what you are getting is the transactions posted to all the sub accounts.
An inventory sub-account is nothing more than an account for each and every inventory item and assembly item you have listed in the item list. So if you could see how QB lists things, the inventory asset account and sub-account list would look something like this.
Inventory Asset, total=0
widget-A qty=0 ave-cost=0 value=0
widget-B qty=0 ave-cost=0 value=0
widget-C qty=0 ave-cost=0 value=0
widget-D qty=0 ave-cost=0 value=0
widget-E qty=0 ave-cost=0 value=0
When you buy one widget-A for 13.50, the account structure looks like this
Inventory Asset, total=13.50
widget-A qty=1 ave-cost=13.50 value=13.50
widget-B qty=0 ave-cost=0 value=0
widget-C qty=0 ave-cost=0 value=0
widget-D qty=0 ave-cost=0 value=0
widget-E qty=0 ave-cost=0 value=0
What happened is that QB increased the qty on hand for widget-A and entered the value and calulated the ave-cost, then the account inventory asset added up all the value amounts in the sub-accounts and displays a total.
So lets buy 5 more of widget-A and you got a deal this time, the total cost for 5 is 21.75
QB sets the qty for widget-A at 6 (5 new + the one on hand)
QB sets the total value to 35.25 (old value + new purchase price [13.50+ 21.75])
Then QB calculates average cost for the 6 that are on hand (35.25 / 6 = 5.875)
So the account structure now looks like this (to save space I am not showing all the other widgets in inventory):
Inventory Asset, total = 35.25
widget-A qty=6 ave-cost=5.875 value=35.25
widget-B qty=0 ave-cost=0 value=0
Then we make two seperate purchases of widget-B, 3 for 5.50 and 7 for 9.99 – the numbers below show the inventory accounts as the first purchase (number 1) is recorded and then the second (number 2) is recorded.
1. Inventory Asset, total = 40.75
widget-A qty=6 ave-cost=5.875 value=35.25
widget-B qty=3 ave-cost=1.33333 value=5.50 (QB only carries calculations out to 5 decimal places)
2. Inventory Asset, total = 50.74
widget-A qty=6 ave-cost=5.875 value=35.25
widget-B qty=10 ave-cost=1.549 value=15.49
And the opposite thing happens when you sell something. The quantity on hand is reduced, and the total value of the item is recalculated, and of course the account inventory asset adds up the new total values and displays the new result.
Let’s sell 2 of widget-A (number 1) and 4 of widget-B (number2) (I am not going to go into the sales income here but it goes the sales income account you select on the item screen)
We had the following:
Inventory Asset, total = 50.74
widget-A qty=6 ave-cost=5.875 value=35.25
widget-B qty=10 ave-cost=1.549 value=15.49
1. Inventory Asset, total = 38.99
widget-A qty=4 ave-cost=5.875 value=23.50
widget-B qty=10 ave-cost=1.549 v value=15.49
What happened was that QB lowered the quantity by the 2 you sold, then it multiplied the 2 you sold by the average cost and sent that amount to the expense account you selected on the item screen (normally COGS), then QB subtracted the amount sold from the total value to get the new total value of what is left in inventory.
6 – 2 = 4 remaining on hand
2 * 5.875 (ave-cost)= 11.75 cost of items sold
35.25 – 11.75 = 23.50 value of what is on hand
2. Inventory Asset, total = 32.79 ( it is actually 32.794 but QB rounds to two decimals when displaying)
widget-A qty=4 ave-cost=5.875 value=23.50
widget-B qty=6 ave-cost=1.549 value= 9.294
Notice that nothing ever happens to the account inventory asset, everything is done to the sub-accounts.
Since QB never does anything to the account inventory asset, neither should you!
Part 2 – what happens when you build an assembly
An assembly in QB is a set of inventory parts that make a new part you stock and sell. That list of parts is normally called a “Bill of Materials” or BOM for short.
Our assembly for this is going to be called hoogalator, which is different than “thing-a-ma-bob” – little attempt at humor here.
The hoogalator BOM looks like this
Assembly hoogalator
widget-A qty 2
widget-B qty 1
That means that to build one hoogalator you have to have 2 of widget-A and 1 of widget-B for every hoogalator you build.
The inventory asset account list looks like this to start with.
Inventory Asset, total = 32.79
widget-A qty=4 ave-cost=5.875 value=23.50
widget-B qty=6 ave-cost=1.549 value= 9.294
hoogalator qty=0 ave-cost=0 value=0
Then you tell QB to build one hoogalator. QB looks at the BOM to see what is needed and checks the qty on hand of each item in the BOM, if there are enough parts on hand then it will build the hoogalator. When you see the build assembly screen, at the bottom of the screen it tells you how many assemblies you can build based upon the parts on hand.
This is going to be hard to follow I think but bear with me.
QB takes two of widget-A and holds the cost of those two aside as part of the cost of the hoogalator you are building, so the widget-A item was
widget-A qty=4 ave-cost=5.875 value=23.50
and is now
widget-A qty=2 ave-cost=5.875 value=11.75
Then QB takes one of the widget-B item and holds the cost aside as part of the cost of the hoogalator you are building, so the
widget-B item was
widget-B qty=6 ave-cost=1.549 value= 9.294
and is now
widget-B qty=5 ave-cost=1.549 value= 7.745
Then QB adds up the costs of widget-A and widget-B to get 13.299 (11.75 [widget-A] + 1.549 [widget-B]) and sets the quantity of the hoogalator to one and the value to 13.299, then it calculates ave-cost.
Now the inventory asset account list looks like this
Inventory Asset, total = 32.79
widget-A qty=2 ave-cost=5.875 value=11.75
widget-B qty=5 ave-cost=1.549 value= 7.745
hoogalator qty=1 ave-cost=13.299 value=13.299
When you add up the total value of the items in inventory you get 32.794 which displays as 32.79. The same total value for inventory asset as we had before we built the hoogalator.
So all building an assembly does is reassign the costs of the parts to another part, and of course changes the quantity on hand for the parts that are involved.
I am not going to go through the assembly after you have another purchase of a widget which results in a different average cost for the widget. QB always uses the **current** average cost when building an assembly. As a result the new assemblies built may have a different total cost than those you built last time. When that happens QB handles the sub-account the same way it handles an inventory item sub-account. Quantity is increased by the number built, items in the BOM are lowered by the quantity used, the new cost of the assembly you built is added to the old value of what is on hand for that assembly, and a new assembly ave-cost is calculated.
And once again there is no entry being made to the inventory asset account itself.
Part 3 – adjustments
So if you followed the above ramblings you should know that nothing ever happens to inventory without it affecting both the quantity on hand and the ave-cost.
Double entry bookkeeping requires that every debit (increase) in an account there is a credit (decrease) in one of the other accounts. And that holds true for adjustments too.
When you adjust an inventory item so the quantity is lower, not only the qty is lowered, but the cost of that quantity has to go somewhere, usually an expense account. So if you did a physical inventory, as an example, and found that 1 widget-A was missing, you would bring up inventory adjust and lower the quantity of widget-A by one. And the cost of the widget you lost or was stolen or was destroyed has to go somewhere – typically a COGS-lost expense account. It can be named whatever you want, but an expense to the business it is. And that is why you have to select an account on the adjustment screen, that account you select is where the cost of that inventory item is posted to.
When you adjust inventory quantities higher, the cost of the new items has to come from somewhere, and this is where most people get lost. Mostly because they don’t think it through. Anything that adds to the business is an income to the business, but what kind of income is the question.
——example 1——
In the above example you lost a widget-A and sent the cost of the loss to an expense account. Suppose on your next physical inventory you find the widget-A (maybe someone had it in the shop van for some reason). To increase the qty on hand you also need to increase the cost of the total number of widget-A. And here it gets dicey, there are two situations to consider.
If you have bought more of widget-A between the loss and finding it again, the average cost of the item widget-A has probably changed. If you just do an adjustment increasing the quantity and select the COGS-loss account (since that was where you posted the loss to and it is not a loss now) what QB will do is take the **current** ave-cost out of the selected account. So before you just add the quantity you need to run a quick report on the COGS-loss account and find out what the cost was.
1. If the ave-cost in the COGS-loss account is the same as the ave-cost on the item screen, fine make the adjustment.
2. But if the ave-cost in the COGS-loss account is not the same as the current average cost, you need to make a value adjustment, instead of a plain inventory adjustment.
a. Write down the value of the adjustment found in the COGS-loss account
b. Bring up inventory adjust and at the lower left click value adjustment
c. Find the item widget-A and note down the current value that is displayed
d. Increase the quantity of widget-A AND add the value of the adjustment to the current value and enter the new total value in the new value column.
Doing it that way tells QB how much to take out of the account COGS-loss, the same amount you sent there when you thought it was a loss. QB will calculate the new average cost for widget-A and use that going forward.
——example 2——
Let’s say you have some of widget-A on hand as personal items and you want to give those to the business. This situation can get arguments because there are basically two ways of looking at it. You are donating something of value to the business and donations are an income to the business, but you are also adding to your equity just as if you invested more money to keep the business going. Since you are the owner I tend to fall on the equity side of this argument.
So I first set a value for the widget-A that I have on hand. Then bring up inventory adjust, set it to a value adjustment, find the widget-A and increase the quantity on hand by the number I am giving over, then add the value I set to the current value and enter it in the new value column. I select the equity account “Owner-investment” as the adjusting account. QB will throw up a warning about it normally being an expense account kind of thing, just click through it.
——example 3——
If you brother has some of widget-A and wants to donate them, you use the same process as above except you select an income account for donations (which you will probably have to set up first). And again click through the QB warning.
——example 4——
If all this seems too much trouble, you can go another route.
What I do in situations like this is to look at the current value of the item (that means you have to have the adjustment marked as a value adjustment), then when I change the qty QB fills in the new value amount. But you will notice that the new value QB fills in is based upon the current ave-cost (QB takes the current ave-cost and multiplies it by the new quantity to get new value). If the difference between the old and the new is not too significat, I set the new value to the old value and let it lower ave-cost per item.
Basically that brings the widgets on hand with a zero change to income or equity.
——Conclusions——
You cannot do anything to inventory without affecting cost and quantity at the same time.
Never post an adjustment to the account Inventory Asset, not using the general journal or the inventory adjustment screen.
And yes the accounts called “Accounts Receivable” (and Accounts Payable) work the exact same way, each customer (or vendor) is a sub-account.