If you are using QuickBooks to manage your inventory, you need to understand how QuickBooks deals with the cost of inventory items. Unfortunately, the term “cost” is used in several different ways, and it can get confusing. Here is a quick rundown of how QuickBooks handles things.
I’ll focus on Inventory Part items, which are the true “inventory” items in QuickBooks, with a little detour to talk about Inventory Assembly items.
Cost Fields in QuickBooks
If you look at an Inventory Part item, you will see that there are two cost fields.
Cost, on the left, is a “reference” field. That is, it doesn’t have any direct bearing on the valuation of your inventory, the cost of your inventory in your inventory asset account. I wish they had another name, because it is confusing to talk about it. I refer to this as the “last purchased cost”, although that isn’t always exactly right.
If you purchase an item and receive a bill for it, the cost that you receive the item at will usually be stored here (but not always, that depends on how your company file is set up). You can edit this cost directly in this window. This does not have a direct effect on your inventory valuation.
The avg cost field, bottom center, is the field that is used in the calculation of the value of your inventory. This is calculated by QuickBooks based on the cost of receipt (and adjustment) transactions. You cannot directly edit this in this window.
If you look at the edit item window for an Inventory Assembly item you will see a third cost, the total bill of materials cost, which is another “reference” cost (not directly affecting inventory valuation). I’ll discuss that in more detail later.
Inventory Valuation
QuickBooks values your inventory using an average costing calculation, as opposed to other types you may be familiar with, such as LIFO, FIFO, or specific costing. This can be a complicated subject – I am only going to go into this lightly. Let’s look at a simple example.
- If start with an item with no quantity, no value, and receive a quantity of 10 at $1.00 each
- 10 items and a value of $10.00, we added another 10 items at a value of $20.00, so, you will see that the cost is $1.00, and the avg cost is also $1.00. You have $10.00 of inventory in your inventory asset account.
- If I then receive another 10 items, but at a unit cost of $2.00, you will usually see the cost value set to be $2.00. However, the avg cost of your inventory will show as $1.50. We started with we have 20 items with a value of $30.00. That gives us an average cost of $1.50.
If you sell one of these items in an invoice, the Cost of Goods Sold (COGS) account is incremented by the average cost of the item at the time of the sale.
One thing that I will note, briefly – if you sell all of your inventory, and then continue to sell the item so that you go to a negative quantity, the costing calculation runs into problems. QuickBooks can’t accurately account for a negative balance, and you can see some very odd figures show up in the average cost field, and your inventory valuation reports. Once you bring the balances back to positive these figures should resolve themselves, but it is always a good idea to not allow inventory balances to go negative.
Editing the cost field in an inventory record will have no bearing on the avg cost, or your inventory valuation. The only way to directly change the avg cost or valuation is to use the inventory adjustment function and do a “value” adjustment.
Manufacturing Cost
Let’s take a look at an inventory assembly item. The WHAS wheel assembly has two components, a screw (two of them) and a roller. Note that there are three costs shown in this window.
The Cost field (15.00) has no real bearing on valuation of this item as I have discussed above.
The Avg Cost field (32.00) is the cost that QuickBooks uses to calculate the value of this item.
The Total Bill of Materials Cost field (32.00) is not directly tied to the cost or avg cost values. This is the sum of the cost values of the components in the BOM. In our starting example it matches the avg cost, but they are not connected.
If I build this assembly item, the avg cost of the assembly will NOT be adjusted by this total bill of materials cost. Instead, QuickBooks will take the avg cost of the component items and roll that into the received cost of the assembly. You can’t look at this screen and tell what the exact cost of the build will be. Remember, the total bill of materials cost shown here is based on the cost field of the components, not the avg cost value. But avg cost is what is used in valuation.
For a more detailed explanation of costs in inventory assembly items, see my article on Understanding Total Bill of Materials Cost in QuickBooks.
A reader asked the following question:
We are a small contractor in San Diego and we are wondering how we get around having to always do an inventory adjustment to get our purchases to the correct COGS account? We have (2) departments but they are both doing construction projects: Service dept does smaller installs and Contracts dept does the bigger jobs so I have been doing a JE to move the material from the Contracts material COGS account to the service COGS account.
Is there an add-on for QB Enterprise 8 that we could use?
Thank you so much for your website/blog. I’ve been reading it faithfully every day!
____________________________________________________________________
There are several inventory add-ons for QuickBooks Pro, Premier and Enterprise; check out these 3rd party add-ons at the Intuit Marketplace.
Recording costs and income with an item
Based on your comment about “always having to do an inventory adjustment in order to get your Purchases to the correct COGS account”, makes me think that perhaps your items are not correctly set up.
Make sure that your QuickBooks Inventory Items are set up so that they capture both the cost/purchase account as well as a sales account; this method is called a “double-sided” item.
When any type of QuickBooks Service, Inventory, Non-Inventory, Other Charge Item is set up this way you are able to capture the purchase price as well as the sales price.
When you enter a bill from a vendor for the inventory item (or write a check) you should be using the ITEM tab and not the Expense tab.
I’m confident that if you aren’t currently using the QuickBooks Purchase Order function that you would find that beneficial also.
Additionally, rather than using Journal Entries to classify whether it was the Service or Contracts Department – consider using “classes” to handle that.
Question:
How do I determine the Cost of Goods Sold for an item?
Answer:
I tell my clients that Cost of Goods Sold (COGS) is any cost incurred that directly relates to getting the sold goods out the door.
I have them ask the question “Would you have this expense if you hadn’t made the sale?”
Typical examples of COGS are product purchased for resale, subcontractors or vendors you hire specifically for preparing a product for sale, shipping materials like packaging, freight costs of receiving the resale product and shipping the product to your customers, payroll/labor costs of your employees who are directly related to preparing the goods to be sold or shipped out (would you have hired them if you didn’t have the product to sell?).
Costs that are not directly related to getting the product out the door are considered Expenses or Operating Expenses and include things like your liability insurance premiums, telephones, office supplies, office-related postage and delivery, advertising, clerical payroll, employee benefits and health insurance for the employees and would be considered costs of managing the paperwork for the overall business,
Again, if you would have the expense if you weren’t selling your product or service, it is an expense considered overhead. If you have the expense only because you selling the product or service, it’s COGS.
This is a very simplistic definition and there are certainly areas of disagreement among different people, but if you relate it strictly to your business you should be able to come up with your COGS vs Expenses.
In a nutshell…
Cost of Goods sold is anything and everything that costs you money to buy items for resale, have them delivered to your store to sell, package and label them, import them, fix them or otherwise make them fit to sell.
If it costs you $100 to purchase an item, $5.00 to have each one shipped to your store, it costs $2.50 each in import duty and taxes, $10.00 each to have them inspected by QC, and $5.00 each to fix little problems with each item, your COGS is $122.50.
The QuickBooks Chart of Accounts is the framework used to categorize the information and transactions used to create reports. By using a chart of accounts and creating reports, you will always know the current state of your business.
The chart of accounts is made up of five types of accounts common to all businesses- the income and expense accounts used by the Profit and Loss Statement, and the asset, liability, and equity accounts used by the Balance Sheet. Each time you enter a transaction, QuickBooks will prompt you to categorize it into one of these five types of accounts.
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Questions & Answers:
Why is the chart of accounts important? The Chart of Accounts is the backbone of your accounting system. It is the complete list of all the accounts you need to categorize your business activities. Based on the information you provide in this interview, QuickBooks will create a recommended Chart of Accounts that is designed to track your business and help you to make good financial decisions for your company. As your business grows, you can tailor your Chart of Accounts to meet your business needs. Understanding your chart of accounts. The chart of accounts is the backbone of your accounting system. That’s why it’s so important to understand how it works. Think of a chart of accounts as a file cabinet, with a file for each type of accounting information you want to track. For example, if you need to know how much money you spend on postage, you’ll set up a file (an account in the chart of accounts) for Postage Expense. Although you aren’t required to use account numbers in your chart of accounts in QuickBooks, your accountant may recommend that you do so. |
What are standard chart of accounts number ranges?
You’ll find that many accounting professionals will have their “own” numbering theory, however, below is a list of Standard chart of accounts number ranges that we feel is best suited to the construction indusry – you may wish to print this article for future reference.
| Account # | Type, Description, and Examples |
| 10000-19999 | Assets
Assets are things your company owns. They’re usually divided into two groups-current assets and fixed assets. Current assets are generally numbered from 10000- 14999. These are assets that you can easily turn into cash, such as checking accounts, savings accounts, money market and CD accounts, accounts receivable, and inventory. So you might want to use account number 10000 for your company checking account because a checking account is a current asset.
Fixed assets are usually numbered from 15000 – 19990. These are items with a minimum cost (for example, $500.00 or more) that you would have to sell to generate cash. Automobiles, equipment, and land are examples of fixed assets. For example, suppose last year your company bought a new computer system for $1,100. Since the cost of the system was more than $500, the purchase was entered to an asset account rather than to an expense account. Consult your accountant or tax preparer to determine the actual minimum cost you should use to determine fixed assets.
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| 20000-29999 | Liabilities
Liabilities are funds your company owes. For example, say your company borrowed $20,000 from the bank. When the $20,000 loan was deposited to the checking account, the deposit was entered in the liability account Bank Loans, not an income account. Liabilities are usually broken down into two groups. Current Liabilities are generally numbered 20000-24999. These are liabilities that will be paid off within a year, this would include accounts payable, credit cards, payroll taxes, etc.
Long-term Liabilities are generally numbered 27000-29999. These are liabilities that will take more than a year to pay off, this would include a truck loan, equipment loan, a loan to buy a piece of property, etc. |
| 30000-39999 | Equity/Capital
Your capital account structure depends on whether your company is organized as a sole proprietorship, partnership, or corporation. If your company is a sole proprietorship, you need an Equity account and an Owner’s Drawing account. Use the Equity account to keep track of the total amount of money you’ve invested since starting the business. Use the Owner’s Drawing account for money you take out of the business for personal use, such as checks to the grocery store, dry cleaners, ATM transactions, your salary, and any money that gets deposited into your personal accounts. It’s important to keep in mind that the owner of a sole proprietorship doesn’t get a regular “employee” paycheck with money deducted for payroll taxes. Instead you pay quarterly estimated taxes, which you should always allocate to the Owner’s Drawing account. If your company is a partnership or LLP (Limited Liability Partnership), you need to set up Equity and Drawing accounts for each partner. If your company is an “S or C corporation” or an “LLC corporation,” it should have a Common Stock account and sometimes a Preferred Stock account. Common stock and preferred stock represent the total sum of stock the company has issued. An LLC might have Member stock if there is more than one person who owns stock. |
| 40000-49999 | Income or Revenue
“Income” or “revenue” is the income you get from your normal day-to-day business tasks, such as professional fees, income for services rendered, reimbursable expenses, or products you sell. |
| 50000-59999 | Cost of Goods Sold/Job or Project Costs/Direct Expenses
Job or Project Costs, or Cost of Goods Sold (as it is called in QuickBooks), are all the costs associated with your line of business. For example, if you’re a home builder, the job costs are whatever it costs you to build a home, including direct labor, materials, subcontractors, dump fees, and equipment rental. If you sell products, this includes cost of inventory, raw materials, freight charges, and any labor for building the finished goods. Other examples of project costs include reimbursable expenses such as overnight mail, court costs (for an attorney’s office), blue prints (for an architect), and purchases made on behalf of the customer such as furnishings bought by an interior designer or auto parts bought by a mechanic. If you design homes, the job costs include all your costs of designing a home, such as design labor, drafting materials, supplies, and engineering costs. If you do both designing and building, you’ll have both sets of costs. For professional service businesses, project costs are the costs that you incur in order to complete a project. Project costs are also referred to as direct costs. For example, if you hire an outside consultant and his or her time is billable to the customer, that is a direct or project cost. Other examples of project costs are reimbursable expenses such as overnight mail, messenger service, court costs (for an attorney’s office), blue prints (for an architect or engineer), and purchases made on the behalf of a customer, such as furnishings bought by an interior designer or computer parts bought by a computer technician. Cost of Goods Sold also includes the cost of raw materials, freight charges for getting raw material to a warehouse, labor for building the finished goods, and freight charges for getting the goods to the customer. For manufacturing businesses, the Cost of Goods Sold includes the costs incurred in producing or building a product. For a wholesale business, Cost of Goods Sold are the costs of the goods you purchase for resale. for a distributor business, Cost of Goods Sold are the costs to purchase and distribute goods to the customer. |
| 60000-69999 | Expenses or Overhead Costs
Overhead Costs, or Expenses, are fixed costs you have even if you run out of work. Examples include rent, telephone, insurance, and utilities. |
| 70000-79999 | Other Income
Other Income is income you earn outside the normal way you do business, including interest income, gain on the sale of an asset, insurance settlement, a stock sale, or rents from buildings you own. |
| 80000-89999 | Other Expense
Other Expense is an expense that’s outside of your normal business, such as a loss on the sale of an asset or stockbroker fees. |
Using Subaccounts
If you intend to use subaccounts (and we recommend that you do), when you set up your main/parent accounts, be sure to leave enough “open numbers” to be able to fit in all the subaccounts that you’ll need. It’s a good idea to plan to increment subaccount numbers by 10 and to try to number your accounts so that the names will end up alphabetically, just to make reading easier. For example you might have a main account for Insurance, and want to track subaccounts for General Liability, Health, Life & Disability; you would set it up as follows:
63300 Insurance
63310 General Liability
63320 Disability
63330 Health
63340 Life
