How to Calculate Inventory Costs in QuickBooks

Calculating inventory costs can be a complex endeavor for any business.

Luckily, QuickBooks Online provides powerful tools to streamline inventory costing and valuation across products and SKUs.

In this comprehensive guide, you'll learn step-by-step how to configure inventory items, record purchases and sales, choose valuation methods like average cost or FIFO, analyze inventory asset value and COGS, and generate insightful reports using QuickBooks Online.

Introduction to Calculating Inventory Costs in QuickBooks

Calculating inventory costs accurately is critical for businesses to understand their cost of goods sold (COGS) and properly value inventory assets. QuickBooks provides several methods to track inventory costs and automate COGS calculations.

Understanding Inventory Costs in QuickBooks Online

Inventory costs refer to the amount paid to purchase goods intended for resale to customers. As inventory is sold, its costs are transferred from the inventory asset account to the cost of goods sold expense account. The key inventory accounts in QuickBooks include:

Inventory Asset: Tracks the value of goods purchased and available for sale. This is an asset until the items are sold.
Cost of Goods Sold: An expense account that accumulates the costs of inventory items sold to customers.

COGS calculations are driven by the inventory valuation method set in QuickBooks, such as first-in-first-out (FIFO) or average cost.

Overview of Inventory Valuation Methods

QuickBooks supports several major inventory valuation methods:

FIFO: Values ending inventory and COGS based on the actual purchase costs of earliest inventory items. Assumes first items purchased are the first sold.
Average Cost: Values inventory and COGS based on the average cost of all units on hand. Smooths out price fluctuations.
Specific Identification: Allows manual assignment of costs to individual inventory items when they are sold. More precise but time-consuming.

The valuation method impacts the balance sheet value of inventory and the COGS expense flow to the income statement.

The Role of Inventory Assets in QuickBooks

As a current asset account, inventory reflects the value of goods not yet sold. Tracking inventory properly is key for accurate financial statements. Ending inventory directly impacts COGS and profits. QuickBooks automates inventory accounting based on transactions like purchases and sales, providing real-time visibility into this critical metric.

What is the formula for inventory cost?

The inventory cost formula consists of three main components:

Beginning inventory value - This is the value of your inventory at the start of the accounting period. For example, if you started January with $10,000 worth of inventory, this would be your beginning inventory value.
Inventory purchases - This includes all inventory purchases made during the accounting period. So if you purchased $5,000 more of inventory in January, this amount would be included.
Ending inventory value - The value of your inventory at the end of the accounting period. For example, if you had $12,000 worth of inventory remaining at the end of January.

The formula is:

Inventory Cost = (Beginning Inventory Value + Inventory Purchases) - Ending Inventory Value

So for the example numbers above, the inventory cost calculation would be:

Beginning inventory: $10,000
+ Inventory purchases: $5,000 
- Ending inventory: $12,000
= Inventory cost: $3,000

The inventory cost figure represents the cost of goods sold during the period. This is an important metric for determining gross margins and assessing inventory management efficiency.

Tracking inventory costs accurately requires keeping diligent count of inventory purchases, sales, returns, damages, waste, etc. By calculating the cost of goods sold each period, businesses can analyze profitability and make better decisions about pricing, suppliers, product mix, and more.

How does QuickBooks calculate inventory?

QuickBooks uses the weighted average cost method to calculate inventory value and cost of goods sold. Here's an overview of how it works:

Calculating Average Cost

QuickBooks calculates the average cost per inventory item based on the purchase transactions over time. It takes the total cost of all units purchased and divides it by the total number of units. As more units are purchased at different costs, the average cost per unit changes.

For example, say you purchased:

100 units at $1 each, so $100 total cost
Then 50 units at $2 each, so $100 total cost

You've purchased 150 units for a total cost of $200. The average cost is $200 / 150 units = $1.33 per unit.

Recording Cost of Goods Sold

When you sell inventory items, QuickBooks uses the current average cost to calculate the cost of goods sold (COGS).

If you sell 10 units with an average cost of $1.33, it will debit COGS for $13.30 (10 * $1.33). This offsets the inventory asset account.

Benefits

This weighted average method smooths out fluctuations in purchase costs. It provides a more accurate valuation over using FIFO or LIFO accounting.

The key is to keep purchase transactions up-to-date. This allows QuickBooks to precisely calculate the average inventory cost automatically.

I hope this overview explains how QuickBooks handles inventory costing and COGS calculations! Let me know if you have any other questions.

How do you calculate inventory carrying costs?

Carrying costs are additional expenses associated with holding inventory over time. To calculate inventory carrying costs, first determine the total value of your average on-hand inventory for a period. Then multiply this value by your carrying cost percentage.

Typical carrying costs range from 10-30% of inventory value per year. They may include:

Warehouse storage and handling fees
Insurance
Taxes
Depreciation from obsolescence
Opportunity cost of capital tied up in inventory

For example, if your average inventory value last year was $100,000, and your carrying cost percentage is 20%, your estimated annual carrying costs would be:

$100,000 x 20% = $20,000

To optimize carrying costs, aim to hold just enough inventory to meet demand without excess stockpiling. Analyzing historical sales data can help forecast adequate inventory levels.

Reducing carrying costs frees up cash flow to invest in other business areas. However, holding too little inventory can result in stockouts and lost sales. Finding the right inventory balance requires careful calculation using sales histories, trends, and seasonality.

What methods are used to calculate cost of inventory?

There are four main methods used to calculate the cost of goods sold (COGS) and ending inventory in QuickBooks:

First In, First Out (FIFO): With this method, QuickBooks assumes that the items in inventory that were purchased first are the first ones sold. The cost used to value ending inventory and COGS is based on the most recent purchases.
Last In, First Out (LIFO): The opposite of FIFO, LIFO assumes that the most recently purchased items are recorded as the first ones sold. Older inventory costs remain in ending inventory.
Weighted Average Cost: With this method, the cost of goods sold and ending inventory are valued by taking the average costs of all purchases made over a period.
Specific Identification: This method tracks and assigns actual costs to the specific goods that were sold. It enables you to select the exact items that make up your COGS and ending inventory.

The FIFO method is the default setting in QuickBooks. But you can choose the inventory valuation method that best suits your business when setting up inventory items. The choice impacts the value of inventory on your balance sheet and the COGS expense on your profit and loss statement.

Consult with an accounting professional to determine the optimal inventory valuation method for your business based on inventory patterns, tax implications, and accounting requirements. Record the appropriate journal entries to value inventory and COGS accordingly.

Calculating COGS Based on Inventory Method

This section will provide step-by-step instructions for calculating cost of goods sold in QuickBooks using the different inventory valuation methods.

How Does QuickBooks Calculate Cost of Goods Sold

QuickBooks calculates cost of goods sold (COGS) based on the inventory valuation method specified in your QuickBooks settings. The two main methods are:

First In, First Out (FIFO): COGS is calculated based on the cost of the oldest inventory items purchased first. This assumes the oldest products purchased are sold first.
Average Cost: COGS is calculated by taking the average cost of all units in inventory. As new inventory is purchased, the average cost changes accordingly.

By default, QuickBooks uses the average cost method. To change the inventory method and properly calculate COGS:

Go to Edit > Preferences > Items & Inventory
Select the desired inventory valuation method
Click OK to save the changes

With the correct inventory method set, QuickBooks will automatically calculate COGS each time products are sold. The cost will flow from the item receipt/purchase transaction to the item's inventory asset account, and finally to COGS at the time of sale.

Calculating COGS with Average Cost Method

With the average cost inventory method, QuickBooks recalculates the average item cost with each new purchase.

For example:

Purchase 10 units at $1 per unit => $10 total cost
Average cost = Total cost / Units in inventory
- $10 total cost / 10 units = $1 average cost
Sell 5 units => $5 COGS (5 units x $1 average cost)
Purchase 5 units at $2 per unit => $10 total cost
15 units total now in inventory
New average cost = Total cost of all units / Total units
- ($10 + $10) / 15 units = $1.33 average cost
Sell 3 units => $3.99 COGS (3 x $1.33 average cost)

Updating the average cost each time ensures COGS reflects the most recent actual inventory costs.

Comparing QuickBooks Cost of Goods Sold vs Expense

The key difference between COGS and expenses is that COGS is tied directly to inventory and the production of products sold, while expenses represent overhead operating costs.

Calculating COGS accurately is critical for understanding true gross profit margins. Improperly recording inventory and COGS as expenses can incorrectly inflate gross profits.

With the FIFO inventory method, COGS aims to match actual costs of producing inventory sold. The average method simplifies record-keeping but may result in over- or under-valued COGS if costs fluctuate significantly over time.

Monitoring inventory, properly tracking costs, and analyzing COGS is vital for making sound business decisions and maintaining accurate financials.

Setting Up Inventory Items and Accounts

This section covers how to set up inventory-related accounts like Cost of Goods Sold and Inventory Asset accounts in QuickBooks.

Creating a Cost of Goods Sold Account

To track the costs associated with selling inventory items in QuickBooks, you'll first want to create a dedicated Cost of Goods Sold (COGS) account. Here are the steps:

Go to the Chart of Accounts page in QuickBooks
Click the "New" button and select "Account"
Enter a name like "Cost of Goods Sold"
Select the "Expense" account type
Click "Save & Close"

This will create a COGS account that accumulates the direct costs attributable to inventory sold, like material and labor costs. As you sell inventory items in QuickBooks, it will automatically calculate the associated COGS and debit your COGS account.

Setting Up an Inventory Asset QuickBooks Account

You'll also want to create a separate Inventory Asset account for each category of products you sell, such as:

Finished Goods Inventory
Work in Progress Inventory
Raw Materials Inventory

Here's how to add an Inventory Asset account:

Repeat the same steps above to create a new account
Enter a name like "Finished Goods Inventory"
Select "Other Current Asset" as the account type
Click "Save & Close"

As you purchase inventory, QuickBooks will credit this account to track the value of products on hand. When inventory is sold, it will debit the account and credit COGS.

As you incur expenses related to purchasing or managing inventory, like:

Freight/shipping costs
Import duties
Warehouse costs

Set up separate Expense accounts for each type of cost, categorized under COGS. This will allow you to capture all inventory-related costs to accurately calculate profitability.

For example, create an expense account called "Freight and Shipping Expenses" under the parent COGS account. When you receive a bill for shipping purchased inventory, code it to this account.

Carefully categorizing all inventory expenses is crucial for determining the true cost of goods sold.

Recording Inventory Purchases and Sales

This section explains how inventory transactions like purchases, sales, and adjustments actually get recorded in QuickBooks based on inventory method.

Recording Inventory Purchases

First, we'll demonstrate how the purchase of inventory items impacts accounts like Inventory Asset and Accounts Payable in QuickBooks.

When you purchase inventory, you increase the Inventory Asset account to reflect the additional items you now own. You also record a liability in Accounts Payable for the amount you owe the vendor. For example, if you buy $1,000 worth of inventory, you would:

Debit Inventory Asset $1,000
Credit Accounts Payable $1,000

This records both the asset addition and the payment liability you incurred from buying the inventory items.

How to Record Cost of Goods Sold in QuickBooks Online

Next, we'll show how inventory sales get recorded, covering the impact on Accounts Receivable, Revenue, Inventory Asset, and COGS accounts.

When inventory items are sold, the value of those items must be removed from the Inventory Asset account through a credit entry. The offsetting debit gets recorded to Cost of Goods Sold. For example, if you sell $500 worth of previously purchased inventory, you would:

Debit Accounts Receivable $500 (for the sale proceeds owed by the customer)
Credit Revenue $500 (to record the sale)
Debit COGS $500
Credit Inventory Asset $500

The result is a reduction in your inventory account, with the cost of those items moved to COGS. Alongside, you have a receivable and sale recorded.

Handling Inventory Adjustments

We'll also explain how to record write-downs, inventory loss, transfers, and other adjustments in QuickBooks.

If the value of your inventory changes due to spoilage, damage, or errors in counts or pricing, you need to record adjusting entries. Common examples include:

Writing down out-of-date items to liquidation value
Removing lost, stolen or damaged goods from inventory
Transferring items between locations

In all cases, you adjust the Inventory Asset account through credits or debits, recording the offset to an expense account like Spoiled Inventory or Inventory Adjustment. This ensures your books show the most accurate inventory value.

Analyzing Inventory Costs with QuickBooks Reports

Finally, this section will illustrate how to leverage QuickBooks' built-in inventory reports to gain visibility into inventory costs.

Inventory Valuation Summary Report

The Inventory Valuation Summary report provides a snapshot of the total value of your inventory over any date range. To access it, go to Reports > Inventory > Inventory Valuation Summary.

This report sums up the total value of all inventory items across all locations. It shows the quantity on hand, average cost per unit, and total value per item. It also rolls up to provide an overall total value of your entire inventory.

Monitoring this report periodically lets you track increases or decreases in your inventory value over time. Sudden spikes or dips may indicate issues like theft/loss, overstocking, or problems with your inventory costing method.

Inventory Stock Status Report

The Stock Status by Item report gives inventory usage statistics for each item. Go to Reports > Inventory > Stock Status by Item.

This report shows the quantity of each item on hand, on purchase orders, on sales orders, and total quantity available. It calculates important metrics like months of stock on hand, average monthly usage, and stock to sales ratio.

Analyzing stock to sales ratios over time can reveal faster/slower moving items. Watching months of stock on hand highlights potential excess or shortage issues. Tracking average monthly usage aids with forecasting future inventory needs.

COGS & Inventory Detail Reports

Additional QuickBooks inventory reports provide transaction-level visibility for troubleshooting.

The COGS by Item Summary shows the accumulated cost of goods sold value for each inventory item over a date range. This helps determine profitability by item.

The Inventory Detail report displays every inventory transaction including sales, purchases, adjustments, assemblies, and more. Use this for auditing the cost flow of specific items.

Carefully reviewing these reports provides greater insight into item-level costs and usage trends to optimize your inventory management.

QuickBooks Cost of Goods Sold Without Inventory

In this section, we'll explore how to manage and record COGS in QuickBooks when you do not maintain an inventory, using direct expense recording methods.

Understanding Non-Inventory COGS Recording

When not using QuickBooks inventory features, cost of goods sold can be recorded directly as an expense. This bypasses the need to track inventory quantities and values over time.

Here are some key things to know about recording COGS without inventory:

COGS should still capture the costs associated with producing or purchasing goods for resale. This includes material, labor, manufacturing overhead, etc.
Without inventory tracking, COGS is recorded at the time of the sale of goods, rather than when goods are purchased or manufactured.
Expensed COGS is best suited for businesses with simplistic inventory needs that sell goods with predictable or fixed costs.
Reporting may be less detailed compared to full inventory tracking, but can provide adequate cost insights for many small businesses.

Overall, directly expensing COGS sacrifices inventory management features for simpler accounting and may suit businesses with steady, predictable inventory costs.

Step-by-Step Guide to Expense Inventory in QuickBooks Online

Follow these steps to record COGS as a direct expense in QuickBooks Online:

Create an Other Expense account called "Cost of Goods Sold".
When goods are sold, record the sale as normal.
In the same transaction, add a line item for COGS using the "Cost of Goods Sold" expense account. Enter the total cost to produce or purchase the goods sold as the amount.
You can allocate COGS based on a percentage of sales value or using fixed unit costs for simplicity. Update the allocation method as needed.
Run profit and loss reports to view COGS expenses in relation to sales, allowing profit analysis without inventory tracking.

This approach allows COGS to be captured without needing to maintain inventory asset accounts or record the ins and outs of inventory stock levels over time.

While less complex, it does sacrifice first-in-first-out costing, inventory valuation, and other benefits of formal inventory systems in QuickBooks. Assess your inventory and reporting requirements before deciding between expensing COGS or utilizing full inventory features.

Conclusion and Next Steps

Calculating inventory costs accurately is critical for businesses to understand their cost of goods sold and overall profitability. By leveraging QuickBooks' built-in tools and reports, companies can efficiently track inventory costs and cost of goods sold over time.

Here are the key takeaways around calculating inventory costs in QuickBooks:

QuickBooks automatically calculates inventory costs using the average costing method based on purchase transactions. This determines the cost of goods sold when inventory items are sold.
You can view inventory value and cost of goods sold details in key reports like the Inventory Valuation Summary and the Cost of Goods Sold by Item Summary.
When recording inventory purchases, be sure to properly categorize them to update inventory asset accounts and establish correct costs.
Both QuickBooks Online and Desktop provide inventory cost calculation features, with minor differences in setting up inventory items.
Take time to understand how QuickBooks handles inventory and COGS calculations to ensure your financial reporting is accurate.

For next steps, consider the following recommendations:

Review your current inventory valuation method and determine if average costing fits your business needs or if you require more advanced costing.
Set up proper accounts and categories for tracking inventory, costs of goods sold, and expenses appropriately.
Evaluate your item list and build out all inventory items you need to track with details like cost/value.
Run inventory reports frequently and compare to actual inventory counts to catch any discrepancies.
Consult with an accounting professional if you need help optimizing QuickBooks inventory features for your business.

Accurately tracking inventory and costs is vital for healthy financials. With some planning and consistent evaluation, QuickBooks can help make the process smooth and efficient.

How to Calculate Inventory Costs in QuickBooks

Introduction to Calculating Inventory Costs in QuickBooks