Journal entries for inventory transactions
/The inventory system used by a business must be able to track multiple transactions as goods are received, stored, transformed into finished goods, and eventually sold to customers. A number of inventory journal entries are needed to document these transactions. In a modern, computerized inventory tracking system, the system generates most of these transactions for you, so the precise nature of the journal entries is not necessarily visible. Nonetheless, you may find a need for some of the following entries from time to time, to be created as manual journal entries in the accounting system.
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Journal Entry for an Inventory Purchase
This is the initial inventory purchase, which is routed through the accounts payable system. The debit will be to either the raw materials inventory or the merchandise inventory account, depending on the nature of the goods purchased. The entry is:
| Debit | Credit | |
| Raw materials inventory | xxx | |
| Merchandise inventory | xxx | |
| Accounts payable | xxx |
Record Indirect Production Costs in Overhead
There are other types of production-related expenses that are allocated to inventory, such as rent, utilities, and supplies for the manufacturing operation. These expenditures typically begin as accounts payable and are allocated to an overhead cost pool, from which they are then allocated to inventory and the cost of goods sold. The allocation to a cost pool may occur later, but we will assume it occurs at the time of initial accounts payable recordation, with this entry:
| Debit | Credit | |
| Overhead cost pool | xxx | |
| Accounts payable | xxx |
Record Production Labor in Overhead
Various types of production labor, such as production management salaries and materials management wages, are also routed through an overhead cost pool, from which they are later allocated to inventory. The entry for this is usually a shifting of the wages expense into a cost pool, with this entry:
| Debit | Credit | |
| Overhead cost pool | xxx | |
| Wages expense | xxx |
Move Raw Materials to Work in Process
If you are operating a production facility, then the warehouse staff will pick raw materials from stock and shift it to the production floor, possibly by job number. This calls for another journal entry to officially shift the goods into the work-in-process account, which is shown below. If the production process is short, it may be easier to shift the cost of raw materials straight into the finished goods account, rather than the work-in-process account.
| Debit | Credit | |
| Work-in-process inventory | xxx | |
| Raw materials inventory | xxx |
Record Inventory Scrap and Spoilage
There will inevitably be a certain amount of scrap and spoilage arising from a production process, which is normally recorded in the overhead cost pool and then allocated to inventory. If these amounts are abnormal, then you would instead charge the abnormal amount to the cost of goods sold (so that they are not carried as an asset). The entry for the former situation is:
| Debit | Credit | |
| Overhead cost pool | xxx | |
| Work-in-process inventory | xxx |
Record Finished Goods
Once the production facility has converted the work-in-process into completed goods, you then shift the cost of these materials into the finished goods account with the following entry:
| Debit | Credit | |
| Finished goods inventory | xxx | |
| Work-in-process inventory | xxx |
Allocate Overhead
At the end of each reporting period, allocate the full amount of costs in the overhead cost pool to work-in-process inventory, finished goods inventory, and the cost of goods sold, usually based on their relative proportions of cost or some other readily supportable measurement. The journal entry is:
| Debit | Credit | |
| Work-in-process inventory | xxx | |
| Finished goods inventory | xxx | |
| Cost of goods sold | xxx | |
| Overhead cost pool | xxx |
Sale Transaction Entry
Once there is a sale of goods from finished goods, charge the cost of the finished goods sold to the cost of goods sold expense account, thereby transferring the cost of the inventory from the balance sheet (where it was an asset) to the income statement (where it is an expense). The entry is:
| Debit | Credit | |
| Cost of goods sold expense | xxx | |
| Finished goods inventory | xxx |
There is also a separate entry for the sale transaction, in which you record a sale and an offsetting increase in accounts receivable or cash. A sale transaction should be recognized in the same reporting period as the related cost of goods sold transaction, so that the full extent of a sale transaction is recognized at once.
That concludes the journal entries for the basic transfer of inventory into the manufacturing process and out to the customer as a sale. There are also two special situations that arise periodically, which are adjustments for obsolete inventory and for the lower of cost or market rule.
Obsolete Inventory Entry
There is likely to be some amount of obsolete inventory arising on an ongoing basis, so it is best to continually charge a small amount to the cost of goods sold and set up a reserve account for obsolete inventory, using the following entry:
| Debit | Credit | |
| Cost of goods sold expense | xxx | |
| Obsolescence reserve | xxx |
Then, when you locate obsolete inventory and designate it as such, you credit the relevant inventory account and debit the obsolescence reserve account. This approach charges the cost of obsolescence to expense in small increments over a long period of time, rather than in large amounts only when obsolete inventory is discovered.
Lower of Cost or Market Entry
You have to periodically test inventory to see if the market cost of any inventory item is lower than its cost under the lower of cost or market rule. As a result, you may need to reduce the carrying amount of the inventory item to its market value, and charge the loss on inventory valuation expense for the decrease in recorded cost of the inventory. The associated entry is:
| Debit | Credit | |
| Loss on inventory valuation | xxx | |
| Raw materials inventory | xxx | |
| Work-in-process inventory | xxx | |
| Finished goods inventory | xxx |
An interesting point about inventory journal entries is that they are rarely intended to be reversing entries (that is, which automatically reverse themselves in the next accounting period). Instead, the entries are usually one-time events.
Additional entries may be needed besides the ones noted here, depending upon the nature of a company's production system and the goods being produced and sold.