Inventory is usually classified as an asset. After all, it’s something your business expects to sell, which generates revenue. So, until you sell the inventory, it falls under a current asset on the balance sheet. 

Once you sell inventory, the value of that inventory becomes an expense that’s recorded as cost of goods sold (COGS) in your income statement. COGS represents the direct cost of producing or procuring the goods that you sold (which you can later use to calculate gross profit).  

Example: Say your business makes candles. You make 15 candles in a single batch, and each candle costs you $10 to make. Inventory is valued at its cost, not its selling price, so you have $150 worth of inventory. But you haven’t sold them yet — so on your balance sheet, you record $150 as an asset on your balance sheet. 

You end up selling all 15 candles. On your income statement, you record $150 in COGS, because that’s how much it cost to product the 15 candles you sold.  

If inventory get damaged or becomes obsolete, it can be expensed immediately, without having to be sold.  

The accuracy of your financial statements is directly dependent on the accuracy of your inventory accounting.  

Think of it this way: If it costs you $10 to create a product and you sell it for $15, then you can record a $5 profit. But if you think you only spent $9 to manufacture the product, you will record $1 more in profit for that sale than you actually earned.  

These miscalculations can add up quickly and have devastating consequences for ecommerce businesses. 

Perpetual inventory accounting systems allow retail and ecommerce businesses to track orders and inventory levels in real time.  

Perpetual systems: 

• Use point-of-sale (POS) systems or ecommerce platforms that are integrated with inventory management systems.  
• Automatically update inventory counts and data when sales clerks or warehouse personnel scan product codes into the system (so whenever an item is sold or shipped out, the inventory data gets updated to reflect this).  
• Are one of the most effective ways to keep track of inventory movement based on real-time sales information. 

3PLs like ShipBob offer robust inventory tracking systems that integrate with your ecommerce platform. This supports real-time inventory tracking for perpetual inventory accounting.  

However, perpetual systems aren’t great at factoring in inventory theft, product damage, or missing items. This means you’ll still need to do a manual audit occasionally to ensure that your inventory data matches your actual physical inventory. 

Periodic inventory accounting systems involve a physical inventory audit at the end of an accounting period.  

Periodic systems: 

• Are not updated in real time, but are instead calculated at the end of the period instead.  
• Require businesses to perform a complete physical count of their entire inventory.  
• Produce a more accurate physical inventory count 

However, periodic inventory accounting process can be time-consuming, often requiring some operational downtime. This is why many ecommerce brands use a perpetual inventory system to maintain real-time inventory records and reduce the amount of work needed for inventory accounting. 

Another important step in inventory bookkeeping is recording your inventory purchases. You need to accurately account for any new inventory procured and update your stock levels and inventory ledger accordingly.  

1. Scan each inbound inventory item during the warehouse receiving process. This help you maintain accurate data on your stock count, as it automatically updates your inventory in your inventory management software system (IMS).  

2. Record the transaction in your inventory ledger to properly account for inventory costs. Make sure to include details about the purchased inventory, such as the date, quantity, supplier, and cost. Don’t forget to account for shipping, duties, and other acquisition costs on top of the inventory price. 

These purchases will reflect in your books as purchased inventory that’s added to your beginning inventory for the period.

If you return any goods to suppliers, make sure to properly record this as well. This may occur when you bought excess goods or if the supplier made a mistake and sent more products than you actually need.  

Sometimes, businesses put down a deposit for inventory they want to buy in the future. This can cause complexities and timing issues, especially when payments span multiple accounting periods. For example, you may pay a deposit during the first quarter and only receive the inventory in the second quarter because of production delays or raw material shortages. 

Deposits should be recorded as prepayments or advances in your inventory records. You’ll need to enter the prepayment as a separate transaction in your journal entries. It will initially appear as a current asset on the balance sheet because it’s an expense not yet incurred. Once the expense is incurred, the prepayment will be deducted from the prepaid expense account.

Despite your best efforts, you’ll probably hit some snags eventually, such as theft, loss, damage, and obsoletion. You’ll need to account for these events in your records, too.  

This could involve an: 

• Inventory reconciliation: A process where you perform periodic cycle counts to compare your physical inventory against your data to see if they match (and fix it if they do not). 
• Inventory write-down: Write-downs are necessary when your inventory partially loses value but is still sellable. It’s a crucial step in accounting as it helps to reduce tax liability in case of damaged or excess inventory. 
• Inventory write-off: Write-offs involve completely removing inventory from accounting records when it loses all of its value, such as in the case of theft, damage, or expiration. 

If you create or produce your own inventory, you’ll also need to account for inventory across all its stages and forms. This includes: 

• Raw materials inventory: This means tracking and valuing the materials used in production. It will include the costs of acquiring, storing, and using the materials. During the initial raw materials purchase, the raw materials inventory account is debited while the Accounts Payable account is credited. When the materials are used in production, they’ll then be transferred from the raw materials inventory account to the… 
• Work-in-progress inventory: This consists of partially finished materials within the manufacturing process. Accounting for this type of inventory involves tracking the costs associated with partially finished goods, such as raw materials, direct labor, and manufacturing overhead (rent, utilities, and equipment depreciation). Once production is finished, the goods become… 
• Finished goods inventory: This consists of ready-to-sell goods and are reported as current assets in the balance sheet. Accounting for this inventory involves calculating the cost of goods manufactured and the cost of goods sold.  

When accounting for inventory, ecommerce businesses have two accounting standards to choose from:  

• IFRS (International Financial Reporting Standards), which is a globally accepted set of principles used across different countries. 
• GAAP (Generally Accepted Accounting Principles), which is the standard used in the United States. 

There are several key differences between these two options. Here’s a breakdown of some of the biggest differences between IFRS and GAAP to help you decide what works for your business: 

Susan, who runs a pet supply store, starts the accounting period with 80 boxes of dog treats, which she had acquired for $3 each. Later, she buys 150 more boxes at a cost of $4 each, since her supplier’s price went up.  

Susan now has 230 boxes of dog treats in stock. At the end of her accounting period, she determines that of these 230 boxes, 100 boxes of dog treats have been sold.  

Using the FIFO method, Susan assumes that she sold all 80 of the original boxes before dipping into the newer stock. Thus, in her balance sheet, the total cost of goods she sold above (100 boxes) would be:  

COGS = Starting Inventory + Purchases − Ending Inventory  

COGS = (80 units x $3) + (150 units x $4) − (130 units x $4)  

Notice that Susan lists the 130 units remaining in her inventory as costing $4 apiece. This is because she presumes that she sold the 80 units that she bought for $3 apiece first. There are no units of the first, cheaper batch of inventory left.   

She finishes her calculation like so:  

COGS = $240 + $600 − $520  

COGS = $320  

Let’s imagine a stationery business, who purchases 3 batches of 100 units each. The cost of the first batch was $1 each unit. Due to inflation, the next two batches cost $2 each and $3 each unit, respectively.  

Then, this merchant sells 200 pens. With LIFO, the merchant assumes that they first sell all the inventory purchased in Batch 3, and then all the inventory from Batch 2. All of Batch 1 still remains on hand.  

To calculate COGS, the merchant would therefore use the newest purchase prices.   

COGS = (The Number of Newest Units x Their Value) + (Remaining Units From the Second Purchase x Their Value) 

COGS = (100 x $3) + (100 x $2)  = $500 

Meanwhile, items of Batch 1 are considered unsold.  

The ending inventory value reported would be: 

Ending Inventory Value = Remaining Units x Their Value 

Ending Inventory Value = 100 x $1 = $100 

The following formula is used to calculate weighted average cost: 

WAC = Cost of goods available for sale / Total number of units in inventory 

The total cost of the inventory purchased is $2,925. The total number of units in inventory is 1,100. To calculate the WAC, follow the formula as follows:  

WAC = $2,925 / 1,100 units  

WAC = $2.65 per unit