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Thread: Recording Inventory in a Manufacturing Company

  1. #1
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    Default Recording Inventory in a Manufacturing Company

    I am reading an accounting textbook. It says that when we purchase inventory, we record it in Raw Materials Inventory when the items are received and not when actually purchased.

    For example, I order $1000 of inventory in April 28,2012 but receive it on May 4, 2012. I am using the Accrural Method for my books. I thought that under this method, I have to record the expense at the time it is incurred and not when I pay for it.
    This would mean that I record the $1000.00 as an expense in April and not in May. I would debit my Raw Materials Inventory by $1000 and credit the vendor account by $1000.00 on April 28th.

    The textbook says that I should record the inventory and expenses incurred on the day I receive it, which is May 4th. Is this correct? Why or Why not?Is this how it is done in businesses?Wouldn't doing it this way violate the Accrural Method of recording expenses or I think the Matching Principle?


    Thank You

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  3. #2
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    Quote Originally Posted by ekuemoah View Post
    I am reading an accounting textbook. It says that when we purchase inventory, we record it in Raw Materials Inventory when the items are received and not when actually purchased.
    What dictates when inventory should be recorded is the shipping terms. If it is FOB Shipping Point, it is yours when it leaves the warehouse of your vendor. If its FOB Destination, it's not yours until it is received.

    For example, I order $1000 of inventory in April 28,2012 but receive it on May 4, 2012. I am using the Accrural Method for my books. I thought that under this method, I have to record the expense at the time it is incurred and not when I pay for it.
    This depends on the shipping terms, as stated above. Inventory is not an expense, though there are different ways to account for inventory.

    If this was FOB Shipping Point and you ordered April 28th, you'd record it on your books then.
    If this was FOB Destination and you ordered April 28th and received May 4th, you essentially have an "open receiver" that is technically not on the books yet. Accounting programs can handle this in a variety of ways.

    This would mean that I record the $1000.00 as an expense in April and not in May. I would debit my Raw Materials Inventory by $1000 and credit the vendor account by $1000.00 on April 28th.
    This is not an expense.

    The textbook says that I should record the inventory and expenses incurred on the day I receive it, which is May 4th. Is this correct? Why or Why not?Is this how it is done in businesses?Wouldn't doing it this way violate the Accrural Method of recording expenses or I think the Matching Principle?
    If it says to record an expense, the book is wrong. Again, the shipping terms dictate when you should record inventory. Generally speaking, if you are buying things you'd prefer shipping terms of FOB Destination so you do not have "inventory in transit". If you are shipping things, you hope for FOB Shipping Point so you do not have "inventory in transit" as the shipping terms also dictate revenue recognition.

    In this example, if the terms were FOB Destination, the seller of this $1,000 of inventory could not recognize revenue until May even though they shipped it in April.
    ekuemoah likes this.
    Small Business CPA
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    Thank you for your response. If I am using a Periodic Inventory System, I would record the purchase of inventory as an expense by debiting my Purchases account, correct?

    Do I have to keep a separate account or records showing the amount of Goods are in Transit?

    Thank you very much for your help.

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    Yes, under a periodic system, you'd debit "Purchases" which is a Cost of Goods Sold account. However, keep in mind you need to take a physical count at year-end and adjust your inventory balance accordingly. The balance of inventory will depend on if you use FIFO, LIFO, or weighted-average, though FIFO is the method I've seen almost exclusively used.

    I probably wouldn't get caught up too much in the semantics of "goods in transit" unless you have substantial amounts of inventory, or if the method of receipt is slow (e.g. by boat).
    Small Business CPA
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