Adjusting entry for inventory
Adjusting entry for inventory is made at the end of an accounting period to ensure that a company’s recorded inventory tally with the actual inventory on the ground. The adjustments to the journal entry for inventory enable companies to monitor any increase or decrease in inventory. It also aids in having correct financial statements as the inventory on hand adds to the company’s assets on the statement of financial position and those that have been sold add to the company’s revenue on the income statement. This means that when the adjusting entry for inventory is not properly made, the company’s financial statements will be negatively affected.
The adjusting entry for inventory is further important when calculating the company’s gross profits since the cost of goods sold (COGS) which is an important component when calculating gross profit captures the expenses associated with the manufacturing or sale of inventory. It is therefore important that we understand what the adjusting entry for inventory looks like and when it should be done.
See also: Adjusting Entry for Prepaid Insurance
What are inventory adjustments?
Positive changes in inventory may occur due to the production of more goods or excess goods that did not get sold in the previous accounting cycle. Negative changes in inventory could occur due to stock loss, breakage, waste, internal use, or write-offs. Stock loss refers to the loss of inventory due to the theft of goods, this is also referred to as shrinkage. For companies that are into the manufacturing of products that have a specified shelf-life after which they become expired, such as food, cosmetics, drugs, and other consumables, negative inventory adjustments become necessary at the expiration of these goods.
Breakage could occur in companies that produce items that could be affected either due to a fall or some other reasons that may make them break. When a company uses some of its inventory, that part has to be accounted for too as “internal use”. Adjusting entries for inventory due to reasons other than shrinkage, breakage, internal use, or waste is written off and thus, recorded as write-offs. The adjustments of inventory can be made at varying times depending on the accounting method used by the company.
See also: When are adjusting entries recorded?
Adjusting entry for inventory
The adjusting entry for inventory records modifications to the inventory account due to selling, internal use, waste, breakage, theft, or some other reasons. In order to make this modification to the inventory account, companies could use the periodic accounting method or the perpetual accounting method. The periodic method is mainly a manual method that requires a physical inventory count while the perpetual method is mostly computerized.
Companies that use the perpetual accounting method normally have a computerized system that tracks the company’s inventory. Due to this computerized system, an adjusting entry for inventory is automatically made once there is a sale, loss, or another event that affects the inventory and requires an adjusting entry. However, there are companies that use a manual system but use the perpetual accounting method. They track the inventory closely and make adjustments immediately after there is a sale or purchase of inventory, making sure the inventory account correctly reflects the amount of inventory at hand.
Companies that use the periodic accounting method otherwise known as the periodic system only make an adjusting entry for inventory at the end of the accounting cycle. This means that the company’s inventory account will only record the cost of inventory for the previous year, otherwise known as the beginning inventory. This beginning inventory is left constant all through the year and only gets adjusted at the end of the year when financial statements for the year are being prepared. All through the year, inventory-related expenses as well as production of goods are recorded in a temporary account such as the purchase account, and get used when making the adjusting entry for inventory at the end of the accounting cycle.
Does inventory need an adjusting entry?
Inventory may require adjusting entries at the end of an accounting period to ensure that the financial statements accurately reflect the value of the inventory on hand. The adjusting entry is necessary to recognize any inventory that has been sold but not yet recognized in the accounting records or any inventory that has been acquired but not yet recorded. The adjusting entry for inventory depends on the inventory accounting method used by the company.
See also: Adjusting Entry for Depreciation
Adjusting journal entry for inventory
The adjusting entry for inventory is made at the end of an accounting period to bring the inventory account balance up-to-date and accurately reflect the actual amount of inventory on hand. If the perpetual inventory system is used, the adjusting entry is typically not needed, as the inventory account balance is updated continuously by the automated system throughout the period with every purchase, sale, or another event that affects the company’s inventory. However, if the periodic inventory system is used, an adjusting entry is necessary to adjust the inventory account balance to its correct ending balance.
The adjusting entry for inventory typically involves two accounts; inventory and Cost of Goods Sold (COGS). If the physical inventory count at the end of the period reveals that the actual inventory on hand is less than the amount recorded in the accounting system, the adjusting entry for inventory would be a debit to COGS and a credit to inventory. This entry reduces the Inventory account to its actual ending balance and increases the cost of goods sold account to reflect the cost of the inventory that was sold but not yet recorded. The adjusting entry for inventory reduction will be as follows:
| Date | Account name | Debit | Credit |
|---|---|---|---|
| DD/MM/YYYY | Cost of Goods Sold (COGS) | $$ | |
| Inventory | $$ |
Conversely, if the physical inventory count at the end of the period reveals that the actual inventory on hand is more than the amount recorded in the accounting system, the adjusting entry for inventory would be a debit to inventory and a credit to the cost of goods sold. This entry increases the Inventory account to its actual ending balance and reduces the Cost of Goods Sold account to reflect the cost of the inventory that was not sold but was already recorded. This adjusting entry for inventory will be as follows:
| Date | Account name | Debit | Credit |
|---|---|---|---|
| DD/MM/YYYY | Inventory | $$ | |
| Cost of Goods Sold (COGS) | $$ |
How do you record ending inventory in adjusting entry?
See also: Adjusting entry for unearned revenue
Inventory adjustment example
Assuming a dog food retailer has the following information as of March 22, 2023:
Beginning inventory = $10,000
Purchases during the period = $20,000
Sales during the period = $25,000
Assume that this retailer uses the First-In, First-Out (FIFO) inventory valuation method where the first inventory gets sold first and the last inventory gets sold last. To determine the amount that would be recorded in the adjusting entry for inventory, we have to first calculate the ending inventory. To calculate the ending inventory, we need to assume that the most recent inventory items purchased are still on hand, and the oldest items have been sold. Therefore, the ending inventory will consist of the cost of the oldest items in stock.
Using the FIFO method, we can calculate the cost of the ending inventory as Ending inventory = Beginning inventory + Purchases during the period – Sales during the period
Ending inventory = $10,000 + $20,000 – $25,000 = $5,000
To record the ending inventory for this adjusting entry, we would credit the inventory account for $5,000 and debit the cost of goods sold for $5,000 based on the accounting debit and credit rules. By making this entry, we are adjusting the inventory and COGS accounts to reflect the value of the ending inventory and the related cost of goods sold for the period. When recorded in the company’s journal, the entry would look like this:
| Date | Account name | Debit | Credit |
|---|---|---|---|
| 23/3/2023 | Cost of Goods Sold (COGS) | $5,000 | |
| Inventory | $5,000 |
Conclusion
Adjusting entries for inventory is an integral part of the different adjustments entries that companies may have to make from time to time. This particular adjusting entry tracks a company’s inventory and is necessary to ensure that the company’s financial statements reflect the true value of inventory on hand and the cost of goods sold. It is therefore1 important for companies to review their inventory records regularly and make any necessary adjustments to maintain accurate financial records.
See also: Adjusting entry for supplies
