If you are using QuickBooks to manage your inventory, you need to understand how QuickBooks deals with the cost of inventory items. Unfortunately, the term “cost” is used in several different ways, and it can get confusing. Here is a quick rundown of how QuickBooks handles things.
I’ll focus on Inventory Part items, which are the true “inventory” items in QuickBooks, with a little detour to talk about Inventory Assembly items.
Cost Fields in QuickBooks
If you look at an Inventory Part item, you will see that there are two cost fields.
Cost, on the left, is a “reference” field. That is, it doesn’t have any direct bearing on the valuation of your inventory, the cost of your inventory in your inventory asset account. I wish they had another name, because it is confusing to talk about it. I refer to this as the “last purchased cost”, although that isn’t always exactly right.
If you purchase an item and receive a bill for it, the cost that you receive the item at will usually be stored here (but not always, that depends on how your company file is set up). You can edit this cost directly in this window. This does not have a direct effect on your inventory valuation.
The avg cost field, bottom center, is the field that is used in the calculation of the value of your inventory. This is calculated by QuickBooks based on the cost of receipt (and adjustment) transactions. You cannot directly edit this in this window.
If you look at the edit item window for an Inventory Assembly item you will see a third cost, the total bill of materials cost, which is another “reference” cost (not directly affecting inventory valuation). I’ll discuss that in more detail later.
Inventory Valuation
QuickBooks values your inventory using an average costing calculation, as opposed to other types you may be familiar with, such as LIFO, FIFO, or specific costing. This can be a complicated subject – I am only going to go into this lightly. Let’s look at a simple example.
- If start with an item with no quantity, no value, and receive a quantity of 10 at $1.00 each
- 10 items and a value of $10.00, we added another 10 items at a value of $20.00, so, you will see that the cost is $1.00, and the avg cost is also $1.00. You have $10.00 of inventory in your inventory asset account.
- If I then receive another 10 items, but at a unit cost of $2.00, you will usually see the cost value set to be $2.00. However, the avg cost of your inventory will show as $1.50. We started with we have 20 items with a value of $30.00. That gives us an average cost of $1.50.
If you sell one of these items in an invoice, the Cost of Goods Sold (COGS) account is incremented by the average cost of the item at the time of the sale.
One thing that I will note, briefly – if you sell all of your inventory, and then continue to sell the item so that you go to a negative quantity, the costing calculation runs into problems. QuickBooks can’t accurately account for a negative balance, and you can see some very odd figures show up in the average cost field, and your inventory valuation reports. Once you bring the balances back to positive these figures should resolve themselves, but it is always a good idea to not allow inventory balances to go negative.
Editing the cost field in an inventory record will have no bearing on the avg cost, or your inventory valuation. The only way to directly change the avg cost or valuation is to use the inventory adjustment function and do a “value” adjustment.
Manufacturing Cost
Let’s take a look at an inventory assembly item. The WHAS wheel assembly has two components, a screw (two of them) and a roller. Note that there are three costs shown in this window.
The Cost field (15.00) has no real bearing on valuation of this item as I have discussed above.
The Avg Cost field (32.00) is the cost that QuickBooks uses to calculate the value of this item.
The Total Bill of Materials Cost field (32.00) is not directly tied to the cost or avg cost values. This is the sum of the cost values of the components in the BOM. In our starting example it matches the avg cost, but they are not connected.
If I build this assembly item, the avg cost of the assembly will NOT be adjusted by this total bill of materials cost. Instead, QuickBooks will take the avg cost of the component items and roll that into the received cost of the assembly. You can’t look at this screen and tell what the exact cost of the build will be. Remember, the total bill of materials cost shown here is based on the cost field of the components, not the avg cost value. But avg cost is what is used in valuation.
For a more detailed explanation of costs in inventory assembly items, see my article on Understanding Total Bill of Materials Cost in QuickBooks.
Determining the cost-per-hour for each piece of equipment or machinery that your company owns and uses on a job site is a great tool for understanding, and even eventually, recouping the actual cost of the machine itself. Once you have this information, you can improve the accuracy of your bidding, book equipment and machinery costs in your accounting software, and even identify ways in which you can maximize expenditures throughout the year.
Equipment and machinery cost-per-hour rates are calculated by adding together three distinct pieces of information:
- What it costs to own or lease (acquisition cost-per-hour)
- What it costs to maintain (maintenance cost-per-hour)
- What it costs to run operate it (running time fuel consumption cost-per-hour)
1. Calculating Acquisition cost-per-hour (ACPH)
Formula: Divide the total price paid (including interest paid) by the projected number of lifetime hours.
Example:
| 21” rotary mower purchase price: | $1,100.00 |
| Interest | none |
| Lifetime hours: | 750 hours (2.5 hours/day, 5 days week/30 weeks/year for 2 years) |
| Salvage value: | none |
Acquisition cost-per hour: $1,100.00 divided by 750 hours = $1.47 per hour
2. Calculating Maintenance cost-per-hour (MCPH)
Formula: Divide the estimated lifetime maintenance cost (repairs, parts, labor, blades, spark plugs, oil changes, filters, etc.) by the number of lifetime hours.
Example:
Lifetime maintenance cost: $600.00
Maintenance cost per hour: $600.00 divided by 750 hours = $0.80 per hour
3. Calculating Running-time Fuel Consumption cost-per-hour (RT/FC CPH)
Formula: Determine how long one gallon of fuel lasts for the piece of machinery. Divide the price per gallon of the fuel by the hours used each day.
Example:
Cost per gallon of fuel: $2.50
Running-time fuel consumption cost-per-hour: $2.50 divided by 2.5 hours = $1.00 per hour
| Total Cost-Per-Hour:$1.47 Acquisition cost-per-hour (ACPH)$0.80 Maintenance cost-per-hour (MCPH)
$1.00 Running-time Fuel consumption cost-per-hour (RT/FC CPH) $3.27 |
Let’s look at another example, this time determining the cost-per hour for a compact tractor.
| Purchase Price: | $23,000.00 |
| Interest: | $ 5,520.00 |
| Salvage Value: | $ 8,000.00 |
| Life Expectancy: | 3,000 hours (300 hours per year for 10 years) |
| Lifetime Maintenance Cost: | $18,000.00 |
| Fuel Price: | $2.50 per gallon |
| Fuel Used per hour: | 1.5 gallons |
Acquisition cost-per-hour (ACPH): ($23,000.00 + $5,520.00 – $8,000.00 = $20,520.00)
$20,520.00 divided by 3,000 hours = $6.84
Maintenance cost-per-hour (MCPH): $18,000.00 divided by 3,000 hours = $6.00
Running-time fuel cost-per-hour (RT/FC CPH): $2.50 divided by 1.5 hours = $1.67
Total Cost-Per-Hour: $6.84 + $6.00 + $1.67 = $14.51
| Notes: Your dealer should have data regarding estimated lifetime maintenance cost and fuel consumption. If you buy used equipment, cost it out using the “new” purchase price. The total cost-per-hour is usually the same for new and used equipment, and useful life, repair and maintenance costs, are easier to determine for new equipment. Using the new purchase price also automatically adjusts your rates for inflation and price increases.You can cost out leased machines using the same formulas and adjusting the life expectancy, lifetime maintenance and fuel price, to account for the shorter term.
To determine fuel cost, you can also fill up the tank and divide the fill-up price by the total running hours. Even if you prefer to base your estimates on a per-labor-hour rate, the Cost-Per-Hour method prevents you from understating or overstating the actual equipment cost for the job being bid. |
You can verify your Cost-Per-Hour figures in several ways:
- Compare your hourly rates to those of your local equipment rental company. Reduce their rental rates by 40-50% to remove their markups. Your rates should be reasonably close to theirs.
- Contact your local dealer to verify maintenance costs, production rates, fuel consumption, lifetime hours, etc.
- Contact your local Department of Transportation (DOT) office, they have manuals containing CPH data for maintenance, and will often share these figures with you for comparison purposes.
Ways in which you can reduce your Cost-Per-Hour figures:
- Take advantage of multi-unit discounts offered by some manufacturers.
- Check with your local dealer about new engine technologies.
- Use the CPH calculations to develop a better understanding of which piece(s) of equipment will lower your field operation costs over time.
You can also use the Equipment Cost-Per-Hour (ECPH) to develop a better understanding of which pieces of equipment, or brand, could actually lower your field operation costs over time. By matching up the purchase price of several different pieces of machinery against long-term variables, such as annual maintenance cost and serviceability, production rates, fuel costs, etc., the ECPH will help you to confirm the truth of you get what you pay for.
Armed with the knowledge of equipment cost-per-hour, bring this into your accounting program and job costing. This will help you to take the “guess-work” out of future bidding and increase your company’s bottom line.
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Realizing that these formulas are complex and time-consuming to perform; and the fact that given the current state of the economy, that it is extremely critical to be able to quickly and accurately, update these prices at a moment’s notice – we’ve developed an Excel spreadsheet that will allow you to quickly and easily update these figures.
Download our Equipment Cost Calculator at http://www.sunburstsoftwaresolutions.com/view-document-details/equipment-costs-calculator.htm.
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Once you know your Equipment Costs per hour, use QuickBooks to track these costs for job costing purposes by downloading our FREE 17-page eBook “Advanced Job Costing – Getting Equipment Costs into Job Costing” by clicking here. |
