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.
The end of the year always adds even more tasks to your already busy schedule, and sometimes it is simply overwhelming and I’ve often been asked – “What do I need to do?”
Intuit has built a very good “QuickBooks Year-End Guide/Checklist” and it’s included right in your QuickBooks program by going to the Help Menu and choosing Year-End Guide. Over the next few days, we’ll cover each topic listed in the Year-End Guide, and offer some additional tips on each of the three sections: Tasks to prepare for filing taxes, Tasks to do if you use subcontractors, Tasks to do if you have employees and some Tips for the upcoming year.
Tasks to prepare for filing taxes:
Reconcile all bank and credit card accounts – now really you should have been doing this every month…but if for some reason it’s been several months since these accounts were reconciled here’s a quick way to reconcile multiple months all at once – accurately.
- Determine which month was the last month that was reconciled.
- Gather all of your bank or credit card statements and put them in order; oldest on top and most recent on the bottom. If you don’t have all the statements, please don’t be tempted to just “skip” that month, contact the bank and ask for a copy, or if you have on-line banking capabilities get a copy off the internet.
- In QuickBooks go to the Banking Menu and choose Reconcile.
- In the Begin Reconciliation window
- Choose the Account you wish to reconcile (you can choose either your bank account or your credit card account) from the drop down Account List.
- The Statement Date should be the ending date of your most recent statement.
- The Beginning Balance should be the same as the Beginning Balance of your oldest statement. If for some reason the amounts are not the same, click the link that says “What if my beginning balance doesn’t match my statement?” and follow the instructions in the QuickBooks Help file to determine what is wrong and how to correct the problem.
- The Ending Balance should be the amount shown as the ending balance on your most recent bank statement.
- Enter any Service Charge for the most current statement only – (we’ll put the rest in manually), please don’t be tempted to “add them all up” and put that amount here.
- Enter any Interest Earned for the most current statement only – (we’ll put the rest in manually), please don’t be tempted to “add them all up” and put that amount here.
- Click the Continue button which will bring you to the Reconciliation window.
- To enter Service Charges and/or Interest Earned for additional months, leaving the reconciliation window open, from the Banking Menu – choose Use Register and enter the transactions individually using the closing date of the statement as the date of the entry. Additionally you might want to create “Other Names” called Bank Service Charge and Interest to use in the Payee Field when recording these transactions, just to make reconciling easier.
- Working from the statements, oldest one first, just go through and check off each deposit and check until you are finished.
- If you find checks or deposits on the statements that are not in your QuickBooks file, go to the Banking Menu and choose Use Register, record the transaction with its original date, assigning the amount to either Ucategorized Income or Uncategorized Expenses – so that later you can run a Year to Date Profit and Loss Report, zoom in on those accounts and find the hard copy of the original transaction and correct the entry or entries.
Verify petty cash entries for the tax year – again, this is something that you should be doing every month, but if you have several months that you need to reconcile, it can be accomplished following the instructions above.
Make year-end accrual adjustments and corrections – I usually suggest that you work with your accountant on these matters.
Close your books – I usually suggest that you close your books for the fiscal year with a password – only the QuickBooks Administrator can do this, but it does prevent accidental changes to already reconciled transactions by others. Of course, the QuickBooks Administrator can make changes to transactions as required and a closing date exception report can be generated by going to the Reports Menu, choosing Accountant & Taxes, and then selecting the Closing Date Exception Report. With QuickBooks 2011 you don’t need to worry about this effecting Non-Posting transactions such as Estimates & Purchase Orders.
Adjust Retained Earning – QuickBooks does this automatically, so there should be no need for you to have to do this manually.
Review details of all new equipment purchased during the year – if you are using QuickBooks Premier (including Premier Contractor, Manufacturing, etc.) you should and can enter details about your fixed asset purchases by going to the Lists Menu and choosing Fixed Asset Item List – otherwise you will have to track these items on an Excel Worksheet, a Word Document, or in QuickBooks itself by adding Sub-Accounts to your main Fixed Asset account for each piece of Equipment that was purchased and adding as much detail as possible in the Name, Description, and Notes boxes.
Make all asset depreciation entries and adjustments – I usually suggest that you work with your accountant on these matters.
Review fringe benefits that need to be reported on Form W-2 – Fringe benefits can include Health and Life insurance, public transportation subsidies, moving expense reimbursements, employer provided vehicles, educational reimbursements plans, group-term life insurance, employee loans that are forgiven, and Union Fringe Benefits. If you aren’t sure if any of the benefits that you offer your employees should be included on their W-2’s consult your accountant.
Take a physical inventory and reconcile with book inventory – it is important that you take a year end physical inventory; I usually suggest that you include a copy of that physical inventory sheet for your accountant and let them give you the appropriate adjusting entries to record in QuickBooks.
Print financial reports – from the QuickBooks Year-End Guide/Checklist click on this topic for reports to print. Keep in mind that these reports will not have adjusting entries from your accountant and that amounts will change. I would recommend that when you create the suggested reports that you modify them and add a report subtitle called “Prior to Adjusting Entries”. After you have entered the adjusting entries from your accountant, rerun these same reports adding a new subtitle called “After Adjusting Entries”.
Print income tax reports to verify tax tracking – from the QuickBooks Year-End Guide/Checklist click on this topic for an explanation of what is involved for this action item. You should ask your accountant for help in setting up the correct tax tracking for each item on your Chart of Accounts.
Import your tax-related data to Turbo Tax or ProSeries – from the QuickBooks Year-End Guide/Checklist click on this topic for an explanation. If you do not prepare your own tax returns you can definitely skip this section.
Print and mail forms W-2, W-3, 1099, 940, 941, and 1096 – remember you no longer need to buy pre-printed W-2 and W-3 forms as QuickBooks will print these forms on plain paper; you will still need to purchase preprinted 1099 and 1096 forms.
Archive and back up your data – backing up your data is something that you should be doing on a very regular basis as part of a disaster recovery plan in the event of computer virus, computer failure, etc.
Archiving your data is something that you should do if your file is large – contains more than 3 years of data – although some businesses will have extremely large files after only 2 years. Creating a new company file each year is not necessary and not recommended for contractors; you probably have jobs that span over the course of 2 calendar years or more and you will want access to complete details relating to those jobs for job costing reports. There are, however, times when creating a new file is appropriate, such as you have several years of data with early years containing lots of data entry errors, or your data file has become damaged and cannot be repaired.
The primary purpose of using QuickBooks to keep books is to provide financial and management information in order for you to run your business, make sound business decisions, and to prepare your taxes.
Most business owners are very worried about generating income; however, running a business involves a lot of other tasks. You will need to invoice customers, record payments from customers, pay your own bills to outside vendors, perhaps manage inventory, and analyze your financial data to see where you need to focus your efforts next. QuickBooks is a tool that you can use to automate the tasks you are already performing as a business owner or to set up a new business.
Financial Management is the process of:
- Running your business
- Recording money coming in
- Recording money going out
- Using Reports to
- Understand how your business is doing
- Make decisions
Unfortunately, many contractors have bookkeeping systems that are or have been designed by accountants and/or bookkeepers which are designed to provide tax information as their primary goal. While you certainly need to have information to complete your tax returns, how they have set things up does not always make sense for your needs or purposes, and there really is not any requirement to keep your books as a mirror image of your tax return.
Bookkeepers and accountants know taxes; after all, that is what they do best. Most are unfamiliar with the construction industry and its intricacies. We will teach you how to setup QuickBooks so that both you and your accountant will get the information that you each need in order to perform your respective jobs.
If there wasn’t any conflict between your management needs and your tax needs, this wouldn’t be an issue. Unfortunately, the IRS does not know much about the construction business either. Their goal and their rules are focused on forcing you to calculate your profits, and thus your taxable income, in a manner that produces consistent results across all types of businesses. In short, they only want to “box” you in and limit your parameters for calculating your income so that you can only fudge your numbers to a limited extent. None of this exercise has anything to do with managing your business!
Six Ways Financial Management Helps Your Business Succeed:
Why take the time to learn and use financial management methods?
Accounting is the language of business, so you and other parties (banks, IRS, etc.) should all speak the same language in order to:
- Stay on top of your cash flow: Track money in and out of your business. Even a profitable business can go bankrupt if it does not track cash flow.
- Manage your customers and sales: Track what they are buying, keep records up-to-date so you can contact them.
- Track Production and Inventory: Know how to obtain goods and services from your vendors and establish credit.
Once your records are centralized, you can create reports for a variety of important activities:
- Filing with the IRS
- Understanding how your business is doing (this will help on pricing products and services)
- Sharing your financial picture with third parties (banks, SBA, etc.) to secure loans
And then, of course, tracking the money going in and out of your business. All companies, even huge established one’s with billions in revenue and tens of thousands of employees, rely on financial management for these areas.
Whatever your business, sound financial practices are a toolset that can help you get the greatest return from your efforts.
Information is Power!
There are certain questions that all business owners would like answered. Businesses that practice sound financial management and record-keeping will have the answers to these questions (and more) at their fingertips.
Ok, so you “might” have some rough figures in your head, but without proper record-keeping, you will never “really” know.
Financial Accounts – Why they matter to your business
Accurate record-keeping lets you understand and use all of your information.
- Money in from payments received
- Data on customers and vendors
- Record of your bank accounts
- Money out for checks written, refunds, and other expenses
A reader asked the following question:
We are a small contractor in San Diego and we are wondering how we get around having to always do an inventory adjustment to get our purchases to the correct COGS account? We have (2) departments but they are both doing construction projects: Service dept does smaller installs and Contracts dept does the bigger jobs so I have been doing a JE to move the material from the Contracts material COGS account to the service COGS account.
Is there an add-on for QB Enterprise 8 that we could use?
Thank you so much for your website/blog. I’ve been reading it faithfully every day!
____________________________________________________________________
There are several inventory add-ons for QuickBooks Pro, Premier and Enterprise; check out these 3rd party add-ons at the Intuit Marketplace.
Recording costs and income with an item
Based on your comment about “always having to do an inventory adjustment in order to get your Purchases to the correct COGS account”, makes me think that perhaps your items are not correctly set up.
Make sure that your QuickBooks Inventory Items are set up so that they capture both the cost/purchase account as well as a sales account; this method is called a “double-sided” item.
When any type of QuickBooks Service, Inventory, Non-Inventory, Other Charge Item is set up this way you are able to capture the purchase price as well as the sales price.
When you enter a bill from a vendor for the inventory item (or write a check) you should be using the ITEM tab and not the Expense tab.
I’m confident that if you aren’t currently using the QuickBooks Purchase Order function that you would find that beneficial also.
Additionally, rather than using Journal Entries to classify whether it was the Service or Contracts Department – consider using “classes” to handle that.
QuickBooks provides you with a powerful, and time saving tool within your items list, which is often under utilized and often misunderstood — the QuickBooks Group Item.
5 Reasons To Use QuickBooks Group Items:
- Creating and using Group Items is useful for quickly entering a group of individual items that you have already set up as single items in your Item List.
- Group Items are versatile – you can choose to print – or – not to print the items within the group, meaning you can track more detail than your customer needs to see.
- Group Items ensure that you don’t “leave something out” – which means lost dollars on your part.
- Group Items speed up the creation of Estimates and Invoices – imagine being able to pull in 19 items with a single click of a mouse.
- Group Items allow you to bridge the difference in units of measure used to buy and sell products or materials.
“Back in the day”, as my son-in-law would say, before QuickBooks had a Unit of Measure option – I think it was introduced with QuickBooks 2007 – we had to rely on QuickBooks group items to perform Unit of Measure calculations.
Using Group Items to bridge differences in units of measure used to buy and sell materials.
Suppose you are an Electrician and buy wire in spools of 1,000 feet, but when you invoice your customers you do so by the foot. By using group items we could effectively bridge this difference by following the steps below.
1. Verify that Inventory & Purchase Orders are active, by choosing Edit, Preferences, Purchases & Vendors, Company Preferences
2. Add a Sub-Account to your main Inventory Asset Account on your Chart of Accounts called Wire
3. Create an Inventory Part item for a foot of wire, called “Feet of Wire” and assign it to the “Wire” Account from your Chart of Accounts
4. Create a Group Item called “Spool of Wire”
5. Add the “Feet of Wire” Inventory Item with quantity of 1000
How we used these items once they were created:
When you buy the wire, use the “Spool of Wire” Group Item on your Purchase Orders, your checks, or bills and QuickBooks will add 1000 feet of wire to Inventory.
When you sell the wire, use the “Feet of Wire” Inventory Part Item on your Estimates, Sales Orders, or Invoices and QuickBooks will remove those amounts of wire from Inventory.
Would you believe that even though QuickBooks now comes with a Unit of Measure ability, there are still some people that prefer this method?
How many of you remember this method of creating a Unit of Measure using Group Items?
