Keeping track of your inventory accurately helps you connect your costs to the sales you made. If you file taxes on a cash basis, you can use journal entries to record inventory purchases and track changes in inventory over time using accrual accounting. This allows you to both file taxes and record your inventory in a way that helps you understand your business. You can read more about cash and accrual accounting in our Ambrook Education newsletter here.
How to record and adjust inventory
Step 1: Record cash expense for inventory
When you make the initial purchase, you will first record the expense on your ledger as an “asset adjustment” and select the inventory account you created. This does not record the purchase as an expense on your P&L, but will increase the value of the inventory account.
Next, you’ll record a cash-basis journal entry to record the inventory as an expense (see below).
You’ll debit the inventory account (in this case, Finishing Cattle)
You’ll credit the cost account (in this case, Livestock for Resale)
The cash-basis journal entry will record this purchase as an expense at the time it was purchased, but you’ll hold it in your inventory account that you can later adjust when you sell through the product.
Step 2: Adjust inventory when you use it
When you sell the product or use the inventory later in the year, you can then make an accrual adjustment to your inventory account to record the usage of your inventory. You’ll record:
A debit on the inventory account (in this case, Finishing Cattle)
A credit on the cost account (in this case, the cost of good sold category “Livestock for Resale”)
This will ensure you can look at both your income and costs in the same period to understand profitability. See below for an example journal entry.
