How to manage inventory in accounting

Inventory is an asset, not an expense

The first and most common mistake is recording purchases as an expense the moment they are bought. Goods you have bought but not yet sold are not an expense; they are an asset on the balance sheet called “inventory”. They become an expense (cost of goods sold) only when sold. Whoever books purchases as expenses shows a phantom loss in the month of purchase and a phantom profit in the month of sale.

The basic entries

• On purchase: debit Inventory (asset up), credit Suppliers or Cash.
• On sale, two entries: first debit Customers, credit Sales and Output VAT; second debit Cost of Goods Sold, credit Inventory at the cost of the items sold.
• On a customer return: reverse both entries with a credit note.
• On a count: a shortage debits Inventory Shrinkage and credits Inventory; a surplus is the reverse.

Inventory valuation methods

When you buy the same item at different prices, which cost do you deduct at sale? The two most used methods:

• Moving weighted average: the item’s cost is updated with every purchase as the average of the existing balance and the new quantity. Simple, stable and suitable for most trading companies; it is what Barah Plus uses.
• First in, first out (FIFO): the oldest batches are deducted first. Suits perishable goods but is harder to track.
• Specific identification: each unit carries its own cost; suits serialised goods such as vehicles.

Warehouses and transfers

A transfer between two warehouses does not change total inventory value and produces no profit or expense; it merely moves quantity from one location to another. But it needs a referenced document so each warehouse knows its true balance and quantity in transit can be tracked.

Stock counts and adjustments

A count compares the physical balance in the warehouse with the book balance. The difference (shortage or surplus) is recorded through an adjustment that corrects the balance and posts the difference to a dedicated account, so the books and the shelf stop disagreeing. Periodic counts (monthly or quarterly for key items) beat a single annual count that reveals accumulated surprises.

Common mistakes that distort profit

• Recording purchases as a direct expense.
• Managing inventory in a spreadsheet separate from the accounting system, so cost of sales is computed by hand and late.
• Selling without deducting from stock, leaving a phantom balance.
• Receiving goods without a document, so the supplier bill is recorded late in another month.
• Skipping counts because “the numbers are close”, until an unexplained difference builds up.