If you do job-costing in QuickBooks, and you don’t sell individual items to your clients, I recommend you avoid using Inventory Parts if at all possible. But, sometimes it’s not possible.
Here’s what you need to know about how inventory accounting works, and what you need to do in order to keep your inventory straight and get the inventory items to show up on your job-cost reports.
QuickBooks can handle most inventory based accounting really well for businesses that buy and sell specific items to their customers. The catch for Contractors? If you don’t set it up and use it a certain way, your accounting will make about as much sense as an IRS manual.
First, you’ll want to understand exactly how Inventory accounting really works, because inventory parts are a specific type of item in QuickBooks designed to handle it correctly. And, unfortunately, this doesn’t always work well in the job-costing scheme of things.
What is Cost of Goods Sold?
Most people understand the concept of Cost of Goods Sold – the name itself is pretty self-explanatory. It is, literally, the cost of the products that you sell. What many people don’t understand about Cost of Goods sold and inventory accounting is how to arrive at a Cost of Goods Sold figure that makes your financial statement accurate and useful.
What many people logically do when they record the cost of the products they sell is simply choose the cost of goods sold account whenever they pay a vendor for the products that they will be selling. This never works with inventory, though, and you probably know by now that you will always use an item of some kind when purchasing job-related costs. It’s different than entering your standard job-cost items, though, when you are using inventory parts.
In logic, and in practice, inventory accounting in QuickBooks is extremely simple for true inventory based businesses who buy and sell individual products to their customers. It works like this:
- You set up each item that you sell in QuickBooks as an inventory item.
- You use the enter bills or write checks feature in QuickBooks to purchase the items from your vendors. But, unlike most job-related costs, you must also enter the number of these items that you are purchasing in the quantity field. It’s important to know, though, that when you are purchasing these items, NO COST IS BEING CREATED. No cost for these items will show up on the job-cost reports or on the Profit and Loss statement at the time of purchase, even if you assign the items to a specific job. This is because of how inventory accounting works – when you purchase an inventory part, you are simply adding the cost of this item to your inventory asset, it’s when you SELL the item that cost of goods sold happens.
- In most inventory based businesses, you will use the invoices or sales receipts feature in QuickBooks to sell the items to your customers. This is where it gets really tricky for Contractors because often times, you never sell individual items to your customers, but rather these costs are included in a lump sum billing.
Now, if you are a service-based specialty contractor, and you sell your inventory items to customers on an invoice or sales receipt, it’s not a problem. But, in my experience, most contractors are either not selling the items at all or have a mix of selling items to service based clients and do not sell individual items to contract clients.
However, inventory-based accounting works the same, regardless of what your business practice is:
When you purchase an inventory part item, QuickBooks “remembers” how much you paid for the item and adds that amount to your inventory asset account. As you buy the same item for different amounts, QuickBooks will average out how much you paid over time for that item and when you sell that item to a customer, QuickBooks will post a cost of goods sold amount to that customer/job at the rate of the average calculated cost of that item(s) and deduct that same amount from your inventory asset.
What you should NEVER do:
- Purchase Inventory parts (items) for a job, put the job name on the transaction and expect the cost of these items to show up on your job-cost and P&L reports without any further action. If you do this, the costs of those items will NEVER post to cost of goods sold. The inventory asset and quantity on hand will continue to increase, and you will never see the cost of that item on your job cost report or P&L.
What you can do:
- Purchase inventory parts by using a check, credit card or bill, using the inventory part item and the quantity of items that you are purchasing in the quantity column. Make sure, by the way, that your unit of measure is very clear, and that you use the SAME unit of measure to both sell and purchase the item (otherwise, you will have a major problem!). If you purchase at per foot, you must also sell at per foot.
- Now, if it is not part of your customer invoicing practice to invoice customers for individual parts, but invoice them in a lump sum for that type of material, you can create a NET ZERO sales transaction. In this scenario, when inventory parts are used on a job, you create a sales receipt and zero out the sales price. Even if your sales price is 0, the inventory accounting will post that cost to the job and to the P&L, as well as relieve your inventory for that value. Do not use inventory adjustments, because while they will relieve inventory and post the cost to the cost of goods sold account (if you use the cost of goods sold account as the adjustment account), Inventory adjustments DO NOT show up on Job Cost reports!
- This method requires careful tracking and workflows, as is apparent. Someone must be keeping track of the inventory items that are being used on jobs, and someone must then post net zero sales receipts for those items.
- As with any inventory based accounting, you should also regularly take a physical inventory and make inventory adjustments as needed.
- OR: Use non-inventory parts or service items to track the cost of materials. This can be problematic if you purchase certain materials in bulk and you don’t know the customer or job the materials will be assigned to in the future. I have a great workaround for this, though, leveraging the “journal entry on a check form” I demonstrate in this video – but with a twist – when you purchase your original items with no job attached, later, when the items go out to a job: you use the journal entry on a check form to “buy” the item on the first line of the check form as a positive amount with the customer job name in the customer/job column, and then put the same item on a second line with a negative and NO JOB. The transaction should result in a net zero transaction, while “pushing” the cost of the item to the job on the first line.
I recommend that anyone who is not confident get help from an experienced Pro-Advisor (like me!) setting up their inventory system in QuickBooks from the beginning.
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