Inventory accounting records the money tied up in stock through three stages. Goods go on the books at cost when bought, stay there as an asset while unsold, and become an expense when sold or lost. That expense, the cost of goods sold, is what turns sales into profit.
Timing is the whole discipline. Under IAS 2 and IFRS for SMEs, the cost of goods sold is an expense of the period in which the sale is recognised. A loss of stock is an expense of the period it happens.
This guide follows one month of a Nairobi electrical shop through the books in Kenyan shillings, entry by entry. It ends with the entries ArmPOS posts for you and the ones you post yourself.
What inventory accounting records
Inventory accounting records four events: buying stock, selling it, losing it and counting it. Each one changes the inventory account, an asset, and all but buying reach the profit and loss.
| Event | In the books | When |
|---|---|---|
| You buy stock | Inventory goes up at cost; cash goes down or the supplier is owed | When the goods become yours |
| You sell it | Sales are recorded; inventory goes down and cost of goods sold goes up by the goods' cost | In the period of the sale |
| You lose it: breakage, expiry, theft | Inventory goes down; a loss is expensed | In the period the loss happens |
| You count it | The records are corrected to the count; any gap is a loss or a gain | At each count, and always at the year end |
Cost means everything paid to get the goods onto your shelf. Paragraph 13.6 of IFRS for SMEs lists the purchase price, import duties, taxes you cannot recover, and transport and handling, less trade discounts.
Storage, selling and office costs stay out of stock and are expensed as they arise (paragraph 13.13). Both lists are in the IFRS Foundation's module on inventories for SMEs. The guide to inventory valuation methods works them through for one carton of cooking oil.
One month in the books: a worked example in KES
For example, an electrical goods shop in Nairobi starts March with stock that cost KES 400,000. The figures exclude VAT and are illustrative, not a real shop's.
| Event | Amount |
|---|---|
| Opening stock | 400,000 |
| Bought from a supplier on credit | 600,000 |
| Sent back to the supplier: wrong sockets | 20,000 |
| Cost of the goods sold (sales were 900,000) | 540,000 |
| Broken: 10 extension cables at 1,200 | 12,000 |
| Missing at the month-end count | 8,000 |
| Closing stock, counted | 420,000 |
Each event becomes one journal entry. The debit side shows where the value went; the credit side shows where it came from.
| Entry | Debit | Credit | Amount |
|---|---|---|---|
| 1. Purchase on credit | Inventory | Accounts payable | 600,000 |
| 2. Return to the supplier | Accounts payable | Inventory | 20,000 |
| 3. Sales | Cash or accounts receivable | Sales revenue | 900,000 |
| 4. Cost of the goods sold | Cost of goods sold | Inventory | 540,000 |
| 5. Broken cables | Inventory losses, an expense | Inventory | 12,000 |
| 6. Count shortfall | Inventory losses | Inventory | 8,000 |
The inventory account now reads 400,000 + 600,000 − 20,000 − 540,000 − 12,000 − 8,000 = KES 420,000. That matches the count at cost, which is the test every month should pass.
The profit and loss shows sales of KES 900,000, cost of goods sold of KES 540,000 and a gross profit of KES 360,000. Stock losses of KES 20,000 bring it to KES 340,000.
Entry 4 is the one shops miss. Without it, the books show KES 900,000 of sales with no cost against them, and stock that grows on paper while the shelves empty. The IFRS Foundation's module shows the same pair for a sale: revenue first, then cost of goods sold against inventories.
Perpetual vs periodic: what changes in the books
A perpetual system posts entry 4 with every sale; a periodic system works out cost of goods sold once, from the count. Both reach the same profit, but only one shows what was lost.
| Perpetual | Periodic | |
|---|---|---|
| Inventory account updated | With every purchase, sale and loss | Only at the count |
| Purchases are posted to | Inventory | A purchases account, an expense |
| Cost of goods sold | The cost of each sale, added up: 540,000 | 400,000 + 600,000 − 20,000 − 420,000 = 560,000 |
| Losses | Shown on their own line: 20,000 | Hidden inside cost of goods sold |
| Profit after losses | 340,000 | 340,000 |
The periodic figure is KES 20,000 higher because the broken and missing stock sits inside it. The owner sees the same profit and never learns that KES 20,000 of goods were broken or went missing.
That is why a shop that sells every day needs perpetual records. The two systems are compared in full in perpetual vs periodic inventory.
Which cost goes to each sale
When you bought the same item at different prices, a cost formula decides which price each sale carries. IFRS allows FIFO or weighted average for interchangeable goods and specific identification for one-off items. It does not allow LIFO.
The Nairobi shop uses FIFO, so its KES 540,000 comes from its oldest deliveries first. The difference each formula makes to profit is worked through in FIFO vs LIFO, with a quarter of rice bought at rising prices.
Pick one formula and keep it. IFRS for SMEs requires the same formula for all inventories of a similar nature and use, in paragraph 13.18.
At the period end: the lower of cost and net realisable value
Before you close the books, compare each line's cost with what it will sell for, less selling costs. Carry the lower figure. The IFRS Foundation's summary of IAS 2 states the rule: inventories "are measured at the lower of cost and net realisable value".
For example, the shop holds 15 ceiling fans of last year's model that cost KES 3,000 each. They now sell for KES 2,200 less KES 200 to deliver, so each is worth KES 2,000. The shop cuts them by KES 1,000 each, KES 15,000 in total, as an expense of the year.
That cut is an inventory write-down. Stock is cut from its cost to its net realisable value: what it will sell for, less the costs to sell it.
Some shops hold write-downs in a separate account, an inventory reserve. That is an allowance account that holds the write-downs on stock still held, so the inventory account keeps showing cost.
Entries 5 and 6 above were write-offs. In an inventory write-off, stock that is gone or worth nothing comes off the books at its full cost.
Where inventory shows in the financial statements
Unsold stock is a current asset on the balance sheet; sold and lost stock is an expense on the profit and loss. The Nairobi shop's KES 420,000 is March's closing stock and April's opening stock.
Why stock counts as an asset, and when it stops being one, is in is inventory an asset.
Tax starts from the same closing figure, but each country's tax law values it by its own rules. Eight countries' rules, Kenya's among them, are compared in inventory and taxes.
How inventory accounting works in ArmPOS
ArmPOS keeps the quantity and cost of every product as you buy and sell. Its Accounting posts some entries by itself, and you post the rest as a journal, usually once a month.
| Entry | What ArmPOS records | The ledger entry |
|---|---|---|
| 1. Purchase | The stock, when a purchase is saved as received | Posted for you: 1200-INV Inventory up, 2100-AP Accounts Payable up |
| 2. Return to the supplier | The stock comes off with a purchase return | Yours to post |
| 3. Sales | Each sale and payment | Posted for you: Accounts Receivable and Sales Revenue, then Cash when paid |
| 4. Cost of goods sold | Taken off in Reports › Profit and Loss, by FIFO and by average cost | Yours to post |
| 5. Broken cables | The stock comes off with a damage | Yours to post |
| 6. Count shortfall | The stock is corrected with an adjustment | Yours to post |
The chart of accounts guide says it plainly: purchase returns and the cost of the goods you sell are not written to the ledger. The damage guide adds that a damage "books nothing in Accounting".
The month-end entry, step by step
- Check the month's stock movements are in. Send the wrong sockets back with a purchase return. Enter the broken cables in Damages › Create Damage, and correct the count with Adjustment › Create Adjustment (Count and adjust stock).
- Read the stock value. Reports › Inventory Valuation multiplies each product's stock on hand by its cost: KES 420,000.
- Read the ledger. In Accounting › Trial Balance, set From to the day you started Accounting and To to 31 March. There, the debits less the credits of 1200-INV come to KES 1,000,000: the KES 400,000 left after February's entry, plus the KES 600,000 purchase.
- Split the KES 580,000 gap. The return's Total is on Purchases › Purchases Return, the Stock Adjustment Report gives each adjustment's cost, and the broken cables are 10 × their cost. The rest, KES 540,000, is the cost of goods sold.
- Add two expense accounts once. In Accounting › Chart of Accounts, click Create and add Cost of goods sold and Inventory losses, each with the Type Expense.
- Post the gap. In Accounting › Journal Entries, click Create. Debit Cost of goods sold 540,000, 2100-AP 20,000 and Inventory losses 20,000, and credit 1200-INV 580,000.
- Save and post it. Check the badge says Balanced and click Save. The entry is a Draft until you click the check icon on its row.
1200-INV then reads KES 420,000, the counted stock at cost, and the ledger's profit and loss carries the month's cost of sales. The Accounting statements are explained in Trial balance, profit and loss, balance sheet, tax.
Keep write-downs, such as the fans' KES 15,000, out of 1200-INV. Post them to an allowance account under it, as inventory write-down shows, or this month-end entry undoes them.
Accounting comes with some plans only. The automatic entries can be switched off in System Settings › Feature Toggles › Automatic Journal Entries, and they are on for a new shop. ArmPOS keeps the books the same way for shops in Kenya and Egypt.
Frequently asked questions
What are the main inventory accounting methods?
Two record-keeping systems, perpetual and periodic, and three cost formulas allowed under IFRS: FIFO, weighted average and specific identification. LIFO is a fourth formula, allowed under US GAAP but not IFRS.
Is inventory an asset or an expense?
An asset while you hold it, and an expense once it is sold or lost. Buying stock swaps cash for inventory; profit only moves when the goods leave.
What is the journal entry when inventory is sold?
Two entries. Debit cash or receivables and credit sales revenue for the selling price; debit cost of goods sold and credit inventory for the goods' cost.
What is the difference between inventory accounting and inventory management?
Inventory management decides what to buy, store and sell, in units. Inventory accounting records what that stock cost and where the cost went, in money. Every movement the first records is an entry for the second.
How often should inventory accounts be updated?
With every movement in a perpetual system, and at least once a month against a count. Close each month on an inventory balance that matches your stock at cost.
Run the month-end test this month: compare your counted stock at cost with the inventory figure in your books, and post the gap. To get both figures from one system, create a free ArmPOS account and record your next delivery as a purchase.
