Balance Sheet vs Profit and Loss Statement for the Cost of Inventory

I know this is not a manager issue and it is my lack of accounting knowledge but why isn’t the cost of stock on hand something that appears in the profit and loss statement?

I know as far as the Balance Sheet is concerned, Inventory on Hand has the value of the stock as at the price purchased as an asset, so it IS recorded / reportable, but why is the expense of having that stock only attributed at point of sale (we’re only talking about inventory items here).

I think my confusion is stemming from the fact I wasn’t treating the drinks in the fridge as inventory, just as an expense of their purchase and that was readily identifiable on the P&L statement because the “drinks—water” and “drinks—carbonated” had values for their purchases. Their purchases being attributed to losses, but then their sales attributed to the profit side of the sale

Since moving half of my stock to inventory, I’m seeing their effect of their purchase on my bank statement and in the cash accounts or cash on hand, but I’m not seeing it reflected as the expense. ie, there’s no net effect of their purchase on the P&L.

I’m realising this is the way it’s meant to be, I’m just trying to understand why.

I was basically seeing that everything I spent as a cost of the business (ie an expense) and so spending $1000 with a supplier, I saw it reflected in the appropriate expense accounts. But now, spending $1000 only created (say) a $500 expense and a $500 increase in assets.

I’m realising to understand the position of my business is based on looking at the documents in tandem and not singularly.

But to humour this poor sorry soul, is there any way to classify an inventory item as an expense before it’s sold?

Because Stock on Hand is an asset and is not an expense until it has generated income.
Or put this way, you open a new shop tomorrow and purchase 10,000 of inventory today to stock the shelves, if that cost was to appear in the P&L then you would be making a loss of 10,000 before the doors even opened and may take a while to be profitable. Sell 5,000 but buy another replacement 3,000 = 13,000 out and 5,000 in.

Whereas, storing inventory in the BS and only transferring its cost when a sale occurs provides a more complete picture of performance at the Gross Profit point - Sales less COGS

Only if you classify it as purchases (immediately expensed) and not as inventory (stored future expense)

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excellent explanation and I’m getting on board with it. I think where I’m struggling then is with the fact that almost everything we purchase IS an expense. (At least that’s where I put it ;))

For example, the drinks are really such a small part of the business, it’s hardly worth tracking them. They’re purchased, can sit on the shelf for weeks and eventually get sold and replaced. Whilst there is good profit in them, they’re not the movers of the business.

What IS a mover is meat, particularly chicken meat. We buy it in bulk bags on an almost daily basis. Then beef every other day and pork maybe twice a week. They’re a HUGE daily expense, but not really trackable against P&L (at least not yet since we’re not tracking portions into meals as well as actual meal sales—this will be starting next week). So purchases of meat hit P&L straight away, but then (I suppose) so does the sales at the end of the day.

(I’m going to apologise for the following question in advance, I have asked the accountant, and she’s not in a hurry to sort this part out yet and has said twice now “just wait til we do your tax, we’ll shuffle everything around then” :slight_smile: )

You said: [quote=“Brucanna, post:2, topic:7808”]
Or put this way, you open a new shop tomorrow and purchase 10,000 of inventory today to stock the shelves, if that cost was to appear in the P&L then you would be making a loss of 10,000 before the doors even opened and may take a while to be profitable. Sell 5,000 but buy another replacement 3,000 = 13,000 out and 5,000 in.

Whereas, storing inventory in the BS and only transferring its cost when a sale occurs provides a more complete picture of performance at the Gross Profit point - Sales less COGS
In essence, because we’re not a grocery store, that IS what we did. We’ve had a massive outlay of initial cooking stock and it’s going to take a while to offset that, although almost everything that was purchased initially has already been replaced at least once—I said almost) For example, 20L drums of all sorts of stuff from cleaners, to sauces, and tubs of curries, vinegar, oils etc… My question being, all those costs, including the cost of fit-out, bonds, maintenance and repairs of existing equipment; these are “expenses” right?

Something I haven’t liked about the P&L, is my lack of understanding of how to have it reflect accurately for a period. Especially when a period may have a one off expense that just throws the whole week, month or quarter out.

Is this some where that I should/could be creating control accounts for things that are regular expenses, and then those other longer term expenses? I mean, I’d like to use the P&L to analyse my meat and veg expenditure against sales but every other week theres something that is on the P&L that throws it out whether it be gas or rent or advertising etc. I realise these are still recurring costs, but they’re more of an attempt to drive further sales, or things that are just required to be paid. I’d like to be able to determine how much extra purchase of meat and veg translates at the til. Our rent doesn’t change, electricity will be marginally differnt. Gas will be different, etc.

I’ve rambled too long. The point I was trying to make, I’m liking the idea of inventory and it being an asset and bringing it into the P&L at the point of sale, but for a restaurant, our biggest purchases and what drives our sales are not tracked at an inventory level.

Or can I in some way do that?

If that part of your inventory has rapid turnover- very short shelf life - then it is possible that expensing directly v’s inventory could be more efficient. By the time you have processed the purchase invoice its sold. Unless you are attempting to track specific sales - chicken legs v’s chicken breasts. A good cash register can provide excellent sales analysis - once its set up.

You can structure you P&L into “cost centres” so that it traps likewise expenses with progressive totals
Operating Expenses (semi permanent, occur every month)
Indirect Expenses (those that occur regularly but on demand, R&M)
Overhead Expenses (the oncers, Ins, Acct fees)

Everything is possible - in the following Product Type A = meat, Product type B = veges

Financial Reports - B&S & P&L - are a management tool, design them to suit the business.

But to some specifics - Bonds (is that rental) then post to a BS - Asset - Prepayments
Fit-out, depending on value, could be capitalised (fixed asset) and expensed over a period - 5 yrs

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Thanks @Brucanna I very much appreciate the time you’ve put into that.

Being a restaurant it’s not quite as straight forward as your example:

Product A - cost
Product A - sales

Product B - cost
Product B - sales

since Product A and Product B makes up Products AAB, ABB, BAB, BBA, BBAA, ABBA lol… not to mention the other big expenses such as rice, sugar and spices/curries.

basically because being a restaurant “chicken” is a part of (almost) every sale point (entree, various main types, and in various form factors), where as beef (for example) is only bought in two types, one type of meat is related to exactly one type of product (so that one falls in nicely), but the other falls into (well, only) mains, but several types of mains.

To the specifics you mentioned: Bond (I couldn’t think of the right word, I’ve looked it up, it’s a “bank guarantee”, yes, an asset. Most of our big costs in setting up, the accountant said we can go either way because this financial year in Aus (I’m not sure where you’re from) we have a business incentive to write off $20K in this one year, and although we can do that (which is why we’ve left it on expenses for now), she’s detailed some benefits to depreciating it instead. So we’re swinging both way.

On your example above, where specifically are we talking? Am I looking to generate custom reports or set up account groups or control accounts? If you could point me to the right guide I would love to start digging into it.

Once again, thanks a million!

Custom Reports aren’t available as yet
Control Accounts only apply to the BS
Account groups would be where to start - so no specific guide

Settings - Chart of Accounts - P&L
Headings - decide on the titles you want and create “new group” to match
=> Use codes to get correct order, but leave spaces for sub-total codes 1,4,7,
=> Tick Expenses and leave Group blank

Existing expense accounts - edit each account and reallocate to “new group”

Sub-totals - create “new total” and give a description - P&L after Operating Expenses
=> Use code one number higher then the preceding heading code.

If you have an existing “Expenses” heading, that can be renamed

@d3mad, this little reply harkens back to your first post, and has nothing to do with the detailed discussion you have engaged in with @Brucanna.

The reason cost of goods is not immediately an expense goes to a fundamental principle of accrual-based accounting. While income is recognized as soon as it is earned (whether or not payment has been received), expenses are recognized in the period when the income they are related to is generated.

This principle prevents companies from distorting their performance by buying things, potentially on credit, for goods/services they are not delivering. That can make an unprofitable company look profitable without affecting hard cash flow, a trick used to dupe unsuspecting buyers and divest an unprofitable business. That’s fraud, and people have gone to jail in some spectacularly creative examples of ways to try covering it up.

Yes, we ( I ) did get a little side tracked there. Thanks to @Brucanna for entertaining my discussion/questions in that area.

@Tut, from the outset my accountant said to use cash-based accounting mainly because we don’t have clients/customers and just suggested it was a preferred model for me and I’ve just stuck to it, although due to the way manager works I leave it in accrual mode for most of the time since it’s the only way to get to some areas when trying to look at line items in invoices and chasing errant suspense entries. Also, because I wasn’t using inventory at all I could see immediate the immediate effect of spending money on stock/supplies (including inventory) but I was thrown just a little when I didn’t see it (the P&L) change when I’d expected it to.

What you and Brucanna has said makes sense, especially with regards to fudging the numbers and I take that on board, but for my everyday need I’m happy to go cash-based until/unless my accountant says not to or there’s some other reason to change. Although I DO like the look of the summary in accrual mode which takes into account my unpaid bills :smiley:

@Brucanna I have been snowed under the last couple of days and just haven’t had a chance to have a look at this. I know I played with it when I first started but I had no idea what I was doing. Now, having been paying bills, and experiencing the accounting from actually playing the game (as opposed to theorising about it from the side-lines) I think I have a better idea how to look at that area now.

I’ll give it another go when I get a quiet moment (with a backup :smiley: ). I know I made a pretty big mess of it last time and it just didn’t make any sense at all. Thanks for your post and I’ll let you know how I go.

Cheers! :thumbsup:

The thing is, rough draft your concept on paper, do a couple of changes and check it out, then do a bit more. If you like the look of the summary in accrual then go for it, your accountant isn’t the one using it daily, only yearly. Knowing the unpaid bills gives you the complete status of the business, not an abridged view

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I don’t know the tax law where you are, @d3mad, but in some jurisdictions, the mere fact of holding inventory requires the use of accrual-based accounting, I think as an anti-fraud measure.

TBH, I don’t know either. I suppose it’s something I should chase up, but her knowing what i do and suggesting “cash-based”, I would assume that it is fine. At a stretch, the “inventory” isn’t even $100.

But, as suggested by @Brucanna, I think I may just leave it as accrual, although (as I type this) I recall my BAS or something I do has said that I’m already cash based. Given the nature of our business, I actually don’t believe it’s a major issue either way.

@Brucanna I have struggled for a while about how to lay out the COA. I actually think your idea of putting it on paper is a good one, or even “bits” of paper and shuffle the account groups around until I get it the way it just right. (When I get the time) lol