Adjusting Inventory

Summary

Adjusting Inventory When Items have Negative On-Hand Quantities

Question

A client has been using the inventory feature (incorrectly, until now) in QBs Premiere Accountant 2005. That is, she has been selling items out of inventory but never receiving items she has ordered into QBs.

I've been trying to adjust these negative item balances through the "Adjust Quantity/Value on Hand" window. However, I end up with a huge negative balance in the Inventory Adjustment Account.

Can you suggest a way I revise the inventory item balances to reflect the current reality, and clear the Inventory Adjustment Account?

Thanks for you help.

Answer

First a little background: To understand why you have a negative (or CREDIT) balance in the inventory adjustment account after adjusting your inventory items from negative on-hand quantites to actual, you have to think back through all the transactions. 1) When you initially purchased them, the CREDIT went to cash, and the DEBIT went to somewhere, probably Cost of Goods sold, or Purchases, or some "expense" account. The purchase transactions SHOULD have used the inventory items, which would have made the DEBIT go to the inventory account. 2) When you sold the inventory items, QB transfered the average cost of the item out of inventory and into Cost of Goods sold (CREDIT Inventory, DEBIT Cost of Goods Sold). However, since you didn't actually purchase inventory (from QuickBook's point of view that is), the average cost used for each item was whatever you entered in the "cost" field in the item setup. Hopefully this wasn't $0. The sales entries transfered the cost (whatever was entered on each item) out of inventory and into COGS. That resulted in a negative balance in Inventory. It also recorded revenue (CREDIT), Sales Tax (CREDIT) and Cash or AR (DEBIT).

The solution (as ugly as it is...): So... Since you didn't use the items on the purchase transactions, that means you didn't DEBIT inventory when the initial purchase happened, and instead DEBITED Cost of Goods Sold. So what you need to do now is: 1) If it's easy to do so, the BEST solution is to go change all the purchase transactions to use the inventory items, because this fixes everything. The problem is that (a) it's probably too much work, and (b) you might be changing closed periods, so I'll assume this option is not available to you. However, unless you do this, you won't ever have completely accurate "matching" of the flow of debits and credits as purchases and sales occurred. This may mean that your financial statements are, and will remain incorrect.

The SECOND BEST solution is: 1) Take a physical inventory for all items. 2) Make sure each inventory item in the item list has a "Cost" amount in the left side of the item. This should be the average cost of the item and it will be what QB uses until it gets real purchase information to calculate it's own average cost in the future. 3) Find the account that was actually used on the purchase transactions. Hopefully it was only one. If not, see if you can change those transactions so they all use the same account. 4) Use that account as your Inventory Adjustment account in the Adjust Qty/Value on Hand screen. 5) Enter 0 in the actual on-hand quantities so that from here forward, sales transactions will transfer average costs of each item out of inventory and into COGS.

Your adjustment transaction will DEBIT Inventory and CREDIT the adjustment account you select.

The net in the COGS account will be this: (a) Total DEBITS from original purchase transactions (b) Plus DEBITS from sales transactions (c) Minus total adjustment CREDITS that "rebooks" the total of (a) above into the Inventory account.

Lots to think about, but in the end, it's pretty simple.