Inventory Accounting for Ecommerce: Step-by-Step Guide

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Accounting impact

Analyze sales data and trends

Examine historical sales data and identify patterns or trends to help forecast future demand.

Accurate trend analysis and forecasting will help to reduce write-offs for excess inventory or stock shortages because it will help to ensure inventory levels align with customer purchasing behaviors.

Forecast demand

Once you’ve completed your sales analysis, you can predict the quantity of products needed based on sales trends, seasonality, and market factors.

Determine lead times

Understand the time it takes to receive inventory after placing an order.

Lead times will ultimately influence when purchases are recorded and how inventory is classified on Balance Sheets (e.g., in transit vs. available).

Determine quantity and timing of purchases

Calculate the optimal order quantities and scheduling purchases at the right times to ensure sufficient stock (while minimizing holding costs and waste).

Quantity and timing decisions affect cash flow, supplier payments, and the timing of inventory costs in accounting records.

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Accounting impact

Determine raw materials and produce a bill of materials

A bill of materials (BOM) is a detailed list of all the raw materials, components, parts, and quantities required to manufacture a finished product. It serves as a comprehensive blueprint for production, outlining everything needed for assembly or manufacturing.

By detailing the materials consumed in manufacturing, the BOM helps allocate costs to finished goods, supports accurate valuation of inventory, and ensures compliance with accounting standards for COGS and financial reporting.

Come up with a plan for production and produce a production schedule

A production schedule is a detailed plan that outlines what products need to be manufactured, in what quantities, and by when. It aligns production timelines with inventory levels and demand forecasts, ensuring raw materials are available and efficiently used.

This schedule dictates when costs for materials, labor, and overhead are incurred and transferred into work-in-progress or finished goods inventory.

Order raw materials

Order raw materials as per your BOM and production schedule.

When materials are purchased, they are recorded as inventory assets on the Balance Sheet. Once these materials are used in production, their costs are allocated to work-in-progress or finished goods inventory, eventually contributing to the COGS on the Income Statement.

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Accounting impact

Determine supplier pricing and come up with an approval process

This step involves negotiating pricing with suppliers and establishing approval workflows to ensure purchases align with budgets and policies.

Clear pricing agreements and approval processes ensure accurate cost tracking and prevent unauthorized or unrecorded purchases, aiding in expense management and financial reporting.

Issue purchase order

A purchase order (PO) is a formal request sent to a supplier detailing the goods, quantities, and agreed-upon pricing.

Issuing POs creates a financial obligation and provides a reference point for matching invoices and inventory received, ensuring accuracy in accounts payable and inventory records.

Receive bill

The supplier's invoice is reviewed against the PO and shipment details to verify charges before processing payment.

Receiving and validating bills ensures accurate expense recording and prevents discrepancies between received goods and supplier charges.

Issue pre-payment to supplier

A pre-payment is made to secure an order, often for custom or high-value inventory purchases.

Pre-payments are recorded as prepaid expenses or advances in accounting, impacting cash flow and requiring adjustments once the goods are received.

Track shipments

Monitoring the status of orders ensures timely receipt of inventory and helps address delays or discrepancies.

Tracking shipments ensures inventory in transit is accounted for appropriately, maintaining accurate inventory levels and preventing mismatches in financial records.

Step

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Accounting impact

Receive raw materials

Record the delivery of materials from suppliers to ensure they match the purchase order and meet quality standards.

Increases raw material inventory on the Balance Sheet.

Manufacturing the product (according to the bill of materials and production schedule)

Assemble or create the product using raw materials, guided by the bill of materials and production schedule.

Costs of raw materials, labor, and overhead are transferred from raw materials inventory to work-in-progress or finished goods inventory, impacting inventory valuation and COGS calculations.

Move finished product to finished goods in product tracking

Once production is complete, the finished products are moved from work-in-progress to the finished goods inventory for storage or sale.

This step finalizes the cost allocation, transferring the total production costs to finished goods inventory, which will later be recognized as COGS when the products are sold.

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Accounting impact

Receive goods

Goods are delivered from the supplier or manufacturer and logged into the system upon arrival.

This step increases inventory assets on the Balance Sheet, initiating the tracking of inventory costs for future sales or usage.

Inspect quality and quantity and produce a receiving slip

The delivered goods are inspected to ensure they meet the purchase order (PO) specifications, and a receiving slip is created to document the inspection.

Accurate inspection and documentation prevent discrepancies, ensuring inventory valuation reflects only usable and correct items.

Mark PO as received

The purchase order is updated to indicate that the goods have been delivered and accepted.

Marking the PO as received triggers inventory updates and ensures that accounts payable aligns with received goods.

Receive final bill

The supplier provides a final invoice for the goods, which is reviewed for accuracy against the purchase order and receiving slip.

The bill establishes the financial liability in accounts payable and ensures accurate expense recording.

Resolve disputes or pricing differences

Any discrepancies between the PO, receiving slip, or bill are addressed with the supplier to ensure accurate pricing and quality.

Resolving disputes avoids overpayment and ensures inventory costs are accurately reflected in financial records.

3-way verification of PO, rec slip, bill

This step involves cross-checking the purchase order, receiving slip, and invoice to confirm consistency before payment.

Ensures inventory, accounts payable, and expenses are accurately recorded, preventing financial discrepancies or errors.

Approval process – pay bill

The bill is approved for payment after all verifications are complete, and the supplier is paid.

Payment reduces accounts payable and impacts cash flow, while ensuring accurate financial records for inventory costs.

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Accounting impact

Create sales receipt / invoice AR

A sales receipt or invoice is generated to document the transaction, detailing items sold, quantities, and payment terms for the customer.

This step records revenue in the accounting system and, if unpaid, increases accounts receivable, ensuring accurate tracking of sales income and outstanding customer payments.

Create picking slip

A picking slip is created to guide warehouse staff in locating and preparing the sold items for shipment.

While this step doesn’t directly impact accounting, it initiates the inventory adjustment process, ensuring inventory records align with physical stock.

Sales activity reported, recorded, and reconciled

Sales transactions are reported in the accounting system, reconciled with inventory systems, and matched with payments to ensure accuracy.

This step ensures revenue, accounts receivable, and inventory levels are updated accurately, maintaining reliable financial records and preventing discrepancies.

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Calculate COGS

The Cost of Goods Sold (COGS) is calculated based on the costs associated with the inventory sold during the transaction.

COGS is recorded on the Income Statement, reducing inventory on the Balance Sheet and directly impacting profit calculations and gross margin analysis.

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Accounting impact

Pick & pack (create a packing slip)

This involves selecting items from inventory to fulfill an order and creating a packing slip to include with the shipment (to help ensure accuracy).

Picking reduces the physical inventory count, while packing creates documentation that supports inventory adjustments, ensuring records reflect the stock used for fulfillment.

Create a shipping label

A shipping label includes customer details and delivery information for the chosen carrier to ensure the package reaches its destination.

Shipping costs may be recorded as expenses or passed to the customer as revenue, impacting profitability and requiring accurate tracking of associated fees.

Use the shipping label to ship box

The labeled package is handed over to the shipping carrier for delivery to the customer.

Shipping confirms the fulfillment process and triggers recognition of revenue and the recording of COGS in accounting systems.

Update fulfillment status

The order status is marked as fulfilled in inventory and sales systems, reflecting that the product has been shipped.

This step ensures inventory records are updated to reduce stock levels, aligning inventory accounting with the actual sale and shipment. It also closes the sales transaction for proper financial reporting.

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Accounting impact

Customer processes return; create a return authorization

The customer initiates the return process, and a return authorization (RA) is issued to approve and track the return.

The RA ensures that the return is logged for tracking purposes, creating a record that will reverse revenue and adjust inventory or COGS once the product is returned.

Product received back into warehouse or 3PL

The returned product is inspected upon receipt to determine if it can be restocked, needs repair, or should be written off.

Inventory levels are updated, potentially increasing stock for restocked items or recording losses for damaged goods. Accurate adjustments are essential for maintaining correct inventory valuation.

Inventory value / COGS adjusted

The value of the returned product is recorded, and the COGS is reversed or adjusted to account for the returned inventory.

Adjusting inventory value and reversing COGS ensures accurate financial reporting, aligning sales and inventory records with actual returns and their financial impact.

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Accounting impact

Products counted

Physical inventory is manually counted or scanned to determine the actual quantity of products in stock, identifying discrepancies with recorded inventory levels.

Counting provides the basis for identifying shrinkage, overstock, or miscounted items, highlighting the need for adjustments to maintain accurate inventory valuation in financial records.

Inventory adjusted

Inventory records are updated to align with the actual stock levels identified during the count, correcting for any discrepancies.

Adjustments affect the inventory value reported on the Balance Sheet and may impact COGS on the Income Statement. These updates ensure accurate financial reporting and help prevent future errors in inventory management.