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Beginner's guide to stock accounting: What is it and why do it?

Accounting and stock may seem like two separate yet critical components of any business, but they are linked. Accounting for stock by calculating stock in accounting terms is a specific and single part of a business’s success. 

Whereas stock management tracks and controls the movement of stock, the accounting side deals with the financial information intimately tied to the buying and selling of finished goods. When it comes to stock accounting, you’ll learn everything you need to know in this guide to stock accounting.

What is stock accounting?

Accounting is the discipline of calculating, processing, and communicating financial information for businesses and individuals. Stock accounting is the type of accounting that covers these financial operations and responsibilities of the business’s stock, accurately depicting the assets of the company.

As stock is always changing, the variables associated with its accounting must follow specific methods and procedures to ensure an accurate depiction of a business’s finances. Stock accounting is an important and often monumental task for any company. It must cover both sold and unsold products as they come and go from the stock and the bookkeeping records.

How does stock accounting work?

Stock accounting involves accurately depicting a business’s financial health as determined by its stock. There are many variables that stock accounting deals with, from the movement of the stock, daily fluctuations in quantity, ageing stock and dead stock, and so on.

Companies will need to choose a specific stock accounting system and method of cost valuation and adhere to their guidelines in order to extract and calculate the required financial information from fluctuating expenses and revenue. Stock accounting works by tracking stock costs and recording stock assets and the overall value of stock at the beginning and end of an accounting period to determine the metrics of a business.

There are two central stock accounting systems that your business can choose to use when tracking and recording stock finances.



Perpetual vs. periodic stock accounting systems

The perpetual stock system records and tracks stock balances continuously. Updates are made automatically to the perpetual system, tracking when a product comes into or leaves the stock account. In contrast, the periodic stock system tracks stock by periodically checking the stock with a physical count to measure the stock and cost of sales.


Cost of sales (COS)

The cost of sales, also known as COS, refers to all costs associated with a business’s production process, such as the raw materials needed to manufacture those goods. It is the value of all stock goods sold within a given period.



How is stock classified in accounting?

In accounting, stock is classified as a current asset and will show up as such on the business’s balance sheet. When recording a stock item on the balance sheet, these current assets are listed by the price the goods were purchased, not at the price the goods are selling for.

Opening stock balance and ending stock balance will need to be recorded on the balance sheet each period.



Do I have to report stock?

Yes, simply put, all businesses must report their stock to their country’s revenue collection agency. However, revenue collection agencies do not need to know the specific stock items, but rather the costs of sales and net income, which are both calculated using the stock balance.



Does stock count as income?

Stock as an entity does not count directly as income on a person’s income statement. Nonetheless, the stock’s value is directly linked to the business’s revenue and overall income. Therefore, the stock itself is not income, but the value of the stock is required for determining income.

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Does stock count as income?

Stock as an entity does not count directly as income on a person’s income statement. Nonetheless, the stock’s value is directly linked to the business’s revenue and overall income. Therefore, the stock itself is not income, but the value of the stock is required for determining income.

1. FIFO method

The FIFO method, known as the first-in, first-out stock management technique, tracks the value of goods as they enter and exit the stock. This method concludes that the stock first purchased for stock is also the first stock to be sold, even if it is physically not.

This technique provides businesses with an accurate depiction of the ending stock and its value. Many companies will opt to use the FIFO stock method to offload their older stock first. As a result, the calculations for a stock’s cost of sales will reflect the movement and value of the goods. This stock accounting method is one most often used by businesses, especially ones with perishable inventories.

FIFO example

Suppose Mary owns a kitchenware store and follows the FIFO accounting method of stock costing. She will need to assign costs to her stock based on the goods purchased first for her retail business.

If Mary were to buy 50 wine glasses at $12 each, and then order another 50 wine glasses but this time, paying $16 each, she would assign the cost of the first wine glass as resold at $12. Once 50 wine glasses are sold, the next 50 glasses are set at the $16 value, no matter the additional stock purchased within that time.



2. LIFO method

The LIFO method or last-in, first-out technique asserts that the last stock added to stock will be the first sold. At the end of an accounting period, the stock leftover would be the oldest purchased goods.

The disadvantages associated with this costing method outweigh the advantages. Many companies would consider this stock management technique unrealistic, as businesses seek to sell their oldest stock first. The LIFO stock valuation method is typically inaccurate with its stock value portrayal as it generates prices that fluctuate throughout the year. Overall, many industries opt to use FIFO over its counterpart, LIFO.

LIFO example

Say Robert runs a jewellery shop and uses the LIFO costing method to manage his stock. Suppose he buys 100 silver necklaces at $25 per necklace. Later, he chooses to buy another 50 silver necklaces, but this time, the price has gone up to $30 per item.

If Robert uses LIFO to determine the cost of his stock, the first necklace sold will be priced at $30, even if it came from the previously ordered stock. Following the last-in, first-out method, the first 50 necklaces would be assigned the cost of $30, while the following 100 necklaces sold would be priced at $25.

3. Weighted average method

The weighted average method, or average cost method, deals with stock utterly different from the FIFO and LIFO methods. This method dictates that the overall value of stock is based on the average cost of items purchased and sold within a given accounting period.

If your business industry deals with erratic price fluctuations throughout a given time, then this costing method may not be the best option when evaluating your stock, as significant price differences will skew the calculations.



Weighted average example

Suppose Lisa runs a beauty store and decides to purchase lipstick to sell to customers. She opts to buy 40 lipsticks at the beginning of the year for $10 each. Halfway through the year, she decides to order a further 30 at $15, and then another 20 lipsticks at $20 each at the end of the year. Lisa’s stock consists of 90 lipsticks, and by the end of the period, she has sold 15 of them.

She will need to use the weighted average costing method to determine the cost of units sold. Lisa calculates this number by taking the total stock purchased in the year, $1,250, dividing it by the total number of lipstick units, 90. The average cost of lipstick would then be $13.89, so she, therefore, sold 15 lipsticks at $13.89, for a total of $208.35.



Why is stock accounting important?

Part of running a professional business ensures all government and industry-specific laws and regulations are followed as necessary. Companies and individuals must produce the appropriate financial statements and income tax returns each year as dictated by their country’s revenue collection agency. Failure to comply will result in fines and penalties and possible incarceration.

That means keeping accurate and up-to-date financial records for business management purposes and tax return filing. Following International Financial Reporting Standards (IFRS), a business can determine the appropriate information as required, like corresponding stock accounting numbers.

Many business owners look to accounting software to help them track and calculate financial information- this also includes stock management and accounting. Millions of individuals and businesses manage stock using QuickBooks as a means to simplify this monumental undertaking.

QuickBooks Online offers small businesses stock tracking software to organise and keep track of stock quantities, purchase orders, insights, valuation, and more! Try this popular software as a free trial today!


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