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I have 2 main issues with understanding double entry accounting, that i haven't really been able to grasp properly: 1 - How do i use it to keep track of multip

by jdasdf 4y ago

I have 2 main issues with understanding double entry accounting, that i haven't really been able to grasp properly: 1 - How do i use it to keep track of multiple "currencies"? It's simple enough to remove 1$ from the cash account into the inventory account, but that 1$ i now have in the inventory isn't actually cash... How can i use this to keep track of the number of widgets i actually have in storage? Rather than the cost it took me to get them there. 2 - How do i account for profits? Back to the example, i move the 1$ from my cash onto the inventory. Great now i have 1$ in inventory. I sell half my inventory for 2$. How exactly do i account for this? I still have presumably 0.5$ in inventory, and now i got 2$ in cash, but where did that come from and go? Presumably i'd take 2$ from the inventory and put it in a client account, but does that mean i now have negative 1$ inventory? Sure the client account would also have another transaction putting the 2$ into my cash account. And wouldn't this make one transaction into actually 2 transactions? One from inventory to client, and one from client to cash? If you can help me grasp this i would really appreciate it!

sbuttgereit 4y ago
This is going to be quick, dirty, and simplistic. I've explained deeper in a different comment. But this should help. Things to keep in mind... The accounting equation: Assets = Shareholder Equity + Liabilities. This expresses what we own (assets) and who has a claim over what we own (shareholders, creditors). Shareholder's equity can be expanded as: Retained Earnings + (Revenue - Expenses); retained earnings is revenue - expenses in prior years. Transactions assuming you start with $1 in cash. When you buy the inventory you credit the Cash Account (asset) by $1 and debit the Inventory Account (asset) by $1. In essence you've converted the cash asset into an inventory asset. When you sell the inventory you have a multi-part transaction. Inventory movement: Credit the Inventory Account (asset) by $1 and Debit the Costs of Goods Sold Account (Expense) by $1. You no longer have the inventory. The Sale part: Debit the Cash Account (asset) by $2 and Credit the Sales Account (Revenue) by $2. You have received a new $2. In the end you remove the inventory as an expense to Costs of Goods Sold and you have new cash from sales revenue. From the accounting equation perspective it looks like: Before inventory purchase: $1 (Asset/Cash) = $1 (Equity, assuming it wasn't borrowed) + $0 (Liabilities) After Inventory Purchase: $1 (Asset/Inventory) = $1 (Equity) + $0 (Liabilities) After Sale: $2 (Asset/Cash) = $1 (Equity) + ($2 (Revenue/Sales) - $1 (Expense/COGS)) + $0 (Liabilities)
- jdasdf 4y ago
  >When you sell the inventory you have a multi-part transaction. Inventory movement: Credit the Inventory Account (asset) by $1 and Debit the Costs of Goods Sold Account (Expense) by $1. You no longer have the inventory. The Sale part: Debit the Cash Account (asset) by $2 and Credit the Sales Account (Revenue) by $2. You have received a new $2. So that answers part of question 2, but not entirely. And it doesn't address question 1 at all. You statement works if you're zero-ing out your inventory account, but what happens if you have 3 dollars, and put them into your inventory account in 2 transactions, one for 1$ and one for 2$. Both transactions actually added the exact same number of widgets to your actual inventory, say 2 widgets one cost 1$ the other 2$. They are otherwise in differentiable. When you go to credit the COGS account because you sold 1 widget, how much do you credit? 1$ (the cheapest you bought), 2$ (the most expensive), or 1.5$ (the average)? Whichever one you pick, you're going to have issues later on when you buy/sell additional widgets...
  - rest4thewicked 4y ago
    It depends on the accounting treatment that you need to track under. Average cost is easier to track with a Ledger type solution. You keep track of inventory in two ways on two different Ledger Accounts under different "currencies." Inventory in dollars and inventory in units. When you make a sale calculate average per unit value by dividing inventory USD value by number of units. Then your COGS value is driven by that average * units. Each purchase adds to both the USD and the units accounts.
  - drc500free 4y ago
    Under GAAP rules, you could use FIFO, LIFO, or average for inventory costs. IIRC firms generally use LIFO, since that usually results in higher cost of goods sold, and therefore lower taxes. They can't do exactly "most expensive first," but LIFO is pretty close to that since inventory prices tend to increase. Tracking how many units were bought at each time at each price is not part of the core accounting ledgers of debits and credits, that would be supplemental info that helps you determine how large the debits and credits should be whenever you use up inventory.
  - 4y ago
rthomas6 4y ago
My non-expert understanding for number 1 is that you would record the widget account in denominations of widgets, and separately, record the widget cost for that transaction. That's what you do in beancount anyway, which is what I use for home budgeting. Like this: 2022-08-17 * "Purchase Widgets" Assets:Cash -100.00 USD Assets:Inventory:Widgets 10 WIDGET {10 USD} Number 2 is just the reverse: 2022-08-18 * "Sell Widget" Assets:Cash 20 USD Assets:Inventory:Widgets -1 WIDGET {20 USD} Probably there's some other more professional way to do it, but this is what makes sense to me, and it's double entry.
- jdasdf 4y ago
  Wouldn't that lead to a negative inventory value when the number of widgets is still positive?
  - rthomas6 4y ago
    No, because the inventory value is denominated in widgets, not USD. What's important is that each transaction balances to zero. It doesn't have to balance across transactions.
meekaaku 4y ago
Inventory is not a second currency. Multiple currencies are handled using Exchange loss/gain accounts. I will try running your example from scratch. You begin business with $100 capital which is deposited to your bank account. I am using Cr for credit, Db for Debit 1. Starting capital: Capital Cr $100, Bank Db $100 2. Purchase widgets worth $50: Bank Cr $50, Inventory Db $50 3. You sell half of this inventory (valued $25) for $75 in cash: Sales Cr $75, Cash Db $75 Inventory Cr $25, Cost of goods sold Db $25 4. You sell rest of your inventory on credit to John for $110: Sales Cr $110, Accounts Receivable-John Db $110, Inventory Cr $25, Cost of goods sold Db $25 5. You pay $30 salaries via cheque: Bank Cr $30, Expense-Salary Db $30 At the end of all this your PL (profit loss statement) would look like this Sales: $185 (110 + 75) Cost of goods sold: $50 (as you sold all of the inventory) Gross profit = sales - cost of goods sold = 185 - 50 = $135 Expenses = $30 (salaries only) Net profit = gross profit - expenses = 135 - 30 = $105 Your balance sheet at the end of all this will be : Capital: Cr $100 Accumulated profit: Cr $105 Bank: Db $20 Cash: Db $75 AR John: Db $110 Inventory: 0 (as you sold all). Note the balance sheet balances nicely as Capital + Accumulated profit = bank + cash + AR + inventory
GeorgeDewar 4y ago
I can help with number 2. Two transactions are happening at the same time. Your "sales" revenue account is going up (Credit) by $2 and your cash asset account is going up (Debit) by the same $2. That is the first balanced transaction. The second transaction is that your inventory asset account is going down (Credit) by $0.50 as you have less inventory now, and an expense account called "Cost of Goods Sold" is Debited by the same $0.50. Your profit gets calculated on demand. There are two ways to do it, both yielding the same result. You can look at revenue minus expenses over a period, giving $2 sales minus $0.50 cost of goods sold = $1.50 profit for the period. Or, you can look at how your equity (assets minus liabilities) has changed over that period. In this example, no liabilities have changed and your assets (bank account) have increased by $1.50 because bank has gone up by $2 while inventory has gone down by $0.50.

by jdasdf 4y ago

sbuttgereit 4y ago

This is going to be quick, dirty, and simplistic. I've explained deeper in a different comment. But this should help. Things to keep in mind... The accounting equation: Assets = Shareholder Equity + Liabilities. This expresses what we own (assets) and who has a claim over what we own (shareholders, creditors). Shareholder's equity can be expanded as: Retained Earnings + (Revenue - Expenses); retained earnings is revenue - expenses in prior years. Transactions assuming you start with $1 in cash. When you buy the inventory you credit the Cash Account (asset) by $1 and debit the Inventory Account (asset) by $1. In essence you've converted the cash asset into an inventory asset. When you sell the inventory you have a multi-part transaction. Inventory movement: Credit the Inventory Account (asset) by $1 and Debit the Costs of Goods Sold Account (Expense) by $1. You no longer have the inventory. The Sale part: Debit the Cash Account (asset) by $2 and Credit the Sales Account (Revenue) by $2. You have received a new $2. In the end you remove the inventory as an expense to Costs of Goods Sold and you have new cash from sales revenue. From the accounting equation perspective it looks like: Before inventory purchase: $1 (Asset/Cash) = $1 (Equity, assuming it wasn't borrowed) + $0 (Liabilities) After Inventory Purchase: $1 (Asset/Inventory) = $1 (Equity) + $0 (Liabilities) After Sale: $2 (Asset/Cash) = $1 (Equity) + ($2 (Revenue/Sales) - $1 (Expense/COGS)) + $0 (Liabilities)

jdasdf 4y ago
>When you sell the inventory you have a multi-part transaction. Inventory movement: Credit the Inventory Account (asset) by $1 and Debit the Costs of Goods Sold Account (Expense) by $1. You no longer have the inventory. The Sale part: Debit the Cash Account (asset) by $2 and Credit the Sales Account (Revenue) by $2. You have received a new $2. So that answers part of question 2, but not entirely. And it doesn't address question 1 at all. You statement works if you're zero-ing out your inventory account, but what happens if you have 3 dollars, and put them into your inventory account in 2 transactions, one for 1$ and one for 2$. Both transactions actually added the exact same number of widgets to your actual inventory, say 2 widgets one cost 1$ the other 2$. They are otherwise in differentiable. When you go to credit the COGS account because you sold 1 widget, how much do you credit? 1$ (the cheapest you bought), 2$ (the most expensive), or 1.5$ (the average)? Whichever one you pick, you're going to have issues later on when you buy/sell additional widgets...
- rest4thewicked 4y ago
  It depends on the accounting treatment that you need to track under. Average cost is easier to track with a Ledger type solution. You keep track of inventory in two ways on two different Ledger Accounts under different "currencies." Inventory in dollars and inventory in units. When you make a sale calculate average per unit value by dividing inventory USD value by number of units. Then your COGS value is driven by that average * units. Each purchase adds to both the USD and the units accounts.
- drc500free 4y ago
  Under GAAP rules, you could use FIFO, LIFO, or average for inventory costs. IIRC firms generally use LIFO, since that usually results in higher cost of goods sold, and therefore lower taxes. They can't do exactly "most expensive first," but LIFO is pretty close to that since inventory prices tend to increase. Tracking how many units were bought at each time at each price is not part of the core accounting ledgers of debits and credits, that would be supplemental info that helps you determine how large the debits and credits should be whenever you use up inventory.
- 4y ago

rthomas6 4y ago

My non-expert understanding for number 1 is that you would record the widget account in denominations of widgets, and separately, record the widget cost for that transaction. That's what you do in beancount anyway, which is what I use for home budgeting. Like this: 2022-08-17 * "Purchase Widgets" Assets:Cash -100.00 USD Assets:Inventory:Widgets 10 WIDGET {10 USD} Number 2 is just the reverse: 2022-08-18 * "Sell Widget" Assets:Cash 20 USD Assets:Inventory:Widgets -1 WIDGET {20 USD} Probably there's some other more professional way to do it, but this is what makes sense to me, and it's double entry.

jdasdf 4y ago
Wouldn't that lead to a negative inventory value when the number of widgets is still positive?
- rthomas6 4y ago
  No, because the inventory value is denominated in widgets, not USD. What's important is that each transaction balances to zero. It doesn't have to balance across transactions.

meekaaku 4y ago

Inventory is not a second currency. Multiple currencies are handled using Exchange loss/gain accounts. I will try running your example from scratch. You begin business with $100 capital which is deposited to your bank account. I am using Cr for credit, Db for Debit 1. Starting capital: Capital Cr $100, Bank Db $100 2. Purchase widgets worth $50: Bank Cr $50, Inventory Db $50 3. You sell half of this inventory (valued $25) for $75 in cash: Sales Cr $75, Cash Db $75 Inventory Cr $25, Cost of goods sold Db $25 4. You sell rest of your inventory on credit to John for $110: Sales Cr $110, Accounts Receivable-John Db $110, Inventory Cr $25, Cost of goods sold Db $25 5. You pay $30 salaries via cheque: Bank Cr $30, Expense-Salary Db $30 At the end of all this your PL (profit loss statement) would look like this Sales: $185 (110 + 75) Cost of goods sold: $50 (as you sold all of the inventory) Gross profit = sales - cost of goods sold = 185 - 50 = $135 Expenses = $30 (salaries only) Net profit = gross profit - expenses = 135 - 30 = $105 Your balance sheet at the end of all this will be : Capital: Cr $100 Accumulated profit: Cr $105 Bank: Db $20 Cash: Db $75 AR John: Db $110 Inventory: 0 (as you sold all). Note the balance sheet balances nicely as Capital + Accumulated profit = bank + cash + AR + inventory

GeorgeDewar 4y ago

I can help with number 2. Two transactions are happening at the same time. Your "sales" revenue account is going up (Credit) by $2 and your cash asset account is going up (Debit) by the same $2. That is the first balanced transaction. The second transaction is that your inventory asset account is going down (Credit) by $0.50 as you have less inventory now, and an expense account called "Cost of Goods Sold" is Debited by the same $0.50. Your profit gets calculated on demand. There are two ways to do it, both yielding the same result. You can look at revenue minus expenses over a period, giving $2 sales minus $0.50 cost of goods sold = $1.50 profit for the period. Or, you can look at how your equity (assets minus liabilities) has changed over that period. In this example, no liabilities have changed and your assets (bank account) have increased by $1.50 because bank has gone up by $2 while inventory has gone down by $0.50.