How does Xero account for inventory?

Xero accounts for tracked and untracked inventory transactions in different ways. With tracked inventory, Xero keeps track of the quantity of items on hand, and calculates their value using the average cost method. With untracked inventory, Xero records purchases and sales, but does not keep track of quantities or values on hand.

Accounting for tracked inventory

Xero uses the average cost method to value tracked inventory, and calculates the cost of goods sold for each tracked inventory sales transaction. Xero updates the quantity and value on hand for the tracked inventory item when the transaction is approved, not as at the transaction date.

Transactions that affect a tracked item's quantity and value on hand are invoices, bills, credit notes, spend money, receive money transactions and inventory quantity adjustments. Quotes and purchase orders do not affect tracked inventory quantity on hand or values.

Before you can use tracked inventory you need to set up at least one inventory asset account and set up or designate one cost of goods sold account.

Getting started with tracked inventory

We'll use an example to show how Xero accounts for tracked inventory transactions.

Example

Acme Inc. is starting to use tracked inventory for its widgets. It has set up the following accounts in its chart of accounts:

  • 630 Inventory - an account with the account type 'Inventory' to hold the value of tracked inventory items

  • 310 Cost of Goods Sold - an account with the account type 'Direct Costs' to record cost of goods sold for tracked inventory items. (Note: We recommend using 'Direct Costs' for the account type for your cost of goods sold account. Consult with your accountant or bookkeeper to determine the right account type for your organisation.)

Acme Inc. does not have any opening stock. It carries out the following transactions (VAT is ignored).

  1. 5 July - Purchase 200 widgets at 5.00 per widget. Accounting entries in Xero:

    Dr 630 Inventory 1000

    Cr Accounts Payable 1000

  2. 10 July - Purchase 150 widgets at 6.00 per widget. Accounting entries in Xero:

    Dr 630 Inventory 900

    Cr Accounts Payable 900

    On 10 July the widget inventory record is as follows:

    Image showing widget inventory record.

  3. On 12 July, Acme Inc. sells 300 widgets for 10.00 each. The cost of widgets sold is 1629, being 300 widgets at 5.43 average cost per widget. The accounting entries are:

    Dr Accounts Receivable 3000

    Cr Sales 3000

    Dr 310 Cost of Goods Sold 1629

    Cr 630 Inventory 1629

    After the sale, the widget inventory record is as follows:

    Image showing widgets inventory record after sale.

The balances of the accounts used, assuming no other transactions have taken place, are:

AccountDebitCredit

Accounts Payable

 

1900

Accounts Receivable

3000

 

310 Cost of Goods Sold

1629

 

630 Inventory

271

 

Sales

 

3000

Accounting for untracked inventory

Xero does not calculate inventory average cost, nor does it maintain inventory records for untracked inventory.

Using the same example as for tracked inventory, the accounting entries in Xero using untracked inventory are:

  1. 5 July - Purchase 200 widgets at 5.00 per widget. Accounting entries in Xero:

    Dr Purchases 1000

    Cr Accounts Payable 1000

  2. 10 July - Purchase 150 widgets at 6.00 per widget. Accounting entries in Xero:

    Dr Purchases 900

    Cr Accounts Payable 900

  3. On 12 July, Acme Inc. sells 300 widgets for 10.00 each. Accounting entries in Xero:

    Dr Accounts Receivable 3000

    Cr Sales 3000

The balances of the accounts used, assuming no other transactions have taken place, are:

AccountDebitCredit

Accounts Payable

 

1900

Accounts Receivable

3000

 

Purchases

1900

 

Sales

 

3000