Visual EstiTrack. Understanding Inventory Reconciliation (Supplement) November 2005

Visual EstiTrack Understanding Inventory Reconciliation (Supplement) November 2005

OVERVIEW: Methods of Reconciling Inventory Values Most companies that maintain raw material, work in process and finished goods inventories post net changes to these asset accounts on a monthly basis. The net changes posted to these accounts represent the change in value from one month to another. Not every business uses the same method for calculating inventory values and net changes. Some businesses simply perform physical inventory counts each month for each item within each of the three inventory classifications (i.e., Raw Material (RM), Work in Process (WIP) and Finished Goods(FG)) to determine month ending values of these inventories. They then compare the current month s values to the previous month s values to determine the net changes in these inventory accounts and use the general journal to post the net changes calculated. There are a wide variety of methods that businesses use to calculate actual inventory value. This includes using actual cost, standard cost or at times a percentage of the item s selling price. Actual cost is typically used on valuation of raw material (i.e., directly purchased items) because this cost can be easily determined by the purchased cost of the item. What is more complicated for businesses is the determination of WIP and FG values when manufactured added value and overhead expenses are added to the cost of the raw materials. Many companies want to calculate their work in process and finished goods cost at actual value but lack the discipline to accurately account for each added value cost and overhead components. Only through the very detailed tracking and reporting of each added value and overhead component can an accurate cost value be derived. The four major component costs tracked in Visual EstiTrack includes material, labor, burden/overhead and other (outside processes and miscellaneous costs). The shop order is the container for recording these component costs. It is only through the accurate capturing of these component costs that an accurate actual value is calculated and assigned to the WIP and FG items being produced. This means all labor hours for the shop order must be accurately reported; both employee labor and workcenter burden/overhead rates must be accurately defined and maintained. In addition, all raw material and manufactured components must be accurately consumed and all other costs entered and assigned to the appropriate shop order to get a complete and accurate actual cost. If a business fails to completely capture and enter any of the actual cost details (i.e., material, labor, burden/overhead and other costs) the calculated actual cost of an item will be inaccurate thus distorting the final WIP and FG inventory valuations. Visual EstiTrack provides a formalized method for tracking actual job costs through shop order time and materials reporting. Visual EstiTrack s Inventory Monthly Reconciliation screen provides the bookkeeper an interactive worksheet designed to summarize actual cost details in order to generate the monthly net changes accounting entry for RM, WIP and FG inventory values. In addition, the Inventory Monthly Reconciliation screen will calculate the movements of cost of goods sold (i.e., absorption of costs into WIP and recognizing the costs of goods shipped/sold). If a business lacks the discipline to accurately record shop order component costs then the Visual EstiTrack s Monthly Inventory Reconciliation screen cannot be used and an alternative manual accounting method for Raw Material, WIP and FG valuations must be used. Henning Industrial Software, Inc. Page 1 Visual EstiTrack 11/2005

Alternative manual inventory accounting methods include using a standard cost for finished good items, using a standard cost for work in process items based on a percentage of completion or using a percentage of the selling price of an item. In the end, there are a wide variety of methods used by businesses to valuate inventory and it is your responsibility to determine which method works best for your company. The remainder of this document describes Visual EstiTrack s formalized Inventory Monthly Reconciliation method of calculating actual inventory values and cost of goods sold and the different options available. PROCEDURES: Monthly Inventory/Cost of Goods (COG) Adjustments To accurately reflect profit and loss on the Income Statement it is important that you make appropriate monthly adjustments to move expenses back and forth between the Income Statement and the Balance Sheet. The goal is to have the expenses that are reflected in cost of goods occurring during the same fiscal period as the sales of the goods sold. While many accountants choose to calculate and enter these monthly adjustment entries manually, Visual EstiTrack s Inventory Reconciliation Screen provides the means to calculate and generate the necessary monthly adjustment entries directly via the general journal so that it can be posted to the general ledger. The following outlines the typical monthly procedure used to make inventory and cost of goods general ledger adjustments. These monthly adjustments are used to absorb expenses from the Income statement to the Balance sheet s WIP account for shop orders that are in process. Visual EstiTrack s shop orders track all WIP component costs (i.e., direct labor, burden/overhead, material and other subcontracting/miscellaneous costs) that occur during the life of the shop order. These summarized component costs are used to move costs from the Balance sheet inventory accounts (i.e., either FG if you are using FG inventory or WIP if you are not using FG Inventory) to the Income Statement s cost of goods sold accounts when FG items are shipped/sold or when a WIP to COGS shop order is closed to match these expenses with the shipment/sales of items actually sold during the month. In Visual EstiTrack these adjustment entries must be made as monthly general journal entries. Visual EstiTrack supports a wide variety of inventory accounting methods. It is important that you determine your type of business operation to determine which inventory accounting method applies to you. For example, some businesses don t track Raw Material or Finished Good inventory. They simply buy directly to WIP (i.e., shop orders) and then ship directly from WIP without reporting a finished good item. In this case, costs are reported directly to WIP via the shop order and then moved directly to cost of goods sold from WIP when the item is shipped/sold or when the shop order is closed. In other cases, businesses formally track Raw Material, WIP and FG inventory and all the movements between each inventory account. While other businesses use a combination of both of these methods. Let s take a closer look at Visual EstiTrack s Inventory Reconciliation criteria screen and options. Henning Industrial Software, Inc. Page 2 Visual EstiTrack 11/2005

Inventory Reconciliation Criteria Fields and Options defined The Reconciliation Criteria tab allows the user to define the accounting fiscal period, business specific options to customize the cost accounting methods and specific general account numbers used to generate the general journal monthly entries. What follows is a description of each field and option. Accounting Month and Year Provides selection of the Account Month and Year to reconcile inventory and generate the appropriate General Journal entry. Accounting Division / Accounting Department Provides selection of the specific Accounting Division / Department to reconcile inventory and generate the appropriate Division / Department General Journal entry. These fields are available upon checking the Adjust Inventory by Division / Department and/or the Adjust Cost of Goods Sold by Division / Department checkboxes. Selecting a Division and Department will calculate using transactions assigned to the selected Division / Department combination. Selecting a Division only will calculate using transactions assigned to the selected Division and all Departments of the Division. Selecting a Department only will calculate using transactions assigned to the selected Department and all Divisions the Department belongs to. And leaving both fields blank (right-click on the field to clear) will calculate all transactions of the company. This provides the ability to generate Division / Department entries when the accounts for each Division / Department have different account numbers. The Accounting Division and Departments are entered in Visual Books via the Tables submenu. Default General Ledger Account Numbers Henning Industrial Software, Inc. Page 3 Visual EstiTrack 11/2005

Provides one time entry of standard account numbers used to generate the General Journal Entries. Each Division / Department combination will have its own default account numbers. You can use the same account numbers in multiple default entries to combine the account types into the same general ledger account number. Adjust Inventory Accounts by Division / Department Check if you want to reconcile each Division/Department separately. This allows selection of an account Division / Department to post the Inventory accounts to. The Raw Material and Finished Goods item s Inventory Division / Department combination is defined by the Product code assigned to each Inventory item. The Work in Process item s Inventory Division / Department combination is defined by the Product code assigned to each Shop Order. Each product code is in turn assigned to an accounting Division / Department. Adjust Cost of Goods Sold by Division / Department Check if you want to make reconcile each Division/Department separately. This allows selection of an account Division / Department to post the Cost of Goods Sold to. The Raw Material and Finished Goods item s Cost of Goods Sold Division / Department combination is defined by the Product code assigned to each Inventory item. The Work in Process item s Cost of Goods Sold Division / Department combination is defined by the Product code assigned to each Shop Order. Each product code is in turn assigned to an accounting Division / Department. Post Raw Material Inventory by Distribution Codes Check if you separate the Raw Material account into multiple sub-accounts. This option posts to Raw Material based on the item s Distribution code. Each Distribution code can be assigned a Raw Material account number. If the Distributions code s Raw Material account number is blank that item s transactions are posted to the default Raw Material account number entered on the Reconciliation Criteria screen. Multiple Distribution codes can have the same Raw Material account number. Post Finished Goods Inventory by Product Codes Check if you separate the Finished Goods account into multiple sub-accounts. This option posts to Finished Goods based on the item s Product code. Each Product code can be assigned a Finished Good account number. If the Product code s Finished Goods account number is blank that item s transactions are posted to the default Finished Goods account number entered on the Reconciliation Criteria screen. Multiple Product codes can have the same Finished Goods account number. Post Cost of Goods Sold by Product Codes Check if you separate the Cost of Goods Sold component accounts into multiple sub-accounts. This option posts to the Cost of Goods Sold components (Direct Materials, Direct Labor, Burden / Overhead and Other) based on the item s Product code. Each Product code can be assigned Cost of Goods Sold account numbers for Materials, Labor, Burden and Other. If the Product code s Cost of Goods Sold component account number(s) is blank that item s transactions are posted to the default Cost of Goods Sold component account number(s) entered on the Reconciliation Criteria screen. Multiple Product codes can have the same Cost of Goods Sold account numbers. Exclude Inventory Purchases portion of entry Check if you directly buying to the inventory accounts on the vendor invoice. This options excludes the Materials Purchase Receipts portion of the General Journal entry to avoid double posting the material receipts of the Distribution code s Purchases (Uninvoiced) account number is the inventory account instead of using a formal purchases account or uninvoiced material receipts account. Henning Industrial Software, Inc. Page 4 Visual EstiTrack 11/2005

Exclude Direct Work In Process portion of entry Check this if you are posting cost of goods sold via the customer invoice and sales journal (option in the company table in Visual Books). This option excludes the Cost of Goods Sold components portion of the General Journal entry to avoid double posting the sales/shipped component costs of the Product code s Cost of Goods Sold component costs (Material, Labor, Burden and Other) that are posted via the Customer Invoice. Post Rework to Rework Cost of Goods Sold Accounts Check if you are posting rework shop orders to separate rework cost of goods sold accounts. If a shop order is a rework order, indicated by checking the Rework checkbox on the shop order, the generated General Journal entry will use the Rework Cost of Goods Sold components account numbers entered on the Reconciliation Criteria screen under this checkbox instead of the standard Cost of Goods Sold component account numbers. Henning Industrial Software, Inc. Page 5 Visual EstiTrack 11/2005

Henning Industrial Software, Inc. Page 6 Visual EstiTrack 11/2005

Henning Industrial Software, Inc. Page 7 Visual EstiTrack 11/2005

Henning Industrial Software, Inc. Page 8 Visual EstiTrack 11/2005

Let s take a closer look at the components of Inventory Reconciliation. Henning Industrial Software, Inc. Page 9 Visual EstiTrack 11/2005

(A) ABSORBING COSTS TO Work In Process (WIP) for Open/Active Shop Orders 1) DIRECT BUY MATERIALS (Items bought directly to the Shop Order) a. You should tie the purchase order line item to the Shop Order and Cost of Goods directly by entering the appropriate shop order number and COGS account number into the line item of the Purchase Order. Be sure to select a non-inventory Distribution Code. b. Use the receiving screen to receive in the lines items of a Purchase Order. c. Vendor invoices are directly tied to the received PO Line Items through the Get Receipts button found on the Vendor Invoice maintenance screen. This marks the receipt records as being invoiced and defaults the received quantity and appropriate COGS account number into the vendor invoice to prepare it for posting to the general ledger. d. The WIP account net change is adjusted through Inventory Reconciliation. 2) INVENTORIED RAW MATERIAL a. You should NOT tie the purchase order line items to the shop order but directly tie the line item to the Uninvoiced Receipts GL account. Be sure to select an inventory type Distribution Code. b. Use the receiving screen to receive in the line items of the purchase order. c. Vendor invoices are directly tied to the received PO Line Items through the Get Receipts button found on the Vendor Invoice maintenance screen. This marks the receipt records as being invoiced and defaults the Uninvoiced Receipts account number into the vendor invoice to prepare it for posting to the general ledger. d. The Raw Materials account net change is adjusted through Inventory Reconciliation. 3) MOVING COSTS FROM RAW MATERIAL or FINISHED GOODS TO WIP a. Movements of costs from RAW MATERIAL or FINISHED GOODS to WIP are based on shop order job card inventory usage activity during the month. b. Use the Inventory Journal Report selecting the Used in Production transaction type and either the RAW MATERIAL or FINISHED GOODS inventory type to calculate the amount of material that needs to be credited (decreased) from the RAW MATERIAL or FINISHED GOODS GL accounts and debited (increased) to the WIP inventory account. c. Make a general journal entry to Credit (reduce) either the RAW material GL account or the Finished Good account and Debit (Increase) the WIP Inventory Account. 4) LABOR (Direct Labor on Shop Orders) a. Direct Labor payroll is typically directly expensed out on Income Statement through the posting of the Payroll journal but then offset (removed as an expense) back to the WIP inventory account on the Balance sheet based on all the Job Card direct labor activity occurring during the month. b. Most clients achieve this movement by setting up a LABOR ABSORPTION account. The absorption account is used to move direct labor expenses off the income statement to the balance sheet s WIP account. c. Calculate the total WIP Direct Labor by running the Production Costs report for job cards that were executed during selected month. d. The total direct labor number will then be used to reduce total labor expenses by crediting (reducing) the labor absorption account and debiting the WIP account. Henning Industrial Software, Inc. Page 10 Visual EstiTrack 11/2005

e. The net effect of this is to reduce the payroll expense that occurred during the month by the direct labor that was performed on active shop orders thus moving those direct labor expenses from the income statement to WIP on the balance sheet. 5) BURDEN a. Burden (Overhead such as office salaries, rent) is typically directly expensed out on Income Statement but then offset (removed as an expense) back to WIP inventory account on the Balance sheet for the all Job Card activity occurring during the month. b. Most clients set up a BURDEN ABSORPTION account to move burden expense off the income statement to the balance sheet s WIP account. c. Calculate the total WIP Burden expense by running the Production Costs report for job cards that were executed during selected month. d. The total Burden number will then be used to reduce total burden expenses by crediting (reducing) the Burden absorption account and debiting the WIP account. e. The net effect of this is to reduce the burden expense that occurred during the month by the burden that was carried on active shop orders thus moving those Burden expenses from the income statement to WIP on the balance sheet. 6) OUTSIDE (SUBCONTRACTED) a. You should tie the purchase order line item to the Shop Order and Cost of Goods GL account directly by entering the appropriate shop order number and COGS account number into the line item of the Purchase Order. b. Use the receiving screen to receive in the lines items of a Purchase Order. c. Vendor invoices are directly tied to the received PO Line Items through the Get Receipts button found on the Vendor Invoice maintenance screen. This marks the receipt records as being invoiced and defaults the appropriate COGS account number into the vendor invoice to prepare it for posting to the general ledger. d. The WIP account net change is adjusted through Inventory Reconciliation. (B) MOVING FROM WIP TO COG (EXPENSES) Many clients do not use finished goods inventory but rather ship directly out of WIP. The following procedure outlines the required procedure for moving costs out of WIP on the balance sheet back to the cost of goods sold on the Income statement. Make sure that ALL costs are against the shop order before closing the shop order. PLEASE NOTE: If you need to split parts out of an existing shop order to get them shipped out faster, you should use the Split Shop Order screen to separate the parts and the costs that you are finishing out into its own shop order. In this way you can complete the processing of the split shop order and close it so you can ship the parts so the cost of the goods sold will be updated appropriately. The original shop order would remain in WIP until it is completed. When the Shop Order is closed and the items are shipped you should then move the summarize component costs out of the WIP account and back to the cost of goods accounts. Use the Cost of Sales analysis report or one of the Work in Process Reports to determine the component costs (i.e., labor, burden, material and other) of the shop orders that closed during the month. Once the total costs and component costs have been determined use these numbers to: Henning Industrial Software, Inc. Page 11 Visual EstiTrack 11/2005

1) Credit (decrease) WIP for the total costs of the shop orders closed during the month and debit (increase) the appropriate COG expense accounts on the Income Statement (i.e., Debit Material, Labor and Burden). This adjustment aligns the cost of goods with the actual sales of the goods. (C) MOVING FROM WIP TO FINISHED GOODS If you make to stock and then sell from your finished good inventory then you will need to make a monthly adjustment to move costs from your WIP asset account to your FINISHED GOODS asset account. The following procedure outlines the required procedure for moving costs out of WIP on the balance sheet to Finished Goods on the Balance sheet. Make sure that ALL costs are against the shop order before closing the shop order. PLEASE NOTE: If you need to split parts out of an existing shop order to get them shipped out faster, you should use the Split Shop Order screen to separate the parts and the costs that you are finishing out into its own shop order. In this way you can complete the processing of the split shop order and close it so you can ship the parts so the cost of the goods sold will be updated appropriately. The original shop order would remain in WIP until it is completed. When the Shop Order is closed you should then move the summarize component costs out of the WIP account to the Finished Goods account. Use the Cost of Sales analysis report or one of the Work in Process Reports to determine the component costs (i.e., labor, burden, material and other) of the shop orders that closed during the month. Once the total costs and component costs have been determined use these numbers to: 1) Credit (decrease) WIP for the total costs of the shop orders closed during the month and debit (increase) FINISHED GOODS inventory for the same amount. 2) The net effect of this transaction is that all costs stay on Balance sheet they simply move from one asset account to another (i.e., from the WIP inventory account to the Finished Good inventory account) (D) MOVING FROM FINISHED GOODS TO COG (Expenses) If you sell directly out of Finished Goods inventory it is important that you calculate the costs of the Finished goods sold during the month so that you can credit (reduce) the finished goods inventory account and increase (debit) the appropriate cost of goods accounts. When finished good items are sold 1) Use the show component costs on the Inventory Journal report filtering by the Sale/Shipped transaction type to determine the total and component costs of the goods sold during the month. 2) Use these summarized costs to credit (reduce) Finished Good inventory on Balance Sheet and debit (increase) COG expenses on Income Statement by debiting the values of Labor, Burden and Material. 3) The net effect of this adjustment is to reduce finished goods and increase the cost of goods expenses so the appropriate expense are in same fiscal period as the actual Sales of those items. (E) TEMPORARY LIABILITY ACCOUNT Henning Industrial Software, Inc. Page 12 Visual EstiTrack 11/2005

It is quite common that goods are received into inventory (i.e., Raw Material and WIP inventory) prior to the actual receipt of the Vendor Invoice. Many clients want to reflect that future liability on the general ledger even though the liability is not yet reflected in Accounts Payable. You can achieve this adjustment by running the Receiving Log report for all uninvoiced receipts. The number that is shown can be used to update a temporary liability account. Inventory Reconciliation - Processing costs using materials out of inventory Be sure to define your default G/L chart of accounts numbers. Keep in mind that you MUST define a Standard Cost in Finished Good Inventory. The system uses Standard Cost when calculating the finished goods into inventory. Upon closing the Shop Order the system will recalculate using the Actual Cost and show the adjustment in another month, if applicable. Henning Industrial Software, Inc. Page 13 Visual EstiTrack 11/2005

Let s begin with 0 balances. Visual EstiTrack Understanding Inventory Reconciliation I ve created job cards to complete the first operation. Costs moved into WIP, out of raw materials and burden, labor were absorbed. Let s now take a look at the G/L Entries. Henning Industrial Software, Inc. Page 14 Visual EstiTrack 11/2005

Next I created a purchase order for heat treating and received it in. Notice the change in WIP and Other Direct Costs Absorption. Henning Industrial Software, Inc. Page 15 Visual EstiTrack 11/2005

Next I finished the job making and completing finished goods into inventory. Notice the costs being moved from WIP into Finished Goods at the Standard Cost. This is what the G/L Entries would look like if we posted now. Henning Industrial Software, Inc. Page 16 Visual EstiTrack 11/2005

I will now create a shipment and close the shop order. This recalculates the FIN costs from Standard to Actual and then moves expenses to COG. Let s look at the G/L Entries. Henning Industrial Software, Inc. Page 17 Visual EstiTrack 11/2005

This is the break down. Debit Credit Sales 3400.00 COSTS OF GOODS Cost of Goods Sold 2800.00 Inventory WIP 441.52 Inventory Raw Materials 580.48 Direct Labor Absorption 438.00 Burden/OH Absorption 440.00 Other Direct Costs Absorption 900.00 TOTALS: 2800.00 2800.00 Profit (Loss) 600.00 Processing costs without using materials out of inventory, but buying directly to the job. Henning Industrial Software, Inc. Page 18 Visual EstiTrack 11/2005

Let s begin with 0 balances. I created a purchase order for materials to go directly to a specific job and received it. Henning Industrial Software, Inc. Page 19 Visual EstiTrack 11/2005

If you look at the G/L Entries you will see WIP Debited and Direct Costs Absorption Credited. Upon receiving the Vendor Invoice you will be Debiting Purchases in Cost of Goods and Crediting Accounts Payable. Debit Credit WIP (Asset) 1501.00 Direct Costs Absorption (COG) 1501.00 Direct Purchases (COG) 1501.00 AP (Liability) 1501.00 I next created job cards to complete produce these parts. Costs moved through WIP and then to Finished Goods. Henning Industrial Software, Inc. Page 20 Visual EstiTrack 11/2005

Let s now take a look at the G/L Entries. Since I did not post transactions until the end of the month the first line item will not occur. Also note that the Finished Goods is based on Standard Cost. Debit Credit WIP (Asset) 1501.00 Direct Costs Absorption (COG) 1501.00 Direct Purchases (COG) 1501.00 AP (Liability) 1501.00 FIN (Asset) 268.28 WIP (Asset) 1531.72 Absorptions (COGS) 1800.00 Henning Industrial Software, Inc. Page 21 Visual EstiTrack 11/2005

I will now create a shipment and close the shop order. This recalculates the FIN costs from Standard to Actual and then moves expenses to COG. Let s look at the G/L Entries. Henning Industrial Software, Inc. Page 22 Visual EstiTrack 11/2005

Since I did not post transactions until the end of the month the only entry remaining open will be Purchases and Payroll. Debit Credit WIP (Asset) 1501.00 Direct Costs Absorption (COG) 1501.00 Direct Purchases (COG) 1501.00 AP (Liability) 1501.00 FIN (Asset) 2073.68 WIP (Asset) 273.68 Absorptions (COGS) 1800.00 COGS Absorption 1800.00 COGS Absorption 1800.00 This is how it would look in the GL: Debit Credit Sales 2467.00 COSTS OF GOODS Materials Purchased 1501.00 Actual Payroll 200.00 Labor Absorption 184.02 184.02 Burden/OH Absorption 115.02 115.02 Direct Costs Absorption (materials) 1500.96 1500.96 TOTALS 3501.00 4267.00 Profit/Loss 766.00 Henning Industrial Software, Inc. Page 23 Visual EstiTrack 11/2005