Businesses can acquire their products intended for sale either through purchasing them from their suppliers or through manufacturing them. In either case, the money the business spends in order to acquire those products are added to an asset account called inventory and deducted as cost of goods sold or cost of goods manufactured once the products are sold. The value of inventory changes when more units of product are added to it, when units of product are sold to the business's customers in exchange for revenue, and when units of product are lost to damages and accident.
Accounting Ledger
Each transaction is recorded on both sides of the accounting ledger; the left side is called debit and the right side credit. Different classes of accounts are recorded on different sides of the accounting ledger when their values increase and on the opposite side when their values decrease. Normal assets, including inventory, are recorded as debits when their value increases and as credits when their value decreases.
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Purchases and Goods Manufactured
The value of inventory increases when additional units of the product are added. Depending on whether the business acquires its products through purchases or manufacturing, the value of the products is either their purchase costs or the costs spent to produce them, such as direct labor, raw materials and manufacturing overhead. In either case, the addition of product is recorded as a debit to inventory and a corresponding credit to whatever was used as payment, most often either cash or the creation of an account payable recognizing that the business owes money to its supplier.
Inventory Sales
The value of inventory is not recorded as cost of goods sold or cost of goods manufactured until the products are sold. Different businesses use different methods of calculating such costs. Some simply count inventory at the beginning and then the end of the period and allocate the difference as cost of goods sold or cost of goods manufactured. Others record it throughout the period based on the products that are sold. In any case, the selling of inventory is recorded as a debit to cost of goods sold or cost of goods manufactured and a corresponding credit to the inventory account.
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Inventory Loss
Sometimes, inventory is lost due to damages incurred through accidents or theft. In some cases, the lost inventory is not found until the end of the period when the business counts its inventory in order to compare its value against its records. In such cases, losses of inventory are recorded as a debit and a corresponding credit to the inventory account itself.
