Advice On Stock Control

CAPITAL GL Controller provides two ways of calculating cost of sales and updating the value of your stock. Both systems are commonly recognised by accountants. You will need to decide which method you wish to use in your organisation if you intend to integrate your general ledger with CAPITAL Office.

The first method is known in CAPITAL as the direct adjustment system or by most accountants as the perpetual inventory system. Using this method, a "cost of sales" account is directly updated as each transaction in CAPITAL Office is processed.

The second method is known in CAPITAL as the opening stock/purchases/closing stock method, or by accountants as the periodic inventory system. It involves determining your cost of sales by adding your opening stock balance to your period's purchases, and then subtracting the end of period closing stock balance.

Direct Adjustment

In direct adjustments a "cost of sales" account (debit type) is maintained in your chart of accounts. When CAPITAL Office processes an invoice, for example, automatic journals are created that credit your "inventory on hand" account and debit the "cost of sales" account. The advantage of this approach is that the value of your stock is maintained automatically. In theory, the general ledger balance should equal the total of your stock quantity report, when printed by cost.

In practice the automatic maintenance of your stock balance in the general ledger may not be practical. For example, most businesses will often need to invoice goods that have not yet been taken delivery of. This usually results in temporary negative stock balances in the stock control system, which is eventually rectified when the relevant deliveries are entered. Two serious problems result, however, when this is done:

1. If the cost of the goods change as a result of taking delivery of new stock, the updated balance in the general ledger will be wrong.

2. If you are using the average stock cost method to calculate the value of your goods (recommended), negative balances can result in incorrect "average" cost calculations.

Furthermore, shrinkage due to damaged, shop soiled, lost or stolen goods, as well as general waste due to spillage, off-cuts, evaporation, etc., Will also tend to distance the "real" value of your goods from your general ledger "book" value. If you have got into the habit of directly adjusting the "stock in" column in stock control to account for these discrepancies, then using the direct adjustment system, an account called "stock adjustments" will be effected each time such an adjustment is made. The automatic journals are:

• Credit (or debit) stock

• Debit (or credit) stock adjustments

• You will need to reconcile the stock adjustments account at some point. Was the stock adjustment made because the stock is now obsolete? This might require a journal such as:

• Credit (or debit) stock adjustments

• Debit (or credit) stock written off

In your general ledger. If the discrepancy was due to off-cuts, perhaps the adjustment needs be accounted for by adjusting "cost of sales", etc.

The point of the above discussion is to emphasise that a direct adjustment system would still require a great deal of supervision (and in some firms an unrealistically accurate and up to date stock file) in order for it to produce accurate figures.

To run a direct adjustment system ensure that your general ledger sets are set-up in the following way:

Stock (on hand/inventory)

Link this to your inventory account.

Stock adjustments

This should be linked to a debit type account stock adjustment clearing" or something to that effect. This account may need to be cleared via general ledger journals each month to account for direct adjustments made through stock control. Use the security system to disable or restrict the direct adjustment feature in CAPITAL's stock control system if you wish to avoid this duty.

Stock purchases

Link this to a purchases account in your chart of accounts. This account should be excluded from your profit and loss and balance sheet reports. See below.

Closing purchases

Link this to a "closing purchases" account in your chart of accounts or to the "purchases" account. Every time stock purchases is debited, closing purchases will be credited. If both accounts are linked the "purchases" account will always be zero. Since the inventory account is being directly updated, the "purchases" and "closing purchases" accounts should always be treated as a pair, whose net effect on your balance sheet will be nil.

Cost of sales

This should be linked to your "cost of sales" account which will be a debit type.

Stock purchases (variance)

This is the difference between what you paid for the goods (the "purchase" or creditor invoice) and what the stock control system valued the stock at. If the average stock costing method is used, the most likely cause for this is rounding error. Link this account to a "purchase variance" debit type account. If automatic batch updating is not occurring the balance of this account will always be zero.

Cost of sales (variance)

This is the difference between what the cost of the sale was, according to invoicing and the general ledger, as opposed to the actual effect on stock control. Link this to a "cost of sales variance" account, debit type, in your chart of accounts. The balance of this account should always be zero. A non-zero balance may indicate a set-up error. For example, allocating a "cost" to a non-diminishing stock item will produce a variance equal to the cost of the item invoiced.

Opening stock/purchases/closing stock method

This is the preferred method of calculating the cost of your stock and the method used by the sample company data supplied with CAPITAL GL Controller.

Using this system, there is no "cost of sales" account in your chart of accounts. Cost of sales is calculated by:

1. Adding opening stock as of the start of the period.

2. Adding purchases for the period.

3. Subtracting closing stock as of the end of the period.

The above three accounts must be in your chart of accounts. Opening stock must be a debit, "opening stock" type, purchases a debit, "posting" type, and closing stock a credit, "closing stock" type.

Opening stock is the stock balance in stock control as of the first day of trading, before trading commences, for the new period.

Purchases are all purchases of stock for the month or period.

Closing stock is the closing stock balance as of the final moment of the last day of the month of trading. The closing stock figure is obtained by printing a stock report, listing the value of stock at cost. This is a crucial point. In order to use the opening stock/purchases/closing stock method, a stock value report must be printed at the end of each month without fail.

At first glance this way of doing things seems less attractive than the direct adjustment method, since the closing stock figure is not automatically updated by CAPITAL Office. It must be manually input into the general ledger each month. The advantage of this approach, however, is that the general ledger "book" value of your stock and the stock control "real" value will always match. Adjustments made to stock control due to shrinkage, damage, etc., Are automatically taken up into your "cost of sales" each month.

At the end of each month the following set of journals must be entered into CAPITAL GL. It is recommended that you create a standing journal batch for these journals to minimise typing:

1. The inventory account is credited the full inventory balance.

2. The opening stock account is debited the full inventory balance. These two journals effectively move stock out of the balance sheet and temporarily into the profit and loss statement.

3. Your closing stock (as per your stock report) is credited to the closing stock account.

4. The inventory account is debited the closing stock amount as well. These two journals move stock out of the profit and loss statement and back into the balance sheet.

The closing stock balance for the current period then becomes the opening stock balance of the next period, and so on.

It is useful to note that opening and closing stock accounts differ from regular profit and loss accounts in certain important respects. As you already know, because of the way balance sheet accounts are shown on reports, figures reported for either monthly or yearly results refer to the total balance up to and including the current period. This is the same for year-to-date reports for profit and loss accounts. However, monthly profit and loss accounts normally only show monthly activity. For example, your sales account for the period of January would display only January sales.

The opening stock figure, however, shows the opening stock balance for the current period, not just monthly activity. The year-to-date opening stock balance is therefore the total of all opening stocks for all periods up to and including the current period. The same applies to closing stock. Keep this in mind when reading, creating or editing financial statements.

As far as general ledger sets are concerned, it is important to ensure that no direct adjustment to your "inventory" account takes place. Inventory is only effected during the opening and closing journal adjustments made each month. Instead, a debit, posting type account, "purchases", is updated. Set-up your general ledger sets in the following way:

Stock (on hand/inventory)

Keep this linked to your "inventory" account.

stock adjustments link this to your "inventory" account as well. Any direct adjustment to stock will then, for example, credit "inventory" and debit "inventory". The net effect on your inventory account will be nil.

Stock purchases

Link this to your "purchases" account.

Closing purchases

Link this to your "inventory" account. Each time the "inventory" account is debited, for example, closing purchases will be credited. The net effect on your inventory account will be nil.

Cost of sales

Also link this to your "inventory" account. When stock is sold, for example, your "inventory" account will be credited and your cost of sales (also "inventory") will be debited. The net effect on your inventory account will be nil.

Stock purchases (variance)

This is the difference between what you paid for the goods (the "purchase" or creditor invoice) and what the stock control system valued the stock at. If the average stock costing method is used, the most likely cause for this is rounding error. Link this account to a "purchase variance" debit type account. If automatic batch updating is not occurring) the balance of this account will always be zero.

Cost of sales (variance)

This is the difference between what the cost of the sale was, according to invoicing and the general ledger, as opposed to the actual effect on stock control. Link this to a "cost of sales variance" account, debit type, in your chart of accounts. The balance of this account should always be zero. A non-zero balance may indicate a set-up error. For example, allocating a "cost" to a non-diminishing stock item will produce a variance equal to the cost of the item invoiced.

Hints & Tips

• Throughout the above discussions reference has been made to single accounts. However, it is quite acceptable (and often necessary) to have multiple cost of sales, purchase, inventory, opening stock, and so on, accounts set-up in your system.

• The quick report writer assumes, when constructing year-to-date profit and loss reports using the opening stock/purchases/closing stock method, that the opening balance of stock for the year has been allocated to period 1. It is recommended that you allocate your opening stock for the year to period 1. This will allow you to avoid editing any of the standard financial statements or those generated by the quick report writer.

• Stock transfers do not effect stock levels. This is logical, as in principle, you are only moving inventory from one physical location to another. CAPITAL maintains the same costing method for transferred stock when it has to create a new stock item during a transfer. (For example, if product ABC at location 2 does not yet exist, it is added to the stock file, and it inherits the same stock group/costing type as product ABC at the originating location.) Keep in mind, however, that operators have the ability to change the costing type for stock items. For example, product ABC at location 1 may be changed to Average Cost, while product ABC at location 2 may be left at Last Cost. In most cases this unusual situation presents no problem. However, if you are setting up a company that has a direct cost of sales account (rather than use the opening/closing stock method) and you will be using the Make New Systems Batches utility to generate journals, then costing variances caused by these types of transfers will not be accounted for. In this case you must ensure that your stock items are assigned to stock groups that follow the same costing types/methods.