Cash to accrual for inventory and cost of goods sold?
If you are confused about how to go from cash to accrual for inventory and cost of good sold, then you are in the right spot! Here is the video explanation that walks through all of the information that is laid out below!
This tutorial will describe the difference between cash and accrual accounting for inventory and cost of goods sold. You’ll learn how to use the balance sheet method, which can be used to answer almost any cash to accrual (or accrual to cash) question on inventory and cost of goods sold. We’ll also go through two examples so that you become a master of this method!
Fundamental Difference Between Cash and Accrual for Inventory
Under the cash method, we would record the expense for raw materials or finished goods when we purchase the items. However, under the accrual method and the matching principle, we would only record cost of goods sold when we recognize the revenue from selling that item.
The timing of when the expense is recorded may not vary for some companies, but for other companies, there could be a massive time lag. For example, if a company purchased materials on February 25, Year1 and didn’t sell that item until June 15, Year1, then there would be a big difference between when the expense would be recorded under the cash and accrual basis.
What Increases or Decreases Inventory on the Balance Sheet?
We need to understand what increases the inventory balance and what decreases the inventory balance. As you can see below, purchasing material (raw materials or finished goods) would increase the inventory balance, while recognizing cost of goods sold would decrease the inventory balance.
Journal Entries for Recording Material Purchases and Cost of Goods Sold
Let’s go through the journal entries so that we understand what accounts are impacted when we purchase materials, and what accounts are impacted when we recognize cost of goods sold. As you can see, when we purchase materials under the accrual method, the income statement is not impacted. The income statement is only impacted when the inventory is sold, and we recognize the revenue and cost of goods sold on that sale.
Example #1 – Cash to Accrual Question
So let’s dive into an example cash to accrual question. If the question provides material purchases and the beginning and ending inventory balances, then it will likely ask for the amount of cost of goods sold recorded in the period. If this is the case, then you will know that it is a cash to accrual question.
The inventory rollforward will always be setup in the same manner as it is below. Just plug in the information the question provides, and then solve for the missing variable. So in this case, if we have cost of goods available for sale of $1,250 and ending inventory is $250, then we know we recognized cost of goods sold of $1,000 in the period. Remember, cost of goods sold is negative (expense) because it reduces the inventory balance.
Example #2 – Accrual to Cash Question
So this question is similar to the one above, except the question provides us with the cost of goods sold figure (accrual method). That means we will need to solve for the amount of material purchased during the period (cash basis).
So the beautiful thing about the balance sheet approach is that the inventory rollforward is set up exactly the same. Again, just plug in the information the question gives us. Solving for material purchases can be a little more difficult, but our first step should be to add cost of goods sold back to ending inventory, which tells us that cost of goods available for sale is $1,250. So if beginning inventory was $500, then to get to cost of goods available for sale of $1,750, that means we purchased $750 of material.
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