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The recording of raw materials in accounting is crucial for accurate financial reporting, cost analysis, and inventory and project management.
Profitability in Manufacturing and Construction Contracting
Key Benefits of Proper Raw Material Recording:
Accurate Financial Reporting: Reflects the true cost of production and profitability.
Enhanced Budget Management: Supports project managers in tracking project-specific costs.
Regulatory Compliance: Ensures adherence to accounting standards and inventory valuation methods (FIFO, LIFO, or Weighted Average).
Improved Decision-Making: Facilitates data-driven decisions through clear visibility into material usage and costs.
Follow Consistent Accounting Procedures:
Accounting in QuickBooks follows a specific and structured process. As an accrual-based system that complies with GAAP standards, following consistent accounting procedures is imperative. Proper setup of products and services, including standard sales and purchase prices, is essential for calculating COGS when no bill is linked to an invoice. The primary goal of GAAP accounting is to align expenses and bills with the revenue generated from invoices, creating a clear audit trail to connect all transactions seamlessly.
The accounting process is:
Estimate (optional) to PO (optional) to Bill Item or Expense (marked billable, attach receipt) to bank feed (expense) matched to bill, will populate the Unbilled Charges Report adding Inventory (quantity) and COGS (amount) to your financial statements. When invoiced (add bills to the invoice from the suggested transaction pop out drawer). This process Bill + Invoice is critical for correct accounting of Sales, COGS and Inventory, is GAAP Compliant and produces accurate financial statements.
The Importance of Establishing and Following Consistent Accounting Procedures: Fraud Prevention
The rule of COGS calculations:
An invoice (income) + bill attachment (COGS) with markup = gross profit.
An invoice (income) + bill attachment (COGS) and no markup is a reimbursement = zero gross profit.
An invoice with no bill or expense attachment will not calculate COGS (if not stated in your products and services), increasing your stated gross profit-income.
An Invoice with only a receipt attachment may not calculate the true COGS to your income statement (from the receipt) if the price and cost are pulling from the Products and Services and no billable expense is attached.
Use the Item drop down on an invoice for billable Products and Services and the Category drop down for non-billable General Direct Overhead Expenses.
Sales, Inventory and COGS should be reconciled EOM.
Category line items are reserved for direct overhead expenses.
QBO engineers have been altering transactions, including estimates, you may need to tweak the process to show invoiced, remaining and closed and watch your Estimates Report for correctness. When the invoices are paid, the attached bill and invoice will distribute the bill(s) cost of cogs and the income to the Income Statement, clearing unbilled charges. (12/30/2024 Please send feedback to QBO Gear Icon > Feedback to QBO engineers to correct their work)
Here's an explanation of how the process works:
Profitability in Manufacturing and Construction Contracting
First turn on Markup in Accounts and Settings and then
Set up Products and Services Inventory for the type of raw materials you are going to use before beginning the project. Include standard (or actual) purchase cost and sales price to each item. Inventory COGS will not calculate without purchase price information if no bill is received at the time of invoicing. Remember: The truth (Specific identification) for current cost and current sales price is the most recent bill and invoice as attached (hence, GAAP accounting) for the particular item, and should be reflected on the Income Statement, regardless of FIFO Inventory Build.
Don't forget to select sales tax for the item from Products and Services
(Income = Income Line Item and Expense/Purchase = COGS Line Item). The Chart of Accounts Income and associated COGS account can be Manufacturing or Construction Sales, respectively.
Use caution with Excel spreadsheet sync. Do not overwrite quantities on hand and be sure to maintain a bill of materials (BOM) production report at regular intervals (avoiding the potential for fraudulent asset manipulation, and inventory theft).
Running a test of the project workflow before starting is always a good idea.
I recommend QuickBooks Online Advanced with Excel Spreadsheet Sync for large projects.
Here is an example of basic production workflow for material inventories recorded in progress:
1.) Purchase of Raw Materials (typically tax exempt): (Job Purchase Order) When raw materials are purchased, an accounting entry is made to record the transaction using a Purchase Order (from the Pending Estimate) and when the materials are received a Bill or Customer: Bill Bundle *see below
Bill #1 *date of movement (+) QTY and AMT Raw Materials Received from the
Purchase Order to (A/P)
Debit: Raw Materials Inventory the Bill will Credit: Accounts Payable or if Cash/Check Bill Payment.
2.) Issuance of Raw Materials for Production (Job Order):
As raw materials are issued for use in the production process, an accounting entry is made to record the transaction using a
Bill #2 *date of movement (-) QTY and AMT Raw Materials (+) QTY and AMT WIP Issuance Inventory (from copy Bill #1 change fields (-) and (+) line items, date)
Debit: Work-in-Process Inventory Issuance and Credit: Raw Materials Inventory
3.) Conversion of Raw Materials into WIP Conversion (Installation):
As the work begins, the cost of raw materials is gradually transferred to the Work-in-Process Inventory using a
Bill #3 *date of movement (-) QTY and AMT WIP Issuance Inventory (+) QTY and AMT WIP Conversion Inventory (from copy Bill #2 change fields (-) and (+) line items, date)
Debit: Work-in-Process Inventory Conversion and Credit: WIP Inventory Issuance
4.) Completion of Production and Transfer to Finished Goods (Job Phase Completion):
When the production of goods is completed, the cost of raw materials, and WIP inventories are fully transferred to the finished goods
Bill #4 *date of movement (-) QTY and AMT WIP Conversion Inventory (+) QTY and AMT Finished Goods (from copy Bill #3 change fields (-) and (+) line items, date)
Debit: Finished Goods Inventory and Credit: WIP Inventory Conversion
5.) Sale of Finished Goods: (Ready to Invoice)
When finished goods are sold, the cost associated with the production of those goods (from the attached finished goods bill) is transferred from Inventory to the Cost of Goods Sold (COGM), and the revenue is recognized on the Income Statement.
Invoice + Bill + sales tax *dated will produce the following GAAP Compliant transaction.
Debit: Cost of Goods Sold Manufacturing or COGS construction and Credit: Finished Goods Inventory, while also increasing the earned revenue.
These accounting entries ensure that the materials are accurately accounted for at various stages of the process. The goal is to match the cost of producing goods with the revenue generated from their sale, providing a clear picture of the profitability of the business operations at each interval or job phase, ensuring GAAP compliant accounting. Effective Inventory and Project Management is the key to accurate reporting.
Some notes about bundles:
Bundle Item (Multi-Inventory Items) (Income = Sales for Invoices, and the Purchase/Expense = COGS for Bills/Expenses)
Bundles can have up to 50 items (last I checked with QBO and requested an increase).
(The National Association of Home Builders estimates that over 3,000 components are used in constructing a house, in 6-10 Phases. Therefore, a Job Phase may include as many as 6-10 bundles.)
There is no additional markup or change in price for bundles. (Bundles aren’t assemblies) Rather the price of a bundle = The total price of all its finished goods inventory items. (Inventory Lot for instance, a complete kitchen)
Bundles can be used for estimating projects and job phases (e.g.: kitchens, bathrooms, et...) by using Job Phase Bundles when estimating. This process is GAAP compliant and conducive to efficient and accurate Inventory and Project Management (and associated accounting collaboration) as well as planning and analysis.
(Optional Production Workflow for Bundling Multi-Products)
First complete the steps to Revenue Deferral (Review Details of: Revenue Deferral)
Begin Inventories in progress:
Once all inventory items are verified as received and the deferral revenue deposit invoice paid, a Bill is created for inventory tracking. This is the zero balance Customer: Bundle Bill includes all product items that were bundled on the estimate (by Job Phase, consistent with the received items from the unbilled charges report. the Customer: Bill Bundles are NOT connected to the PO's). For the zero balance Customer: Bundle Bill leave the line item amounts as a zero balance but leave item quantity and check mark as billable. This net zero bill does not increase A/P but will create an open transaction on the Unbilled Charges Report and is used for job progress workflow tracking of inventory quantities, for the particular Job Phase. You can use Spreadsheet Sync to create the customer: Bundle Bill, in comparison to the bill(s) for the job phase on the Bill(s) detail report.
Use this zero balance Customer: Bundle Bill to begin the workflow production process from Raw Materials through to Job Phase Completion. This will allow you to monitor the bundle inventory movement from start to finish. Track the job progress workflow according to the Project Managers report of progress (along with any inventory debits/credits (Inventory Adjustments) reported during production.
When all customer: bill bundles of a job phase have been completed, and the finished goods items are ready to be invoiced, the original PO sales invoice (earned revenue) can be voided and replaced with a new sales invoice (earned revenue), for the same or actual(s) by job phase end date. Select > Create Invoice from the approved estimate, adding the actual inventory items received and open on the unbilled charges report to the new invoice. (if the job is a cost-plus billing, the mark-up line amount(s) will be separate line items on the Income Statement. This is assuming the quantities and amounts of the approved estimated materials are identical to the billed amounts and are consistent with the deferred revenue deposit invoice. If not, a change order would be necessary or otherwise expect that the profit margin at the end of the project will be reduced by higher actual costs than were estimated and invoiced. The new sales invoice (earned income) will clear the unbilled charges report, track amounts and quantities invoiced against the approved estimate and any remaining unbilled amounts (evidenced from the Estimates & Progress Invoicing Summary by Customer or Project report or Estimates vs Actuals Report) It will also reduce inventory quantities on hand, while not affecting A/P (plan payments to A/P after the deferral revenue deposit is received, to avoid late fees and take advantage of vendor discounts). Your Income Statement will now reflect the earned revenue and COGS, at the appropriate time. Job Phase-GAAP compliant accounting complete.
The zero balance Customer: Bundle Bills can be DELETED at the end of production for each Job Phase. Before job sign off of each Job Phase, use the zero balance Customer: Bundle Bill(s) and a transaction detail by account report, filtered to the customer, or sales of inventory report, or in spreadsheet sync the bill details report
1.) to make comparisons of PO's, bill(s), and invoice(s) comparing Inventory from the approved estimate by Job Phase, and 2.) to reconcile job inventory received, and invoiced with quantity on hand or, negative quantities on hand from the products and services list (BOM). This process will maintain inventory asset integrity on your balance sheet and substantiate PO to Bill to Invoice amounts (verifying your Income Statement). Any final billings to adjust for inventory discrepancies can be presented as a Change Orders and issued prior to Sign off. The same comparisons apply to Project Substantial Completion, if appropriate.
The Sales Price quoted on an Estimate should be consistent with the products and services of the invoiced job phase bundle(s) and include markup. (best to try and maintain bundle pricing for all customers or create customer specific bundles as is described by the above process) Change orders would be used for any deviations as a result of an increase in material costs, or unbilled costs, et...
Run a bill of materials (BOM) production report, generated from the products and services list reports. Produce these reports periodically throughout the job and file to My Accountant > Shared Documents. This will maintain a complete historical record of the project through each job phase.
Approved Estimates used for invoicing purposes will have a line or field representing the item and amounts invoiced, remaining to be invoiced, or marked fully converted. The Estimates & Progress Invoicing Summary by Customer will track the open balance (filtered by class, location and customer job) Use this information to determine if there are unbilled items. When the project is concluded there should be no balance left on the approved estimate.
Tracking Inventory Assembly or Job Phase Production:
To check the stage of the inventory in production, run a Balance Sheet, dig into (double click) the inventory asset account (with any subcategories) to view the Bills or customer: Bill Bundles and the date of job progression, along with inventory quantity and/or value. This enables you to determine when the finished goods are ready to be sold on invoice (earned revenue). **One broken in progress (Create an inventory quantity adjustment, from the products and services list for that item) Details of the inventory in stock and movement are also available on other reports such as the Product/Service List Report. The example transaction report below demonstrates the quantity and value movement of inventory as of the report date. (Customize by vendor, customer, product, and more) Note *customer: Bill Bundles track inventory only.
Manufacturing
The Invoice formula for calculating COGS in manufacturing and assemblies:
COGM = Direct Materials Used + Direct Labor + Manufacturing Overhead
*Don't forget to add sales tax on the Finished Goods Sale (setup by product and service item). The final invoice will contain the costs (bills) linked to the revenue, aligning with the GAAP matching principle and is consistent with the ASC 606 guidelines.
Construction
The Invoice, formula for calculating COGS in construction is similar:
COGS = Materials Inventory + Billable Labor + Billable Subcontractor Costs + Billable Equipment Costs + Billable Overhead Costs (*Costs that are not directly associated with a specific project should be excluded) The sales invoice(s) will contain the costs (PO to bill) linked to the revenue, aligning with the GAAP matching principle and is consistent with ASC 606 guidelines.
Progress tracking of construction inventory is a necessary activity and can be accomplished using bundles and the zero balance Customer: Bundle Bill process described above.
From inventory stock order to job order and job completion, through each job phase of construction (Preparing the Homesite, Laying the Foundation, Framing the Home, Installing HVAC, Plumbing, and Electrical, Adding the Insulation, Affixing the Drywall, Inserting the Interior and Exterior Finishes to Completing the Final Inspection and Walkthrough) Inventory progress tracking serves as a valuable tool for measuring compliance with AIA, ASC 606, and IFRS 15 Revenue Recognition Standards: For a performance obligation satisfied over time, an entity would select an appropriate measure of progress to determine how much revenue should be recognized as the performance obligation is satisfied.
Construction inventory tracking also provides a good control measure to identify and reduce inventory shrinkage and assist in identifying overspending, ultimately a measure to job cost containment and is compatible with inventory and project management (and associated accounting collaboration), planning and analysis. Conduct a physical inventory count before construction starts and after final walkthrough, or as necessary. Make any adjustments (inventory quantity adjustments to an item) accounting for inventory shrinkage, if required, or to identify inventory that can be returned for vendor credit/refund.
You can also utilized standard project progress invoicing against an estimate based on the AIA model of % of project complete. In this case, only the amounts actually retained (deferred revenue deposit) + invoice paid (earned revenue) along with any cost plus or change order invoices, would be recognized on your financial statements. The balance of the estimate remains (non-posting-off the balance sheet and is invoiced in progression) WIP Reports in QuickBooks Online Advanced serve as your guide to job progression. Due to sales tax obligations, job progress reporting purposes, planning and analysis, I do not recommend the (off balance sheet) % completion method of progress invoicing. With the revenue recognition method, reports are available to demonstrate % completion and can be invoiced accordingly.
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See Also: APPS Integrate with QuickBooks Online
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