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When an inventory item is sold, the cost is calculated in different ways depending on the valuation method assigned to the item. Negative quantity adjustments are only posted for items using the Average Cost valuation method. When an Average Cost item is sold, the system looks at the average cost of all items on hand in the selling warehouse and uses that amount as the average cost of the sale. If a transaction is created that sells more of the item than is on hand, the system estimates that these pre-sold items will have the same cost as the rest of the stock on hand.

Later, when a receipt is processed, the receipt's cost is compared to the cost that was used in the pre-sales phase. If the two costs do not match, an adjustment is needed to correct the postings made at the estimated cost. The adjustments are made to the general ledger Inventory account, and offset against an adjustment account. A transaction is also posted to the inventory transaction detail table. This posting is noted with a transaction type of IZ. There are no quantities or prices associated with this transaction, only the total adjustment amount. The purpose is to make sure the value posted to inventory matches the amount posted if the receipt was created first.

 Example 1

You receive 5 widgets at $6.00 each. Debit the Inventory account for $30 and create an offset posting to the Purchases account (a credit balance of $30).

 

You sell 15 widgets, but there are only 5 in stock. You estimate that the other 10 widgets will cost the same $6.00 as the 5 on hand. A credit of $90 is made to the Inventory account and offset with a posting to the Cost of Goods Sold account. You now have a -10 widgets quantity on hand with an average cost of $6 for a total value of -$60 which matches the Inventory balance in general ledger (a credit balance of $60).

 

You receive 30 widgets for $8 each. Debit the Inventory account for $240 and offset it with a posting to Purchases account. Because there was a -10 on hand when the receipt was created, the system makes an adjustment to allow for the difference between the cost estimated for the sale and actual cost during the receipt. You sold 10 widgets you did not have and estimated their cost at $6 each. The actual receipt was at $8 each. The sale transaction generated a credit for $60, but the true amount is $80. The adjustment will credit the Inventory account for $20 and offset it with a posting to the adjustment account. The system needs to make the same adjustment to the average cost of the item as it affects the value on hand. There are now 20 widgets on hand with an average cost of $8 for a total value of $160 that matches the inventory balance in the general ledger (a debit balance of $160).

 

 Example 2

You receive 5 widgets at $6.00 each. Debit the Inventory account for $30 and offset it with a posting to the Purchases account. You have 5 widgets on hand with an average cost of $6 for a total value of $30 which matches the Inventory balance in general ledger (a debit balance of $30).

 

You sell 15 widgets. There are only 5 widgets in stock, so the system estimates that the other 10 will cost the same $6 when they are received. Credit the Inventory account for $90 and offset it with a posting to Cost of Goods Sold account. There are now -10 widgets on hand with an average cost of $6 for a total value of -$60 which matches the Inventory balance in general ledger (a credit balance of $60).

 

You receive 4 widgets at a cost of $8 each. Debit the Inventory account for $32 and offset it with a posting to the Purchases account. Because there was a -10 on hand when this receipt was made, the system needs to make an adjustment to allow for the difference between the cost estimated for the sale ($6) and the actual cost during the receipt ($8). Because only 4 widgets were received, we will only make the adjustment for those 4, as those are the only ones for which there is an actual cost. The system will credit the Inventory account for $8 and offset it with a posting to the Adjustment account. We will make this same adjustment to the average cost of the item as it affects the quantity on hand. You now have -6 widgets on hand with an average cost of $6 for a total value of -$36 which matches the Inventory balance in general ledger (a credit balance of $36).

 

You receive 16 widgets at a cost of $4 each. Debit the Inventory account for $64 and offset it with a posting to the Purchases account. Because you had a -6 quantity on hand when this receipt was created, the system makes an adjustment to allow for the difference between the cost estimated for the sale ($6) and the actual cost during the receipt ($4). Because the amount received was more than the negative quantity on hand, we will make an adjustment for the remaining 6 that were pre-sold. Debit the Inventory account for $12 and offset it with a posting to the adjustment account. The system makes this same adjustment to the average cost of the item as it affects the quantity on hand. There are now 10 widgets on hand with an average cost of $4 for a total value of $40 which matches the Inventory balance in general ledger (a debit balance of $40).

 

Note The standard cost must be entered whenever a new item is created. If the first transaction processed for the item is a sale and there is no standard cost, the sale occurs at a cost of zero because there is no other cost method for the system to use. If subsequent sales are made, they will be processed at a zero cost. Even if receipts are processed at a positive value, the average cost will remain at zero, unless the receipt quantity exceeds the negative quantity on hand.

 

 Example 3

You receive 10 widgets into warehouse 000 at zero cost. No postings need to be made to the general ledger because the inventory value is zero. You receive 10 into warehouse 001 at $0.50 each. Debit the Inventory account for $5.00 and credit the Purchases account. The total on hand for both warehouses is 20 and the total value for both warehouses is $5. The item’s average cost is $0.25 ($5.00 / 20). You sell 25 from warehouse 000. Because there were 10 on hand at zero cost, the system estimates the additional 15 will also be at zero cost. No general ledger postings are needed. In warehouse 000, you now have -15 on hand at zero cost and 10 in warehouse 001 at a total cost of $5. The total on hand quantity for both warehouses is -5 and the total value for both warehouses is $5 resulting in an average cost of $1.

 

Note The standard cost must be entered whenever a new item is created. If the first transaction processed for the item is a sale and there is no standard cost, the sale occurs at a cost of zero because there is no other cost method for the system to use. If subsequent sales are made, they will be processed at a zero cost. Even if receipts are processed at a positive value, the average cost will remain at zero, unless the receipt quantity exceeds the negative quantity on hand.

For more information, see Item Maintenance.