Accounting for Inventory in a Business Purchase

Take physical inventory immediately following a business purchase.

If you purchase a business with existing inventory, it is important to properly account for the inventory when recording the purchase entry on the accounting general ledger. The value assigned to inventory directly affects the net sales revenue, which then affects net income. Failure to assign an appropriate value to inventory can also result in bad pricing decisions, which can lead to lost sales due to over-pricing or lost profit margin on sales due to under-pricing.

Take a Physical Inventory

When you acquire a business with inventory, the first thing you should do to properly account for the purchase is to take a physical inventory of the products on hand. You can use spreadsheet software, an inventory accounting system or even a pad of paper to record your findings. Simply list each individual inventory item and the number of that item available. If you find damaged inventory items during the physical inventory, include those items in the count.

Inventory Valuation

Once you have determined the exact type and number of inventory items in your business purchase, you can assign a value to the inventory. In some cases, the seller will provide you with a current valuation for each inventory item at his most recent cost, but that information is not always provided. Because inventory items are products available for resale, the most accurate value to assign to each product is the cost of the product if you were to acquire it now. If you cannot get the valuation information from the original business owner, contact vendors that provide the products in your inventory and get a current price for the products. If more than one vendor provides the products in your inventory, you may want to average the purchase cost from two or more vendors.

Recording Inventory on the General Ledger

You should record inventory on the accounting general ledger at the valuation amount determined from your physical inventory and valuation research. If you maintain a separate inventory system, you may want to group items on the accounting general ledger as you have more detailed level information available in another financial system. For example, you may want to combine purses, scarves and wallets into one inventory account called Ladies Accessories. If you do not maintain a detailed inventory system, you should separate the items into individual general ledger accounts based on the exact inventory type. Record an increase to each inventory account for the total valuation of all the inventory items in that product line.

Damaged Inventory

When you took the physical inventory, you included damaged inventory items in your physical product count, but those items do not have the same value as an undamaged product. In order to properly reflect the lower valuation of damaged inventory, record a decrease to the appropriate inventory account for the estimated loss due to damage and an increase to the Inventory Damage Loss account. Document your method of determining the loss amount. For example, you may determine the discounted sales price for the damaged item and reduce the valuation price by the same dollar amount. As long as your valuation method is reasonable and the calculations are correct, the IRS will allow the valuation method.

Documentation

In the event of an Internal Revenue Service audit, you must keep all the paperwork associated with the business purchase and subsequent inventory accounting. Maintain the physical inventory taken immediately after purchase along with the documents you used to determine inventory valuation. The IRS will want to determine that your method of valuation was reasonable, given the circumstances of the purchase.

References

• "Intermediate Accounting"; James Stice, Ear Kay Stice, Fred Skousen; 2004