Inventory consists of the products you sell to customers. Receivables, or accounts receivable, are the outstanding balances you have yet to collect for sales made on credit. Although inventory and accounts receivable are accounts you report on your small business’ balance sheet, certain expenses on the income statement involve these items. Cost of goods sold on the income statement represents the cost of the inventory you sold during an accounting period. Bad debts expense on the income statement is the portion of new accounts receivable that you expect will not be collectible.
Determine the amount of inventory you had at the beginning of an accounting period, the amount you had at the end of the period, the amount of inventory you purchased during the period and the shipping costs you paid for new inventory. For example, assume your business had $100,000 of inventory at the beginning of the quarter and $70,000 of inventory at the end of the quarter. Also, assume you bought $29,000 in new inventory and paid $1,000 in shipping costs.
Add the shipping costs to the inventory you purchased. Subtract from your result the amount of refunds and discounts you received from your suppliers to figure your net purchases. In this example, assume you received $5,000 in refunds and discounts from your supplier. Add $1,000 in shipping costs to $29,000 in new inventory to get $30,000. Subtract $5,000 from $30,000 to get $25,000 in net purchases.
Add net purchases to beginning inventory, and subtract ending inventory from your result to calculate cost of goods sold. Continuing with the example, add $25,000 to $100,000 to get $125,000. Subtract $70,000 from $125,000 to get $55,000 in cost of goods sold.
Report cost of goods sold and its amount below the sales revenue line on your income statement. In this example, write “Cost of goods sold $55,000” on your income statement.
Estimate the percentage of credit sales you made during an accounting period that you expect will not be collectible. Credit sales are those that you added to your accounts receivable balance during the period. You can base your estimate on the portion of credit sales that you were unable to collect from customers in the past. For example, assume your small business is typically unable to collect 2 percent of its credit sales.
Multiply the percentage by the amount of credit sales generated during the period to determine your bad debts expense. In this example, assume you generated credit sales of $50,000. Multiply 2 percent, or 0.02, by $50,000 to get a $1,000 bad debts expense.
Report the bad debts expense and its amount as a line item in the operating expenses section of your income statement. Continuing with the example, write “Bad debts expense $1,000” on your income statement.
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