Inventory is an asset until it sells, and then it is a cost

Buy $50,000 of stock and nothing has happened to your profit. You converted cash into a different asset. The cost appears only when the goods leave.

The entries#

Purchase creates an asset:

Account	Debit	Credit
1500 · Inventory	50,000.00
2100 · Accounts Payable		50,000.00
Total	50,000.00	50,000.00

The sale then does two things at once — records revenue, and releases the cost of what was sold:

Account	Debit	Credit
1200 · Accounts Receivable	18,000.00
4000 · Sales		18,000.00
5000 · Cost of Goods Sold	11,000.00
1500 · Inventory		11,000.00
Total	29,000.00	29,000.00

Matching revenue with the cost that produced it is the entire point. Gross margin only means something when both sides of the same transaction land in the same period.

Perpetual or periodic#

Perpetual updates inventory and cost of goods sold on every sale, as above. You always know the balance, at the price of needing a system that tracks it.

Periodic leaves inventory untouched during the period and computes cost of goods sold at the end from a count:

Opening inventory + purchases − closing inventory = cost of goods sold

Simpler to run, and it has a real weakness: shrinkage is invisible. Anything stolen, broken or lost is simply absorbed into cost of goods sold, because the formula assumes everything not in the closing count was sold. Perpetual systems surface the difference between what the records say and what the count finds, which is what makes a count worth doing.

Which cost, when prices move#

If you bought the same item at $10 and later at $12, which cost leaves when one sells?

Weighted average — a blended cost across units held. Simple, stable, and the usual choice for small businesses.

First-in, first-out — the oldest cost leaves first. Closer to physical reality for perishable goods, and it leaves the balance sheet holding recent prices.

Last-in, first-out is not permitted under Canadian standards. Whichever you pick, consistency matters more than the choice — switching methods changes reported profit without anything changing in the business.

The count is the control#

Whatever the system says, a physical count is the only evidence of what is actually there. The difference between counted and recorded is your shrinkage, and it is a number worth knowing rather than absorbing.

Frequent partial counts of high-value lines usually beat one annual count of everything: the discrepancy is smaller, more recent, and easier to explain while someone still remembers the period.

Where it goes wrong#

Expensing purchases directly, which puts cost in the wrong period and leaves no asset to reconcile.

Never writing down dead stock, so the balance sheet carries value that will never convert to cash.

Freight and duty left out of cost. The cost of inventory includes what it took to get it to you. Booking freight to a separate expense understates cost of goods sold and overstates gross margin — which then misprices the product.

That last one is the quiet one, because the margin looks better than it is, and pricing decisions get made on it.