How Do You Account for Supplies
Supplies can be accounted for in one of two ways, depending on whether the supplies are used directly in the production of goods or services (direct materials) or are used to support the operating activities of the business (indirect materials).
Direct materials, such as raw materials used in manufacturing, are typically included in the cost of goods sold. When these supplies are purchased, they are recorded as an inventory asset. When they are used in production, the value of these materials is transferred from inventory to the cost of goods sold.
Indirect materials, such as office supplies, are typically recorded as an expense when they are purchased. This method is used because the cost of tracking these supplies until they are used is often more than the benefit derived from such tracking.
Here’s a more detailed breakdown:
- When supplies are purchased: When you purchase supplies, the expense is typically not immediately recognized. Instead, the cost of the supplies is recorded as a current asset (usually under “supplies” or “prepaid expenses”) on the balance sheet.
- When supplies are used: The cost of the supplies is recognized as an expense when they are used. This is done by debiting (increasing) the supplies expense account and crediting (decreasing) the supplies asset account.
Example of How to Account for Supplies
Let’s say a graphic design company purchases $5,000 worth of office supplies (e.g., paper, ink, pens) at the beginning of the year. The initial journal entry at the time of purchase would be:
- Debit Supplies (an asset account) $5,000
- Credit Cash (another asset account) $5,000
This entry means that the company has decreased its cash asset by $5,000 and increased its supplies asset by $5,000.
As the year progresses, the company uses these office supplies. At the end of the year, the company takes inventory of its supplies and finds that it has $2,000 worth of office supplies left.
This means the company has used $3,000 worth of supplies throughout the year ($5,000 initial supplies – $2,000 remaining supplies). The company would then recognize this $3,000 as an expense. The journal entry at the end of the year would be:
- Debit Supplies Expense $3,000
- Credit Supplies $3,000
This entry decreases the supplies asset by $3,000 (now reflecting the $2,000 worth of supplies it has left) and recognizes a $3,000 supplies expense. The $3,000 expense is reported on the income statement, reducing the company’s net income for the fiscal year.
The remaining $2,000 worth of supplies will be carried forward as a supplies asset on the balance sheet into the next year.
