6.3 Inventory Tracking, Purchase Orders & FIFO Costing in QBO
Key Takeaways
- Perpetual inventory tracking in QuickBooks Online is available exclusively in QBO Plus and Advanced editions, utilizing the First-In, First-Out (FIFO) cost flow assumption under U.S. GAAP.
- Purchase Orders are non-posting operational documents that track ordered quantities; when goods arrive, copying the PO to a Bill, Check, or Expense posts the cost to Inventory Asset and Accounts Payable.
- Creating an Inventory Item requires establishing a three-way general ledger link: Inventory Asset (Balance Sheet), Income Account (Income Statement), and Cost of Goods Sold Account (Income Statement).
- Every sale of an inventory item automatically triggers two simultaneous journal entries: one recording customer revenue and sales tax, and an invisible entry debiting Cost of Goods Sold and crediting Inventory Asset.
- Physical inventory variances (spoilage, shrinkage, theft, count discrepancies) are reconciled using the Inventory Quantity Adjustment form, updating Inventory Asset against an Inventory Shrinkage/COGS expense account.
6.3 Inventory Tracking, Purchase Orders & FIFO Costing in QBO
Core Principle: QuickBooks Online (Plus and Advanced) maintains a perpetual inventory system utilizing the First-In, First-Out (FIFO) cost flow assumption. QBO automates inventory accounting by binding each product to three general ledger accounts (Asset, Income, COGS) and generating simultaneous dual journal entries on every sale—instantly matching revenue with cost of goods sold without manual period-end calculations.
Inventory Capabilities Across QBO Subscriptions
Not all QuickBooks Online subscription tiers support native inventory tracking. Understanding subscription limitations is essential for CPB candidates advising small business clients:
| QBO Subscription Tier | Native Inventory Tracking? | Purchase Orders? | Costing Method Supported |
|---|---|---|---|
| Simple Start | No | No | N/A (Periodic manual adjustments only) |
| Essentials | No | No | N/A (Periodic manual adjustments only) |
| Plus | Yes (Full) | Yes | Perpetual FIFO (Strict) |
| Advanced | Yes (Full) | Yes | Perpetual FIFO (Strict) |
Note: Under U.S. GAAP, QBO strictly enforces the First-In, First-Out (FIFO) inventory valuation method. Unlike QuickBooks Desktop, QBO does not support Average Cost, LIFO (Last-In, First-Out), or Specific Identification costing.
The Three-Account Item Configuration
To track inventory perpetually, the feature must be enabled under Gear Icon > Account and Settings > Sales > Products and services by toggling on:
- Track quantity and price/rate
- Track inventory quantity on hand
When setting up an Inventory Item (Gear > Products and Services > New > Inventory), QBO mandates establishing a three-account linkage in the General Ledger:
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| THE THREE-ACCOUNT INVENTORY LINKAGE |
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| 1. INVENTORY ASSET ACCOUNT (Balance Sheet - Current Asset) |
| • Debited when inventory is purchased via Bills, Checks, or Expenses. |
| • Credited when inventory is sold via Invoices or Sales Receipts. |
| |
| 2. INCOME ACCOUNT (Income Statement - Revenue) |
| • Credited for the retail sales price when items are sold to customers. |
| |
| 3. COST OF GOODS SOLD (COGS) ACCOUNT (Income Statement - Expense) |
| • Debited for the historical FIFO acquisition cost at the exact moment of sale. |
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[!WARNING] The Initial Quantity on Hand Trap: When creating a new inventory item, QBO asks for "Initial quantity on hand" and an "As of date". Entering a quantity here generates an automatic journal entry: DR Inventory Asset / CR Opening Balance Equity. In professional practice, bookkeepers should enter
0as the initial quantity for established companies and instead record initial inventory via a historical vendor bill or journal entry to avoid corrupting equity accounts.
The Purchase Order (PO) Workflow
A Purchase Order (PO) (+ New > Purchase Order) is an authorized commercial document sent by a buyer to a vendor indicating types, quantities, and agreed prices for products or services.
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| THE 3-STAGE INVENTORY PROCUREMENT CYCLE |
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| STAGE 1: ISSUE PURCHASE ORDER (+ New > Purchase Order) |
| • Operational status: Open / Pending |
| • Accounting Impact: NON-POSTING (No debits or credits to the General Ledger) |
| |
| STAGE 2: RECEIVE GOODS AGAINST PO (+ New > Bill or Check) |
| • Bookkeeper opens Bill, selects Vendor, and clicks 'Add' from the right-hand PO drawer. |
| • QBO populates quantities and agreed purchase costs. |
| • Accounting Impact: POSTING ──► DR Inventory Asset / CR Accounts Payable |
| • Inventory quantity on hand increases immediately. |
| |
| STAGE 3: CLOSE PURCHASE ORDER |
| • If fully received, QBO marks the PO 'Closed' automatically. |
| • If partially received, the PO remains 'Open' with remaining unfulfilled quantities. |
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Automated FIFO Costing Mechanics in QBO
Under the First-In, First-Out (FIFO) costing method, QBO assumes that the earliest inventory units purchased are the first units sold. When merchandise is sold, QBO pulls costs from the oldest available purchase layer until that layer is exhausted, then rolls over to the next layer.
Comprehensive FIFO Cost Layer Numerical Demonstration
Consider the following purchasing and sales activity for Widget-A over a two-month operating cycle:
PURCHASE HISTORY (Cost Layers Created):
• Layer 1 (June 1): Purchased 20 units @ $10.00 each = $200.00
• Layer 2 (June 10): Purchased 30 units @ $15.00 each = $450.00
• Layer 3 (June 20): Purchased 25 units @ $18.00 each = $450.00
Total Inventory Available: 75 units | Total Cost = $1,100.00
SALES TRANSACTION (June 25):
• Issued Invoice #201 for 40 units of Widget-A at a retail price of $30.00 each ($1,200.00 total sale).
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| FIFO COST OF GOODS SOLD CALCULATION |
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| To fulfill the 40-unit sale, QBO consumes cost layers chronologically: |
| |
| 1. Consume 100% of Layer 1: 20 units @ $10.00 = $200.00 (Layer 1 is now exhausted: 0 left)|
| 2. Consume 20 units of Layer 2: 20 units @ $15.00 = $300.00 (Layer 2 has 10 units remaining) |
| ───────────────────────────────────────────────────────────── |
| TOTAL COGS RECOGNIZED: 40 units = $500.00 |
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| ENDING INVENTORY VALUATION |
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| Remaining inventory on hand (35 units): |
| • From Layer 2: 10 units @ $15.00 = $150.00 |
| • From Layer 3: 25 units @ $18.00 = $450.00 |
| ───────────────────────────────────────────────────────────── |
| ENDING INVENTORY ASSET BALANCE: 35 units = $600.00 |
| |
| Mathematical Proof: Total Goods Available ($1,100) = COGS ($500) + Ending Inventory ($600) |
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The Dual Journal Entry on Sale of Inventory
When a sales transaction (Invoice or Sales Receipt) containing an inventory item is saved, QuickBooks Online automatically executes two simultaneous journal entries behind the scenes:
ENTRY 1: THE REVENUE & RECEIVABLE TRANSACTION (Visible on Invoice Form)
Date Account Titles and Explanation Debit Credit
June 25 Accounts Receivable ......................... $1,200
Merchandise Sales Revenue ............... $1,200
(To record sale of 40 widgets @ $30.00 retail price)
ENTRY 2: THE COGS & INVENTORY ASSET REDUCTION (Automated Invisible FIFO Entry)
Date Account Titles and Explanation Debit Credit
June 25 Cost of Goods Sold .......................... $500
Inventory Asset ......................... $500
(To relieve inventory asset and record FIFO cost)
Financial Statement Impact Analysis
- Income Statement: Gross Profit is computed instantly: Sales Revenue ($1,200) - COGS ($500) = $700 Gross Profit.
- Balance Sheet: Accounts Receivable increases by $1,200 and Inventory Asset decreases by $500, yielding a net asset increase of $700 (which perfectly matches the increase in Retained Earnings via Gross Profit).
Inventory Quantity Adjustments (Shrinkage, Spoilage & Count Discrepancies)
Under perpetual inventory tracking, the general ledger record will inevitably diverge from physical warehouse reality due to theft (shrinkage), breakage, spoilage, vendor shipping errors, or data entry mistakes. GAAP requires businesses to conduct periodic physical inventory counts and adjust the general ledger to match physical reality.
In QBO, this reconciliation is executed via the Inventory Quantity Adjustment form (+ New > Inventory Quantity Adjustment).
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| INVENTORY QUANTITY ADJUSTMENT JOURNAL MECHANICS |
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| CASE A: PHYSICAL COUNT < BOOK QUANTITY (Inventory Shrinkage / Shortage) |
| • Book count = 100 units; Physical count = 92 units (8 units missing @ $15 FIFO cost = $120) |
| • Journal Entry: |
| DR Inventory Shrinkage (Expense/COGS) .............. $120 |
| CR Inventory Asset .............................. $120 |
| |
| CASE B: PHYSICAL COUNT > BOOK QUANTITY (Inventory Overage) |
| • Book count = 50 units; Physical count = 54 units (4 extra units found @ $10 FIFO cost = $40) |
| • Journal Entry: |
| DR Inventory Asset ................................. $40 |
| CR Inventory Shrinkage (Contra-Expense / COGS) .. $40 |
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Adjustment Best Practices for CPB Exam
- Adjustment Account Selection: When creating an Inventory Quantity Adjustment, QBO requires the user to specify an Adjustment Account. For routine shrinkage or minor counting variances, map this to an expense account such as Inventory Shrinkage or Cost of Goods Sold. For major catastrophic write-offs (e.g., warehouse flood or fire), map to an Other Expense account (e.g., Casualty Loss).
- Never Use Standard Journal Entries for Quantity Fixes: Recording a manual General Journal Entry debiting COGS and crediting Inventory Asset adjusts the financial dollar balance on the Balance Sheet but does not update the physical quantity on hand in the Products & Services sub-ledger! This causes severe perpetual unit tracking errors. Always use the dedicated Inventory Quantity Adjustment screen.
When an invoice is saved in QuickBooks Online Plus for the sale of 10 tracked inventory units at a sales price of $100 each (which cost $60 each under FIFO), what simultaneous journal entries are recorded behind the scenes?
A business has the following purchasing history for an inventory item in QBO: • May 1: Purchased 50 units at $20 each • May 12: Purchased 50 units at $24 each On May 20, the business sells 70 units on an invoice. Under QBO's FIFO costing method, what is the Cost of Goods Sold for this sale and what is the ending Inventory Asset balance?
What is the accounting status and General Ledger effect when a bookkeeper creates and sends a $15,000 Purchase Order to a supplier in QuickBooks Online?
A warehouse manager conducts a physical inventory count and discovers that only 45 units of a product are on hand, while QuickBooks Online reports 50 units on hand. The FIFO cost is $30 per unit ($150 total variance). How should the bookkeeper correct this variance in QBO?