Dealing with Manufacturing Byproducts in QuickBooks

The inventory system in QuickBooks is fairly simple, not a lot of bells and whistles. If you are a manufacturer and you are working with discrete assemblies (things like bicycles, electronics and such) then QuickBooks provides you with the basics, as I’ve discussed in several articles. If you have a process manufacturing business, such as a bakery or chemical plant, you have to work harder to make QuickBooks work. Let’s take a look at how you would deal with a common problem that a process manufacturer would face – byproducts.

A byproduct is typically an item that is created as a part of the manufacturing process. You are building one assembly item, but you get some other useful items as a spin-off. QuickBooks doesn’t have a process that will deal with this easily. There are several ways to deal with it depending on what you want to accomplish and how much effort you want to put into the system.

Dealing with Cost

This is an aspect of the process that you are going to talk about with your accounting advisor. How do you want to handle the cost of the byproducts? There are generally two ways (with many variations of each) – the sales method and the production method.

The sales method recognizes the byproduct at the time of sale. You don’t really assign a “cost” to the byproduct, the cost is resolved as a part of the main assembly. You just see the increase in income in the month that you sell the byproduct. No adjustments, no additional steps. Build the main assembly, sell the main assembly, sell the byproduct (you would probably have it set as a non-inventory part item). This is the simplest approach and is commonly used, but it might not be appropriate for your situation.

The production method has you allocating some of the cost of the manufacturing process to the byproducts, so that it hits your financial statements in the month that you produce the byproduct. In QuickBooks this requires a number of additional transactions, and I’ll give you some alternatives later in this article.

Which is right for you? Ask your accounting professional. In general, the production method is preferred because it complies with GAAP principles.

Let’s Make Cheese!

To illustrate the production method in QuickBooks, let’s work with cheese! I have created an inventory assembly item “Cheese” that has a bill of materials (BOM).

Here is the Bill of Material for this item. This makes a 6 pound wheel of cheese, which I sell as a unit (I’m not worrying about weight of the units).

Here’s my starting point, my item list. Note that I’ve set up “water” and “salt” to be non-inventory part items, because I buy those in bulk and they are very low cost items. I don’t need to track the quantity on hand for those. I also have plenty of milk, rennet and yogurt culture on hand.

This is my starting inventory valuation, so that we can track the effects that my building process will have.

I’m going to be looking at the production method of accounting for costs. This means that I need to find a way to produce “Cheese”, as well as producing “Whey” and “Cream”, which are two byproducts of my cheese manufacturing process. For every six pound wheel of “Cheese” that I make, I also get one quart of “Cream” (I skim it off in the process) and three gallons of “Whey” (you can use that to make Ricotta, and other things). Not only do I have to increase the quantity of Cheese, Cream and Whey, I have to find a way to move the costs of the component items into each of these products.

Let’s issue a “build” transaction for one wheel of cheese:

After this transaction we can see the effects on our inventory valuation. We’ve reduced the value of the component items, and increased the value of the Cheese assembly item.

You’ll notice that the total inventory valuation actually went up a bit – that is because we have incorporated the cost of the two non-inventory part items. The cost of those items was pulled into the cost of the cheese (see my article on Item Types in a QuickBooks Bill of Materials).

At this point, if you used the sales method, you would be finished. You just have to sell the items (although you would not have the Cream and Whey as inventory assembly items, they would need to be non-inventory part items so that you don’t count the quantity on hand).

For the production method we need to increase the quantity of the two byproducts.

How Much Cost to Distribute?

That is a tough question. I know what the cost of making all the products and byproducts will be, that is the $7.21 total cost for a wheel of Cheese. How much of that cost should be allocated to Cream and Whey? That is something that, again, you need to discuss with your financial consultant. One way to do it is to determine what the fair market value of those items is at any point of time – but that can be a bit tricky.

In my example I’m going to allocate 30% of the cost to the Whey and 10% to the Cream. So if I consume $7.21 in components, $2.16 should go to Whey, $0.72 to Cream, and the rest ($4.33) to Cheese.

Byproducts by Inventory Adjustments

One approach is to use inventory adjustments. Sounds simple! You just increase the quantity on hand of Cream and Whey, and you are all set, right? Well, not really, because we have to deal with cost.

Here’s what I mean. I built one wheel of Cheese, so I have a quart of Cream and three gallons of Whey. I can just enter a quantity adjustment.

If I look at my inventory valuation I see that the quantity was adjusted, but the cost of the byproducts is not adjusted. All of the cost stayed with the Cheese. That doesn’t work. In this case I had a “cost” of zero for the byproducts – but if I have a cost assigned to them I have added that cost to the valuation, without taking it from somewhere else.

If I want to disburse the cost to the byproduct items I’ll need to make a different kind of inventory adjustment.

Let’s create a Quantity and Total Value adjustment. I’ll enter the quantity of the byproducts, and manually add the value of the production to the value shown. In my example that is simple, since I started with a zero quantity. However, when you start making these items, you have to do the math (you can use the built in calculator). I’m increasing both the quantity and the total value of each item by the amounts produced in my build transactions.

Before you save this transaction you have a few more things to do. Look at the Total Value of Adjustment in the lower corner. This is the amount that we need to remove from the Cheese item.

Now, in this same transaction, add the Cheese item. Do not change the quantity, it needs to stay the same. The new value needs to be adjusted down by the total value of adjustment. The new value field will show the current valuation before the adjustment. Click the + key in that field to open the QuickBooks calculator, and subtract that total value of adjustment.

If you enter this transaction correctly then the total value of adjustment should be zero.

The result of this adjustment is to move a portion of the cost ($2.88 in this case) out of the Cheese assembly and into the Cream and Whey items, without changing your total inventory valuation. That is a lot of work, and you have to do the valuation calculations manually. This is why many businesses will just use the sales method, even if it might not be what their financial advisor wants.

Byproducts by Assembly Builds

Here is another approach that can be used, which avoids inventory adjustments and the need to manually calculate new values. We will work with an intermediate assembly. The advantage is that you have less room for error, the disadvantage is that it takes more transactions and adds an item to the item list.

Let’s create an assembly that will be used as an intermediate step. This assembly holds the BOM that we created earlier for “Cheese”, I’ll call it “Cheese Intermediate”.

Now we’ll change the Cheese item to have just one component, the Cheese Intermediate. Note that I’ve changed the quantity to show that this assembly uses 0.6 of the intermediate assembly.

The next step is to make both of my byproducts into inventory assembly items as well. They also use the Cheese Intermediate assembly as the only component. The quantity reflects my earlier estimate of what percentage of the cost should go into the byproducts. The Quantity value for all of the assemblies (the main product and byproducts) should total 1.0.

And here is the Cream.

When I want to build a wheel of Cheese I first issue a build transaction for the Cheese Intermediate. This will pull the costs of the component items into the new assembly item just as before.

Here’s the valuation report.

Now I have to issue three additional builds. This will create each of the products (main and byproduct) and allocate the costs properly. Here is the Cheese build.

Next I’ll build the Cream assembly.

And finally, the Whey assembly.

Looking at our inventory valuation you’ll see that the cost of the components has been properly distributed through to the byproducts.

Clearly this takes more steps than doing an adjustment, but you’ll note that there is less room for error. You don’t have to manually calculate the new value of the main assembly.

Is this a lot of work? Yes. I’m offering two approaches that can be used to manage the production of byproducts – there may be other ways to deal with this than what I’m laying out here.The alternatives are to not worry about the valuation of byproducts, but that might not be acceptable for your financial statements.

You also may find that you can use one of the inventory add-on programs that can make this a simpler process. For example, ACCTivate allows you to add a “negative component” in the BOM, so that the build process can add the byproduct automatically. I’m not sure how that program handles costs in this case, but it is something worth looking into. Note that the more flexibile manufacturing add-on programs use their own inventory system, rather than the inflexible one used in QuickBooks.