Whether you’re new to selling on Amazon, or you’re a seasoned pro, you still may have some questions around properly accounting for your Amazon sales. One of the hardest aspects of accounting that most sellers struggle with is cash vs. accrual accounting. Let’s break this down to try and help you out (and so you can sound smarter at your next meetup).
Cash accounting is what people use in their everyday lives. When you receive cash, it’s income. When you spend money (whether in cash, or on your credit card), it’s an expense. Cash accounting is very intuitive for most people, so we won’t spend too much time on this.
The two biggest issues facing Amazon sellers if they use cash accounting are: inaccurate Cost of Goods Sold (we’ll cover this in detail later), and the Amazon payment schedule, which for most sellers is every two weeks. This means that two months out of the year, your sales look awesome (because three payments hit your bank account), and the other 10 months they look worse than they should. If you’re trying to sell your business, or get investor/bank financing, they’re going to ask about those two months, which may lead to some awkward conversations about why you’re using cash accounting for a retail business.
The more accurate method of accounting for Amazon, and e-commerce in general, is accrual accounting. Under accrual accounting, we are matching the income and expenses with the time period in which the transaction is realized.
So what does this mean?
For revenue, under accrual accounting, you would recognize the revenue in the month that you sell an item, even if the Amazon settlement does not hit your bank account in that month.
For example, let’s say your settlement period is June 24 to July 8, and the deposit hits your bank on July 10. Under cash accounting, you would recognize all of the revenue in July (when the cash is deposited into your account). Under accrual accounting, you would need to split that settlement into two periods: June 24-30, and July 1-8*. This way, even though the deposit clears in July, you are recognizing the June 24-30 sales in the correct period: June. The actual mechanics of this will depend on what type of accounting software you’re using.
For Cost of Goods Sold (COGS), this takes a bit more work. The idea behind COGS is to match the expense of inventory with the recognition of revenue.
Under cash accounting, you would expense the inventory when purchased. Under accrual accounting, you would expense the inventory when sold.
How does this look in the real world?
Let’s say you purchased $100,000 in inventory in December 2018, it arrived in February 2019, and you sold 75% of it in March, and sold the remaining 25% in April.
Under cash accounting, you would have a $100,000 expense in December 2018.
Under accrual accounting, the $100,000 you spend on inventory would sit on your Balance Sheet as an asset until you sell the products. You would record $75,000 of COGS in March 2019 (75% of $100,000), and $25,000 of COGS in April 2019 (the remaining 25% of the $100,000 inventory purchase).
At the end of the day, the goal of accrual accounting is to accurately reflect the profitability and operations of your company.
If you have questions about this article, or any other accounting or tax questions related to e-commerce, please reach out to us.
*Pro-tip: make sure that you’re recording your Amazon settlement as each of its parts: total revenue, amazon fees, etc. If you just classify the amount of the deposit as revenue, you will never match the 1099k that Amazon sends you at the end of the year.