When the on-hand quantity is less than or equal to zero, the system uses the transaction unit cost as the new average cost for the inventory.

Average Cost = Transaction Unit Cost

For example, the NCAS shows that your warehouse has a negative on-hand balance of -10 units for an item with a current average cost of $9 per unit. In other words, the Reserve for Inventory account has a debit balance and the Inventory asset account has a credit balance of $90.
 
 
 

Your warehouse has just received an additional 100 units of the item at a cost of $10 per unit. In this example, the transaction unit cost is $10 per unit. The NCAS uses $10.00 per unit as the new average cost.

The NCAS will debit the Inventory asset account and credit the Reserve for Inventory account for $1000. (Refer to the Receipt transaction in the Accounting Activities Table.) The accounting entries generated by this receipt are shown in the following table:
 

The system-maintained or perpetual inventory records now show an on-hand balance of 90 units (i.e., 100 units minus the beginning balance of negative 10 units). Because the new average cost is $10 per unit, the perpetual inventory value is $900 (i.e., the on-hand balance of 90 units multiplied by the $10 per unit). However, as seen in the preceding table, the general ledger asset value in the Inventory account is $910 (i.e., $1000 minus $90). In other words, the general ledger asset value needs to be adjusted to match the perpetual inventory value.

Therefore, the system automatically computes an item value adjustment. The item value adjustment is the product of the difference between the new average cost and the old average cost and the absolute value of the negative on-hand quantity.

Item Value Adjustment = (New Avg. Cost - Old Avg. Cost) (Beginning On-hand Balance)

Continuing our example, your warehouse records show the following values:

New Average Cost                     =         $10
Old Average Cost                      =          $9
Beginning On-hand Balance       =          -10

The system substitutes these values in the preceding formula to calculate the item value adjustment:

Item Value Adjustment               =         (10-9)             (-10)
                                                =         (1)                  (10)
                                                =         $10

If the item value adjustment is less than zero (i.e., if the new cost is lower than the old cost), the NCAS debits the Inventory asset account (event ID A010) and credits the Inventory Adjustment account (event ID A090) for the value of the item value adjustment.

If the item value adjustment is greater than zero (i.e., if the new cost is higher than the old cost), the NCAS debits the Inventory Adjustment account (event ID A090) and credits the Inventory asset account (event ID A010) for the amount of the item value adjustment.

Note: In order to ensure that the Inventory and the Reserve for Inventory accounts remain in balance, the Inventory Adjustment account should be an account that can be rolled up to the Reserve for Inventory account on the BD reports.

Note: Because the Inventory Adjustment account will roll up to the Reserve for Inventory account for reporting purposes, in effect the debit/credit to the adjustment account is a debit/credit to the Reserve for Inventory account.

When an item reflects a negative on-hand balance, the warehouse manager should immediately verify the exact quantity of the item available in the warehouse. The on-hand quantity in the system should then be adjusted by the warehouse manager to match the actual physical quantity. When this quantity adjustment is made, the perpetual inventory value is updated to reflect the updated physical quantity. In this example, your warehouse manager should adjust the on-hand quantity to 100 units. If this quantity adjustment is made, the perpetual inventory value is now $1000 (100 units multiplied by the average cost of $10 per unit). However, the GL asset value is still $900.

The NCAS then generates another adjustment to reconcile the GL value with the perpetual value. (This adjustment is explained in the Accounting for Inventory Reconciliation topic. See the "Add Adjustment" and "Deduct Adjustment" transactions in the Accounting Activities Table.)