Chapter 5 Inventory Transactions Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

Chapter 5 Overview 5.1 Profit measurement 5.2 Recording inventory 5.3 Errors in valuation Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

Chapter 5 Objectives Describe merchandising activities Identify merchandising business examples Introduce and contrast the perpetual and periodic systems of recording inventory Record inventory transactions using the perpetual system Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

Chapter 5 Objectives Identify and record cash discounts Analyse transactions for inventory using the perpetual system Record transactions using source documents Identify and record cash discounts Account for sales and purchase returns Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

Chapter 5 Objectives Prepare closing entries for inventory Identify effects of errors in inventory valuations on reported profit Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

Introduction This chapter introduces: Accounting processes of merchandisers Businesses who buy goods and sell them for profit The methods available for accounting for the purchase and sale of inventory How the financial statements reflect merchandising activities Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.1 Profit measurement Merchandisers buy inventory and sell it at a profit Merchandisers may be wholesalers or retailers Inventory = goods held for the purpose of resale Other names for inventory include: Merchandise Stock Goods Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

Cost of Goods Sold (COGS) 5.1 Profit measurement Cost of Goods Sold (COGS) An extra category of expenses is added which records the cost to the entity of any goods sold Using COGS provides useful information as Sales Revenue – COGS = Gross Profit Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.1 Profit measurement Service Entity Merchandiser Entity Income Statement Service revenue xx Less expenses xx Net profit XX Merchandiser Entity Income Statement Sales revenue xx Less cost of goods sold xx =GROSS PROFIT xx Less expenses xx Net Profit XX Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.1 Profit measurement Inventory and COGS deserve a lot of attention because they may be one of an entity’s largest and most valuable assets Examples in Australia include: Woolworths (inventory = 34.1% of assets) Coles Myer (inventory = 35.1% of assets) Compared with Qantas (inventory = 2.7%) Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory Two key methods for recording inventory: Perpetual method Periodic method Choice will depend on the type of business and the type, value and volume of inventory Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory Periodic method Does not continuously update inventory Entity has no record of inventory on hand at any one particular time A physical stocktake (counting of stock) takes place each period to determine the inventory level and, therefore, the amount sold Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory EXAMPLE 5.1 ‘Party Supplies’ starts business with 200 hats Purchases 1500 more hats during the year Stocktake reveals 150 hats at the end of the year How many were sold? Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory ‘Party Supplies’ + Purchases 1500 Inventory (start) 200 + Purchases 1500 – Inventory (end) 150 = Inventory SOLD 1550 (assumed amount) Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory Perpetual method Maintains a continuous record of inventory Provides an inventory balance at any time Enables calculation of stock loss/theft Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory EXAMPLE 5.2 ‘Party Supplies’ starts business with 200 hats Purchases 1500 more hats during the year 1500 units are sold Stocktake shows 200 units (50 damaged) Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory + Purchases 1500 – Units sold 1500 ‘Party Supplies’ Inventory (start) 200 + Purchases 1500 – Units sold 1500 Stocktake 200 – Stock loss (damage) 50 Ending inventory 150 Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory Perpetual method Records inventory as an asset The ‘asset’ approach When sold the inventory asset decreases and The COGS expense account is increased Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory Perpetual method Journal entries are required for: 1. Purchase of inventory 2. Returning inventory to supplier 3. Sale of inventory 4. Returns of inventory by customers 5. Stock losses Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory 1. Purchase of inventory Buy 1000 masks for $1 each (on credit) Date Account Debit Credit 2/4/X5 Inventory 1000 Accounts Payable 1000 Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory 2. Return inventory to supplier Return 50 faulty masks to supplier Date Account Debit Credit 3/4/X5 Accounts Payable 50 Inventory 50 Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory 3. Sale of inventory Sold 90 masks on credit for $6 each Date Account Debit Credit 3/4/X5 Sales Revenue 540 Accounts Receivable 540 COGS 90 Inventory 90 Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory 4. Return of inventory by customer Customer returns 12 masks Date Account Debit Credit 5/4/X5 Sales Returns 72 Accounts Receivable 72 Inventory 12 COGS 12 Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory 5. Stock losses Stocktake reveals 2 masks are lost Date Account Debit Credit 7/4/X5 Stock loss 2 Inventory 2 Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.2 Recording inventory Merchandiser Entity Income Statement Sales revenue xx less sales returns xx = Net sales xx Less cost of goods sold xx = Gross profit xx Less expenses xx Net Profit XX Here is a detailed version of the Income Statement presented earlier Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.3 Errors in valuation Due to the vast number of products and the variety of different products that an entity may have, errors are often inevitable If inventory is overvalued, this will increase profit by the same amount Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

5.3 Errors in valuation If the error is corrected in the next year, the error will be reversed (but both years’ profit figure will be incorrect) Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

Summary Inventory is a main asset for merchandising entities and may be accounted for using: The perpetual system The periodic system The perpetual system always has current figures regarding inventory and COGS and also allows the calculation of stock loss by comparing records with a stocktake Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

Summary Journal entries are required for: Purchases of inventory Returning inventory to suppliers Sales of inventory Returns of inventory by customers Stock losses Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes

Summary As computerisation of accounting records is becoming more commonplace, the obstacles to using the perpetual system are decreasing The closing entries for the periodic system are found in Appendix A to Chapter 5 Copyright  2004 McGraw-Hill Australia Pty Ltd. PPTs t/a Accounting by Jackling et al Prepared by Courtney Clowes