Chapter 5 Inventory Transactions Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

Chapter 5 Objectives Describe merchandising activities and identify business examples Contrast the perpetual and periodic systems of recording inventory Analyse and record transactions for inventory using the perpetual system Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

Chapter 5 Objectives Record transactions using source documents for inventory Identify and record cash discounts Account for sales returns and purchase returns Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

Chapter 5 Objectives Prepare closing entries for inventory under the perpetual inventory system and the periodic system (Appendix A) Identify effects of errors in inventory valuations on reported profit Record transactions involving a goods and services tax (Appendix B) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

Chapter 5 Overview 5.1 Profit measurement: merchandiser and service enterprises 5.2 Recording inventory: contrasting periodic and perpetual systems Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

Chapter 5 Overview 5.3 Using source documents in recording of inventory transactions 5.4 Accounting for inventory and computers 5.5 Errors in stock valuation Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

Introduction Importance of accurate inventory records: For many organisations, inventory is one of their largest assets Inventory information therefore important to both internal and external users In particular, information related to the control of inventory There are several different inventory control systems that can be used Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

Looking Back (previous chapter) Focus was on: recording of transactions including recording in the ledger describing the closing process and preparation of final reports Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

Looking Forward This chapter: Accounting processes of merchandisers Businesses which buy goods and sell them for profit Business and accounting practices engaged in purchase and sale of inventory Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

Looking Forward This chapter: How financial statements reflect merchandising activities How new elements are incorporated in the recording and reporting process Merchandisers as retailers and wholesalers Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.1 Profit measurement: merchandiser and service enterprises 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  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.1 Profit measurement: merchandiser and service enterprises Merchandising organisation versus service organisation Profit determination Service organisation: Service revenue Less expenses Equals operating profit Merchandising organisation Net sales Less cost of goods sold Equals gross profit Equals net profit Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.1 Profit measurement: merchandiser and service enterprises 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: Sales Revenue – COGS = Gross Profit Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.1 Profit measurement: merchandiser and service enterprises Income statement for the period XX Sales revenue $1 000 less Sales returns 10 Net sales 990 less Cost of good sold 440 Gross profit 550 less Expenses 50 Net profit $500 Service enterprise Income statement for the period XX Service revenue $1 000 less Expenses 500 Operating profit $500 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.1 Profit measurement: merchandiser and service enterprises For example: supermarket Sells goods for revenue Incurs costs of buying the goods and of selling the goods Service enterprise For example: accounting firm Sells the labour of the owner and/or employees Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.1 Profit measurement: merchandiser and service enterprises Important distinguishing aspects of reporting for merchandisers: Sales revenue (the gross amount earned from the sale of inventory) Cost of goods sold accumulates all the costs associated with the inventories sold Gross profit is determined by subtracting cost of goods sold from net sales revenue Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.1 Profit measurement: merchandiser and service enterprises Aspects of similarity in reporting for merchandising and service firms Expenses sections of both income statements generally contain the same types of accounts (eg. telephone, electricity and other general expenses) Both are subject to a goods and services tax (Appendix B for recording process) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.1 Profit measurement: merchandiser and service enterprises The relative importance of inventory as a proportion of total assets Inventory represents one of an entity’s largest and most valuable assets Examples in Australia include: Woolworths (inventory = 22.1% of assets) Compared with Qantas (inventory = 1.83%) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems 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  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems Periodic system Does not continuously update inventory Entity has no record of inventory on hand at any one particular time A physical stock-take (counting of stock) takes place each period to determine the inventory level and, therefore, the amount sold Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems EXAMPLE ‘Party Supplies’ starts business with 200 hats Purchases 1500 more hats during the year Stock-take reveals 150 hats at the end of the year How many were sold? Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems Number of hats Beginning inventory (count) 200 plus Purchases 1 500 Number of party hats for sale 1 700 less Ending inventory (count) 150 Equals inventory sold (i.e. cost of goods sold) (By deduction, the number of hats assumed to be sold) 1 550 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems Maintains a continuous record of inventory Provides an inventory balance at any time Enables calculation of stock loss/theft Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems EXAMPLE ‘Party Supplies’ starts business with 200 hats Purchases 1500 more hats during the year 1500 units are sold Stock-take shows 200 units (50 damaged) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems Number of hats Beginning inventory (from records, supported with physical count, if desired) 200 plus Purchases of inventory (from records) 1 500 Number of party hats for sale 1 700 Cost of inventory sold (from records) Inventory losses (damaged hats – from records) 50 Ending Inventory (supported with physical count, if desired) 150 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems The recording process Perpetual inventory system: Records inventory as an asset The ‘asset’ approach When sold the inventory asset decreases and The COGS expense account is increased Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems Purposes of physical count of inventory in a perpetual system discrepancy between actual and recorded levels provide indication of efficiency of inventory control draw attention to existence of obsolete or damaged inventory Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.3 Using source documents in the recording of inventory transactions Source documents form an important part of internal control Source documents provide input for processing information in journals and ledgers Data/input Processing Output Source documents Journal and ledger Financial reports Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.3 Using source documents in the recording of inventory transactions Journal entries are required for: 1. Purchase of inventory 2. Return of inventory to supplier 3. Sale of inventory 4. Return of undamaged inventory 5. Return of damaged inventory by customers 6. Theft or loss of inventory Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.3 Using source documents in the recording of inventory transactions Perpetual inventory system Example: Transaction 1: April 1 Harry Traders was established with contributed capital of $40 000 cash April 1 Cash + A 40 000 Capital OE Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.3 Using source documents in the recording of inventory transactions Perpetual inventory system Purchase of merchandise Transaction 2: April 2 Bought 1000 smiling face masks for $1 each on credit from Smiling Face Masks (owner, D.S. Geise) April 2 Inventory + A 1 000 Accounts payable - L Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.3 Using source documents in the recording of inventory transactions Perpetual inventory system Purchase returns and allowances Transaction 3: April 3 Returned 50 masks that were found to be scowling and received a credit note April 3 Accounts payable - L 50 Inventory A Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.3 Using source documents in the recording of inventory transactions Perpetual inventory system Sales transactions Transaction 4: April 4 Sold 90 masks on credit to Party Jinks for $6 each April 4 Accounts receivable + A 540 Sales R Cost of goods sold Ex 90 Inventory - Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.3 Using source documents in the recording of inventory transactions Perpetual inventory system Sales returns and allowances Sales returns of undamaged inventory Transaction 5: April 5 Party Jinks returned 12 masks that were no longer needed and received credit April 5 Sales returns + - R 72 Accounts receivable - A Inventory 12 Cost of goods sold Ex Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.3 Using source documents in the recording of inventory transactions Perpetual inventory system Sales returns and allowances Sales returns of damaged inventory Transaction 6: April 6 Party Jinks returned eight masks that had arrived with broken noses and received credit. The masks were destroyed. April 6 Sales returns + - R 48 Accounts receivable - A Inventory damages losses Ex 8 Cost of goods sold Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.3 Using source documents in the recording of inventory transactions Perpetual inventory system Stock count and stock loss/gain Stock loss Transaction 7: April 7 A stock count at end of the week revealed 870 masks on hand 1000 inventory at start – 50 returns – 90 sales + 12 return undamaged = 872 (according to records)  2 units of inventory missing April 7 Inventory shortage loss + Ex 2 Inventory - A Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.3 Using source documents in the recording of inventory transactions Perpetual inventory system Recording entries in the financial statements HAPPY TRADERS Financial statements Income Statement for the week ended 7 April 20X8 Sales revenue $540 less sales returns 120 Net sales (70 units) 420 less Cost of goods sold (70 units) 70 Gross profit 350 less Expenses Inventory damage losses $8 Inventory shortage losses 2 10 Net profit $340 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.3 Using source documents in the recording of inventory transactions Perpetual inventory system Recording entries in the financial statements Balance Sheet As at 7 April 20X8 Assets Liabilities Cash at bank $40 000 Accounts payable $950 Accounts receivable 420 Inventory 870 Owner’s equity Capital 40 340 $41 290 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.4 Accounting for inventory and computers Computers enhance management’s control over inventory Computers are able to determine an inventory reorder point Computers are able to implement management policies that will maximise use of business’s resources Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.5 Errors in stock 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  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

5.5 Errors in stock valuation If the error is corrected in the next year, the error will be reversed (but both years’ profit figure will be incorrect) Over two periods the error in stock valuation will cancel out Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

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 stock-take Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low

Summary As computerisation of accounting records is becoming more commonplace, the obstacles to using the perpetual system are decreasing Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines Slides prepared by Mary Low