Learning Objectives 1. Identify major classifications of inventory. 2. Distinguish between perpetual and periodic inventory systems. 3. Identify the effects of inventory errors on the financial statements. 4. Identify the items that should be included as inventory cost.

Inventory Classification Inventory consists of: - finished goods held for sale in the ordinary course of business - goods held or consumed in the production of finished goods A merchandising concern has one inventory account Merchandise Inventory A manufacturing concern will normally have three inventory accounts: Raw materials Work in process Finished goods

Merchandising Operations Inventory Cost Flows Merchandising Operations Merchandise Inventory Purchases COGS Cost of goods sold $$$

Inventory Control Inventory control is important for: - ensuring availability of inventory items - preventing excessive accumulation of inventory items The perpetual system maintains a continuous record of inventory changes The periodic system updates inventory records only periodically

Perpetual System Purchases and sales of inventory recorded directly to Inventory account Inventory purchases, freight, purchase returns and discounts are debited to the Inventory account Cost of Goods Sold (COGS) is debited and Inventory is credited for each sale Subsidiary ledger is maintained for individual inventory items Periodic inventory counts are still required to ensure reliability

Periodic System Inventory purchases recorded as a debit to Purchases account COGS is a calculation on the Income Statement Physical inventory is counted and verified periodically Under both periodic and perpetual inventory systems, physical counts of inventory are conducted at least once a year Any differences in counted and recorded quantities are posted to a separate account – Inventory Over and Short

Perpetual and Periodic Systems: Example Fesmire Limited reports the following data for 2000: Beginning Inventory : 100 units at $6 Purchases: (all credit) March 12: 300 units at $6 July 6: 600 units at $6 Sales: (all credit) April 8: 200 units at $12 August 9: 400 units at $12 Ending Inventory: 400 units at $6 Provide all journal entries under each method.

Perpetual System Date Record Inventory Changes Record Sales Revenue March 12 Inventory 1,800 Accts Payable 1,800 April 8 Cost of goods sold 1,200 Accts Receiv. 2,400 Inventory 1200 Sales 2,400 (200 *$6) (200 * $12) July 6 Inventory 3,600 Accts Payable 3,600 August 9 Cost of goods sold 2,400 Accts Receiv. 4,800 Inventory 2,400 Sales 4,800 (400 * $6) (400 * $12)

Perpetual System Dollar amounts are optional Inventory Stock Card (Subsidiary Ledger) Date Purchases Sales Balance January 1 Opening 100 units March 12 300 units 400 April 8 200 units 200 July 6 600 units 800 August 9 400 units 400 units Dollar amounts are optional Periodic inventory system would not normally maintain a subsidiary ledger for inventory

Periodic System Date Record Inventory Changes Record Sales Revenue March 12 Purchases 1,800 Accts Payable 1,800 April 8 No entry Accts Receiv 2,400 Sales 2,400 July 6 Purchases 3,600 Accts Payable 3,600 August 9 No entry Accts Receiv 4,800 Sales 4,800 Dec. 31 Cost of goods sold 3,600 Inventory (ending) 2,400 Adjusting Purchases 5,400 Entry Inventory (beg) 600

Financial Statement Presentation Perpetual Periodic Net Sales $,$$$ Cost of Goods Sold $$$ Gross Profit $,$$$ Net Sales $,$$$ Cost of Goods Sold: Opening Inventory $$$ Add: Net Purchases $$$ Cost of Goods Available for Sale Less: Ending Inventory $$$ Cost of Goods Sold $$$ Gross Profit $,$$$