Accounting for Merchandise Inventory Chapter 15 Accounting for Merchandise Inventory © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Learning Objective 1 Understanding and journalizing transactions using the perpetual inventory system and explaining the difference between perpetual and periodic inventory systems LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Perpetual Inventory System Two key accounts Merchandise Inventory Asset Current balance of Inventory at all times Entries are recorded for each purchase and each sale of Inventory Cost of Goods Sold Cumulative total cost of all merchandise sold to customers during accounting period Both accounts provide current info to mgmt LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Perpetual vs. Periodic System Perpetual system Value of Inventory is known after every purchase & sale Cost of goods sold is known after every sale Purchases, purchase returns & allowances, and freight accounts don’t exist Periodic system Does not give accurate info about Merchandise Inventory or C.O.G.S. until ending Inventory is done LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Perpetual Inventory System We will use Problem 15B-1 to illustrate the journal entries involved with the perpetual inventory system. Transactions for March: 15-Purchased merchandise on acct. totaling $1,800, terms n/30. 16- Sold merchandise costing $71 on acct. for $92 to B. Hackett. 18- Returned $120 of defective merchandise purchased Mar. 15. 19- Sold $230 of merchandise for cash. It costs $175. 19- Allowed merchandise sold on Mar. 16 return for credit -$14. It costs $11. 20- Bought $900 merchandise on acct. from JT Supply; terms n/30. 22- Received pmt from B. Hackett for Mar. 16 sale less return. 23- Sold $410 of merchandise costing $320 for cash. LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Problem 15B-1 LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Problem 15B-1 LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Problem 15B-1 LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Problem 15B-1 LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Learning Objective 2 Maintaining a subsidiary ledger for inventory LO-2 © 2010Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Inventory Subsidiary Ledger A business with a variety of products in Inventory will use Inventory subsidiary ledger Maintain an individual record for each different product Companies like Wal-Mart and Target use this ledger LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Merchandise Inventory Subsidiary Accounts Controlling Account Merchandise Inventory Bal. 292 LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Merchandise Inventory Subsidiary Accounts Controlling Account Merchandise Inventory Bal. 292 Sep. 4 150 Bal. 442 Bal. 442 Purchased 5 units of Product A for $30 on Sep. 4. LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Merchandise Inventory Subsidiary Accounts Controlling Account Merchandise Inventory Bal. 292 210 Sep. 8 Sep. 4 150 Bal. 232 Bal. 232 Sold 7 units of Product A on Sep. 8. LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Learning Objective 3 Understanding periodic methods of determining the value of the ending inventory LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Inventory Valuation Methods-Periodic Inventory System Specific Invoice First In, First Out (FIFO) Last In, First Out (LIFO) Weighted Average LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Inventory Valuation Methods-Periodic Inventory System Method used will have effect on Ending Inventory Cost of goods sold Gross profit LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Specific Invoice Method Identify each item in ending Inventory by a specific purchase price and invoice number Also known as specific identification method Would be used with cars, boats, and antiques. LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Specific Invoice Method Pros Simple if small amounts of high-cost goods Flow of goods and flow of cost are same Costs are exactly matched with Sales Cons Difficult if large unit volume and small unit prices © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

First In, First Out Method Assume that the oldest goods are sold first Ending Inventory valued at costs shown on most recent invoices Refer to Problem 15B-4 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

First In, First Out Method At end of year, 400 units unsold LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

First In, First Out Method Cost of Goods Available for Sale $43,800 Less Cost of Ending Inventory 22,000 Cost of Goods Sold $21,800 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

First In, First Out Method Pros Cost flow tends to follow physical flow Ending Inventory valuation is made up of current costs on balance sheet Cons During inflationary periods, FIFO produces higher net income, thus more taxes to be paid Recent costs are not matched with recent Sales LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Last In, First Out Method Assume that the goods most recently acquired are sold first Ending Inventory valued at earliest invoice costs Refer again to Problem 15B-4 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Last In, First Out Method At end of year, 400 units unsold LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Last In, First Out Method Cost of Goods Available for Sale $43,800 Less Cost of Ending Inventory 11,300 Cost of Goods Sold $32,500 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Last In, First Out Method Pros Cost of goods sold is near current costs Matches current costs with current selling price During inflationary periods, LIFO produces lowest net income, a tax advantage Cons Ending Inventory is valued at old prices Does not match physical flow of goods LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Weighted-Average Method Average unit cost = Total cost of goods available for sale Total units of goods available for sale Usually falls between FIFO & LIFO amounts LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Weighted-Average Method Average Unit Cost = $43,800 / 1,010 = $43.37 Ending Inventory = 400 units x $43.37 = $17,348 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Weighted-Average Method Cost of Goods Available for Sale $43,800 Less Cost of Ending Inventory 17,348 Cost of Goods Sold $26,452 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Weighted Average Method Cons Current prices have no more significance than older prices Most recent costs are not matched with current Sales Cost of ending Inventory is not most recent costs Pros Good for products sold in large volume An equal unit cost is assigned to each unit in Inventory LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

When Can An Inventory Method Be Changed? Consistency Principle – requires companies to follow the same accounting methods or procedures from period to period Full Disclosure Principle – requires companies to disclose on their financial reports changes in accounting procedures and methods along with effect of the change as well as justification for change LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Items That Should be Included in the Cost of Inventory Goods in Transit F.O.B. shipping point – buyer becomes owner when merchandise is placed on carrier at shipping point F.O.B. destination – seller maintains ownership until merchandise reaches the destination LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Items That Should Not be Included in the Cost of Inventory Merchandise on consignment - merchandise sold through agent (consignee) who does not own it, but has possession Damaged or obsolete merchandise - if not saleable, should not be added to cost of Inventory. If saleable at lower cost, value should be conservatively estimated & added to Inventory LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Items That Should be Included in the Cost of Inventory Goods in Transit - When inventory is taken, add only if ownership of inventory has been transferred to buyer. Only use with F.O.B. - shipping point Damaged or Obsolete Merchandise - only if saleable, estimate value at conservative cost. LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Learning Objective 4 Estimating ending inventory using the retail method and gross profit method and understanding how the ending inventory amount affects financial reports LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Methods of Estimating Ending Inventory Retail Method Gross Profit Method LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Retail Method Must know Beginning Inventory at cost and at retail Cost of net purchases at cost and at retail Net Sales at retail LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Retail Method – Problem 15B-5 LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Retail Method – Problem 15B-5 LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Retail Method – Problem 15B-5 LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Retail Method – Problem 15B-5 LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Gross Profit Method Develops relationship among Sales, Cost of Goods Sold, and gross profit Can also be used to determine amount of Inventory on hand at time of a fire Can verify accuracy of physical Inventory at year’s end LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Gross Profit Method Helps prepare financial statements Must know Average gross profit rate Net Sales, beginning Inventory, net purchases LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Gross Profit Method Step 1: Compute cost of goods available for sale Step 2: Estimate Cost of Goods Sold by multiplying cost percentage times Net Sales Step 3: Subtract Cost of Goods Sold from cost of goods available for sale LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Problem 15B-6 LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Effects of Inventory Errors Error in ending Inventory in Year 1 affects income statement for two years Year 1 ending Inventory becomes Year 2 beginning Inventory. LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Effects of Inventory Errors If the item is: Overstated Understated Beginning Inventory Profit is understated Profit is overstated Ending Inventory LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

End of Chapter 15 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater