Chapter 3 Inventory Chapter 3 Inventory

Learning objectives After you have studied this chapter, you should be able to: Explain why it is inappropriate to use an inventory account to record increases and decreases in inventory Describe the two causes of inventory increasing Describe the two causes of inventory decreasing

Learning objectives (Continued) Explain the difference between a purchase account and a return inwards account Explain the difference between a sales account and a return outwards account Explain how to record increases and decreases of inventory in the appropriate accounts Explain the meanings of the terms ‘purchases’ and ‘sales’ as used in accounting

Learning objectives (Continued) Explain the differences in recording purchases on credit as compared to recording purchases that are paid for immediately in cash Explain the differences in recording sales on credit as compared to recording sales that are paid for immediately in cash

Inventory Normally, goods and services are sold above cost price, the difference being profit. As you know, when goods and services are sold for less than their cost, the difference is a loss.

An increase in inventory An increase in inventory can be due to one of two causes: The purchase of additional goods. The return in to the business of goods previously sold.

An increase in inventory (Continued) To distinguish the two aspects of the increase of inventory, two accounts are opened: A purchases account, in which purchases of goods are entered. A return inwards account, in which goods being returned into the business are entered.

A decrease in inventory A decrease in inventory can be due to one of two causes: The sale of goods. Goods previously bought by the business now being returned to the supplier.

A decrease in inventory (Continued) To distinguish the two aspects of the decrease of inventory, two accounts are opened: A sales account, in which sales of goods are entered. A return outwards account, in which goods being returned out to a supplier are entered.

Activity

Purchase of inventory on credit On 1 August 2012, goods costing £165 are bought on credit from D. Henry.

Purchase of inventory for cash On 2 August 2012, goods costing £310 are bought, cash being paid for them immediately at the time of purchase.

Sales of inventory on credit On 3 August 2012, goods were sold on credit for £375 to J. Lee.

Sales of inventory for cash On 4 August 2012, goods are sold for £55, cash being received immediately at the time of sale.

Returns inwards On 5 August 2012, goods which had been previously sold to F. Lower for £29 are now returned to the business.

Returns outwards On 6 August 2012, goods previously bought for £96 are returned by the business to K. Howe.

Special meaning of ‘sales’ and ‘purchases’ Both ‘sales’ and ‘purchases’ have a special meaning in accounting. Purchases means the purchase of those goods which the business buys with the sole intention of selling. Sales means the sale of those goods in which the business normally deals and which were bought with the prime intention of resale.

Learning outcomes You should have now learnt: That it is not appropriate to use an inventory account to record increases and decreases in inventory because inventory is normally sold at a price greater than its cost That inventory increases either because some inventory has been purchases or because the inventory that was sold has been returned by the buyer

Learning outcomes (Continued) That inventory decreases either because some inventory has been sold or because inventory previously purchased has been returned to the supplier That a purchase account is used to record purchases of inventory (as debit entries in the account) and that a return inwards account is used to record inventory returned by customers (as debit entries in the account)

Learning outcomes (Continued) That a sales account is used to record sales of inventory (as credit entries in the account) and that a return outwards account is used to record inventory returned to suppliers (as credit entries in the account) How to record increases and decreases of inventory in the appropriate accounts

Learning outcomes (Continued) That in accounting, the term ‘purchases’ refers to purchases of inventory. Acquisitions of any other assets, such as vans, equipment and buildings, are never described as purchases That in accounting, the term ‘sales’ refers to sales of inventory. Disposals of any other assets, such as vans, equipment and buildings, are never described as sales That purchases for cash are never entered in the supplier’s account

Learning outcomes (Continued) That purchases on credit are always entered in the supplier’s (creditor’s) account That sales for cash are never entered in the customer’s account That sales on credit are always entered in the customer’s (debtor’s) account