Perpetual Inventory System

Perpetual Inventory Detailed record of items in stock is kept up to date on an ongoing basis As items sold, info. is transferred directly to store’s central computer which is programmed to make the appropriate deductions from the inventory and make accounting entries Sales returns are generally handled by separate department System cannot automatically know when goods are lost, stolen or broken; therefore have to do manual check of inventory

Purchases When goods are purchased for resale, inventory account is immediately updated by the cost price of the merchandise. At any time, the business can look in the general ledger and see the book value of the inventory on hand. Remember -- this is the book value and may not be 100% accurate (damaged goods, theft, clerical errors, etc.).  Merchandise Inventory (at Cost Price) 3800      Bank or A/P 3800  To record the Purchase of Inventory in Perpetual System

Purchase Returns & Allowances Goods purchased may be damaged, defective, of inferior quality, or they may not meet purchaser’s specifications Goods may be returned or purchase price may be reduced (an allowance) Entry to record: Cash or Accounts payable 300 Merchandise Inventory (for amount of return or adjustment) 300 4

Quantity and Purchase Discounts Quantity discount: reduction in price due to the quantity being purchased Purchase discount: reduction in price due to early payment of amount due Entry to record: Accounts payable 3500 Merchandise Inventory (for amount of discount) 70 Cash 3430

Freight Costs Purchase agreement indicates when ownership of the goods is transferred from buyer to seller FOB Shipping Point: Buyer accepts ownership at place of shipping and pays for shipping costs Merchandise Inventory 150 Cash 150 FOB Destination: Buyer accepts ownership when goods are delivered to buyer’s place of business and seller pays freight costs Seller debits Freight Out for cost of shipping 6

Merchandise Inventory Summary of Purchases Merchandise Inventory (Purchase) May 4 3800 May 9 300 (Purchase Return) (Freight) 4 150 14 70 (Purchase Discount) Bal. 3580

Sale of Merchandise (two journal entries needed) The first entry identifies the sale at the selling price. A second entry shows the merchandise going out of the business and the inventory account decreasing by the cost price of the goods (the price the business paid for the merchandise). Step 1  Bank or Accounts Receivable (at Selling Price) 3800      Sales (at Selling Price) 3800  To record the sale of merchandise in a perpetual system   Step 2:   Cost of Goods Sold (at cost price) 2400      Merchandise Inventory (at cost price) 2400  To record the inventory sold at cost price in a perpetual system 

Sales Taxes Collected by merchandising companies on the goods that they sell Periodically remitted to government Sales taxes collected are not revenue Treated as a liability until paid (as they are due to the government) recorded in HST Payable account

Sales Returns & Allowances Sales returns: when customers return merchandise to seller for credit or refund Sales allowances: when seller grants customers a price reduction Seller’s entry required: Sales returns and allowances 300 Accounts receivable or cash 300 If merchandise returned, additional entry required: Merchandise inventory 140 (recorded at orig. cost) Cost of goods sold 140 To record cost of returned goods.

Quantity and Sales Discounts Quantity discount: Reduction in selling price due to the volume of goods purchased Sale is recorded at reduced price Sales discount: Discount offered for early payment of bill Discount amount taken is debited to Sales Discounts (a contra revenue account) Original amount in Sales is not changed

Journal Entry Cash 3430 Sales Discount 70 Accounts Receivable 3500 To record collection of invoice #731 within discount period

Summary of Sales Transactions Sales Sales Returns & Allowances May 4 3800 May 9 300 Sales Discounts Cost of Goods Sold May 14 70 May 4 2400 May 9 140 Bal. 2260

COGS Cost of beginning inventory + cost of goods purchased = Cost of goods available for sale – cost of ending inventory = cost of goods sold i.e.42500+143000=185500-36400 = 149100 COGS Calculation is completed after each sale

Completing the Accounting Cycle Same types of adjusting entries as a service company One additional adjustment for inventory To ensure the recorded inventory amount agrees with the actual quantity on hand A physical count is an important control feature A perpetual system indicates what should be there An inventory count will determine what exists Additional accounts to be closed: Sales, Sales Returns and Allowances, Sales Discounts, Cost of Goods Sold, Freight Out

Merchandise Inventory Inventory counted at fiscal year-end It becomes the beginning inventory figure for the next fiscal period If the amount on hand is different than what is displayed in the merchandise inventory account, an adjustment needs to be made

Adjusting Entry Cost of Goods Sold 500 Merchandise Inventory 500 To record difference between inventory records and physical units on hand.

Financial Statements Merchandisers use the classified balance sheet Two forms of income statements are widely used: multiple-step and single-step

Multiple-Step Income Statement Five main steps: Net Sales Gross Profit Income from Operations Non-operating Activities (interest, dividend revenue, gains from sale of property, interest expense, losses) Net Income

Multiple-Step Income Statement Calculation of Net sales and Gross profit Calculation of Income from operations Calculation of Non-operating activities and Net income

Single-Step Income Statement All data are classified as either (1) revenues or (2) expenses

Classified Balance Sheet Merchandise Inventory reported as a current asset following Accounts Receivable

Gross Margin Ratio The relation between sales and COGS Gross Margin/Net Sales = Gross Margin Ratio i.e. (in millions) $645.1 /$1396.5 = 46.2% Means that each $1 of sales yields about 46.2 cents in gross margin to cover all other expenses