1. Chapter 5 Inventory Transactions
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

2. Chapter 5 Overview 5.1 Profit measurement 5.2 Recording inventory
5.3 Errors in valuation
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

3. Chapter 5 Objectives Describe merchandising activities
Identify merchandising business examples
Introduce and contrast the perpetual and periodic systems of recording inventory
Record inventory transactions using the perpetual system
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

4. Chapter 5 Objectives Identify and record cash discounts
Analyse transactions for inventory using the perpetual system
Record transactions using source documents
Identify and record cash discounts
Account for sales and purchase returns
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

5. Chapter 5 Objectives Prepare closing entries for inventory
Identify effects of errors in inventory valuations on reported profit
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

6. Introduction This chapter introduces:
Accounting processes of merchandisers
Businesses who buy goods and sell them for profit
The methods available for accounting for the purchase and sale of inventory
How the financial statements reflect merchandising activities
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

7. 5.1 Profit measurement
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  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

8. Cost of Goods Sold (COGS)
5.1 Profit measurement
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 as
Sales Revenue – COGS = Gross Profit
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

9. 5.1 Profit measurement Service Entity Merchandiser Entity
Income Statement
Service revenue xx
Less expenses xx
Net profit XX
Merchandiser Entity
Income Statement
Sales revenue xx
Less cost of goods sold xx
=GROSS PROFIT xx
Less expenses xx
Net Profit XX
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

10. 5.1 Profit measurement
Inventory and COGS deserve a lot of attention because they may be one of an entity’s largest and most valuable assets
Examples in Australia include:
Woolworths (inventory = 34.1% of assets)
Coles Myer (inventory = 35.1% of assets)
Compared with Qantas (inventory = 2.7%)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

11. 5.2 Recording inventory 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  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

12. 5.2 Recording inventory Periodic method
Does not continuously update inventory
Entity has no record of inventory on hand at any one particular time
A physical stocktake (counting of stock) takes place each period to determine the inventory level and, therefore, the amount sold
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

13. 5.2 Recording inventory EXAMPLE 5.1
‘Party Supplies’ starts business with 200 hats
Purchases 1500 more hats during the year
Stocktake reveals 150 hats at the end of the year
How many were sold?
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

14. 5.2 Recording inventory ‘Party Supplies’ + Purchases 1500
Inventory (start)
+ Purchases
– Inventory (end)
= Inventory SOLD
(assumed amount)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

15. 5.2 Recording inventory Perpetual method
Maintains a continuous record of inventory
Provides an inventory balance at any time
Enables calculation of stock loss/theft
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

16. 5.2 Recording inventory EXAMPLE 5.2
‘Party Supplies’ starts business with 200 hats
Purchases 1500 more hats during the year
1500 units are sold
Stocktake shows 200 units (50 damaged)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

17. 5.2 Recording inventory + Purchases 1500 – Units sold 1500
‘Party Supplies’
Inventory (start)
+ Purchases
– Units sold
Stocktake
– Stock loss (damage) 50
Ending inventory
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

18. 5.2 Recording inventory Perpetual method Records inventory as an asset
The ‘asset’ approach
When sold the inventory asset decreases
and
The COGS expense account is increased
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

19. 5.2 Recording inventory Perpetual method
Journal entries are required for:
1. Purchase of inventory
2. Returning inventory to supplier
3. Sale of inventory
4. Returns of inventory by customers
5. Stock losses
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

20. 5.2 Recording inventory 1. Purchase of inventory
Buy 1000 masks for $1 each (on credit)
Date Account Debit Credit
2/4/X5 Inventory 1000
Accounts Payable
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

21. 5.2 Recording inventory 2. Return inventory to supplier
Return 50 faulty masks to supplier
Date Account Debit Credit
3/4/X5 Accounts Payable
Inventory
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

22. 5.2 Recording inventory 3. Sale of inventory
Sold 90 masks on credit for $6 each
Date Account Debit Credit
3/4/X Sales Revenue 540
Accounts Receivable 540
COGS 90
Inventory
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

23. 5.2 Recording inventory 4. Return of inventory by customer
Customer returns 12 masks
Date Account Debit Credit
5/4/X Sales Returns
Accounts Receivable
Inventory
COGS
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

24. 5.2 Recording inventory 5. Stock losses
Stocktake reveals 2 masks are lost
Date Account Debit Credit
7/4/X Stock loss
Inventory
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

25. 5.2 Recording inventory
Merchandiser Entity
Income Statement
Sales revenue xx
less sales returns xx
= Net sales xx
Less cost of goods sold xx
= Gross profit xx
Less expenses xx
Net Profit XX
Here is a detailed version of the Income Statement presented earlier
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

26. 5.3 Errors in 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  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

27. 5.3 Errors in valuation
If the error is corrected in the next year, the error will be reversed (but both years’ profit figure will be incorrect)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

28. 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 stocktake
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

29. Summary Journal entries are required for: Purchases of inventory
Returning inventory to suppliers
Sales of inventory
Returns of inventory by customers
Stock losses
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes

30. Summary
As computerisation of accounting records is becoming more commonplace, the obstacles to using the perpetual system are decreasing
The closing entries for the periodic system are found in Appendix A to Chapter 5
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes