1. Chapter 5 Inventory Transactions
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

2. Chapter 5 Objectives
Describe merchandising activities and identify business examples
Contrast the perpetual and periodic systems of recording inventory
Analyse and record transactions for inventory using the perpetual system
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

3. Chapter 5 Objectives
Record transactions using source documents for inventory
Identify and record cash discounts
Account for sales returns and purchase returns
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

4. Chapter 5 Objectives
Prepare closing entries for inventory under the perpetual inventory system and the periodic system (Appendix A)
Identify effects of errors in inventory valuations on reported profit
Record transactions involving a goods and services tax (Appendix B)
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

5. Chapter 5 Overview
5.1 Profit measurement: merchandiser and service enterprises
5.2 Recording inventory: contrasting periodic and perpetual systems
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

6. Chapter 5 Overview
5.3 Using source documents in recording of inventory transactions
5.4 Accounting for inventory and computers
5.5 Errors in stock valuation
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

7. Introduction Importance of accurate inventory records:
For many organisations, inventory is one of their largest assets
Inventory information therefore important to both internal and external users
In particular, information related to the control of inventory
There are several different inventory control systems that can be used
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

8. Looking Back (previous chapter)
Focus was on:
recording of transactions
including recording in the ledger
describing the closing process and
preparation of final reports
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

9. Looking Forward This chapter: Accounting processes of merchandisers
Businesses which buy goods and sell them for profit
Business and accounting practices engaged in purchase and sale of inventory
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

10. Looking Forward This chapter:
How financial statements reflect merchandising activities
How new elements are incorporated in the recording and reporting process
Merchandisers as retailers and wholesalers
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

11. 5.1 Profit measurement: merchandiser and service enterprises
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  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

12. 5.1 Profit measurement: merchandiser and service enterprises
Merchandising organisation versus service organisation
Profit determination
Service organisation:
Service revenue
Less expenses
Equals operating profit
Merchandising organisation
Net sales
Less cost of goods sold
Equals gross profit
Equals net profit
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

13. 5.1 Profit measurement: merchandiser and service enterprises
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:
Sales Revenue – COGS = Gross Profit
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

14. 5.1 Profit measurement: merchandiser and service enterprises
Income statement for the period XX
Sales revenue
$1 000
less Sales returns 10
Net sales
990
less Cost of good sold
440
Gross profit
550
less Expenses 50
Net profit
$500
Service enterprise
Income statement for the period XX
Service revenue
$1 000
less Expenses
500
Operating profit
$500
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

15. 5.1 Profit measurement: merchandiser and service enterprises
For example: supermarket
Sells goods for revenue
Incurs costs of buying the goods and of selling the goods
Service enterprise
For example: accounting firm
Sells the labour of the owner and/or employees
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

16. 5.1 Profit measurement: merchandiser and service enterprises
Important distinguishing aspects of reporting for merchandisers:
Sales revenue (the gross amount earned from the sale of inventory)
Cost of goods sold accumulates all the costs associated with the inventories sold
Gross profit is determined by subtracting cost of goods sold from net sales revenue
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

17. 5.1 Profit measurement: merchandiser and service enterprises
Aspects of similarity in reporting for merchandising and service firms
Expenses sections of both income statements generally contain the same types of accounts (eg. telephone, electricity and other general expenses)
Both are subject to a goods and services tax (Appendix B for recording process)
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

18. 5.1 Profit measurement: merchandiser and service enterprises
The relative importance of inventory as a proportion of total assets
Inventory represents one of an entity’s largest and most valuable assets
Examples in Australia include:
Woolworths (inventory = 22.1% of assets)
Compared with Qantas (inventory = 1.83%)
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

19. 5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems
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  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

20. 5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems
Periodic system
Does not continuously update inventory
Entity has no record of inventory on hand at any one particular time
A physical stock-take (counting of stock) takes place each period to determine the inventory level and, therefore, the amount sold
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

21. 5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems
EXAMPLE
‘Party Supplies’ starts business with 200 hats
Purchases 1500 more hats during the year
Stock-take reveals 150 hats at the end of the year
How many were sold?
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

22. 5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems
Number of hats
Beginning inventory (count)
200
plus Purchases
1 500
Number of party hats for sale
1 700
less Ending inventory (count)
150
Equals inventory sold (i.e. cost of goods sold)
(By deduction, the number of hats assumed to be sold)
1 550
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

23. 5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems
Maintains a continuous record of inventory
Provides an inventory balance at any time
Enables calculation of stock loss/theft
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

24. 5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems
EXAMPLE
‘Party Supplies’ starts business with 200 hats
Purchases 1500 more hats during the year
1500 units are sold
Stock-take shows 200 units (50 damaged)
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

25. 5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems
Number of hats
Beginning inventory (from records, supported with physical count, if desired)
200
plus Purchases of inventory (from records)
1 500
Number of party hats for sale
1 700
Cost of inventory sold (from records)
Inventory losses (damaged hats – from records) 50
Ending Inventory (supported with physical count, if desired)
150
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

26. 5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems
The recording process
Perpetual inventory system:
Records inventory as an asset
The ‘asset’ approach
When sold the inventory asset decreases
and
The COGS expense account is increased
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

27. 5.2 Recording inventory for a merchandiser: contrasting periodic and perpetual systems
Purposes of physical count of inventory in a perpetual system
discrepancy between actual and recorded levels provide indication of efficiency of inventory control
draw attention to existence of obsolete or damaged inventory
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

28. 5.3 Using source documents in the recording of inventory transactions
Source documents form an important part of internal control
Source documents provide input for processing information in journals and ledgers
Data/input Processing Output
Source
documents
Journal and
ledger
Financial
reports
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

29. 5.3 Using source documents in the recording of inventory transactions
Journal entries are required for:
1. Purchase of inventory
2. Return of inventory to supplier
3. Sale of inventory
4. Return of undamaged inventory
5. Return of damaged inventory by customers
6. Theft or loss of inventory
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

30. 5.3 Using source documents in the recording of inventory transactions
Perpetual inventory system
Example:
Transaction 1: April 1
Harry Traders was established with contributed capital of $ cash
April 1
Cash + A
40 000
Capital OE
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

31. 5.3 Using source documents in the recording of inventory transactions
Perpetual inventory system
Purchase of merchandise
Transaction 2: April 2
Bought 1000 smiling face masks for $1 each on credit from Smiling Face Masks (owner, D.S. Geise)
April 2
Inventory + A
1 000
Accounts payable - L
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

32. 5.3 Using source documents in the recording of inventory transactions
Perpetual inventory system
Purchase returns and allowances
Transaction 3: April 3
Returned 50 masks that were found to be scowling and received a credit note
April 3
Accounts payable - L 50
Inventory A
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

33. 5.3 Using source documents in the recording of inventory transactions
Perpetual inventory system
Sales transactions
Transaction 4: April 4
Sold 90 masks on credit to Party Jinks for $6 each
April 4
Accounts receivable + A
540
Sales R
Cost of goods sold Ex 90
Inventory -
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

34. 5.3 Using source documents in the recording of inventory transactions
Perpetual inventory system
Sales returns and allowances
Sales returns of undamaged inventory
Transaction 5: April 5
Party Jinks returned 12 masks that were no longer needed and received credit
April 5
Sales returns +
- R 72
Accounts receivable - A
Inventory 12
Cost of goods sold Ex
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

35. 5.3 Using source documents in the recording of inventory transactions
Perpetual inventory system
Sales returns and allowances
Sales returns of damaged inventory
Transaction 6: April 6
Party Jinks returned eight masks that had arrived with broken noses and received credit. The masks were destroyed.
April 6
Sales returns +
- R 48
Accounts receivable - A
Inventory damages losses Ex 8
Cost of goods sold
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

36. 5.3 Using source documents in the recording of inventory transactions
Perpetual inventory system
Stock count and stock loss/gain
Stock loss
Transaction 7: April 7
A stock count at end of the week revealed 870 masks on hand
1000 inventory at start – 50 returns – 90 sales + 12 return undamaged = 872 (according to records)
 2 units of inventory missing
April 7
Inventory shortage loss + Ex 2
Inventory - A
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

37. 5.3 Using source documents in the recording of inventory transactions
Perpetual inventory system
Recording entries in the financial statements
HAPPY TRADERS
Financial statements
Income Statement for the week ended 7 April 20X8
Sales revenue
$540
less sales returns
120
Net sales (70 units)
420
less Cost of goods sold (70 units) 70
Gross profit
350
less Expenses
Inventory damage losses $8
Inventory shortage losses 2 10
Net profit
$340
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

38. 5.3 Using source documents in the recording of inventory transactions
Perpetual inventory system
Recording entries in the financial statements
Balance Sheet
As at 7 April 20X8
Assets
Liabilities
Cash at bank
$40 000
Accounts payable
$950
Accounts receivable
420
Inventory
870
Owner’s equity
Capital
40 340
$41 290
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

39. 5.4 Accounting for inventory and computers
Computers enhance management’s control over inventory
Computers are able to determine an inventory reorder point
Computers are able to implement management policies that will maximise use of business’s resources
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

40. 5.5 Errors in stock 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  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

41. 5.5 Errors in stock valuation
If the error is corrected in the next year, the error will be reversed (but both years’ profit figure will be incorrect)
Over two periods the error in stock valuation will cancel out
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

42. 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 stock-take
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low

43. Summary
As computerisation of accounting records is becoming more commonplace, the obstacles to using the perpetual system are decreasing
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting: A Framework for Decision Making 2e, by Jackling, Raar, Williams & Wines
Slides prepared by Mary Low