Accounting for Inventory

Accounting for Inventory Definition Inventory Management and Control Inventory Recording System Periodic Inventory System Perpetual Inventory System Inventory Valuation Effects of Inventory Errors

Importance of Inventory • Integral part of profit determination • Inventories should be turned over as quickly as possible. The faster the turnover the greater the opportunity to make profits • Often one of the largest item in current asset (merchandising and manufacturing business) • Large amount of money invested in inventories, adequate controls must be implemented, so that theft and other losses are kept to a minimum

Control of inventories • Control over purchase • Control over sale of inventories (& issuance for production in manufacturing firm) • Control over stored inventories • Stocktaking

Control of inventories • Control over purchase of inventories • Ordering inventories • Purchase Requisition • Purchase Order • Receiving inventories • Goods received note/slip • Invoice from supplier

Control of inventories • Inventory returns • Debit note sent to supplier • Credit note received from supplier to confirm tha goods return or allowance made • Accounting for purchases • Invoice check against order form and goods received note • Invoice use

Inventory • Goods either manufactured or purchased for resale. • Inventory is reported on balance sheet as an asset. • When sold, inventory is reported on income statement as an expense (cost of goods sold). • COGS: the cost of inventory sold during the period.

Manufacturing business • Raw materials • Work in process • Partially completed • Finished goods • Completed and ready for sale

Merchandising • Items to be resold. • For a supermarket, food is inventory, the shopping cart is not

Who owns inventory? • When goods are in transit? • Q: Who owns the inventory on a truck or railroad car? • A: The party who is paying the shipping costs. • When goods are on consignment? • Q: Who owns inventory stocked in a warehouse? • A: The supplier until the inventory is sold. The warehouse owner stocks and sells the inventory and receives a commission on sales as payment for services rendered.

Periodic Inventory System • Records are not updated when a purchase or a sale is made. • Only the dollar amount of the sale is recorded. • Usually used when • inventory is composed of a large number of diverse items, • each with a relatively low value

Perpetual inventory system • Records are updated when a purchase or sale is made. • Records reflect total items in inventory or sold at any given time. • Most often used when • each item has a relatively high value, or • the cost of running out of or overstocking an item is expensive

Illustration • Beginning inventory 10 hats @ $10 each = $100 • March 1 Purchase 15 hats @ $15 each = $225 • March 1 Freight in $10 • March 1 Purchase return 3 hats @ $15 each = $ 45 • May 2 Purchase 10 hats @ $20 each = $200 • May 2 Purchase discount 2/10, n/30 • June 30 Sales 20 hats (10 @ $10, 10 @ $15) • July 3 Sales return 1 hat @ $15 = $ 15 • Ending inventory 13 hats

With a periodic system, a physical count is the only way to get the information necessary to compute COGS: • Beginning Inventory, January 1, 2005 • + Purchases for the year • = Cost of goods available for sale during 2005 • – Ending Inventory, December 31, 2005 • = Cost of Goods Sold for 2005

Illustration of Perpetual and Periodic Journal Journal Entries

Perpetual Periodic

Sales of goods (Perpetual)

Sales of Goods (Periodic)

Sales Returns (Perpetual) Sales returns (Periodic)

Inventory Valuation • Specific Identification • FIFO (First In First Out) • LIFO (Last In First Out) • Weighted Average

Specific Identification • A method of valuing inventory and determining cost of goods sold whereby the actual costs of specific inventory items are assigned to them

First In First Out • First goods purchase purchased are assumed to be the first goods sold • Ending inventory consists of the most recently purchased goods

Last In First Out • Last goods purchased are assumed to be the first goods sold • Ending inventory consist of the first goods purchased • Not allowed by FRS 112

Weighted average cost • Cost of goods sold and cost of ending inventory are determined by using an average cost of all merchandise available for sale during the period

Illustration of Inventory Valuation

Comparison of all Inventory Costing Method

Accounting for Inventory