Accounting for Merchandise Inventory

1. Accounting for Merchandise Inventory Chapter 16

2. Inventories Every business must choose an inventory evaluation method. This method must be used consistently from one accounting period to the next.

3. Inventories • Inventory management is a key to every successful business. • Insufficient inventory levels discourage customers from patronizing a business. • A store must also consider the cost of carrying inventory. • Dollars tied up in inventory cannot be used for other cash needs.

4. Understanding and journalizing transactions using the perpetual inventory system, and explaining the difference between a perpetual and periodic inventory system. Learning Objective 1

5. Learning Unit 16-1 • A perpetual inventory system provides better internal control over inventories. • This type of system keeps a running balance in the inventory account. • This balance should equal inventory on hand.

6. Learning Unit 16-1 What are two key accounts? Merchandise Inventory Cost of Goods Sold

7. Learning Unit 16-1 The inventory debit balance is the up-to-date cost of inventory on hand. As goods are sold, the cost of the goods are debited to this account and credited to the inventory account.

8. Learning Unit 16-1 • Purchases are debited to the inventory account. • Cash or accounts payable is credited. • A sale necessitates two entries: Debit Cash or Accounts Receivable Credit Sales Revenue Debit Cost of Goods Sold Credit Inventory

9. Learning Unit 16-1 Debit Inventory Credit Cost of Goods Sold (For the cost of the goods returned by customer) Debit Sales Returns & Allowances Credit Cash (For the sales price of the goods returned)

10. Learning Unit 16-1 Debit Accounts Payable Credit Inventory (For the cost of the goods returned by to the supplier)

11. Learning Unit 16-1 • The perpetual system gives a day-to-day picture of sales and the cost of goods sold. • The periodic system shows the proper balance in inventory at year end only.

12. Maintaining a subsidiary ledger for inventory. Learning Objective 2

13. Learning Unit 16-2 • Accounting for inventory items becomes complicated as soon as product lines expand. • Subsidiary ledgers are necessary to properly track inventory items. • Daily posting (or instant recording through electronic computerized systems) allow managers easy access to information.

14. Learning Unit 16-2 Inventory Control Item: VX113 Received Sold Balance Unit Unit Unit Date Qty. Cost Total Qty. Cost Total Qty. Cost Total Jan. 1 14 $50 $700 12 2 $50 $100 12 50 600 19 10 $60 $600 12 50 10 60 1,200 25 8 50 400 4 50 10 60 800

15. Understanding periodic methods of determining the value of the ending inventory. Learning Objective 3

16. Learning Unit 16-3 • Different inventory valuing methods are used. • These methods often are not realistic in depicting the physical flow of goods sold. • Inventory amounts affect both the income statement and balance sheet. • Ending inventory errors affect more than one period’s financial statements.

17. Learning Unit 16-3 • Consistency is a key factor in inventory accounting. • Once a business selects a particular inventory method, it should be used every year, so that year-to-year comparisons can be made. • Inventory items are counted, but the cost of the inventory has to be decided also.

18. Learning Unit 16-3 Inventory Accounting Methods Specific Invoice FIFO LIFO Weighted Average

19. Learning Unit 16-3 Units Purchased in 200x January 1 20 units @ $10 = $ 200 May 1 25 units @ $20 = $ 500 October 2 25 units @ $30 = $ 750 Total 70 $1,450 Units sold 55 Units left 15

20. Learning Unit 16-3 Units sold by date: Jan 5 15 (Jan purchases) May 9 20 (May purchases) Oct 10 20 (5 from Jan., and 15 from Oct. purchases) Total sales 55 15 units left in inventory

21. Learning Unit 16-3 Specific Invoice Method Cost of Goods Sold Oct 10 $ 500 May 9 400 Jan 5 150 Total $1,050 Ending Inventory Oct $300 May 100 Total $400

22. Learning Unit 16-3 FIFO Method Cost of Goods Sold Jan 5 $ 150 May 9 450 Oct 10 550 Total $1,150 Ending Inventory Oct $300 Total $300

23. Learning Unit 16-3 LIFO Method Cost of Goods Sold Oct 10 $ 250 May 9 600 Jan 5 450 Total $1,300 Ending Inventory Jan $150 Total $150

24. Learning Unit 16-3 Weighted Average Method January 1 20 units @ $10 = $ 200 May 1 25 units @ $20 = 500 October 2 25 units @ $30 = 750 Total 70 $1,450

25. Learning Unit 16-3 • $1,450 total cost/70 total units • $20.72 per unit • Cost of goods sold = 55 × $20.72 = $1,139.60 Ending inventory = 15 × $20.72 = 310.80 $1,450.40* *.40 rounding difference

26. Learning Unit 16-3 • What items are included in inventory? • Freight terms for purchases must be checked. • These items are included in the merchandise inventory count if they were sent F.O.B. shipping point.

27. Learning Unit 16-3 • Consignment merchandise is merchandise held for sale for others who hold legal title. • Do not include these items in inventory.

28. Estimating ending inventory using the retail method and gross profit method, and how the ending inventory amount affects financial reports. Learning Objective 4

29. Learning Unit 16-4 Estimating Ending Inventory: Retail Method Goods Available CostRetail Beg. Inventory $ 4,100 $ 6,900 Net Purchases 7,900 13,100 $12,000 $20,000 Ratio: $12,000 ÷ $20,000 = 60%

30. Learning Unit 16-4 Deduct net sales from retail goods available for sale. Multiply the cost ratio times the retail price ending inventory.

31. Learning Unit 16-4 $20,000 – $14,000 = $6,000 $6,000 × 60% = $3,600

32. Learning Unit 16-4 Estimating Ending Inventory: Gross Profit Method Beginning Inventory $10,000 Net Purchases $ 4,000 Net Sales at retail $ 6,000 Cost percentage 70% Estimated Cost of Goods Sold 4,200

33. Learning Unit 16-4 Beginning Inventory $10,000 Net Purchases $4,000 + Cost of Goods Available for Sale $14,000 = Estimated Cost of Goods Sold $4,200 Ending Inventory $9,800 – =

34. End of Chapter 16