1 / 93

Importance of Inventory in Business Operations

Understand the vital role of inventory management in financial decisions, showcasing perpetual and periodic inventory systems with practical examples. Learn about purchase returns, allowances, discounts, and their impact on financial statements.

gaylordm
Download Presentation

Importance of Inventory in Business Operations

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. CHAPTER 11 Inventory

  2. Checklist

  3. Inventory • Inventoryrepresents physical goods purchased/manufactured for resale to a customer.

  4. Checklist

  5. Why is Inventory Important? A reader of financial statements needs to know how much gross profit a business is generating to make informed business decisions. • Examples include: • Pricing policies • Purchasing decisions • The Cost of Goods Sold is directly linked to the value of inventory used.

  6. Two Types of Inventory Systems • Perpetual inventory system • Periodic inventory system

  7. Perpetual Inventory System When a product is sold, the item is instantly removed from the inventory records and the cost of the product is immediately matched to the sale of the product. Example: Supermarket sales. A barcode is scanned and immediately records the sale of inventory

  8. Perpetual Inventory System • You are already familiar with this system. When an item is sold, the cost of the product is immediately matched to the sale so that the gross profit is known each period. CURRENT ASSETS CASH Jan March Feb SHORT-TERM INVESTMENTS SALES REVENUE SALES REVENUE SALES REVENUE $100 $150 $130 ACCOUNTS RECEIVABLE COST OF GOODS SOLD COST OF GOODS SOLD COST OF GOODS SOLD $20 $60 $40 INVENTORY GROSS PROFIT GROSS PROFIT GROSS PROFIT $80 $90 $70 PREPAID EXPENSES

  9. Periodic Inventory SystemExample: Restaurant • Under a periodic inventory system the value of inventory and cost of goods sold is not known until it is physically counted. • When food is sold, the sale is recorded as revenue. However the cost of goods sold and inventory value is not exactly known. • At the end of the period, a physicalcount of ingredients (ending inventory) will help calculate how much was sold, which is then matched to sales for the period. Quarterly Periods

  10. Inventory Systems - Question True or False? A perpetual inventory system continually tracks changes in inventory, and matches COGS to revenue as the sale is generated. • True • False

  11. Inventory Systems - Question Which inventory system is more costly to implement? • Perpetual • Periodic

  12. Checklist

  13. Inventory Purchase • Assume for the following transactions, that all inventory purchases were made on account. BALANCE SHEET ASSETS LIABILITIES CASH ACCOUNTS PAYABLE x 10,000 CR ACCOUNTS RECEIVABLE UNEARNED REVENUE x x BANK LOAN INVENTORY x STOCKHOLDERS’ EQUITY 10,000 DR COMMON STOCK PREPAID EXPENSES x RETAINED EARNINGS PROPERTY, PLANT & EQUIPMENT x

  14. Purchase Returns • Goods that are purchased, often need to be returned. • Reasons can include: • Incorrect products • Over-shipments • Inferior quality products

  15. Purchase Returns • Entry to record the return of goods purchased on account to supplier ($300 worth of inventory returned): BALANCE SHEET ASSETS LIABILITIES CASH ACCOUNTS PAYABLE x 300 DR ACCOUNTS RECEIVABLE UNEARNED REVENUE x x BANK LOAN INVENTORY x STOCKHOLDERS’ EQUITY 300 CR COMMON STOCK PREPAID EXPENSES x RETAINED EARNINGS PROPERTY, PLANT & EQUIPMENT x

  16. Purchase Allowances (for Goods that have not been Sold) • Rather than returning goods, a business can offer an allowance. The buyer agrees to keep undesirable goods at a reduced cost. • An allowance reduces the value of the inventory purchased and reduces the amount owing to the supplier.

  17. Purchase Allowances Occurs when the buyer agrees to keep undesirable goods at a reduced cost. For example: • Offer a 20% allowance for the company to keep the goods rather than returning them • Calculation: $300 potential return x 20% allowance = $60 BALANCE SHEET ASSETS LIABILITIES CASH ACCOUNTS PAYABLE x 60 DR ACCOUNTS RECEIVABLE UNEARNED REVENUE x x BANK LOAN INVENTORY x STOCKHOLDERS’ EQUITY 60 CR COMMON STOCK PREPAID EXPENSES x RETAINED EARNINGS PROPERTY, PLANT & EQUIPMENT x

  18. Purchase Allowances - Question When recording an allowance for inventory that has been purchased from a supplier but not yet sold to customers, what account should the allowance reduce? • Inventory • Cost of Goods Sold When product is still in inventory, the adjustment must reduce inventory. When the product has been sold, the adjustment is recorded to COGS.

  19. Purchase Discounts • Companies often offer discounts • There are two types of purchase discounts • Trade discounts • Cash discounts

  20. Trade Discounts • Given based on volume of goods purchased • For example: Receive 10% discount for ordering 15 or more products • Why are trade discounts useful? • Encourages more volume of sales

  21. Cash Discounts • A cash discount is used to encourage quick payment from the customer • Why are cash discounts useful? • Encourages quick payment, which increases cash flow Example: 2/10 net 30 A 2% discount if payment is received in 10 days. The remaining amount must be paid within 30 days.

  22. Cash Discounts • Example: 2/10, n/30 • 2% discount is applied if paid within 10 days. Net amount owing is due in 30 days 1. Original purchase of inventory for $4,200 2. Make full payment within the 10 day discount period

  23. Purchase Discounts - Question If the payment terms of an invoice dated May 1stare shown as “2/10 net 20”, on which date does the discount expire? • May 3 • May 21 • May 11

  24. Freight • FOB Shipping Point • Indicates that ownership of the items being purchased changes when the goods leave the seller’s place of business. The buyer pays for the shipping costs. • FOB Destination Point • Indicates that ownership of the items being purchased changes when the goods arrive at the buyer’s place of business. The seller pays for the shipping costs.

  25. Freight • Freight –in: • Freight-in costs are added to the cost of inventory BALANCE SHEET ASSETS LIABILITIES CASH ACCOUNTS PAYABLE 100 CR 60 DR ACCOUNTS RECEIVABLE UNEARNED REVENUE x x BANK LOAN INVENTORY x STOCKHOLDERS’ EQUITY 100 DR COMMON STOCK PREPAID EXPENSES x RETAINED EARNINGS PROPERTY, PLANT & EQUIPMENT x

  26. Checklist

  27. Sales Transactions • Adjusting entries relating to sales are, for the most part, a mirror image of those for purchases. • This section will address: • Reversing entries • Tracking merchandise returns • Allowances • Discounts allowed

  28. Sales (Perpetual Method) Two entries to record a cash sale under perpetual system: • Record the sale • Record the COGS BALANCE SHEET INCOME STATEMENT ASSETS LIABILITIES SALES REVENUE 1. Record sale CASH ACCOUNTS PAYABLE 15,000 CR EXPENSES 15,000 DR COST OF GOODS SOLD ACCOUNTS RECEIVABLE UNEARNED REVENUE 9,000 DR x x GROSS PROFIT BANK LOAN INVENTORY 2. Record the COGS BAD DEBTS MAINTENANCE x STOCKHOLDERS’ EQUITY x x COMMON STOCK DEPRECIATION MISCELLANEOUS PREPAID EXPENSES 9,000 CR x x INCOME TAX PAYROLL x x x RETAINED EARNINGS PROPERTY, PLANT & EQUIPMENT INSURANCE RENT x x x INTEREST TELEPHONE x x NET INCOME (LOSS)

  29. Tracking Returns • Customers can frequently return purchased goods. • It is important to track customer returns. • High return rate could indicate many problems. • To track sales returns and allowances a contra-revenue account is used.

  30. Sales Return and Sales Allowance - Difference Sales Return • Occurs when undesirable products are returned to the seller Sales Allowance • Occurs when the customer decides to keep such undesirable products at a reduced price.

  31. Sales Returns & Allowances INCOME STATEMENT • In order to keep track of returns and allowances use a contra revenue account • Sales Returns • Undesirable product is returned to seller • Sales Allowances • Customer decides to keep undesirable products at a reduced price SALES REVENUE SALES RETURNS AND ALLOWANCES EXPENSES COST OF GOODS SOLD GROSS PROFIT DEPRECIATION MISCELLANEOUS x x MARKETING SALARIES x x INSURANCE RENT x x INTEREST TELEPHONE x x NET INCOME (LOSS)

  32. Sales Returns and AllowancesExample: Sales Return • How should you record a merchandise return assuming $4,000 worth of goods (i.e. its cost) were sold for $6,000? BALANCE SHEET INCOME STATEMENT 1. Record sales return from client SALES REVENUE ASSETS LIABILITIES CASH ACCOUNTS PAYABLE SALES RETURNS AND ALLOWANCES 100 CRdsdx100 60 DR 6,000 DR ACCOUNTS RECEIVABLE UNEARNED REVENUE EXPENSES COST OF GOODS SOLD x 6,000 CR 4,000 CR BANK LOAN INVENTORY GROSS PROFIT x STOCKHOLDERS’ EQUITY 2. Restock inventory returned from client 4,000 DR DEPRECIATION MISCELLANEOUS COMMON STOCK x x PREPAID EXPENSES INCOME TAX PAYROLL x x x RETAINED EARNINGS INSURANCE RENT PROPERTY, PLANT & EQUIPMENT x x INTEREST TELEPHONE x x x NET INCOME (LOSS)

  33. Sales Returns and AllowancesExample: Sales Allowance • A company sold $2,000 of goods on account. How should a sales allowance of $100 be recorded? BALANCE SHEET INCOME STATEMENT SALES REVENUE ASSETS LIABILITIES CASH ACCOUNTS PAYABLE SALES RETURNS AND ALLOWANCES 100 DR ACCOUNTS RECEIVABLE UNEARNED REVENUE EXPENSES COST OF GOODS SOLD x 100 CR BANK LOAN INVENTORY GROSS PROFIT x STOCKHOLDERS’ EQUITY DEPRECIATION MISCELLANEOUS COMMON STOCK x x PREPAID EXPENSES INCOME TAX PAYROLL x x x RETAINED EARNINGS Notice that there is no change to COGS because the goods are not returned. INSURANCE RENT PROPERTY, PLANT & EQUIPMENT x x INTEREST TELEPHONE x x x NET INCOME (LOSS)

  34. Sales Discount • On March 1st,Dorval sold $4,000 of services with payment terms of 2/10 net 30. On March 5th, Dorval received payment. How should Dorval record the receipt of payment? BALANCE SHEET INCOME STATEMENT SALES REVENUE ASSETS LIABILITIES CASH ACCOUNTS PAYABLE SALES DISCOUNT 3,920 DR 60 DR 80 DR ACCOUNTS RECEIVABLE UNEARNED REVENUE EXPENSES COST OF GOODS SOLD x What is the sales discount amount? $4,000 x 2% = $80 3,920 CR BANK LOAN INVENTORY GROSS PROFIT x STOCKHOLDERS’ EQUITY 100 DR DEPRECIATION MISCELLANEOUS COMMON STOCK x x PREPAID EXPENSES INCOME TAX PAYROLL x x x RETAINED EARNINGS INSURANCE RENT PROPERTY, PLANT & EQUIPMENT x x INTEREST TELEPHONE x x x NET INCOME (LOSS)

  35. Sales Returns and Allowances - Question True or False? When a customer returns a product, an entry to cost of goods sold is not required. • True • False

  36. Sales Discount - Question An invoice in the amount of $100 is dated April 1, with payment terms “2/15 net 25”. If it is paid on April 20, what is the total discount? • $0 (i.e. no discount) • $2 • $15 • $25

  37. Income Statement • The multistep income statement can be prepared based on the sales transactions that have occurred: Sample Company Income Statement For the Period Ended mm/dd/yy Separate tracking allows for separate reporting

  38. Gross Profit Margin • When a company tracks sales returns and discounts separately, gross profit margin is calculated using net sales (not sales revenue). Sample Company Income Statement For the Period Ended mm/dd/yy

  39. Closing Entries in a Perpetual Inventory System • Step 1: Adjust Inventory* *Assuming shrinkage = $200 (i.e. the balance in the inventory account was $200 more than the physical count)

  40. Closing Entries in a Perpetual Inventory System ABC Inc.* Adjusted Trial Balance For the Period Ended mm/dd/yy Step 2: Close revenue accounts *A corporation

  41. Closing Entries in a Perpetual Inventory System ABC Inc. Adjusted Trial Balance For the Period Ended mm/dd/yy Step 3: Close expense and debit balance accounts New additions to the usual list

  42. Closing Entries in a Perpetual Inventory System • Step 4: Close income summary to retained earnings* *The debit and credit amount for this entry is equal to the net income for the period. Income summary is closed to retained earnings since ABC Inc. is a corporation.

  43. Checklist

  44. Four Methods of Valuing Inventory • Specific Identification • First-In-First-Out (FIFO) • Weighted Average Cost • Last-In-First- Out (LIFO)

  45. Specific Identification • When items are sold, they can be specifically identified. • For example: • 3 products are ordered at different times and prices. • Each unit has its own serial number and can be specifically identified. • When 2 units are sold, the sales are specifically identified $50 $50 $51 $52 $50 $51 Opening inventory Ending Inventory = $50+$50+$51+$51 = $202 Cost of Goods sold = $102 $50 $52 Sales

  46. First-In First-Out (FIFO) • Identifies the value of inventory that was delivered first, as the ones to be sold first.

  47. First-In First-Out (FIFO) Purchased Jan 5th Purchased Jan 7th Purchased Jan 1st $50 $50 Suppose you placed 3 orders for a product at different times and prices. $52 $51 $51 $50 $102 $52 $150 $50 $50 Management wants oldest inventory sold first. Therefore when a sale is made, the product that is first in, is the product that is first out. Sold Cost of Goods Sold = 2 x $50 = $100

  48. First-In First-Out (FIFO) $50 $50 Management wants oldest inventory sold first. Therefore when a sale is made, the product that is first in, is the product that is first out. Sold Cost of Goods Sold = 2 x $50 = $100 The Cost of Goods Sold for the sale is matched to the cost of the first item purchased in inventory (Jan 1st ). The Ending Inventory is made up of the last items purchased. $50 $52 $51 $51 Ending Inventory = + + = $204 (4 units)

  49. Weighted Average Cost Calculates the value of inventory using an average cost for all units of inventory.

  50. Weighted Average Cost $50 $50 $51 $52 $51 $50 Total Cost of Goods Available for Sale ($150 + $102+ $52 ) Weighted Average Cost per unit Total number of units available for Sale (6 units) = $304 = $50.67 average Calculate the Cost of Goods Sold and the Value of Ending Inventory using the Weighted Average Cost method. Cost of Goods Sold = 2 x $50.67 = $101 Ending Inventory = 4 x $50.67 = $203

More Related