Chapter 15 Accounting for Merchandise Inventory 2010 Prentice

Chapter 15 Accounting for Merchandise Inventory © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater

Learning Objective 1 Understanding and journalizing transactions using the perpetual inventory system and explaining the difference between perpetual and periodic inventory systems © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-1

Perpetual Inventory System Two key accounts Merchandise Inventory ◦ Asset ◦ Current balance of Inventory at all times ◦ Entries are recorded for each purchase and each sale of Inventory Cost of Goods Sold ◦ Cumulative total cost of all merchandise sold to customers during accounting period Both accounts provide current info to mgmt © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-1

Perpetual vs. Periodic System Perpetual system Value of Inventory is known after every purchase & sale Cost of goods sold is known after every sale Purchases, purchase returns & allowances, and freight accounts don’t exist Periodic system Does not give accurate info about Merchandise Inventory or C. O. G. S. until LO-1 © 2010 Prentice Hall Business ending Inventory is done Publishing, College Accounting: A Practical Approach, 11 e by Slater

Perpetual Inventory System We will use Problem 15 B-1 to illustrate the journal entries involved with the perpetual inventory system. Transactions for March: 15 -Purchased merchandise on acct. totaling $1, 800, terms n/30. 16 - Sold merchandise costing $71 on acct. for $92 to B. Hackett. 18 - Returned $120 of defective merchandise purchased Mar. 15. 19 - Sold $230 of merchandise for cash. It costs $175. 19 - Allowed merchandise sold on Mar. 16 return for credit $14. It costs $11. 20 - Bought $900 merchandise on acct. from JT Supply; terms © 2010 Prentice Hall Business LO-1 Publishing, College Accounting: A n/30. Practical Approach, 11 e by Slater

Problem 15 B-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-1

Problem 15 B-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-1

Problem 15 B-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-1

Problem 15 B-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-1

Learning Objective 2 Maintaining a subsidiary ledger for inventory © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-2

Inventory Subsidiary Ledger A business with a variety of products in Inventory will use Inventory subsidiary ledger Maintain an individual record for each different product Companies like Wal-Mart and Target use this ledger © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-2

Merchandise Inventory Subsidiary Accounts Controlling Account Merchandise Inventory Bal. 292 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-2

Merchandise Inventory Controlling Account Subsidiary Accounts Merchandise Inventory Bal. 292 Sep. 4 150 Bal. 442 Purchased 5 units of Product A for $30 on Sep. 4. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-2

Merchandise Inventory Controlling Account Subsidiary Accounts Merchandise Inventory Bal. 292 210 Sep. 8 Sep. 4 150 Bal. 232 Sold 7 units of Product A on Sep. 8. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-2

Learning Objective 3 Understanding periodic methods of determining the value of the ending inventory © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Inventory Valuation Methods. Periodic Inventory System Specific Invoice First In, First Out (FIFO) Last In, First Out (LIFO) Weighted Average © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Inventory Valuation Methods. Periodic Inventory System Method used will have effect on ◦ Ending Inventory ◦ Cost of goods sold ◦ Gross profit © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Specific Invoice Method Identify each item in ending Inventory by a specific purchase price and invoice number Also known as specific identification method Would be used with cars, boats, and antiques. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Specific Invoice Method Pros Simple if small amounts of high-cost goods Flow of goods and flow of cost are same Costs are exactly matched with Sales © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater Cons Difficult if large unit volume and small unit prices

First In, First Out Method Assume that the oldest goods are sold first Ending Inventory valued at costs shown on most recent invoices Refer to Problem 15 B-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

First In, First Out Method At end of year, 400 units unsold © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

First In, First Out Method Cost of Goods Available for Sale Less Cost of Ending Inventory Cost of Goods Sold © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater $43, 800 22, 000 $21, 800 LO-3

First In, First Out Method Pros Cost flow tends to follow physical flow Ending Inventory valuation is made up of current costs on balance sheet © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater Cons During inflationary periods, FIFO produces higher net income, thus more taxes to be paid Recent costs are not matched with recent Sales LO-3

Last In, First Out Method Assume that the goods most recently acquired are sold first Ending Inventory valued at earliest invoice costs Refer again to Problem 15 B-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Last In, First Out Method At end of year, 400 units unsold © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Last In, First Out Method Cost of Goods Available for Sale Less Cost of Ending Inventory Cost of Goods Sold © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater $43, 800 11, 300 $32, 500 LO-3

Last In, First Out Method Pros Cost of goods sold is near current costs Matches current costs with current selling price During inflationary periods, LIFO produces lowest net income, a tax advantage © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater Cons Ending Inventory is valued at old prices Does not match physical flow of goods LO-3

Weighted-Average Method Average unit cost = Total cost of goods available for sale Total units of goods available for sale Usually falls between FIFO & LIFO amounts © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Weighted-Average Method Average Unit Cost = $43, 800 / 1, 010 = $43. 37 Ending Inventory = 400 units x $43. 37 = $17, 348 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Weighted-Average Method Cost of Goods Available for Sale Less Cost of Ending Inventory Cost of Goods Sold © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater $43, 800 17, 348 $26, 452 LO-3

Weighted Average Method Pros Good for products sold in large volume An equal unit cost is assigned to each unit in Inventory © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater Cons Current prices have no more significance than older prices Most recent costs are not matched with current Sales Cost of ending Inventory is not most recent costs LO-3

When Can An Inventory Method Be Changed? Consistency Principle – requires companies to follow the same accounting methods or procedures from period to period Full Disclosure Principle – requires companies to disclose on their financial reports changes in accounting procedures and methods along with effect of the change as well as justification for change © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Items That Should be Included in the Cost of Inventory Goods in Transit F. O. B. shipping point – buyer becomes owner when merchandise is placed on carrier at shipping point F. O. B. destination – seller maintains ownership until merchandise reaches the destination © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Items That Should Not be Included in the Cost of Inventory Merchandise on consignment merchandise sold through agent (consignee) who does not own it, but has possession Damaged or obsolete merchandise - if not saleable, should not be added to cost of Inventory. ◦ If saleable at lower cost, value should be conservatively estimated & added to Inventory © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Items That Should be Included in the Cost of Inventory Goods in Transit - When inventory is taken, add only if ownership of inventory has been transferred to buyer. ◦ Only use with F. O. B. - shipping point Damaged or Obsolete Merchandise only if saleable, estimate value at conservative cost. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-3

Learning Objective 4 Estimating ending inventory using the retail method and gross profit method and understanding how the ending inventory amount affects financial reports © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Methods of Estimating Ending Inventory Retail Method Gross Profit Method © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Retail Method Must know ◦ Beginning Inventory at cost and at retail ◦ Cost of net purchases at cost and at retail ◦ Net Sales at retail © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Retail Method – Problem 15 B -5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Retail Method – Problem 15 B -5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Retail Method – Problem 15 B -5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Retail Method – Problem 15 B -5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Gross Profit Method Develops relationship among Sales, Cost of Goods Sold, and gross profit Can also be used to determine amount of Inventory on hand at time of a fire Can verify accuracy of physical Inventory at year’s end © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Gross Profit Method Helps prepare financial statements Must know ◦ Average gross profit rate ◦ Net Sales, beginning Inventory, net purchases © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Gross Profit Method Step 1: Compute cost of goods available for sale Step 2: Estimate Cost of Goods Sold by multiplying cost percentage times Net Sales Step 3: Subtract Cost of Goods Sold from cost of goods available for sale © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Problem 15 B-6 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Effects of Inventory Errors Error in ending Inventory in Year 1 affects income statement for two years Year 1 ending Inventory becomes Year 2 beginning Inventory. © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

Effects of Inventory Errors If the item is: Overstated Understated Beginning Inventory Profit is understated Profit is overstated Ending Inventory Profit is overstated Profit is understated © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater LO-4

End of Chapter 15 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11 e by Slater