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Mastering Inventory

Mastering Inventory. American Institute of Professional Bookkeepers. © American Institute of Professional Bookkeepers, 2010. Inventory . Inventory is goods that a company owns. Manufacturing company. Merchandising company. Acquires goods for resale to customers Examples:

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Mastering Inventory

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  1. Mastering Inventory American Institute of Professional Bookkeepers Mastering Inventory © American Institute of Professional Bookkeepers, 2010

  2. Inventory Inventory is goods that a company owns. Manufacturing company Merchandising company Acquires goods for resale to customers Examples: • Walmart (household goods) • TJ Maxx (clothing) • Ralph’s (groceries) • Wholesalers and distributors • Acquires raw materials and/or parts to produce finished goods • Examples: • Toyota, Coca Cola, Papa John’s • There are three kinds of inventory: • Raw materials • Work-in-process • Finished goods Mastering Inventory

  3. Inventory Inventory is goods that a company owns. Manufacturing company Merchandising company This course covers merchandise inventory. The subject of manufacturing inventory is typically covered in “managerial” or “cost” accounting. Mastering Inventory

  4. Recording Purchases Purchases are booked when legal title passes to the buyer. When title passes depends on the terms of the contract. Title is passed in one of two ways: • When goods leave the seller’s location FOB shipping point • When goods arrive at the buyer’s location FOB destination Mastering Inventory

  5. Purchases in Transit Goods in transit must also be accounted for at the end of the period. In summary: • FOB shipping point—title passes when the goods have left the seller. Goods in transit belong to the purchaser and must be recorded as inventory on the purchaser’s books. • FOB Destination—title passes when the goods have arrived at the buyer’s purchaser’s location. Thus, goods in transit still belong to the seller and must remain on the seller’s books as inventory. Mastering Inventory

  6. Recording Purchases Purchasers include in the cost of inventory: • The purchase amount (the actual amount paid –not the price in the catalog or on the purchase order) • Any transportation (freight) and insurance costs paid by the buyer (FOB shipping point) Mastering Inventory

  7. Recording Purchases: Example OrCo buys some inventory. For each purchase below, indicate whether OrCo should record the items as inventory at year end and, if so, for what amount Cost of inventory Inventory? Goods that list for $1,400 that OrCo gets for $1,200, FOB shipping point. Shipping is $100. At year end, the goods are in transit. Yes $1,300 Goods costing $1,000, FOB destination. Shipping is $200. At year end, the goods are in transit. No Goods costing $800, FOB shipping point. Freight is $50. At year-end, the goods have not shipped. No Mastering Inventory

  8. Where is Inventory Reported? Inventory is reported on the balance sheet as a current asset. Mastering Inventory

  9. Where is Inventory Reported? Inventory is not presented on the income statement because it is an asset. But it may appear in the calculation of the expense, cost of goods sold (COGS): Beginning Inventory + Purchases = Goods available for sale  Ending Inventory = COGS Mastering Inventory

  10. Inventory Recordkeeping Inventory records may be kept in one of two ways: the perpetual method and the periodic method. Perpetual Periodic Transactions affecting inventory (e.g., purchases and sales) are recorded in the inventory account as they occur. Transactions affecting inventory are recorded in temporary accounts—but the balance in the inventory account does not change until year end. Mastering Inventory

  11. Purchases Perpetual Periodic Inventory xxx Cash or A/P xxx Purchases xxx Cash or A/P xxx Freight-In xxx Cash or A/P xxx Under the perpetual method, shipping costs paid by the purchaser are recorded in Inventory, an asset account. Under the periodic method, shipping costs are recorded in a separate, Freight-In account. Mastering Inventory

  12. Sales Perpetual Periodic Cash or A/R xxx Sales xxx Cash or A/R xxx Sales xxx COGS xxx Inventory xxx Under the perpetual method, both the Inventory and COGS account balances change every time there is a sale. Under the periodic method, neither the Inventory nor COGS accounts are affected at the time the sale is made. Mastering Inventory

  13. Sales Returns Perpetual Periodic Sales Returns xxx Cash or A/R xxx Sales Returns xxx Cash or A/R xxx Inventory xxx COGS xxx Under the perpetual method, sales returns require two entries. One entry records an increase in Sales Returns and a second entry increases Inventory. Under the periodic method, there is no need to adjust the Inventory account balance because no entry was made to Inventory when the sale was made. Mastering Inventory

  14. Sales Returns: Example 600 OrCo sells some goods for $600, but the customer returns the goods before paying the bill. The units cost OrCo $400. Record the return under the perpetual and periodic methods. 600 400 400 Perpetual Periodic 600 Sales Returns A/R Sales Returns A/R 600 Inventory COGS Mastering Inventory

  15. Purchase Returns Perpetual Periodic Cash or A/P xxx Inventory xxx Cash or A/P xxx Purchase Returns xxx Cash or A/P xxx Freight In xxx Under the periodic method, the seller records a purchase return in separate accounts. The sales price is recorded in Purchase Returns, freight is recorded in Freight-In, and so on. Under the perpetual method, the seller records a purchase return by simply reversing the original entry. Mastering Inventory

  16. Purchase Discounts Suppliers may offer trade discounts. These are based on volume or on the nature of the business relationship Purchases that include a trade discount are recorded net of the discount Mastering Inventory

  17. Gross Method The cash discount is ignored at time of purchase, so the full invoice price is recorded • If the invoice is paid withinthe discount period, the payment will be less than the amount in A/P Perpetual A/P 1,000 Inventory 20 Cash 980 Reduces the inventory account for the amount of the discount Mastering Inventory

  18. Gross Method The cash discount is ignored at time of purchase, so the full invoice price is recorded • If the invoice is paid withinthe discount period, the payment will be less than the amount in A/P Perpetual Periodic A/P 1,000 Inventory 20 Cash 980 A/P 1,000 Purchase Disc. 20 Cash 980 Under the perpetual method, the discount amount reduces Inventory—under the periodic method, the discount amount increases Purchase Discounts. Mastering Inventory

  19. Gross Method The cash discount is ignored at time of purchase, so the full invoice price is recorded • If the invoice is paid afterthe discount period, the payment will be the amount in A/P Perpetual Periodic A/P 1,000 Cash 1,000 A/P 1,000 Cash 1,000 The entry is the same for the perpetual and periodic methods. Mastering Inventory

  20. Gross Method: Example Burton Co. purchases $4,000 of inventory with invoice terms of 2/10, n/30. Prepare the journal entries for the purchase and payment, if: • Burton pays within the discount period Perpetual Periodic To record the purchase: To record the purchase: Inventory 4,000 A/P 4,000 Purchases 4,000 A/P 4,000 To record the payment: To record the payment: A/P 4,000 A/P 4,000 Inventory 80 Purch. Discount 80 Cash 3,920 Cash 3,920 Mastering Inventory

  21. Gross Method: Example Burton Co. purchases $4,000 of inventory with invoice terms of 2/10, n/30. Prepare the journal entries for the purchase and payment, if: • Burton pays after the discount period Perpetual Periodic To record the purchase: To record the purchase: Inventory 4,000 A/P 4,000 Purchases 4,000 A/P 4,000 To record the payment: To record the payment: A/P 4,000 A/P 4,000 Cash 4,000 Cash 4,000 Mastering Inventory

  22. Net Method A purchase is recorded at the invoice price less the discount • If the invoice is paid within the discount period, the payment will be the amount recorded in A/P Perpetual Periodic A/P 980 Cash 980 A/P 980 Cash 980 The entry is the same for the perpetual and periodic methods Mastering Inventory

  23. Net Method A purchase is recorded at the invoice price less the discount • If the invoice is paid afterthe discount period, the payment will be more than the amount recorded in A/P Perpetual Periodic A/P 980 Purch. Disc. Lost 20 Cash 1,000 A/P 980 Purch. Disc. Lost 20 Cash 1,000 The entry is the same for both methods. The additional amount paid for the lost discount is recorded as an expense. Mastering Inventory

  24. Net Method: Example Burton Co. purchases $4,000 of inventory with invoice terms of 2/10, n/30. Prepare the journal entries for the purchase and payment, if: • Burton pays withinthe discount period Perpetual Periodic To record the purchase: To record the purchase: Inventory 3,920 A/P 3,920 Purchases 3,920 A/P 3,920 To record the payment: To record the payment: A/P 3,920 A/P 3,920 Cash 3,920 Cash 3,920 Mastering Inventory

  25. Net Method: Example Burton Co. purchases $4,000 of inventory with invoice terms of 2/10, n/30. Prepare the journal entries for the purchase and payment, if: • Burton pays after the discount period Perpetual Periodic To record the purchase: To record the purchase: Inventory 3,920 A/P 3,920 Purchases 3,920 A/P 3,920 To record the payment: To record the payment: A/P 3,920 A/P 3,920 Purch. Disc. Lost 80 Purch. Disc. Lost 80 Cash 4,000 Cash 4,000 Mastering Inventory

  26. Perpetual Method JEs Under the perpetual method, the Inventory and COGS accounts are always up to date. But is the Inventory account balance correct? To verify the balance, the company conducts a physical count of inventory. If there is shrinkage (loss), an adjustment is made to the Inventory account: Inventory Shrinkage Exp. xxx Inventory xxx Mastering Inventory

  27. Periodic Method AJEs Inventory and COGS are brought up to date at the end of the year (or other period). Until then, Inventory has a beginning balance. Thus, it does not include purchases, which have been recorded in temporary accounts, such as Purchases, Freight-In, etc. One journal entry closes out the temporary accounts, adjusts the balance in Inventory and recognizes the expense, COGS. Mastering Inventory

  28. Periodic Method AJEs BEGINNING INVENTORY NET PURCHASES ENDING INVENTORY COST OF GOODS SOLD The beginning inventory is on the books with a debit balance. Purchases are on the books with a debit balance, as is freight-in. Purchase returns and purchase discounts are on the books with credit balances. + The ending inventory needs to be recorded on the books with a debit balance based on a physical count. _ COGS needs to be recorded on the books with a debit balance. = Mastering Inventory

  29. Periodic Method AJEs BEGINNING INVENTORY NET PURCHASES ENDING INVENTORY COST OF GOODS SOLD Ending Inventory xxx Purchase Returns xxx Purchase Discounts xxx + COGS xxx Purchases xxx Freight-In xxx Beginning Inventory xxx _ = Mastering Inventory

  30. Periodic Method AJEs: Example Brighton had beginning inventory of $24,000. A physical count of the ending inventory revealed $18,000 of goods. The records from the year indicate that Brighton purchased $60,000 of goods, and paid freight of $2,000. There were $3,000 in purchase returns and $1,000 in purchase discounts. Calculate COGS and show the journal entry to close out Inventory. $24,000 18,000 $60,000 2,000 3,000 1,000 BEG. INVENTORY NET PURCHASES +   58,000  ENDING INVENTORY COGS _ $64,000 = Mastering Inventory

  31. Periodic Method AJEs: Example Brighton had beginning inventory of $24,000. A physical count of the ending inventory revealed $18,000 of goods. The records from the year indicate that Brighton purchased $60,000 of goods, and paid freight of $2,000. There were $3,000 in purchase returns and $1,000 in purchase discounts. Calculate COGS and show the journal entry to close out Inventory. Ending Inventory 18,000 Purchase Returns 3,000 Purchase Discounts 1,000 COGS 64,000 Purchases 60,000 Freight-In 2,000 Beginning Inventory 24,000 Mastering Inventory

  32. Units Sold: What Did They Cost? A firm may buy hundreds of units from dozens of vendors and sell them to thousands of customers. Tracking the original cost of each unit sold would be impossible. To make tracking inventory practical, GAAP permits a company to use one of three methods to calculate the cost of units sold: • Average Costing • FIFO (First-In, First-Out) • LIFO (Last-In, First-Out) Mastering Inventory

  33. Average Costing This can be used to under the periodic or perpetual methods: • Periodic method. Because COGS is recorded only once a year, a weighted average is used to compute the of units sold. • Perpetual method. Because COGS is recorded at each sale, a moving average is used to compute the cost of each unit sold. After each purchase, the cost of the units sold “moves.” Mastering Inventory

  34. Weighted-Average Costing Under the periodic method, the average cost of each unit sold is computed at the end of the year (or other period) to determine COGS. The formula to compute weighted-average costing is: Goods available for sale (dollars) Goods available for sale (units) Remember: Goods available for sale = beginning inventory + net purchases (purchases + freight-in – returns and discounts) Mastering Inventory

  35. Weighted-Average: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 April 12 Purchase 100 $8.22 822 July 18 Purchase 210 $8.40 1,764 Sept. 1 Sale 250 @ $12 Nov. 24 Purchase 240 $8.75 2,100 Dec. 12 Sale 128 @ $13 The company uses the periodic method. A physical count on December 31 shows 229 units on hand at year end. What is the average cost per unit? What is ending inventory? What is cost of goods sold? Mastering Inventory

  36. Weighted-Average: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 April 12 Purchase 100 $8.22 822 July 18 Purchase 210 $8.40 1,764 Sept. 1 Sale 250 @ $12 Nov. 24 Purchase 240 $8.75 2,100 Dec. 12 Sale 128 @ $13 Goods available for sale 907 $7,528 = $8.30 avg. cost per unit 229 units (ending inventory) 678 units (cost of goods sold) 907 units (goods available for sale) x $8.30 = $1,900.70 x $8.30 = 5,627.40 x $8.30 = $7,528.10 Mastering Inventory

  37. Weighted-Average: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 April 12 Purchase 100 $8.22 822 July 18 Purchase 210 $8.40 1,764 Sept. 1 Sale 250 @ $12 Nov. 24 Purchase 240 $8.75 2,100 Dec. 12 Sale 128 @ $13 $41.27/5 = $8.25 Note that a simple average of costs does not work here Mastering Inventory

  38. Moving Average Costing Under the perpetual method, the average cost changes (moves) at each new purchase of inventory • The formula to determine the average cost is the same Goods available for sale (dollars) Goods available for sale (units) Mastering Inventory

  39. Moving Average: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 April 12 Purchase 100 $8.22 822 July 18 Purchase 210 $8.40 1,764 Sept. 1 Sale 250 @ $12 Nov. 24 Purchase 240 $8.75 2,100 Dec. 12 Sale 128 @ $13 This company just started up. It uses the perpetual method. What is the cost of goods sold for each sale? If no other sales are made, what will ending inventory be on Dec. 31? What is cost of goods sold on Dec. 31? Mastering Inventory

  40. Moving Average: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 April 12 Purchase 100 $8.22 822 July 18 Purchase 210 $8.40 1,764 Sept. 1 Sale 250 @ $12 Nov. 24 Purchase 240 $8.75 2,100 Dec. 12 Sale 128 @ $13 357 $2,842 =$7.96 Under the perpetual method, COGS for each sales is recognized when the sale is made. Here, the first sale is made on March 15. Mastering Inventory

  41. Moving Average: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 $2,842 =$7.96 357 To compute the cost of the 300 units sold: 300 units × $7.96/unit = $2,388 COGS for the March sale To compute the cost of 57 unsold units in inventory: 57 units × $7.96 per unit = $454 units available for sale Mastering Inventory

  42. Moving Average: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 April 12 Purchase 100 $8.22 822 July 18 Purchase 210 $8.40 1,764 Sept. 1 Sale 250 @ $12 57 $7.96 $454 367 $3,040 = $8.28 The Sept. 1 sale includes previous inventory (before the Apr. 12 purchase) of 57 units @ $7.96 = $454 COGS of all 250 units sold: 250 @ $8.28 = $2,070 COGS of 117 units on hand after Sept. 1: 117 @ $8.28 = $970 Mastering Inventory

  43. Moving Average: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 April 12 Purchase 100 $8.22 822 July 18 Purchase 210 $8.40 1,764 Sept. 1 Sale 250 @ $12 Nov. 24 Purchase 240 $8.75 2,100 Dec. 12 Sale 128 @ $13 57 $7.96 $454 117 $970 $8.28 357 $3,070 = $8.60 The Dec. 12 sale includes previous inventory (before the Nov. 24 purchase) of 117 units @ $8.28. Mastering Inventory

  44. Moving Average: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 April 12 Purchase 100 $8.22 822 July 18 Purchase 210 $8.40 1,764 Sept. 1 Sale 250 @ $12 Nov. 24 Purchase 240 $8.75 2,100 Dec. 12 Sale 128 @ $13 57 $7.96 $454 117 $970 $8.28 $3,070 = $8.60 357 COGS of 128 units sold: 128 @ $8.60 = $1,101 Cost of 229 units on hand after Dec. 12: 229 @ $8.60 = $1,969 Mastering Inventory

  45. Moving Average: Example Beginning Inventory Feb. 3 Purchase March 15 Sale 300 @ $12 April 12 Purchase July 18 Purchase Sept. 1 Sale 250 @ $12 Nov. 24 Purchase Dec. 12 Sale 128 @ $13 300 $7.96 $2,388 250 $8.28 2,070 128 $8.60 1,101 COGS $5,559 Mastering Inventory

  46. Moving Average: Example Beginning Inventory Feb. 3 Purchase March 15 Sale 300 @ $12 April 12 Purchase July 18 Purchase Sept. 1 Sale 250 @ $12 Nov. 24 Purchase Dec. 12 Sale 128 @ $13 300 $7.96 $2,388 250 $8.28 2,070 128 $8.60 1,101 COGS $5,559 Ending inventory 1,969 If there are no purchases or sales after Dec. 12, then the balance on Dec. 31, or Ending Inventory, will be $1,969 Mastering Inventory

  47. First-In First-Out (FIFO) Costing FIFO assumes that the first units purchased are the first units sold. In other words, FIFO costing does not consider which goods actually are sold. Periodic Perpetual COGS is computed once: at the end of the period after a physical count determines ending inventory. Ending inventory then becomes beginning inventory for the next period. COGS is computed for each sale, starting with the units available from the earliest purchases. Mastering Inventory

  48. Periodic Method, FIFO: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 April 12 Purchase 100 $8.22 822 July 18 Purchase 210 $8.40 1,764 Sept. 1 Sale 250 @ $12 Nov. 24 Purchase 240 $8.75 2,100 Dec. 12 Sale 128 @ $13 Periodic method. A year-end physical count shows 229 units in stock. Calculate ending inventory and COGS. Mastering Inventory

  49. Periodic Method, FIFO: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 April 12 Purchase 100 $8.22 822 July 18 Purchase 210 $8.40 1,764 Sept. 1 Sale 250 @ $12 Nov. 24 Purchase 240 $8.75 2,100 Dec. 12 Sale 128 @ $13 Under FIFO, units sold are assumed to be from the earliest purchases—so units remaining are assumed to be from the latest purchases. The latest purchase was on Dec. 12: 240 units @ $8.75. All 229 units in ending inventory must be from this purchase. Mastering Inventory

  50. Periodic Method, FIFO: Example Beginning Inventory 140 $7.90 $1,106 Feb. 3 Purchase 217 $8.00 1,736 March 15 Sale 300 @ $12 April 12 Purchase 100 $8.22 822 July 18 Purchase 210 $8.40 1,764 Sept. 1 Sale 250 @ $12 Nov. 24 Purchase 240 $8.75 2,100 Dec. 12 Sale 128 @ $13 Goods avail. for sale 907 $7,528 Less: Ending inventory 229 @ $8.75 2,004 COGS $5,524 Mastering Inventory

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