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Define merchandise inventory Whose Inventory
Periodic Inventory System
Perpetual Inventory System
Inventory valuation: Specific ID
FIFO
LIFO
Weighted Average
Gross Profit and Retail Methods
Valuation Effects of Inventory on Net Income
Ch. 15 Accounting for Merchandise Inventory
Merchandise Inventory
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Consists of goods held for sale to customers in the normal course of business
In a supermarket, merchandise includes canned goods, meats, fruits, and fresh vegetables
Merchandise Inventory account
The only account that appears on both the balance sheet and the income statement
The ending inventory is reported on the balance sheet as a current asset
Income statement’s cost of goods sold includes both the beginning inventory and the ending inventory
An error in the ending inventory will cause an error on both the Balance Sheet and Income Statement
Whose Inventory ?
The title to the goods passes to the buyer as soon as the seller delivers the goods to the transportation company
Goods in transit are included in the inventory of the buyer, not the seller
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Title does not pass to the buyer until the goods are actually delivered
Goods in transit should not be included in the buyer’s inventory, but would be included in the inventory of the seller
Goods in Transit: FOB Destination
Goods in Transit: FOB Shipping Point
Goods in Transit: FOB Shipping Point vs. FOB Destination
When goods are shipped FOB shipping point, title to the goods passes to the buyer at the point goods are shipped
If goods are shipped FOB destination, title does not pass to the buyer until the goods are delivered
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Consignment: a business (called the consignor) delivers goods to another business (the consignee) to be sold on a commission basis
The consignee does not acquire title to the goods held on consignment
The goods should not be included in the inventory of the consignee
Goods on Consignment
Perpetual Inventory System Accounting records are maintained that continuously show
the amount of inventory on hand When merchandise is purchased, the Merchandise
Inventory account is increased by the amount of the purchase
When merchandise is sold, the Merchandise Inventory account is decreased by the cost of the merchandise sold
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Periodic Inventory System Separate records are not maintained for individual inventory
items No attempt is made to adjust the Merchandise Inventory
account during the accounting period when new merchandise is purchased or when merchandise is sold
Merchandise is counted periodically and the Merchandise Inventory account is adjusted to show the value of the latest inventory
Taking a Physical Inventory Using the Periodic Inventory System Physical Inventory: a count of merchandise on hand at the end of
a period Inventory Sheet: a form on which a physical inventory is recorded Extension: the amount found by multiplying the unit cost of an
item by the quantity
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Perpetual inventory system: Purchases
• In a perpetual inventory system, the Merchandise Inventory account is debited when merchandise is purchased.
• Example: On July 15, DeBice Home Products Company purchases merchandise on account from G. McFarlin Distributors. The terms are 2/10,n/30. The cost of merchandise is $800.
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General Journal
Date Account Title P.R. Debit Credit
20XX
Jul. 15 Merchandise Inventory 800
Accounts Payable-
G. McFarlin Distributors 800
• Under the perpetual system, two journal entries are required when merchandise is sold.
• The first entry records the sales price of the merchandise by Debiting either Cash or Accounts Receivable
Crediting Sales
• The second entry records the cost of the merchandise sold by Debiting Cost of Goods Sold
Crediting Merchandise Inventory
• Example: On July 21, DeBice sells merchandise to Donna Harper on account for $1,200. The cost of the merchandise is $800.
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Perpetual inventory system: Sales
20XX
Jul. 21 Accounts Receivable – Donna Harper 1,200
Sales 1,200
21 Cost of Goods Sold 800
Merchandise Inventory 800
Perpetual inventory system: Sales Returns & Allowances
• When merchandise sold on credit is returned by a customer to the seller Debit the Sales Returns and Allowances account Credit the Accounts Receivable account
• For a cash sale, Cash would be credited • Under the perpetual system, the cost of the merchandise
returned must be transferred from the Cost of Goods Sold account back to the Merchandise Inventory account
• Example: On July 24, Donna Harper returns her purchase of July 21 for full credit.
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20XX
Jul. 24 Sales Returns and Allowances 1,200
Accounts Receivable –
Donna Harper 1,200
24 Merchandise Inventory 800
Cost of Goods Sold 800
Perpetual inventory system: Recording Payment for Merchandise Purchased
• Under a perpetual inventory system, if merchandise is paid for within the discount period, the journal entry to record payment includes a credit to the Merchandise Inventory account for the amount of the discount
• The discount decreases the cost of the merchandise • Example: The following entry represents payment of an $800
invoice to G. McFarlin Distributors on July 25 subject to a 2/10,n/30 credit terms within the discount period.
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General Journal
Date Account Title P.R. Debit Credit
20XX
Jul. 25
Accounts Payable-G. McFarlin
Distributors 800
Cash 784
Merchandise Inventory 16
Perpetual inventory system: Recording Freight In
• Under a perpetual inventory system, freight is debited to the Merchandise Inventory account — because freight increased the cost of the merchandise.
• Example: Assume that on July 28, 20XX, DeBice Home Products Company purchases merchandise from L. A. Lovering Company with a selling price of $1,200.
• The shipping terms are FOB shipping point and L. A. Lovering Company adds $190 to the invoice.
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General Journal
Date Account Title P.R. Debit Credit
20XX
Jul. 28 Merchandise Inventory 1,390
Accounts Payable - L.A.
Lovering Company 1,390
Perpetual inventory system: Adjusting the Merchandise Inventory Account
• Perpetual Inventory Record A record used in a perpetual system to record purchases and
sales of an item of inventory Keeps a running balance of an inventory item
• Physical Inventory Taken at least once a year Compares the actual count of merchandise with the
perpetual records Detects errors or loss of merchandise due to theft and
breakage
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• If a shortage is discovered, the difference is recorded in an Inventory Short and Over account
• The Inventory Short and Over account is similar to the Cash Short and Over account
Example: Adjusting the Merchandise Inventory Account
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• Assume a physical count indicates $32,205 of merchandise on hand, and the perpetual inventory record indicates an inventory value of $32,345.
General Journal
Date Account Title P.R. Debit Credit
20XX
Dec. 31 Inventory Short and Over 140
Merchandise Inventory 140
• When merchandise is received
Increase the Merchandise Inventory account for the total amount
Increase the perpetual record of each item received
• When merchandise is sold
Decrease the merchandise Inventory account
Decrease the perpetual record for each item sold
Perpetual Inventory System: Subsidiary Perpetual Inventory Records
• When a perpetual system is used, the Merchandise Inventory account is a controlling account and the individual inventory records are a subsidiary ledger. This is the same relationship as the Accounts Receivable account and the accounts receivable ledger
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Inventory Valuation: Specific Identification Method
• An inventory costing method in which units are identified as coming from specific purchases and are assigned a cost based on the price of those purchases
• Usually used for high-priced, low-sales-volume items such as Automobiles
Machinery
Expensive Clothing
• Seldom used because is usually too laborious and time-consuming to justify
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Using the following beginning and ending inventory information, assign the cost to the ending inventory using the specific identification method:
Assume the ending inventory consists of 50 units from the
beginning inventory, 50 from the first purchase, 125 from the second purchase, and the remainder from the third purchase.
Example 1:
50 × $2.00 = $ 100.00 50 × $2.10 = 105.00 125 × $2.15 = 268.75 395 × $2.20 = 869.00 620 $1,342.75
First-In, First-Out (FIFO) Method • Costing an inventory assumes that the first goods purchased are the first
goods sold
• Goods remaining at the end of the period are assumed to be made up of
the most recent purchases — the latest costs
• Assumes goods are sold in the same order in which they were bought
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Last-In, First-Out (LIFO) Method • Costing an inventory assumes that the last goods purchased are the first
goods sold
• Goods remaining at the end of the period are assumed to be made up
of the earliest costs
• Assumes that goods are sold in the reverse order in which they were
bought
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Using the following beginning and ending inventory information,
assign the cost to the ending inventory using the FIFO method:
Beginning Inventory 350 units @ $2.00
First Purchase 400 units @ $2.10
Second Purchase 600 units @ $2.15
Third Purchase 450 units @ $2.20
Inventory on May 31 620 units
450 × $2.20 = $ 990.00 170 × $2.15 = 365.50 620 $1,355.50
Example 2:
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Using the following beginning and ending inventory information,
assign the cost to the ending inventory using the LIFO method:
Beginning Inventory 350 units @ $2.00
First Purchase 400 units @ $2.10
Second Purchase 600 units @ $2.15
Third Purchase 450 units @ $2.20
Inventory on May 31 620 units
350 × $2.00 = $ 700.00
270 × $2.10 = 567.00
620 $1,267.00
Example 3:
• Examples of products that could logically be costed by the use of this
method
Grain
Gasoline
Coal
Weighted-Average Method • Assumes that inventory costs should be assigned on the basis of average
cost of identical units
• An average cost of units is determined by dividing the total cost of the
units available for sale by the number of units available for sale
• Is logical when assigning costs to units that become mixed together,
thereby making separate identification difficult or impossible
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• Using the following beginning and ending inventory information,
assign the cost to the ending inventory using the weighted-average
method: Beginning Inventory 350 units @ $2.00
First Purchase 400 units @ $2.10
Second Purchase 600 units @ $2.15
Third Purchase 450 units @ $2.20
Inventory on May 31 620 units
350 × $2.00 = $ 700.00
400 × $2.10 = 840.00
600 × $2.15 = 1,290.00
450 × $2.20 = 990.00
1,800 $3,820.00 ÷ 1,800 units = $2.12 per unit
620 units × $2.12 = $1,314.40
Example 4:
Comparison of Inventory Costing Methods
• Regardless of the inventory method used, the accounting principle of
consistency must be followed
• The consistency principle refers to staying with a method for a period
of time
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Inventory Estimation: Gross Profit Method and Retail
Method
• Financial statements prepared for a period of time less than a fiscal year
• Require a business to determine an inventory at the
End of the month or
Quarter
• The amount of the inventory may be estimated using
Gross profit method or
Retail method
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Beginning inventory $ 80,000
Net purchases 120,000
Cost of goods available for sale 200,000
Less estimated cost of goods sold – 162,500
Estimated cost of ending inventory $ 37,500
The Gross Profit Method
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• Assume net sales for the current period are $250,000, the gross
profit rate is 35%, beginning inventory is $80,000, and net
purchases for the period were $120,000.
• First, estimate cost of goods sold by multiplying net sales times the
cost of goods sold percentage. If the gross profit rate is 35%, then
the cost of goods sold rate is 65%.
• Therefore, cost of goods sold is estimated to be $250,000 × .65 =
$162,500
The Retail Method
• Similar to the gross profit method
• Used extensively by retail businesses to estimate monthly inventories
• Two sets of figures are kept for merchandise
One set for cost
One set for the retail selling price of the merchandise
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• The amount of goods available for sale is determined at both cost and retail
• A Cost Percentage
Calculated by dividing the amount of goods available for sale at cost
by the amount of goods available for sale at retail
Multiplied by the estimated ending inventory at retail to give the
estimated ending inventory at cost
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Assume net sales for the current period are $100,000; the beginning
inventory at cost is $30,000, at retail, $50,000. Net purchases at cost are
$75,000, at retail $100,000. The ending inventory at retail would be
estimated as follows:
Example 6:
Cost Retail
Beginning inventory $ 30,000 $ 50,000
Net purchases + 75,000 + 100,000
Goods available for sale $105,000 $150,000
Less net sales - 100,000
Estimated ending inventory at retail $ 50,000
Cost percentage × 70%
Estimated ending inventory at cost $ 35,000
• Cost of goods sold is an expense and thus enters into the calculation of
net income or net loss for the period
• There is a direct relationship between the ending inventory and net income
In a direct relationship, the two related items move in the same
direction
If ending inventory is overstated, net income will be overstated
If ending inventory is understated, net income will be understated
• The beginning inventory will have the opposite effect of an error in the
ending inventory
If the beginning inventory is understated, net income is overstated
If the beginning inventory is overstated, net income is understated
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Inventory Valuation Effects on Net Income