Module 4: Accounting for Inventory and Cost of Goods Sold

periodic and perpetual systems

Inventory and COGS may be measured using 

Perpetual system

• maintains current and accurate accounts of inventory and COGS.

• This is accomplished by constantly  (or perpetually) updating the balances in these accounts.

• also requires that separate inventory accounts be kept for each stock keeping unit (SKU).

Stock Keeping Unit

• is a unique size, strength and type of  item e.g. Valium  is available in 2, 5, and 10 mg strengths and in 100 and 500 tablet package sizes with six different SKUs.

Periodic systems

• has historically been used by businesses-such as pharmacies, hardware stores, and supermarkets-that sell many different items, each of which has relatively low unit cost. It is a simpler system to use than the perpetual system.

• requires accounts for sales, purchases and inventory

• no accounts for cost of goods sold or for individual SKUs.  Merchandise purchases are recorded in the purchase account .  

Periodic System

• No adjustment  is made to the inventory account for either sales or purchases. 

• he inventory account usually does not reflect the actual amount of inventory the firm holds.

COGS= BI + P-EI

Cost of goods sold in periodic system

beginning inventory (BI) and the total purchases (P)

• is the total value of merchandise that the pharmacy had available for sale for the year.

Advantages of perpetual system

1. It provides the cost of goods sold without a physical inventory.  Consequently, financial statements can be generated easily and inexpensively at any time during the year.

2. It provides information that managers can use to control inventory levels.

3. It provides a basis for measuring shrinkage. 

Shrinkage

• refers to the amount of inventory that is loss broken or stolen

• is estimated by comparing the inventory level recorded in the inventory account with that found by a physical inventory (difference between these two levels represents the term)

 

Disadvantage of perpetual system

• it requires much record keeping. 

1. Weighted Average Cost Method

2. First in First out

3. Last in First out

Methods of Costing Inventory

Weighted average Cost Method

• The weighted average method yields a cost that is representative of the cost of the product over the entire accounting period.

WAC= COGAS/no. of bottles available for sale

Weighted average Cost Method

First in, First out

• An alternate method based on the assumption that the  first  units bought are the first sold

Last in, first out

• based on the assumption that the last unit bought are the first one sold and the first bought are the last sold.

• method of assigning cost to inventory can be artificially changed by buying  extra units of goods at the end of the accounting period. If prices are increasing, this will artificially inflate the cost of goods sold for the period.

• If prices are increasing over time

  • FIFO will give the lowest  cost of goods sold and LIFO will give the highest.

• If prices are decreasing over time

  • FIFO will give the highest cost of goods sold and LIFO will give the lowest.

• If prices do not change

  • all methods will give the same cost of goods sold. 

FIFO vs LIFO

inventory valuation Method

• does not actually affect the what the pharmacy paid for the merchandise it sold during the year.

LIFO

• n a period of inflation, _____ will minimize tax payments and consequently maximize cash flow.

LIFO

• Over the entire life of the pharmacy all methods will give the same income tax payments, though _____ may defer income tax until later years  

Except for their effects on income taxes, the answer to this question is no.

Do Inventory Methods Really Affect Performance?

Cost

• refers to the amount paid for the item when it is bought

Market value

• refers to the replacement value of the item

“loss on write down of inventory

• expense recorded and recognized when the difference between the calculated value of ending inventory and the value after the adjustment represents a loss of inventory for the pharmacy

First ended, First out or First to expire, First out

Inventory management system that moves older products out first to prevent waste from products expiring before they are used.

Purchases

• refer to merchandise  a pharmacy offers for resale to its customers

Interest expense

• The amount of the lost discount is recorded as an _____ , not as part of the purchase price or cost of goods sold.

1) return of unsatisfactory goods

2) shipping cost paid by the pharmacy to be treated as part of the cost of purchase

Two other factors that affect final value of purchases and cost of good sold are 

F.O.B. shipping point 

• means the seller is  responsible  only for loading the goods onto a truck, with the buyer bearing the  freight cost  from the shipping point to the destination.

• re called freight-in-costs and are part of the cost of goods sold.

F.O.B. destination point

• the seller bears the freight  costs necessary  to deliver the goods to the buyers place of business.  The cost is part of the delivery expenses of the seller.

Purchase returns and allowances

• suppliers receiving returned merchandise from pharmacies

Sales returns and allowances

• by pharmacies  receiving returned merchandise from patrons

Merchandise accounts

• enter into the determination of Net income, their balances appear in the income statement.

Purchases, freight-in, sales discounts and sales returns and allowances

• have debit balances

Purchase discounts, purchase returns, and allowances and sales 

• have credit balances.

Operating expenses

• are classified into either selling expenses or general and administrative expenses

Selling expenses

• are associated directly with the marketing and selling functions of a pharmacy.