Accounting for inventory Acc 3/4 Ch8

inventory

goods purchased by a trading firm and held for the purpose of resale at a profit

importance of inventory

main source of revenue (key part to earn profit)

most significant asset

important to manage effectively due to susceptibility to damage, spoilage, theft & change in demand

trading firm

a firm that purchases goods in order to resell them at a profit

perpettual system

method of recording inventory on an ongoing basis, where inventory cards are used to track each inventory movement, allowing records to be updated continuously, although the use of staff training and technology can impact the timeliness of recording.

benefits of perpetual system

Helps identify effective reorder points.

Allows inventory losses or gains to be detected with a physical count.

Identifies fast- and slow-moving inventory.

inventory card

a subsidiary (secondary/upporting) accounting record that records each individual transaction involving the movement in and out of the business of a particular line of inventory

cost price

the original purchase price of each individual item of inventory

identified cost

a method of valuing inventory by physically marking each item in some way so that its individual cost price can be identified

How does FIFO handle recording in the inventory cards?

Inventory gains: use the latest cost price in the IN column (faithful representation)

Inventory losses: assume the oldest inventory is lost (next allocated OUT)

Sales returns: use the latest cost price in the OUT column

Purchase returns: use the cost price on the credit note

How does the Identified Cost method handle recording in the inventory cards?

Inventory number and cost: determined by physical count

Sales returns: use the specific identified cost (e.g., barcoding, colour marking)

Purchase returns: use the cost price on the credit note

How is inventory reported in the balance sheet?

Only the total inventory value is reported; relevance requires only info needed for decision-making.

Inventory is a current asset because it:

Is held for resale

Is a present economic resource controlled by the business

Is expected to be sold within 12 months

What is sales revenue and how is it reported?

Value comes from the sales ledger

Important for decision-making and main source of profit

Reported separately from other revenues

How are sales returns and net sales recorded?

Sales returns: negative revenue showing suitability/quality of inventory sold

Net Sales: sales revenue less sales returns

What is included in Cost of Goods Sold?

Heading reflecting all costs to get inventory ready for sale

Includes: Cost of sales (from cost of sales ledger); Expenses (e.g., customs duty, freight inwards)

What is gross profit and how is mark-up related?

Gross profit = Net Sales - COGS

Shows if mark-up is adequate to make a profit before other expenses

Mark-up: percentage of selling price greater than the cost price

What is adjusted gross profit?

Profit from Net Sales after adjusting for inventory management. it includes inventory gains and losses.

rules for FIFO

Cost price only (no GST)

Record oldest → newest

Oldest inventory sold first

Purchase returns: cost on credit note

Sales returns: last items issued returned in original order

Inventory loss: oldest on hand

Inventory gain: most recent on hand

the income statement

reports for inventory by identifying both gross profit and adjusted gross profit

reasons for inventory loss in perpetual system

LOSS: Theft or shoplifting

Damaged goods (broken, spoiled, or expired)

Errors in recording purchases or sales (e.g., not updating the inventory card)

Counting errors during physical inventory count

reasons for inventory gain in the perpetual system

GAIN: Recording errors (e.g., not recording a sale, overstated purchase)

Misplaced goods found during stocktake

Supplier gives extra stock not recorded

effects on elements of accounting equation of the use of FIFO method in times of increaseing inventory prices

FIFO: assumes the first items in/inventory purchased is the first inventory sold.

Assets: the inventory left on hand will be assumed to be the most recent purchased & is likely to have a higher cost price, leading to a higher inventory valuation, increasing assets.

Owner's equity: increase due to lower cost of sales which will result in a higher net profit, since old inventory is still being sold

Liabilities: no effect

gross profit formula

Gross Profit= Sales−Cost of Sales

adjusted gross profit formula

Adjusted GP=Sales−Adjusted Cost of Sales

Adjusted Cost of Sales = Cost of Sales ± inventory error

selling price formula

Selling Price= Cost Price × (1+Markup %)