Inventory Management and Cash Discounts

Inventory Discounts and Payment Terms

  • Payment Timing

    • Pay within the first ten days after purchase.

    • Start date for consideration: July 5.

  • Discount Percentage

    • Discount offered for early payment: 2%.

    • To calculate the cash discount: Multiply the original amount by the complementary percentage:

    • Opposite of 2% = 98%.

    • Example Calculation:

    • Purchase amount: $60.00.

    • Discount Calculation: 60.00 imes 0.98 = 58.80.

    • Final amount after discount: $58.80.

  • Merchandise Transactions

    • Company purchased $18 worth of merchandise on July 5 under term 2/10, net 30.

    • On July 7, the company returned $200 worth of merchandise.

    • On July 28, full amount due was paid but outside the discount period:

    • Full amount: 69$.

    • Discount not applied.

  • Purpose of Discounts

    • Why offer cash discounts:

    • Increase cash flow.

    • Encourages prompt payments.

    • Comparison with potential loan costs:

      • Loan charges could be higher than offering a discount.

Journal Entries and Inventory Systems

  • Perpetual Inventory System

    • Under this method, all transactions flow through the inventory account.

  • Merchandise Return

    • Journal Entry for returning merchandise under perpetual system:

    • Decrease in inventory:

      • Inventory (Asset account) decreases by crediting it.

    • Reduction in accounts payable:

      • Debit accounts payable to reflect liability reduction.

Payment within Discount Period

  • Provided Information

    • Another example of a company purchased $1,800 worth of merchandise on July 5, terms 2/10, net 30.

    • Returned $200 worth of merchandise on July 7.

    • Full payment made on July 12, within the discount period:

    • Payment amount after return: $1,800 - $200 = $1,600.

    • Discount on $1,600: 2% = 1,600 imes 0.02 = 32.

    • Total Cash Paid: 1,600 - 32 = 1,568.

  • Credit Entries in Journal

    • Credit cash with the amount after discount.

    • Credit merchandise inventory with the discount amount.

Merchandise Purchases and Freight Charges

  • Transportation Costs

    • Freight costs are typically not included in the cash discount. They are paid cash and do not receive discounts.

    • Cost of goods: $4,000 + $350 for freight.

    • If merchandise is returned: $2.75 worth.

  • Final Inventory Calculation

    • Total cost: 4,000 - 2.75 = 3,997.25.

    • Discount on merchandise: 2% on purchase price only, not freight.

Inventory Shrinkage

  • Definition of Inventory Shrinkage:

    • Refers to theft, breakage, or inventory loss.

    • Example: Company reports an inventory balance of $62,001.15, but physical count reveals only $61,900.

    • Adjusting entry to reflect shrinkage:

    • Debit Cost of Goods Sold: $215,

    • Credit Merchandise Inventory: $215 (decrease to asset).

Financial Statement Calculations

  • Calculating Gross Margin

    • Gross Profit = Net Sales - Cost of Goods Sold.

    • Operating Expenses deducted from Gross Margin yields Net Income.

    • Example Calculation:

    • Net Sales: $7,520 - $5,430 = Gross Margin: $2,090.

    • If Operating Expenses are $17,000, then Net Income: 2,090 - 17,000 = -14,910$$ (indicating a loss).

Sales Returns and Allowances

  • Definition: Net sales = Gross sales minus sales discounts and returns.

  • Importance: Reduces overall revenue reflecting how much product returns impact business.

    • Example in a soap business:

    • If some soap products go returned or spoiled, this affects total revenue.

    • Keeping track of these returns is essential for business analysis.

Summary of Inventory Concepts

  • Types of Inventory Valuation

    • FIFO: First in, first out inventory method.

    • LIFO: Last in, first out inventory management.

    • Average Cost: Weighted average cost of inventory calculation.

  • Recording Inventory Purchases

    • Discussed contracts regarding shipping terms (FOB Shipping Point vs. FOB Destination).

    • Goods in transit are included in inventory if sold under terms that transfer ownership during shipping.

  • Inventory Adjustments

    • Concerning consigned goods: Only include inventory owned, exclude that held for another company.

    • Physical inventory must match recorded amounts to avoid discrepancies.

Internal Controls and Inventory Constraints

  • Importance of controls during physical inventory counts:

    • Use sequentially numbered tickets.

    • Confirm counts only once.

    • Involve independent verification of inventory counts.

    • Issues arising from improper counts: overstatement/understatement of inventory leading to financial discrepancies.

Inventory Errors and Financial Impact

  • Effects of Understating Ending Inventory

    • Leads to overstatement of cost of goods sold.

    • Impacts net income negatively, affecting retained earnings in subsequent periods.

  • Importance of Accurate Reporting

    • Errors in inventory reporting can cause significant ramifications in reported profits/losses.

Conclusion and Review

  • Review concepts regularly.

  • Understand calculations pertaining to inventory, returns, and discounts.

  • Be ready for practical applications in financial statements and accounting practices to ensure thorough comprehension and readiness for assessments and real-world applications.