Identified Cost Method and Perpetual Inventory – Quick Notes

Perpetual Inventory System

  • Definition: A system that continuously records all inventory movements in subsidiary records called inventory cards.
  • Key features:
    • Separate inventory card for each line of inventory (item, color, size).
    • Continuous recording of movements (IN on purchases, OUT on sales/returns).
    • After recording, a physical stocktake verifies accuracy and detects losses or gains.
    • Reporting reflects Gross Profit and Net Profit via Cost of Sales adjustments.
  • Inventory cards in practice:
    • Top portion: item details (description, code, location, supplier) and inventory method (e.g., FIFO).
    • Bottom portion: four sections — Date/Details; IN; OUT; BALANCE.
    • All recorded at COST PRICE, GST excluded.
    • BALANCE shows current quantity on hand and its total cost value.
  • Physical stocktake link:
    • Used to verify cards and detect losses/gains; results adjust inventory cards accordingly.
    • Outcomes: match, inventory loss, or inventory gain.

Inventory Cards - Structure and Recording

  • Top portion details:
    • Description, Inventory code, Location, Supplier, Inventory method (e.g., FIFO).
    • Note: If there are multiple sizes/colors, each requires its own card.
  • Bottom portion (transactions):
    • Date/Details: evidence for verification (source documents).
    • IN: items moving in (purchases, returns from customers).
    • OUT: items moving out (sales, returns to suppliers, drawings, etc.).
    • BALANCE: current on-hand quantity and value after each transaction.
  • Recording rules:
    • Always record at COST PRICE (exclude GST).
    • For each OUT, record the COST PRICE of items sold (not the selling price).
    • Balance value = Balance quantity × Cost price.
  • Example expectations:
    • Purchases increase IN and BALANCE by the cost of items bought (no GST in cost row).
    • Sales decrease BALANCE by the cost of items sold (no GST in cost row).

Physical Stocktake (Physical Inventory Count)

  • Purpose: verify inventory on hand and determine cost price of on-hand stock.
  • Steps:
    1) Physically count units of every inventory type.
    2) Determine cost price of all on-hand items.
  • Outcomes:
    1) Count matches inventory card — no adjustment.
    2) Count < card balance — adjust for inventory loss. 3) Count > card balance — adjust for inventory gain.
  • Rule: The physical count is considered the true figure; adjust records to reflect it.

Inventory Loss and Inventory Gain

  • Inventory Loss (expense):
    • Condition: physical count < balance on card.
    • Causes: theft, undersupply/oversupply, double invoicing, recording errors, owner withdrawals without recording, etc.
    • Effect: decreases Current Assets (Inventory) and increases expenses, reducing profit and owner’s equity.
  • Inventory Gain (revenue):
    • Condition: physical count > balance on card.
    • Causes: supplier over-delivery, under-delivery to customers, recording errors, etc.
    • Effect: increases Current Assets and increases revenue, boosting profit and owner’s equity.

Cost Price Methods

  • Identified Cost Method (focus of today):
    • Definition: Identify the actual cost of each item sold by tagging/labeling items at purchase and recording the cost linked to that code.
    • Outcome: When sold, the exact cost price of each unit sold can be identified and recorded.
    • Important: For comparability, use the same method consistently across periods.
  • FIFO (brief):
    • Common alternative where the oldest costs are assigned to cost of sales unless identified cost is used.
  • Mark-up method (used to derive selling price or infer cost price):
    • Relationship: Selling price excluding GST and Mark-up determine cost price.
    • Key formula (Cost Price from Mark-up):
      ext{Cost Price} = rac{ ext{Selling Price}_{exclGST} imes 100}{100 + ext{Markup}}
    • Example: If SPexclGST = 60 and Markup = 50%,
      ext{Cost Price} = rac{60 imes 100}{100 + 50} = rac{6000}{150} = 40.
  • GST handling (important):
    • Selling price often includes GST; remove GST to get price excluding GST for cost calculations.
    • General formulas:
      ext{SP}{exclGST} = rac{ ext{SP}{inclGST}}{1 + rac{ ext{GST}}{100}}
      ext{GST amount} = ext{SP}{inclGST} - ext{SP}{exclGST}
  • Practical note: Inventory card values exclude GST; GST is handled separately in liability accounts.

Recording in Inventory Cards - Purchases and Sales

  • Purchases (when cost price constant):
    • IN entry: Quantity, Cost (per unit, excluding GST), Total (Qty × Cost).
    • BALANCE update: Balance Qty increases; Balance Value = Balance Qty × Cost.
  • Sales (when cost price constant):
    • OUT entry: Quantity, Cost (per unit, excluding GST), Total (Qty × Cost).
    • BALANCE update: Balance Qty decreases; Balance Value updated accordingly.
    • Reminders:
    • Always record at COST PRICE.
    • Exclude GST from the cost calculations to protect gross profit visibility.
    • The cost price used in the OUT column is not shown to customers; it is used for COGS calculation.

Identified Cost Method - Sale of Inventory (Example Highlights)

  • When cost can be identified, sales can be recorded with multiple cost prices in the OUT column.
  • Example outcome: Total Cost of Sales is the sum of the costs of items sold in that OUT event.
    • Example: If 20 shirts sold with 11 at $4.50 and 9 at $5.00, then OUT records reflect those two cost prices, and Total Cost of Sales = $130.50.
    • This amount is classified as an expense.

Formulas to Remember

  • Cost Price from Mark-up:
    ext{Cost Price} = rac{ ext{Selling Price}_{exclGST} imes 100}{100 + ext{Markup}}
  • Selling Price excluding GST from GST-inclusive price (GST rate = r%):
    ext{SP}{exclGST} = rac{ ext{SP}{inclGST}}{1 + rac{r}{100}}
  • GST amount in a selling price:
    ext{GST} = ext{SP}{inclGST} - ext{SP}{exclGST}
  • Balance value on an inventory card:
    ext{Balance Value} = ext{Balance Qty} imes ext{Cost Price}$$

Quick practical takeaways for exam readiness

  • Perpetual system relies on continuous recording of inventory movements in inventory cards; physical stocktakes ensure accuracy and reveal losses/gains.
  • Inventory cards require recording at cost price (GST excluded) and updating balance quantity and value after each transaction.
  • The identified cost method ties each sold unit to its actual cost, enabling precise COGS.
  • GST handling is separate from cost price in inventory records; GST affects GST payable, not the inventory card cost.
  • Mark-up and FIFO are key methods for deriving selling prices or cost prices when item-level identification isn’t used; always maintain consistency to ensure comparability.
  • Stocktake outcomes directly affect the balance sheet (Current Assets) and income statement (Expenses/Revenue), and ultimately owner’s equity.

Practice prompts (reference from content)

  • Calculate GST included in a selling price and derive the price excluding GST.
  • Compute cost price from a given selling price using a specified mark-up.
  • Record a purchase and a sale in an inventory card, showing IN/OUT, cost, and updated BALANCE.
  • Prepare an identified-cost inventory card for a month with a given end stock quantity and known cost per unit.