Week 7

Accounting for Inventory

- Journal entries
-Costing Systems
-GST

LEARNING OBJECTIVES
1. Describe the nature of inventory and retail operations
2. Describe the basic format of an income statement for
retail businesses
3. Account for sales transactions of retail businesses,
including GST, the treatment of sales returns, cash
discounts, trade discounts and freight costs
4. Account for purchases of inventory and cost of sales
under both the perpetual and periodic inventory
systems
5. Describe the net method of recording purchases and
sales whenever there are settlement discounts

INVENTORY
AASB 102/IAS2 - Inventories
Inventory means goods or property
purchased and held for sale in the
operating cycle of a business
Other assets may be sold from
time to time but do not constitute
inventory
Also know as stock or stock in
trade

Different types of business operations

Service firms:
provide services to customers
eg lawyers, accountants,
hairdressers, schools

Manufacturing firms:
purchase raw materials and convert
them to finished products, which they
then sell
eg bakeries, car manufacturers, Levi
Strauss

Merchandising firms:

RETAIL BUSINESS
OPERATIONS
Acquire
Inventor
y

Sell
Inventor
y

Collect
Cash

Determination of profit is a major objective

Calculation of cost of sales is key
This is often a retailers largest expense
The inventory asset is often a significant
part of total assets and is likely to be very
active

RETAILING AND THE GST

Retail business must register for
an Australian Business Number
(ABN) if their sales of goods
exceed $75 000
They must also register for GST
They must issue tax invoices and
collect GST
They can claim input credits (GST
outlays)

Merchandising (Retailing)
Business
SUNRISE CD SALES
Income Statement
for the year ended 31 December 2012

Operating revenues
Sales revenue
Less: Sales returns
Net sales revenue
Less: Cost of goods sold
GROSS PROFIT
Add: Other Operating Revenues
Interest revenue
Less: Other Operating Expenses
Selling expenses
Administrative expenses
Financial expenses
NET PROFIT (before tax)

$714 900
(22 010)
$692 890
470 490
222 400
100
$100 270
78 850
4 260

(183 380)
$ 44 380

Compare to the Service Business

ACME AUTO REPAIRS
Income Statement
for the year ended 30 June 2012

Revenues
Repair revenue
Expenses
Advertising expense
Repair supplies expense
Salaries and wages expense
Rent expense
Telephone expense
Light and Power expense
NET PROFIT

$147 500
$ 6 750
30 570
42 600
13 420
6 730
15 980
116 050
$ 31 450

DISCOUNTS
Cash Discounts
Some firms extend cash discounts to their credit customers
to encourage prompt payment of their accounts.

indicated on sales invoice eg. 2/10, n/30 or 0.5/5, n/14, or

net 30 etc.
usually deducted by the purchaser when making payment
Trade Discounts
Not to be confused with cash discounts
Mostly seen as a percentage reduction granted to customer
from the list price (usually at point of sale and shown as
Sale 20% off today!)
The buyer or seller only records the actual price paid for
the goods (does not record discounted effect)

FREIGHT COSTS
Freight inward costs
paid by the firm when purchasing inventory
Freight-in Expense is part of cost of purchasing
inventory (added to the asset)
Freight outward expense
Who pays freight costs? The buyer or the seller?
FOB shipping point or (EXW) buyer takes delivery from
sellers place of business buyer pays all transport costs
FOB destination or (DDP) the seller delivers to buyers
place of business seller pays all transport costs
Classified as a selling expense if the seller is responsible

INVENTORY SYSTEMS
Each merchandising firm must decide
how they are going to account for their
inventory
There are two systems available. These
are the:
Perpetual inventory system
Continuous record of all movements in inventory levels

Periodic inventory system

Records of inventory numbers are not kept
continuously but are calculated periodically using stock
takes
The method chosen typically depends on factors such
as the type of inventory, the size of the company, the
technology and resources available.

SUMMARY - PERPETUAL
Involves keeping a running record of each
purchase and sale
The inventory account and COS account is
updated after every purchase or sale
As a result, the balance in the inventory
account is the ENDING inventory amount.
A stocktake is only performed to verify the
accuracy of this recorded ending inventory
If the recorded inventory and the stocktake
differ, then an entry to record the correct
amount needs to be processed

Implications of Choice of
Inventory system
Important!
The choice of inventory system used
(perpetual or periodic) will mean:
1. Different ledger accounts
2. Different journal entries for
purchase, purchase returns and sale
of inventory
3. Different amounts for cost of sales
and inventory on balance date
13

JOURNAL ENTRIES -Perpetual

Accounting for Purchase Transactions
Purchased merchandise worth $1400
from Jet Li Pty Ltd, a supplier on credit
Dat
e

Account

Ter
ms

Pos Purcha
t
ses

GST
Account
Outlays s
Payable

Purcha
ses
Jet Li P/L
1,400
140
1,540
Journal
excerp
t
Under the perpetual system every Purchase

requires a posting to the subsidiary ledger AND

the
ledger
Jet
Li Inventory
Pty Ltd
Date

Details

Post

Debit

PJ

1,540

Item M200

Purchase

Sell

Dat
e

Qty

Qty

Pos
t

Pric Tot
e
al

Credit

Pric Tot
e
al

Balance
1,540
Balance
Qty

Pric tota
e
l

JOURNAL ENTRIES -Perpetual

Accounting for Sales Transactions

Dat
Sales e
Journ
al
excer
pt

Sold 80 items of merchandise for

$1,600 plus GST to Ray Stevens, a
Account
Term
Po Sales GST
Account
customer
on credit
s

Ray Stevens

st

1,600

Collect

s
Receiva
ble

160

1,760

Under the perpetual system every sale requires

an entry into the GJ and posting to the subsidiary
andDate
inventory
ledgers (next slide)
Account
Pos Debit
Credit
Note
these
two
account
s

t
COGS

1,120

Inventory (80 items

@ $14)
Sold inventory

1,120

JOURNAL ENTRIES -Perpetual

Accounting for Sales transactions- post to 2
ledgers

Sold 80 items for $1,600 plus

GST to Ray Stevens on credit
Ray Stevens subsidiary ledger
Date

Details

Post

Debit

SJ

1,760

Credit

Balance
1,760

And now post to the subsidiary Inventory

ledger
Item MPurchase
Sell
Balance
200
Dat
e

Pos
t

Qty

Pric Tot
e
al

PJ

100

14

GJ

(6)

14

Qty

Pric Tot
e
al

Qty

Pric tota
e
l

1,40
0

100

14

1,40
0

(84)

94

14

1,31
6

SUMMARY - PERIODIC
No running record of each purchase and sale
Additional inventory purchased is recorded
in the Purchases account, instead of the
Inventory account
The balance in the inventory account
therefore does not change until the end of
the accounting period
A stocktake is performed to determine the
closing inventory balance
This closing balance is then used to
determine the Cost of Sales

JOURNAL ENTRIES -Periodic

Accounting for Purchase Transactions
Purchased merchandise worth $1400 from Jet Li Pty Ltd, a
supplier on credit
Dat
e

Account

Ter
ms

Pos Purcha
t
ses

GST
Account
Outlays s
Payable

Purcha
ses
Jet Li P/L
1,400
140
1,540
Journal
excerp
Under the periodic system every Purchase
t

requires a posting to the subsidiary ledger no

is required
Jetother
Li Pty GJ
Ltdentry
subsidiary
ledger
Date

Details

Post
PJ

Debit

Credit

Balance

1,540

1,540

JOURNAL ENTRIES -Periodic

Accounting for Sales Transactions

Sales
Journ
al
excer
pt

Dat
e

Sold 80 items of merchandise for

$1,600 plus GST to Ray Stevens, a
Account
Term
Po Sales GST
Account
customer
on credit
s

st

Ray Stevens

1,600

Collect

s
Receiva
ble

160

1,760

Under the periodic system every sale

requires no additional GJ entry needed, only
posting
to the
subsidiaryPos
ledger
Ray Stevens
subsidiary
Debit
Credit Balanc
ledger

t
PJ

e
1,760

1,760

CONTRASTING THE TWO

METHODS
Note that the COS account balance
is already recorded under the
Perpetual system
Under the Periodic system, COS
needs to be calculated.
Perpetual = more work and more
detail/control
Periodic = less work, less
detail/control
Which method?

JOURNAL ENTRIES
cash discounts

receive and pay accounts within the discount p

Cash Receipts Journal
CRJ
Dat Account
e

R
Stevens

Post

Bank

1401

Debit
Disc
GST
all
Coll
26.40 2.60

Sales

Credit
Acc Rec
Other

1430

GST
Coll

Cash Payments Journal

CPJ
Dat Account
e

Chq Post
No

Jet Li Pty
Ltd

Debit
Purch Acc Pay Other GS
T
Ou
t

1447.6

Bank

Credit
Disc
GST
Rec
Out

1418.6 26.40

2.60

21

COGS & Ending

Inventory
All firms no matter which system they
use (perpetual or periodic) need to
know two amounts
1. The Cost Price of all inventory sold
during the period -COGS
2. The amount shown for ending
inventory (inventory left on the
shelves) on balance date
22

Is this a problem?
For a perpetual system they will keep a
running balance of ins and outs
(purchases and sales of inventory) and
will have up to date information
For a periodic system they dont keep
running balances and so need to find
the amount of ending inventory by
doing a stock take and working
backwards
23

Assigning Cost to Ending

Inventory & COGS
Cost of all inventories must be assigned using*
either the
first-in, first-out (FIFO) method or
weighted average cost method
Specific identification

Firms must also:

Disclose which inventory costing method they are using
Be consistent to ensure inventory information is comparable
Be conservative following the LCM, or lower of cost or net
realisable value rule
Note: use of the last-in, last-out (LIFO) method is not permitted in
Australia
*

24

Determining the cost of inventory sold

Cost
= cost of purchase
+ cost of conversion (if manufacturing)
+ other costs to bring inventory
to present location & condition
Cost is easily determined if the price does not change
But
if prices change over time, which price do we use to
cost our ending inventory?
25

EXAMPLE INVENTORY COSTING

PERIODIC SYSTEM

Date
1 July Beginning Inventory

Numb
er of
Units

Unit
Cost

Total
Costs

10

$10 $100.0
0

15 Sept. Purchases

12

11 132.00

7 Dec. Purchases

15

12 180.00

27

312.00

37

$412.0
0

Purchases made during the current

period

Total purchases
Goods available for sale
Sales made during the current period
20 Sept. Sales

26

Limitations of the periodic

method
So what are the limitations of the periodic
method?
The balance of inventory is not readily available
If you want to know stock on hand you must count it

The COGS is not readily available

If you want to know COGS you must calculate it by: COGS =
opening inventory + purchases closing inventory
COGS = BI + NP EI

We never really know how much we have sold

We assume that if it is not there, then we have sold it but
the inventory may have been sold, or it may have been
stolen, lost, broken, evaporated etc
27

First-in, First out

Units cannot be specifically identified.
This is a concept- not the actual movement of

inventory.
FIFO assumes that the earliest purchases of inventory
will be the first units to be sold.
The units that remain in inventory are assumed to be
the ones that were from the latest purchases. (ie
newest) (therefore ending inventory reflects current
prices)
So looking at our previous slide- using FIFO the ending
inventory is 100+88=$188 and the COGS is = $412188=$224
28

Using the data in Exercise

13.2 page 585
What is the cost of sales and ending
inventory using FIFO and a periodic
system (not perpetual)?
How many units in opening?
How many units purchased?
How many units available for sale?
How many units sold?
How many units left on the shelf?
What is the value for COGS and ending
inventory?
29

COMPARISON OF
COSTING METHODS
Specific ID
Consistent with the actual movement of the inventory
Offers room for manipulating profit

FIFO
Reflects current prices in ending inventory
Does not permit manipulation of profit

Weighted average
Results in identical items being assigned the same
value
Tends to smooth out profit and inventory values
30

THE LOWER OF COST AND

NET REALISABLE VALUE RULE
Accounting standards require
inventories to be valued at the
lower of cost and net realisable
value
Net realisable value is the estimated
selling price in the normal course of
business less the estimated costs of sale.

31

GST remitted to ATO

During the year, the company collects GST
from customers and pays GST to suppliers. The
GST the company pays is called an input tax
credit and the ATO credits the company with
this amount. As the ATO also wants its amount
collected from customers, the company
deducts their credits and remits the balance to
the ATO. This will be the difference between
outlays and collections.

July
July28
28

GST
130
GSTCollections
Collections
130000
000
GST
110
GST Outlays
Outlays
110000
000
Cash
20
CashatatBank
Bank
20000
000
totorecord
recordthe
theJune
Junequarter
quarterpayment
payment

GST Problem
On 30 June 2010 the ledger accounts of T Ltd
show the following balances. These balances
are reflected on the BAS for the June quarter.
GST collections: $2 500 cr
GST outlays:
3 000 dr
Required: Complete the journal entry required
to reflect the clearing of these accounts on
the
submission of the BAS.

33