ACCT 1510 Chapter Notes - Chapter 6: Perpetual Inventory, Radio-Frequency Identification, Income Statement
20 Jun 2018
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CHAPER 6 – Cost of Goods Sold and Receivables
Nature of Inventory and Cost of Goods Sold
- Inventory – products held for resale, current assets
- Cost of goods sold (cost of sales) – outflow of resources caused by the sale of inventory
- Expense from the cost if inventory a company sells to its customers
- Most important expense on income statements from companies that sell goods instead
of services
- Gross margin (gross profit) = sales revenue – cost of goods sold
- Indicates the extent to which the resources generated by sales can be used to pay
operating expenses and provide for net income
Types of Inventory and Flow of Costs
- Merchandisers – companies (retailers or wholesalers) that purchase inventory in a finished
condition and hold it for resale without further processing.
- Retailers – merchandisers that sell directly to customers
- Wholesalers - merchandisers that sell to other retailers
- Merchandise inventory – inventory held by merchandisers, bought for resale, is an
asset ! when sold to customer ! becomes expense: cost of goods sold
- Manufacturers – companies that buy and transform raw materials into finished products that
are then sold
- Manufacturing inventory – used to produce a product
- Classification of inventory:
- Raw materials inventory – the basic ingredients used to make a product, direct
materials
- When purchased: raw materials inventory account is increased
- When used to manufacture product – become part of work-in-process
inventory
- Work-in-process inventory (WIP) – the raw materials that are used in production
AND other production costs (ex. labour, utilities)
- These costs stay in this account until the product is complete
- Once production process complete – costs are moved to finished goods
inventory account
- Finished goods inventory – represents the costs of the final product that is available
for sale.
- When finished goods inventory sold to customer ! becomes an expense:
cost of goods sold ! shows up in income statement
Cost of Goods sold
= cost to the seller of all goods sold during the accounting period
- matching concept – any costs used to generate revenue must be recognized in same period
that the revenue is recognized
Beginning inventory
+ Purchases
= Cost of goods available for sale
– Ending inventory
= Cost of goods sold
𝐺𝑟𝑜𝑠𝑠!𝑝𝑟𝑜𝑓𝑖𝑡 =𝑆𝑎𝑙𝑒𝑠 −𝐶𝐺𝑆
Inventory Systems
- provide the information needed to determine the costs of goods sold and analyse inventory.
- Provide information necessary to safeguard the inventory from misappropriation or theft
1. Perpetual Inventory System – cost of goods sold updated with every sale
- Requires detailed records to be maintained on a transaction-by-transaction basis
for each purchase/sale of inventory
- Records both revenue and cost side of sales transactions
- Technology helps in this process – bar codes, RFID (radio frequency
identification technology) ! faster response to changes in inventory (ex. buy
more/less items)
- Company should still make a physical count of inventory at least 1x per year
- Advantage: balances of inventory and cost of goods sold continuously available
! greater control over inventory ! timely information
2. Periodic Inventory System – cost of goods sold recorded only at the end of a period
- Does not require companies to keep detailed, up-to-date inventory records
- Periodic system records the cost of purchases as they occur (in an account
separate from the inventory account); physical count of inventory at the end of
period
- Balances for ending inventory and cost of goods sold at end of each accounting
period
- Must be counted by hand, most often an auditor is present
- If information about inventory count needed before end of period:
- Perform a physical count of inventory
- Estimate the amount of inventory using an acceptable estimation
technique
- Advantage: Relatively inexpensive
Periodic System
Perpetual System
1. Date Goods
Received
Dr Purchases
(Income statement account)
Cr Accounts payable/cash
Dr Inventory
(Statement of Fin. position account)
Cr Accounts Payable/Cash
2. Date Goods Sold
Dr Acc. Receivable / Cash
Cr Sales
No entry to adjust inventory
Dr Acc. Receivable/Cash
Cr Sales
Dr Cost of Goods Sold
Cr Inventory
(Statement of Fin. Position Acc.)
3. Date Inventory
Counted
Dr/Cr Cost of Goods Sold
Dr/Cr Inventory
No entry
(assumes inventory on statement of fin.
Statement is accurate)
Recording Inventory Transactions – Perpetual System
- historical cost principle – inventory cost includes the purchase price of the merchandise
plus any cost of bring the goods to a sellable condition and location
- cost of inventory – purchase prices + other “incidental” costs (freight, delivery, insurance,
tax)
1. Accounting for Purchases of Inventory in a Perpetual System
- Purchases – cost of merchandise acquired for resale during the accounting period (recorded
by increasing inventory account)
- Should be supported by source document (ex. invoice) – evidence of transaction and
details
- Cost of purchase must include: effects of purchase discounts, purchase returns,
transportation charges
- Purchase Discounts – price reductions offered by companies selling goods on credit to their
customers, encouraging prompt payment
- Ex. “2/10, n/30” – 2% discount of invoice price if payment made within 10 days of
invoice date (discount period), otherwise: full payment within 30 days
- Discount period – a period when prompt payment is rewarded by offering a discount
- Purchase Returns and Allowances – dissatisfaction with merchandise (ex. wrong
merchandise delivered, merchandise was deformed/defective, merchandise arrived too late)
- Purchase returns – cost of merchandise returned to supplier
- when purchasers are dissatisfied with merchandise ! frequently returned to
seller for credit/cash refund ! cost to supplier
- Purchase allowance – purchaser agrees to keep merchandise if seller is willing to give
a deduction (allowance) from purchase price
- Increase in purchase returns/allowance ! signals deteriorating supplier relationships
! must be closely monitored
- Balances: decrease in inventory, increase in purchase returns/allowance account
(contra expenses in calculation of CGS)
Document Summary
Chaper 6 cost of goods sold and receivables. Nature of inventory and cost of goods sold. Inventory products held for resale, current assets. Cost of goods sold (cost of sales) outflow of resources caused by the sale of inventory. Expense from the cost if inventory a company sells to its customers. Most important expense on income statements from companies that sell goods instead of services. Gross margin (gross profit) = sales revenue cost of goods sold. Indicates the extent to which the resources generated by sales can be used to pay operating expenses and provide for net income. Merchandisers companies (retailers or wholesalers) that purchase inventory in a finished condition and hold it for resale without further processing. Retailers merchandisers that sell directly to customers. Wholesalers - merchandisers that sell to other retailers. Merchandise inventory inventory held by merchandisers, bought for resale, is an asset when sold to customer becomes expense: cost of goods sold.
