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Perpetual Inventory SystemPerpetual Inventory System
• Maintains detailed records of inventory Maintains detailed records of inventory purchases and salespurchases and sales
• Continuously (perpetually) shows quantity Continuously (perpetually) shows quantity and cost of inventory purchased, sold and and cost of inventory purchased, sold and on handon hand
• Cost of Goods Sold is calculated and Cost of Goods Sold is calculated and recorded at the time of each salerecorded at the time of each sale
• When merchandise is purchased for When merchandise is purchased for resale:resale: Dr.Dr. Merchandise inventory (for cost of goods) Merchandise inventory (for cost of goods)
Cr.Cr. Accounts payable (purchases on credit) Accounts payable (purchases on credit) or Cash (cash purchases)or Cash (cash purchases)
• The purchase is normally recorded when The purchase is normally recorded when the merchandise is receivedthe merchandise is received
• Purchase agreement indicates when ownership of Purchase agreement indicates when ownership of the goods is transferred from buyer to sellerthe goods is transferred from buyer to seller
• FOB Shipping Point:FOB Shipping Point:• Buyer accepts ownership at place of shipping and pays Buyer accepts ownership at place of shipping and pays
for shipping costsfor shipping costs• Buyer debits Buyer debits Merchandise InventoryMerchandise Inventory for cost of shipping for cost of shipping
• FOB Destination:FOB Destination:• Buyer accepts ownership when goods are delivered to Buyer accepts ownership when goods are delivered to
buyer’s place of business and seller pays freight costsbuyer’s place of business and seller pays freight costs• Seller debits Seller debits Freight OutFreight Out for cost of shipping for cost of shipping
• Goods purchased may be damaged, Goods purchased may be damaged, defective, of inferior quality, or they may defective, of inferior quality, or they may not meet purchaser’s specificationsnot meet purchaser’s specifications
• Goods may be returned or purchase price Goods may be returned or purchase price may be reduced (an allowance)may be reduced (an allowance)
• Entry to record:Entry to record: Dr.Dr. Cash or Accounts payable Cash or Accounts payable
Cr.Cr. Merchandise Inventory (for amount of Merchandise Inventory (for amount of return or adjustment)return or adjustment)
Recording Sales of MerchandiseRecording Sales of Merchandise
• Revenues are reported when earnedRevenues are reported when earned• Revenue recognition principleRevenue recognition principle• Typically when goods are transferred from seller to Typically when goods are transferred from seller to
buyerbuyer• Two entries needed to record the sale:Two entries needed to record the sale:
• To record sales revenue:To record sales revenue: Dr.Dr. Cash or Accounts payable Cash or Accounts payable
Cr.Cr. Sales Sales• To record cost of goods sold:To record cost of goods sold: Dr.Dr. Cost of Goods Sold Cost of Goods Sold
• Sales returns:Sales returns: when customers return when customers return merchandise to seller for credit or refundmerchandise to seller for credit or refund
• Sales allowances:Sales allowances: when seller grants customers a when seller grants customers a price reductionprice reduction
• Seller’s entry required:Seller’s entry required:Dr.Dr. Sales returns and allowances Sales returns and allowances
Cr.Cr. Accounts receivable or cash Accounts receivable or cash
Quantity and Sales DiscountsQuantity and Sales Discounts
• Quantity discount:Quantity discount:• Reduction in selling price due to the volume of Reduction in selling price due to the volume of
goods purchasedgoods purchased• Sale is recorded at reduced priceSale is recorded at reduced price
• Sales discount:Sales discount:• Discount offered for early payment of billDiscount offered for early payment of bill• Discount amount taken is credited to Discount amount taken is credited to Sales Sales
DiscountsDiscounts (a contra revenue account) (a contra revenue account)• Original amount in Sales is not changedOriginal amount in Sales is not changed
Completing the Accounting CycleCompleting the Accounting Cycle
• Same types of adjusting entries as a service Same types of adjusting entries as a service companycompany
• One additional adjustment for inventoryOne additional adjustment for inventory• To ensure the recorded inventory amount agrees with To ensure the recorded inventory amount agrees with
the actual quantity on handthe actual quantity on hand• A physical count is an important control feature A physical count is an important control feature
• A perpetual system indicates what should be thereA perpetual system indicates what should be there• An inventory count will determine what existsAn inventory count will determine what exists
• Additional accounts to be closed: Additional accounts to be closed: Sales, Sales Sales, Sales Returns and Allowances, Sales Discounts, Cost Returns and Allowances, Sales Discounts, Cost of Goods Sold, Freight Outof Goods Sold, Freight Out
Total current assets 67,400 P roperty, plant, and equipment
Store equipment 80,000$ Less: Accumulated amortization 24,000 56,000
Total assets 123,400$
HIGHPOINT ELECTRONICBalance Sheet (partial)
May 31, 2008
AssetsMerchandise Merchandise Inventory Inventory reported as a reported as a current asset current asset following following Accounts Accounts ReceivableReceivable
• Calculation of Cost of Goods Sold is only Calculation of Cost of Goods Sold is only performed at end of periodperformed at end of period• When physical inventory count is doneWhen physical inventory count is done
• Causes accounting entries to be differentCauses accounting entries to be different• Detailed records are not kept throughout Detailed records are not kept throughout
the periodthe period• Cost of Goods Sold is calculated at the Cost of Goods Sold is calculated at the
end of the accounting periodend of the accounting period
Recording Purchases of Recording Purchases of MerchandiseMerchandise
• Merchandise Inventory account is not Merchandise Inventory account is not used; separate accounts are used instead:used; separate accounts are used instead:• Merchandise purchases are debited to Merchandise purchases are debited to
PurchasesPurchases account account• Freight costs are debited to Freight costs are debited to Freight InFreight In account account• Returns and allowances are credited to Returns and allowances are credited to
Purchase Returns and AllowancesPurchase Returns and Allowances account account• Discounts are credited to Discounts are credited to Purchase DiscountsPurchase Discounts
• At time of sale, only Sales Revenue is At time of sale, only Sales Revenue is recordedrecordedDr.Dr. Accounts receivable or Cash Accounts receivable or Cash
Cr.Cr. Sales Sales• No entry is made to recognize cost of salesNo entry is made to recognize cost of sales
• Freight costs, sales returns, allowances Freight costs, sales returns, allowances and discounts are treated the same as and discounts are treated the same as under a perpetual inventory systemunder a perpetual inventory system
Periodic Inventory SystemPeriodic Inventory SystemCalculating Cost of Goods SoldCalculating Cost of Goods Sold
• Cost of Goods PurchasedCost of Goods Purchased• Add Purchases and Freight InAdd Purchases and Freight In• Subtract Purchase Returns and Allowances and Subtract Purchase Returns and Allowances and
Purchase DiscountsPurchase Discounts• Cost of Goods on HandCost of Goods on Hand
• Based on physical count of inventoryBased on physical count of inventory= Number of units counted x unit cost= Number of units counted x unit cost
• Cost of Goods SoldCost of Goods Sold= Cost of Goods on Hand at beginning of period + Cost = Cost of Goods on Hand at beginning of period + Cost
of Goods Purchased – Cost of Goods on Hand at end of Goods Purchased – Cost of Goods on Hand at end of periodof period
Periodic Inventory SystemPeriodic Inventory SystemCalculating Cost of Goods SoldCalculating Cost of Goods Sold
= Inventory at start of period + Cost of Goods = Inventory at start of period + Cost of Goods Purchased - Inventory at end of periodPurchased - Inventory at end of period
Cost of goods soldInventory, J une 1, 2007 35,000$ Purchases 325,000$ Less: Purchase returns and allowances
and discounts 17,200 Net purchases 307,800$ Add: Freight in 12,200 Cost of goods purchased 320,000 Cost of goods available for sale 355,000$ Inventory, May 31, 2008 40,000 Cost of goods sold 315,000
Cost of goods soldInventory, J une 1, 2007 35,000$ Purchases 325,000$ Less: Purchase returns and allowances
and discounts 17,200 Net purchases 307,800$ Add: Freight in 12,200 Cost of goods purchased 320,000 Cost of goods available for sale 355,000$ Inventory, May 31, 2008 40,000 Cost of goods sold 315,000
Periodic Inventory SystemPeriodic Inventory SystemCompleting the Accounting CycleCompleting the Accounting Cycle
• Regular closing entries for all purchase and Regular closing entries for all purchase and sales discounts, allowances, freightsales discounts, allowances, freight
• Additional entry is required to close beginning Additional entry is required to close beginning merchandise inventorymerchandise inventory
Dr.Dr. Income summary Income summaryCr.Cr. Inventory Inventory
• Another entry is required to establish ending Another entry is required to establish ending merchandise inventorymerchandise inventory
Dr.Dr. Inventory InventoryCr.Cr. Income summary Income summary
Using the Information in the Using the Information in the Financial StatementsFinancial Statements
• Profitability ratios:Profitability ratios: measure income or measure income or operating success for a specific time periodoperating success for a specific time period
• Gross profit margin: Gross profit margin: • Gross profit expressed as a percentageGross profit expressed as a percentage• Measures the effectiveness of a company’s Measures the effectiveness of a company’s
purchasing and pricing policiespurchasing and pricing policies
= Gross Profit = Gross Profit ÷÷ Net Sales Net Sales