ACCT1 C5 ACCT FOR MERCHANDISE INVENTORY.ppt

FUNDAMENTAL ACCT I
(ACFN2012)
CHAPTER 5: ACCT FOR MERCHANDISE
OPERATIONS
2
By: Aregawi Gebru
Tell: 0909919122

5.1. Nature of Inventory
 Merchandising Sector Organization:
 are engaged in purchasing(buys) from suppliers and
awaiting for reselling of merchandises/finished goods to
customers.
 Merchandising entity (generally a retailer or wholesaler)
has a single inventory purchased for resale in the normal
course of business called merchandise inventories.
 Merchandise on hand (not sold) at the end of an
accounting period is called merchandise inventory.
 Merchandise inventory is reported as a current asset on
the balance sheet.
3
By: Aregawi Gebru, MA, 2011
E.C
(Instructor)
Tell: 0909919122

5.1. Merchandise Inventory
4
E.C
(Instructor)
Tell: 0909919122

 Have only one inventory as of merchandise inventory
because without changing the tangible products sell to other
companies.
2. Example 1: Merchandising Sector Organization:
 amazon.com (internet books, music, video),
Supermarkets, boutiques, garment and shoe shops, drug
stores, stationary shops, auto spare parts, importers,
exporters etc.
5
E.C
(Instructor)
Tell: 0909919122

Copyright © 2006, The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
Merchandiser
Current assets
Cash
Receivables
Prepaid Expenses
Merchandise
Inventory
Manufacturer
Current Assets
 Cash
 Receivables
 Prepaid Expenses
 Inventories
1. Raw Materials
2. Work in Process
3. Finished Goods
Difference between Merchandising& Manufacturing Inventories in
Balance Sheet

Copyright © 2006, The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin
SUMMARY OF THE INVENTORY
Merchandiser
Current assets
Cash
Receivables
Prepaid Expenses
Merchandise
Inventory
Manufacturer
Current Assets
 Cash
 Receivables
 Prepaid Expenses
 Inventories
Raw Materials
Work in Process
Finished Goods
Partially complete
products – some
material, labor, or
overhead has been
added.
Completed products
awaiting sale.
Materials waiting to
be processed.
Difference between Merchandising& Manufacturing Inventories in
Balance Sheet

8
E.C
(Instructor)
Tell: 0909919122

By: Aregawi
Gebru(MA)
(Instructor)
Tell: 0909919122
By: Aregawi Gebru(MA PFM) 9
Formula 5.1 Cost of Goods
Sold
Merchandise Co.
Cost of Goods Sold
Begging Merchandise inventory XXX
+ Purchase of inventory XXX
= Goods Available For Sale XXX
- Ending Merchandise inventory (XXX)
= Cost of Goods Sold XXX

By: Aregawi
Gebru(MA)
(Instructor)
Tell: 0909919122
Merchandising Company
Description Amount
Sales XXX
Beginning Merchandise Inventory XXX
+ Inventory Purchases XXX
= Goods Available For Sale XXX
- Ending Merchandise Inventory (XXX)
= Gross Margin(Sales - CGS) XXX
- Operating Expenses: XXX
Selling Expenses (XXX)
Administrative Expenses (XXX)
= Net Income XXX
Formula 5.2 For Net Income In
Merchandising Co.

By: Aregawi
Gebru(MA)
(Instructor)
Tell: 0909919122
R.
No. Description
Beginning
Balance
End Balance
Manufacturing
Co.
Merchandising
Co.
1 Sales 1,500,000 1,000,000
2 Direct Raw Materials Inventory 60,000 50,000
3 WIP Inventory 90,000 60,000
4 Finished Goods Inventory 125,000 175,000
5 Merchandising Inventory 200,000 150,000
6 Cost of Goods Manufactured 850,000
7 Purchase of Merchandise
Inventory
550,000
8 Selling Expenses 250,000 100,000
9 Administrative Expenses 300,000 200,000
Example 1: Assume the annual reports
reveal the following information
concerning Merchandising operations.

By: Aregawi
Gebru(MA)
(Instructor)
Tell: 0909919122
Example 5.3. Formula For Net
CGS In Merchandising
Co.
Merchandise Co.
Cost of Goods Sold
Begging Merchandise inventory 200,000
+ Purchase of inventory 550,000
= Goods Available For Sale 750,000
- Ending Merchandise inventory 150,000
= Cost of Goods Sold 600,000

By:
Aregawi Gebru,
MA(Instructor)
0909919122
Merchandising Company Co.
Income Statement
Sales 1,000,000
Beginning Merchandising Inventory 200,000
+ Purchases 550,000
= Goods Available For Sale 750,000
- Ending Merchandising Inventory (150,000)
= Cost of Goods Sold: (600,000)
= Gross Margin(Sales - CGS ) 400,000
- Operating Expenses:
Selling Expenses (100,000 )
Administrative Expenses (200,000) (300,000)
= Net Operating Income 100,000
Example 5.4. Determining Net Income
In Merchandising Co.

14
By:
Aregawi Gebru, MA(Instructor)
0909919122
5.3. Inventory System

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By:
0909919122
 Companies use one of two types of systems for
maintaining accurate inventory records By:
 Periodic Inventory System.
 Perpetual Inventory System.
 The essential difference between these two systems
from an accounting point of view is the frequency with
which the physical flows are assigned a value.

1.4.1. Periodic Inventory System
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0909919122
 Under this system there is no continuous
record of merchandise inventory account.
 The inventory balance remains the same
through out the accounting period, i.e.
the beginning inventory balance.
 This is because when goods are
purchased, they are debited to the
purchases account rather than
merchandise inventory account.
 The revenue from sales is recorded each time a
sale is made.

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0909919122
I. Periodic inventory Systems
 No entry is made for the cost of goods sold.
 So, physical inventory must be taken
periodically to determine the cost of inventory
on hand and goods sold.
 Less costly to maintain than the perpetual
inventory system, but it gives management less
information about the current status of
merchandise.
 Used by retail enterprises that sell many kinds of
low unit cost merchandise such as groceries,
drugstores, hardware etc.

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By:
0909919122
I. Features of Periodic inventory Systems
 Records inventory purchase or sale in "Purchases"
account.
 "Inventory Purchases" account is updated continuously on
a periodic basis, at the end of each accounting period (e.g.,
monthly, quarterly)
 Inventory subsidiary ledger is not updated after each
purchase or sale of inventory.
 Inventory quantities are not updated continuously.
 Inventory quantities are updated on a periodic basis.
 When financial statements are prepared, the company
takes a physical count of inventory by counting quantities
of merchandise on hand.

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I. Features of Periodic inventory Systems
 Cost of Goods Sold in a Periodic Inventory
System
 No entry is recorded for Cost of Goods Sold at
the time of the sale under a Periodic System.
 The inventory account in a periodic inventory
system keeps its beginning balance until the
end of period adjustment to the physical
inventory count.
 Therefore, a separate cost of goods sold
calculation is necessary.

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By:
0909919122
 Cost of Goods Sold calculation is necessary.
Example 1.4.1.
Description Amount
Beginning Inventory XXX
+ Net Purchases XXX
= Goods Available for Sale XXX
- Ending Inventory (XXX)

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0909919122
 Purchase Returns and Allowances and Purchase Discounts
 "Purchases": has a normal debit balance since it replaces the
debit to "Inventory".
 It has two contra accounts known as "Purchase Discounts"
(Purchase Discount) and "Purchase Returns and Allowances"
(Purchase R&A) that reduce it to determine "Net Purchases".
 The balance of these two contra accounts is a credit because
"Purchases" is a debit.
 Sales Returns and Allowances and Sales Discounts
 Sales have two contra accounts known as "Sales Discounts" and
"Sales Returns and Allowances" (Sales R&A) that reduce it.
 The normal balance for these two contra accounts is a debit.

22
By: Aregawi Gebru, MA(Instructor) ,0909919122
R.N
Description Dr Cr
1 To record the inventory purchase at the time of purchase of
merchandise at Cost፡
Purchases at cost XX
Accounts payable or cash XX
2 To record the sales at the time of sale of merchandise at Retail
Price:
Accounts receivable or cash at retail price XX
Sales XX
3 To record purchase returns and allowance:
Accounts payable or cash XX
Purchase returns and allowance XX
4 To record adjusting entry or closing entry for merchandise
inventory:
Income Summary XX
Merchandise inventory (Beginning) XX
5 To Close Beginning Inventory
Merchandise inventory (Ending) XX
Income summary XX

1.4.2. Perpetual Inventory System
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By:
0909919122
 Accounting Record Continuously Disclose the
Amount of Inventory.
 So, the Inventory Balance will not remain the same
in the accounting period.
 All increases are debited to merchandise inventory
account and all decreases are credited to the same
account.
 There are no purchases and purchase returns and
allowances accounts in this system.
 At the time of sale, the cost of goods sold is recorded
in addition to Journal entry for the sale.

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By:
0909919122
So, we can determine the cost of inventory as well as
goods sold from the accounting record.
No need of physical counting to determine their costs.
Updates inventory accounts after each purchase or
sale.
Inventory quantities are updated continuously.
Inventory subsidiary ledger is updated after each
transaction.
Companies that sell items of high unit value, such as
appliances or automobiles, tended to use the perpetual
inventory system.

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By:
0909919122
 Accounting Features of a Perpetual Inventory System
1) Purchases of merchandise for resale or raw materials for
production are debited to Inventory rather than to Purchases.
2) Freight-in, purchase returns and allowances, and purchase
discounts are recorded in Inventory rather than in separate
accounts.
3) Cost of goods sold is recognized for each sale by debiting the
account, Cost of Goods Sold, and crediting Inventory.
4) Inventory is a control account that is supported by a subsidiary
ledger of individual inventory records.
5) The subsidiary records show the quantity and cost of each type
of inventory on hand.

26

27
Example 1.4.2. Journal Entry For
Periodic& Perpetual Inventory System
By: Aregawi Gebru,
MA(Instructor)
0909919122

28
By: Aregawi Gebru,
MA(Instructor)
0909919122

29
Beginning inventory on Jan 1, 2002, NINI Company had 120 units of
merchandise that cost Br. 8 Per unit.
The following transactions were completed during 2002.
February 5 Purchased on credit 150 units of merchandise at Br. 10 per unit.
February 9 Returned 20 detective units from February 5 purchases to the
supplier.
 June 15 Purchased for cash 230 units of merchandise at Br 9 per unit.
September 6 Sold 220 units of merchandise for cash at a price of Br. 15 per
unit. These goods are: 120 units from the beginning inventory and 100 units for
February Purchases.
December 31 260 units are left on hand, 30 units from February 5 purchases.
Example 1.4.3.
By: Aregawi Gebru, MA(Instructor), 0909919122

30
Required:
Prepare General Journal Entries for NINI
Company to record the above transactions and
adjusting or closing entry for merchandise
inventory on December 31,
a)Periodic inventory system
b)Perpetual inventory system
Example 1.4.3.

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a) Journal entries for Periodic Inventory Systems are:
Solutions

32
Solutions

Difference b/n periodic&
perpetual Inventory System
33 By: Aregawi Gebru, MA(Instructor), 0909919122

34
 A periodic inventory system determines cost of merchandise
sold and inventory at the end of the period.
 We must record cost of merchandise sold and reductions in
inventory as sales occur using a perpetual inventory system.
How we assign these costs to inventory and cost of
merchandise sold affects the reported amounts for both
systems.
2.1. DETERMINING THE COST OF INVENTORY

35
 There are four Inventory Costing Methods under
Periodic Inventory Systems commonly used in
assigning costs to inventory and cost of merchandise sold.
These are:
1. Specific Identification Methods
2. First In First Out (FIFO) Methods
3. Last In First Out (LIFO) Methods
4. Weighted Average Methods
2.1. DETERMINING THE COST OF INVENTORY

 Concerned with each individual units of inventory
is specifically marked, tagged, coded or identified
by number.
 is appropriate when the variety of merchandise carried
in stock is small and the volume of sales is relatively
small.
 It does not depend on a cost flow assumption.
 so that the actual (specific) unit cost of each item sold
and remaining on hand can be identified at any time
easily.
2.1. Specific Identification Method(SIM)

This method tracks the actual physical flow of
the goods.
Used to handled for large or expensive
Items or only small quantities.
Used to identify at any time & at date of sale
the specific unit cost of each item sold and
each item remaining in inventory.

Example: 2.1.
 That southland music company purchases
three 46-inch television sets at cost of birr
7,000, birr 7,500 and birr 8,000
respectively.
 During the year, two sets are sold at birr 11,
200 each.
 According to the above Data Determines the
company determines the Inventory still on
hand Using Specific Identification Method
for December 31.

39
By:
0909919122
Solution: According to the above Data
December 31, the company determines that the
birr 7,500 set is still on hand.
M. Sign Description Amount
Beginning Inventory (7000+7500+8000) 22,500
+ Net Purchases 0.000
= Goods Available for Sale 22,500
- Ending Inventory (7,500)
= Cost of Goods Sold 15,500
1.5.1. Specific identification Method

2.2. FIFO Method
 Concerned units purchased first are sold first.
 Goods sold are valued at the oldest unit costs,
and goods remaining in inventory are valued at
the most recent unit cost amounts.
 First purchased goods are first goods to be sold.
 Used to control spoiled materials
 Concerned with Earliest goods purchased are the first
to be sold.
 The costs of the most recent goods purchased are
recognized as the ending inventory.

2.3. LIFO Method
 The most recently purchased merchandise costs
is assumed to be sold first.
 Inventory costing based on the most recent merchandise
costs should be charged against revenue.
 The remaining inventory is assumed to consist
of the earliest purchases.

2.3. LIFO Method
 The most recently purchased goods are sold first,
because current costs are incurred to make current sales
and to maintain adequate inventories on hand.
 The latest goods purchased are the first to be sold and
that the earliest goods purchased remain in ending
inventory.
 Goods purchased last are assumed to have been sold
first.
 The ending inventory comprises purchases made earlier
in a year.

2.4. Average Cost Method
 The inventories are valued on the basis of average
prices paid for the goods, weighted according to the
quantity purchased at each price.
 The cost allocation of goods available for sale is made on
the basis of the weighted average unit cost incurred.
 Applied to the units sold to determine the cost of goods
sold and to the units on hand to determine the ending
inventory.
 Also called the weighted average method.

 Companies use the average cost method to account nearly
identical (homogenous) and is carried in large quantities, like
lumber, nails, nuts and bolts or gasoline.
 No assumption is made about the sale of specific units.
Rather, all sales are assumed to be of the “average” unit at the
average cost per unit.
 Weighed-average is a periodic inventory costing method
where ending inventory and COGS are priced at a single
weighted-average cost of all items available for sale.

 Applied both to ending inventory and beginning inventory.
 The goods available for sale are homogeneous.
 The allocation of the cost of goods sold available for sale is
made on the basis of the weighted average unit cost area;
 Cost of Goods Available for Sale = Weighted Average Unit Cost
Total Units Available for Sale

Example: 2.4.1 Determining the Cost of Inventory
 Abebe Company began the year and purchased merchandise as follows:
1. Jan. 01 Beginning inventory 80 units@ Br. 60 = Br. 4,800
2. Feb. 16 Purchase 400 units@ 56 = 22,400
3. Sep.02 Purchase 160 units @ 50 = 8,000
4. Nov. 26 Purchase 320 units@ 46 = 14,720
5. Dec. 04 Purchase 240 units@ 40 = 9,600
6. Total Cost of Goods Available for Sale 1200 units ∑ = Br.59, 520
 The Ending Inventory consists of 300 units, 100 units from each of the last
three purchases.

Required :
 According to the above Data Determine Cost
of Goods Sold Based on the following
inventory Costing Methods:
1. Specific Identification Methods
2. First In First Out (FIFO) Methods
3. Last In First Out (LIFO) Methods
4. Weighted Average Methods

 It does not depend on a cost flow assumption.
 Instead it requires that each item of inventory is
marked, tagged, or coded so that the actual
(specific) unit cost of each item sold and
remaining on hand can be identified at any time
easily.
 From the above illustration, the ending inventory
consists of 300 units, 100 units from each of the
last purchases. So, the items on hand are
specifically known from which purchases they
are
Solution For Question 1.
Determination of CGS/Cost of Inventory using Specific
Identification Method(SIM)

Date Explanation of
EIC
Unit
Cost
X Quantity
in Units
= Total
Cost
Dec. 04 Purchase 40 X 100 = 4000
Nov. 26 Purchase 46 X 100 = 4600
Sep.02 Purchase 50 X 100 = 5,000
Ending Inventory Cost 300 units 13,600
= Br. 59,520 – Br. 13,600
= Br. 45,920
Determination of CGS/Cost of Inventory using Specific
Identification Method(SIM)

 First In First Out (FIFO)
 This method assumes that goods are sold in the order in
which they are purchased.
 The goods that were bought first (first-in) are the first
goods to be sold (first-out), and the goods that remain on
hand (ending inventory) are assumed to be made up of
the latest costs.
 For example, easily spoiled goods such as fruits, vegetables
etc., must be sold near the time of their acquisition. So, the
inventory on hand will be from the recent purchases.
Determination of CGS/Cost of Inventory using FIFO Method

Determination of CGS/Cost of Inventory using FIFO Method
Date Explanation of
EIC
Unit
Cost
X Quantity
in Units
= Total
Cost
Jan. 01 Beg inventory 60 X 80 = 4,800
Feb. 16 Purchase 56 X 220 = 12,320
= Br. 59,520 – Br. 17,120
= Br. 42,400

 Last In First Out (LIFO)
 The LIFO method of inventory measurement assumes
that the most recently purchased items are to be the first
ones sold and that the remaining inventory will consist of
the earliest items purchased.
Determination of CGS/Cost of Inventory using LIFO Method

Determination of CGS/Cost of Inventory using LIFO Method
Date Explanation of EIC Unit
Cost
X Quantity
in Units
= Total
Cost
Dec. 04 Most recent purchase 40 X 240 = 9,600
Nov. 26 Next most recent
purchase
46 X 60 = 2,760
= Br. 59,520 – Br. 12,360
= Br. 47,160

Determination of the CGS/Cost of Inventory using WAM
 Weighted Average Method(WAM)
 Average cost per unit = Cost of goods available for sale
Total units available for sale
 Then the weighted average unit cost is multiplied by units
on hand at the end of the period to calculate the cost of
ending inventory.
 Also, the same average unit cost is applied in the
computation of cost of goods sold.

 Weighted Average Unit Cost = Br. 59,520/1,200
= Br. 49.60

 = Br. 49.60x 300
= Br. 14,880

 = Br. 59,520 - Br. 14,880
= Br. 44,640
Determination of the CGS/Cost of Inventory using WAM

2.5. Comparison of Inventory Costing Method
 If the cost of units and prices at which they are sold
remains stable, all the four methods yield/produces
the same results.
 But if prices change, the three methods usually
yield/produces different amounts for:
- Ending inventory
- Cost of merchandise sold
- Gross profit or net income

A. In periods of rising (increasing) prices: (or if there is
inflationary trend):
 FIFO yields/produces
 higher ending inventory
 Lower cost of merchandise sold
 Higher gross profit (net income)
 LIFO yields/produces
 Lower ending inventory
 Higher cost of merchandise sold
 Lower gross profit (net income)
 Weighted average yields the results between the two.

B. In periods of declining (decreasing) prices:
 FIFO yields/produces
 Lower ending inventory
 Higher cost of merchandise sold
 Lower gross profit or net income
 LIFO yields/produces
 higher ending inventory
 Lower cost of merchandise sold
 Higher gross profit or net income
 Weighted average- between the two

 Advantage of the FIFO method
 Appropriate for protecting inflation, the costs allocated
to ending inventory will approximate their current cost.
 Tends to be consistent with the actual flow of costs,
since merchandisers attempt to sell their old stock
first.(perishable items and high fashion items are
examples).
 No manipulation of income is possible because the
cost attached to units sold is always the oldest cost
 FIFO best approximates the current replacement value of
ending inventory in the balance sheet.

 Disadvantage of the FIFO method
 For income determination, earlier costs are matched
with current revenue resulting poor matching in the
income statement.

 Advantage of the LIFO method
 the most recent costs against the current
revenue, thereby keeping earnings from being
greatly distorted by any fluctuating increases
or decreases in prices.
 Tends to excludes inventory/paper profit.

 Disadvantage of the LIFO method
 Does not approximate the physical flow of goods except in special
situations such as for items to be sold out of a stockpile. eg
packages of nails or screws
 The oldest purchase costs are assigned to inventory, which may
result in inventory becoming grossly understated in terms of current
replacement costs.
 Income manipulation is possible. This may cause poor buying habits
 In the period of inflation, the costs allocated to ending inventory may
be significantly understated in terms of current cost.
 Some argue that the use of LIFO in a period of inflation enables the
company to avoid reporting paper or phantom profit as economic
gain.
 Both inventory methods make higher the balance sheet and income
statement when FIFO is used in a period of inflation.

 Advantages of the Weighted Average method
 Relatively simple to implement
 Real based and as paralleling the physical flow of goods,
particularly where there is an intermingling of identical
inventory units(e.g gasoline)
 Disadvantage of the Weighted Average method
 Inventory values may lag significantly behind current prices
in periods of rapidly rising or falling prices.

uestion
&
nswer
By: Aregawi Gebru, MA, 2011 E.C
(Instructor)
Tell: 0909919122

ACCT1 C5 ACCT FOR MERCHANDISE INVENTORY.ppt

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