Stage 2 Accounting. Semester Break Work. Darwin High School. Preparation and Understanding of Management Accounting relating to:
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1 Semester Break Work Preparation and Understanding of Management Accounting relating to: Inventory Cards Cash Flow Statements
2 Inventory Inventories are the trading goods of a business. AASB 1019 defines inventory as: Held for the purpose of sale in the ordinary course of operations In production for such sale To be used in the production for goods To be classified as an inventory item, the item must at least meet one of the above criteria. As businesses are trying to sell this item within twelve months they are classified as a current asset. Inventories are by very nature different things to each individual business. Inventories in general are items held by the business and intended for sale in the normal operation of the business. Inventory Classification Exercise A bookstore holds the two following assets: (tick the descriptions that apply) Books Held for the purpose of sale in the ordinary course of operations In production for such sale To be used in the production for goods Bookshelf Held for the purpose of sale in the ordinary course of operations In production for such sale To be used in the production for goods For Example; A bookstores main inventory is books. Items such as cars, bookshelves and counters are classified as non-current assets. A car salesman main inventory is cars, where as items such as transport trucks, showrooms are classified as non-current assets. For a majority of businesses, inventories represent a large proportion of the owner s investment in the business. Teacher Mr N Smith Page 2
3 Control of Inventory It is important to control assets, there are many issues that can occur it business do not take care of their assets. Examples of issues that can arise are: Theft Destruction Damage Over/under ordering Obsolesce Internal control over inventory is critical to ensure that they are protected from the above issues. Successful businesses take great care in protecting their inventory. Elements of good internal control over inventory include: 1. Physically counting inventory at least once a year, regardless of the inventory accounting system been used 2. Storing inventory to protect it against theft, damage and decay 3. Giving access to inventory only to personnel who do not have access to accounting records 4. Keeping perpetual inventory records for high-unit-cost goods 5. Keeping enough inventory on hand to prevent shortage situations, which lead to lost sales 6. Not keeping too large an inventory stockpiled, thus avoiding the expense of tying money in unneeded items 7. Purchasing inventory in economical quantities It is incredible important for firms to ensure that they do not have too much inventory as it ties up too much cash into inventory when that money can be used to invest elsewhere, however in an increasing competitive market firms also cannot have too little inventory on hand as the customers will go to competitors. It can be very difficult for management to get the inventory balance right. Firms try their hardest to adopt a just in time (JIT) inventory system. This requires suppliers to deliver materials just in time to be used in the manufacturing process. Teacher Mr N Smith Page 3
4 Inventory Records To help keep track of inventory businesses can adopt inventory systems. There are two types of inventory systems: Periodical - A method of accounting for inventories that require a physical stock count whenever the value of the closing inventories is required Perpetual - A method of accounting for inventories that keeps a continuous record of all inventories purchased and sold To date we have been using the periodical method, you have been provided a value for closing inventory. From this closing value you are able to determine the value of cost of goods sold. Under the perpetual system, cost of goods sold is debited every time a sale is made. Depending on the accounting system in use this can be quite easy or extremely difficult. There are five valuation methods for valuing information into the inventory records, this is because it can be difficult for businesses to purchase inventory at the same price. Ultimately the method used will make no difference to the accounts in overall running of the business, however depending on the method will have differences in yearly accounts. The accounts that this will affect are Inventory and Cost of Goods Sold. 1. Weighted Average takes an average cost of the inventory 2. FIFO (First In, First Out) - 3. Specific Identification allocates a cost to the actual item sold, this is easier to determine when stock turnovers are low and/or unique products 4. LIFO (Last In, First Out) 5. Standard Cost only requires you to prepare inventory records for FIFO and Standard Identification. Under AASB 102, LIFO is not allowed to be used in Australia. Ultimately at the end of the day it doesn t matter which system is adopted by the business as all the systems will at the end of the day produce the same overall result, however individual years may differ depending on the method used. FIFO (First In, First Out) This system assumes that the oldest stock is sold first. It is quite a simply non complex system. It is less time consuming than specific identification and the products don t need to be unique. The system can t assume that new stock is stock first even when this isn t necessarily true. For example you are at the grocery store, you have a choice between two identical milk products, and the only difference is the use by date. Most people will of course choose the one that will last longer. When in a customer buys the newer product although the cost maybe different it is assumed that the inventory value for cost of goods sold is the first purchased milk. Not the actual cost as it is too difficult and costly to the business to work out. This is an example of LIFO (Last in, First Out) however under Australian accounting standards business are not allowed to used LIFO Teacher Mr N Smith Page 4
5 as it can severely reduce inventory figures and increase cost of goods sold resulting in significant tax benefits. Specific Identification Under this method of accounting the business can directly identify which product is sold and purchased. This is generally done when products are unique or easily distringable. Examples of such inventories are: Motor Vehicles Real estate Fine arts and antiques Pedigree dogs and cats This system is only appropriate when the individual stock item can be identified in some way, and where turnover volumes do not make stock recording too time consuming. An advantage of using this system of inventory valuation is that the value of Cost of Goods Sold and Stock on Hand can be more accurately calculated. This results in the income statement and balance better reflecting true and fair value. Stocktake- Inventory Adjustment As the business should know how much stock should be on hand, it is possible for the business to determine if there has been theft, damage etc. At intervals, businesses still perform a stock take to check the stock levels. If stock levels disagree, it is assumed that stock has been stolen. Under Australian Taxation law, all trading businesses must undertake a physical stocktake at least once a year to satisfy taxation requirements. Stock Cards Stock cards are necessary for the records of the perpetual system. This is because it keeps a record of the quantity and value of a specific inventory at any point of time. Stock cards keep track of inventory for only one stock item not multiple. Teacher Mr N Smith Page 5
6 Example for Specific Identification Watches are sold by J T Williams Jewellers. Stock Card Specific Identification Item Watches In Out Balance Unit Unit Unit Date Particulars Qty Cost Total Qty Cost Total Qty Cost Total July 1 Balance 1 (C105) (C109) (C117) Sales 1 (C105) (C109) (C117) Purchases 1 (C121) (C105) (C122) (C117) (C121) (C122) Sales 1 (C105) (C117) (C121) COGS = $2 500 Stock on Hand = $ (C117) (C122) (C105) (C122)
7 Example for FIFO Stock Card FIFO (First In, First Out) Item Watches In Out Balance Unit Unit Unit Date Particulars Qty Cost Total Qty Cost Total Qty Cost Total Sept 1 Balance Sales Purchase Returns (1) (100) (100) Purchases Sales Sales Returns (1) Stock Loss Note that it isn t stated which particular sale item was returned on the 24 th. The unit cost figure of $110 has been used to record this sales return. This is from the most recent lot of sales, which was on the 21 st, and uses the older of the two unit cost figures from that date. Use this approach in any exercise in which you are not specifically told which sale was returned.
8 Net Realisable Value Accounting standards state that inventories need to be valued at either cost or net realisable value, whichever is lower. Cost reflects the historical value of the purchased inventory Net Realisable Value reflects the anticipated selling price Why would a business value inventory below the original purchase, consider the following: Goods are no longer in peak condition Goods are obsolete or out of date Goods are made unsellable by new government regulations Demand has fallen Excess supply Management adopts a policy to underprice, to increase market share Items of Inventory Qty Cost/Unit Total Cost NRV/Unit Total Cost Reporting Value A $ 8.00 $ 8, $ 9.25 $ 9, $ 8, B2 600 $ 8.60 $ 5, $ 8.00 $ 4, $ 4, C3 525 $ 5.00 $ 2, $ 4.89 $ 2, $ 2, D4 862 $ $ 8, $ 8.00 $ 6, $ 6, E $ $ 19, $ $ 24, $ 19, Inventory Value $ 44, $ 47, $ 42, Particulars Debit Credit Inventory Adjustment Inventory Control (Balance Day Adjustment cost) Total Cost - Reporting Value Teacher Mr N Smith Page 8
9 Inventory Exercises Complete the following questions in your accounting books for stockcard template 1) Another name for inventories is: a. Depreciation b. Stock c. Amortisation d. Services 2) An important advantage that the perpetual inventory system has over the periodic inventory system is that: a. It reduces time and effort in recording entries dealing with inventories b. It allows a physical stocktake to be carried out each month c. It increases control over inventories because the business knows the value of inventories that should be on hand at any point of time d. It hides the value of lost, stolen or spoiled goods in the cost of goods sold figure 3) Inventories should be valued at: a. Cost b. The lower of cost and net realisable value c. Either cost or net realisable value d. The lower of cost and market value 4) Which of the following is not an inventory accounting system: a. FIFO b. Accounted cost c. LIFO d. Specific identification cost 5) What is a physical stocktake? Why is it important for businesses to conduct a stocktake? Teacher Mr N Smith Page 9
10 6) T Lee sells a range of bottled milk, the businesses uses FIFO method of accounting for inventory. You are to prepare an inventory card for business from the following products that have been bought and sold Dec 1 Balance 350 $2 per unit 4 Sold 200 Units 5 Sold 100 Units 10 Purchased 150 $2.40 per unit 12 Sold 100 Units 21 Purchased 70 $2.30 per unit 24 Sold 110 Units 7) Y Timms is a owner operator of a car yard and sells new and used cars, what type of inventory accounting method could Y Timms use? Why is this type of inventory accounting method appropriate to Y Timms. 8) You are to now prepare an inventory card for Y Timms for the following purchases and sales: Inventory on hand 1 red Holden commodore (rego ), 1 blue Ford Laser (rego ), 1 blue Holden commodore (rego ), 1 white Toyota Landcruiser (rego ) Sold the red Holden commodore Purchased a yellow Mazda 3 (rego ) Purchased blue Toyota Yaris (rego ) Sold silver Toyota landcruiser Teacher Mr N Smith Page 10
11 9) You are to prepare an inventory card for H Williams, for the following stock item product x, (you are to assume that you are using FIFO method) Jan 1 Balance 120 $4 per unit 4 Bought 200 $3.90 per unit 5 Sold 150 Units 15 Sold 80 Units 21 Bought 100 $4.10 per unit 22 Bought 200 $4.15 per unit 24 Sold 250 Units 28 Sold 100 Units 10) You are to determine the reporting value for the following inventory and make the necessary journal entry for the valuation of inventory Item of Inventory Qty Cost/unit NRV/Unit $ $ A B C D E Teacher Mr N Smith Page 11
12 11) Under Australian Accounting standards, LIFO is not and yet however FIFO is. What is the primarily difference between LIFO and FIFO and why does this allow FIFO to be used under Australian Accounting standards. Teacher Mr N Smith Page 12
13 Cash Flow Statements The purpose of the statement of cash flows is to assist the user in assessing the ability of the business to: Generate a positive cash flow where inflows are greater than outflows Service its debts (pay the interest on any borrowings) Fund any desired future expansion or changes Acquire external funds when necessary (loans or debentures if a companies) Pay drawings (if a sole trader) or dividends (if a company) The statement of cash flows provides a link between the Income Statement and Balance Sheet. Businesses can be considered very profitable, yet maybe cash poor. There can be various reasons for businesses been cash poor: Money is tied up in inventory The business has too many assets Money from accounts receivable might be been paid late or not received Categorisation of Cash In the preparation of cash flow statements there are there general categories of activity. AASB107 stipulates that the movement of cash should be classified as one of the following three classifications, these are: 1. Operating 2. Investing 3. Financing In each category there are inflows (cash received) and outflows (cash paid). Operating These are cash flows that relate to the day-to-day operations of a business. These are generally Income Statement Items. They involve a movement of cash that relates to: The sale and purchase of goods and services Interest paid or received Dividends received Taxes paid Rent, wages, advertising, and payments for other expenses Investing Activities Teacher Mr N Smith Page 13
14 These are cash flows that result from the purchase or sale of assets for cash. They generally involve Non Current Assets. They involve a movement of cash that relates to: Acquisition and disposal (purchase and sale) of non current assets and investments Lending money to other entities and repayments of those loans back to the business Financing Activities These are cash flows that correspond to changes in the financial structure of the business. They are generally Non Current Liabilities and Equity Loans. Finance can be obtained from external sources (a mortgage) or internally (owner s personal funds) Cash flows in and out of the business through financing activities will generally occur through the following: Sale, issue, buy-back shares Issuing and redemption of debentures Contribution or withdraw of capital Money borrowed, or repayment of loan Dividends and distributions paid to shareholders Teacher Mr N Smith Page 14
15 Preparation and Structure of Cash Flow Statement A statement of cash flows is prepared from using information from two successive Balance Sheets and a current Income Statement. Ensure that you do not include any non cash items such as depreciation, bad debts, doubtful debts, profit/loss on sale of asset. It is about the net cash movements for each period. Comparative Balance Sheets for Ms U King as at 30 June 2011 Year 2011 Year 2010 Current Assets Bank Debtors Stock Non Current Assets Motor Vehicle Equipment Total Assets Current Liabilities Creditors Non Current Liabilities Loan Owner's Equity Capital Total Equities Income Statement for Ms U King for year ending 30 June 2011 Revenue Sales (cash) Sales (credit) Less Cost of Goods Sold Opening Stock 1600 Purchases (cash) 6000 Purchases (credit) Less Closing Stock Gross Profit Less Expenses Wages 2000 Promotion Net Profit Additional Information: Teacher Mr N Smith Page 15
16 New Equipment was purchased on 1 December for $ with a new loan The owner took drawings of $300 All expenses were paid with cash Debtors will need to be reconstructed to determine receipts from customers. Debtors Control a/c 2010 Bal b/d 4000 Cash 500 Sales 5000 Bal c/d Bal b/d Creditors will need to be reconstructed to determine payments to suppliers. Creditors Control a/c 2010 Cash 1600 Bal b/d 3200 Bal c/d 3600 Purchases Bal b/d 3600 Teacher Mr N Smith Page 16
17 Ms U King Statement of Cash Flows for the year ended 30 June 2011 Cash Flows from Operating Activities Inflow Cash Receipts Receipts from Debtors Outflow Payment to Creditors 1600 Cash Purchases 6000 Payment to Employees 2000 Other Operating Expenses 600 (10200) Net Cash from operating activities 9300 Cash Flows from Investing Activities Outflow Equipment (10000) Net Cash from Investing Activities (10000) Cash Flows from Financing Activities Inflow Loan 6000 Outflow Drawings (300) Net Cash from Financing Activities 5700 Net Increase in cash 5000 Cash balance at beginning 8000 Cash balance at end Teacher Mr N Smith Page 17
18 Cash Flow Statement Exercises 1. Explain the importance of a Statement of Cash Flows: 2. Classify the following items as they would appear in the Statement of Cash Flows Wages and Salaries Loan to an Employee Drawings Bad Debts Rent Revenue Depreciation Repayment of Loan Advertising Expense Payment from Accounts Receivable 3. How can a business that is making huge profits still be considered cash poor. Explain with at least two examples Teacher Mr N Smith Page 18
19 3. Create a cash flow statement for Pet Store NAU from the following information. Comparative Balance Sheet for Pet Store NAU as at 30 June 11 Year 2011 Year 2010 Current Assets Bank Debtors Stock Non Current Assets Motor Vehicle Less Acc Dep'n on Motor Vehicle Fixtures & Fittings Motor Vehicle on Fixtures & Fittings Premises Shares Total Assets Current Liabilities Bank Overdraft Creditors Non Current Liabilities Loan Owner's Equity Capital Total Equities Teacher Mr N Smith Page 19
20 Income Statement for Pet Store NAU for the year ended 30 June 11 Revenue Sales (cash) Sales (credit) Less Cost of Goods Sold Opening Stock Purchases (cash) Less Closing Stock Gross Profit Add Operating Revenue Interest Revenue Less Other Operating Expenses Advertising Sales Wages Depreciation on Motor Vehicle Administrative Costs Depreciation on Fixtures & Fittings 5000 Insurance Finance Expenses Bad Debts 6000 Interest on Mortgage Net Profit Additional Information All acquisitions and disposals of non current assets were for cash Coles Myers shares were sold at cost price Teacher Mr N Smith Page 20
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