Accounting Chapter 22 Merchandise inventory on hand is typically the largest asset of a merchandising business Cost of Merchandise inventory is reported on both the balance sheet and income statement The accuracy of the inventory cost will also assure that gross profit and net income are reported correctly on the income statement Section 1 A merchandise inventory that is larger than needed may decrease net income Requires expensive store and warehouse space/storage Uses capital that could be invested in other assets to earn a profit Requires a business to spend money for expenses (taxes, insurance premiums) that increase with the cost of merchandise inventory Excess inventory may become obsolete and unsaleable Merchandise inventory that s smaller than needed also decreases net income: Sales may be lost to competitors of items not hand Sales may be lost to competitors if there is insufficient variety of merchandise to satisfy customers When small quantities are frequently ordered, the price per unit is higher than if ordered in large quantities Quantity of item in inventory at the end of a fiscal period must be determined to calculate the cost of merchandise sold. o Periodic (Physical) Inventory: determined by counting, weighing, or measuring items of merchandise on hand o Perpetual (Book) Inventory: determined by keeping a continuous record of increases, decreases, and balance on hand. Still will do a physical inventory at end of fiscal period Computers are most often used to keep track of inventory Also need to know the ideal quantity of each item to keep on hand create the ideal minimum quantity and ideal reorder quantity Inventory Record: a form used during a periodic inventory to record information about each item of merchandise on hand.
o Space to record the stock number, description, number of units on hand, unit price, and total cost of each item o Columns 1-3 are completed when business taking inventory o Columns 4-5 are completed after take inventory Businesses frequently established their fiscal period to end when inventory is at a minimum because it takes less time and money to conduct the inventory Preparing an Inventory Record Write stock number and description before periodic inventory starts Write the actual count in the No. of Units on Hand column Write the unit price and calculate the total cost after the physical inventory is completed usually done by the accounting department Stock Record: a form used to show the kind of merchandise, quantity received, quantity sold, and balance on hand. o A separate stock record is prepared for each kind of merchandise on hand Stock Ledger: a file of stock records for all merchandise on hand Perpetual inventory system provides day-to-day information about the quantity of merchandise on hand Minimum balance allowed is also listed on stock record and when reach that reorder the amount listed Purchase Information is recorded in the Increases column when merchandise received Sales Information is recorded in the Decreases column New balance on hand is recorded after each purchase and sale Perpetual records can have errors they are corrected/adjusted when the yearly physical inventory is taken Perpetual inventory can be aided by Universal Product Codes (UPC) Section 2 Costs are not recorded on inventory records at the time a periodic inventory is taken After the quantities of merchandise on hand are counted, purchase invoices are used to find merchandise unit prices Total costs are then calculated using the quantities and unit prices recorded on inventory records Three Inventory Costing Methods First-in, First-out (FIFO) Last-in, First-out (LIFO) Weighted-Average
First-in, First-out inventory costing method: using the price of merchandise purchased first to calculate the cost of merchandise sold first Costing inventory using the FIFO method Enter the total # of units on hand From the most recent purchase, enter the # of units purchased this # may be larger or equal to the amount on hand, if so just enter the # on hand and skip step 3 From the next most recent purchase, enter the # needed for FIFO units to equal the # on hand repeat until all total units on hand are accounted for Multiply the unit price of each appropriate purchases times the FIFO units on hand to figure FIFO cost Add the individual FIFO costs to determine the FIFO cost of the total # of units in ending inventory Last-in, First-out inventory costing method: using the price of merchandise purchased last to calculate the cost of merchandise sold first based on the idea that the most recent costs of merchandise should be charged against current revenue o Each item on the inventory records is recorded at the earliest prices paid for the merchandise Costing inventory using the LIFO method Enter the total number of units on hand Enter the # of units in beginning inventory. In some cases the # of units of beginning inventory will be greater or equal to total # of units on hand. In that case, enter the total # of units on hand and do not complete Step 3 Then continue with the next latest until all LIFO units are accounted for Multiply the unit price of beginning inventory times LIFO units on hand and repeat as necessary Add the LIFO costs of all entries to determine the LIFO cost of total # of units in ending inventory In the LIFO method, the latest purchases are assumed to be sold first ending inventory consists of the units purchased the earliest and the earliest purchase invoice costs are used to value the ending inventory Latest = most recent and Earliest = furthest back Weighted-average inventory costing method: using the average cost of beginning inventory plus merchandise purchased during a fiscal period to calculate the cost of merchandise sold. Costing Inventory using the weighted-average method
Calculate the total cost of beginning inventory and each purchase by multiplying the units by each unit price Calculate the weighted-average price per unit by dividing total cost by the # of units available Calculate the cost of ending inventory by multiplying the weightedaverage price per unit by the units in ending inventory Cost of ending inventory determined using any of the three inventory costing methods can be used to calculate the cost of merchandise sold In period of rising prices Net Income FIFO LIFO Weighted-Average Highest Lowest Intermediate Ending Inventory Cost Highest Lowest Intermediate Cost of Merchandise Lowest Highest Intermediate In period of declining prices FIFO and LIFO switch Same inventory costing method should be used each fiscal period all three are acceptable just need to be consistent in which one you use Section 3 Gross Profit Method of Estimating Inventory: estimating inventory by using the previous year s percentage of gross profit on operations Often used to estimate the cost of ending inventory reported on the monthly financial statements It is less expensive than taking physical inventory or maintaining a perpetual inventory system STEP 1 Beginning Inventory, January 1 (prior period s financial statements) Plus Net purchases for January 1 to January 30 (general ledger) Equals Cost of Merchandise avaible for sale STEP 2 Net Sales for January 1 to January 30 (general ledger) Times Previous year s gross profit percentage (management) Equals Estimated Gross Profit on Operations
STEP 3 Net Sales for January 1 to January 30 Less Estimated gross profit on operations Equals Estimated cost of merchandise sold STEP 4 Cost of Merchandise Available for Sale Less Estimated cost of merchandise sold Equals Estimated Ending Merchandise Inventory When the gross profit method of estimating inventory is used for months other than the first month of a fiscal period, the process is that same with adjustments Net Sales and purchases amounts the previous month s ending balance is subtracted from the current month s ending balance to calculate sales/purchases for that month Beginning Inventory is the previous month s ending inventory both are estimated amounts