ACCOUNTING

Financial and Organisational

Decision Making

Chapter 5
Inventory transactions
Slides written and designed by
Tony Van Eekelen

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book 5.1
Co. Aust.
 Chapter 5: Inventory transactions

Learning Objectives
• In this chapter you will be introduced to
– the difference between the measurement and
reporting of profit for service and
merchandising organisations
– accounting for inventory using the perpetual
system
– accounting for the periodic system

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.2
 Chapter 5: Inventory transactions

Learning Objectives
– the difference between
the perpetual and periodic
methods of recording
inventory
– the preparation of closing
entries under the
perpetual and periodic
systems

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.3
 Chapter 5: Inventory transactions

Learning Objectives
– a comparison of the profit and loss statement
for a merchandising organisation under the
perpetual and periodic systems

– the effects of errors in inventory valuation on

the reported profit

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.4
 Chapter 5: Inventory transactions

Profit measurement: merchandiser and

service enterprises
• Merchandiser buys inventory to resell it at a
profit
– inventory = stock, merchandise
• Merchandisers trade at both retail and
wholesale levels
• Profit determination now includes the
revenue and expenses associated with the
merchandise
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.5
 Chapter 5: Inventory transactions

Comparison
Service Merchandiser
Profit and loss statement for the period Profit and loss statement for the period
ended XX ended XX
Service revenue Sales revenue
less sales returns
Net sales
Less cost of goods sold
Gross profit
Less expenses Less expenses
Net profit Net Profit
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.6
 Chapter 5: Inventory transactions

Comparison
• Revenue is sales revenue not services
revenue
• Reduction in sales for sales returns
• Cost of goods sold is all the costs associated
with the sale of inventory
• Gross profit is the price margin on the
merchandise sold
• Expenses for both would be similar
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.7
 Chapter 5: Inventory transactions

Importance of inventory
• dependent upon the type of firm – inventory
is a major current asset
• eg Retail
– Coles Myer Ltd 37.7%
– Woolworths 41.8%
• Service
– Boral Ltd 8.6%
– Qantas Airways Ltd 1.5%
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.8
 Chapter 5: Inventory transactions

Recording systems
• Two major recording systems
– perpetual
– periodic

• Type used will depend upon the type of

organisation and the characteristics of the
merchandise

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.9
 Chapter 5: Inventory transactions

Perpetual inventory system

• Known as the asset approach to recording
inventory
• All merchandise is recorded as an asset
• When sold the asset is decreased and the
expense increased
• All stock transactions are recorded and at
any time stock levels can be determined
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.10
 Chapter 5: Inventory transactions

Perpetual system
• Discrepancies between actual levels and
recorded levels maybe due to theft, spoilage
or clerical errors

• Discrepancies can be determined by

comparison between a stock take (physical
count of stock) and the records

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.11
 Chapter 5: Inventory transactions

Entries for perpetual system

• As all transactions are recorded under this
system, then both prices, cost and selling,
need to be recorded

• Purchase of merchandise
– Dr. Inventory Cost price
– Cr. Cash/Accounts Payable Cost Price

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.12
 Chapter 5: Inventory transactions

Entries for perpetual system

• Return of merchandise to supplier
– Dr. Accounts payable/Cash Cost price
– Cr. Inventory Cost price
– purchase return

• Sale of merchandise
– Dr. Cash/accounts receivable Selling Price
– Cr. Sales revenue Selling price

– Dr. Cost of goods sold Cost price

– Cr. Inventory Cost price
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.13
 Chapter 5: Inventory transactions

Entries for perpetual system

• Return by customer
– Dr. Sales Returns Selling price
– Cr. Accounts Receivable Selling price

– Dr. Inventory* Cost price

– Cr. Cost of goods sold Cost price

* Maybe inventory damage losses if stock returned is

damaged
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.14
 Chapter 5: Inventory transactions

Entries for perpetual system

• Stock count and stock loss
– Dr. Stock loss Cost price
– Cr. Inventory Cost Price

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.15
 Chapter 5: Inventory transactions

Financial statement
Profit and loss statement
Sales XXX
Less sales returns XX
Net sales XXX
Less cost of goods sold XX
Gross Profit XXX
Less expenses XX
Net profit XX

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.16
 Chapter 5: Inventory transactions

Periodic inventory system

• Perpetual is best for a firm which has stock
that is easily identifiable, high value and
slow turnover.

• If the stock is low value, high-turnover, the

benefits of the perpetual system would be
outweighed by the administrative cost.

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.17
 Chapter 5: Inventory transactions

Periodic inventory system

• The periodic system has a simpler approach
in that only records purchases during the
period and a stock count is conducted at the
end of the period.

• Any stock not accounted for at the end of

the period is assumed to be sold.

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.18
 Chapter 5: Inventory transactions

Periodic inventory system

• This approach is known as the expense
method
• New stock is entered into the purchases
account
• Any stock remaining at the end of the
period is made into an asset

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.19
 Chapter 5: Inventory transactions

Cost of goods sold determination

Cost of goods sold =

Inventory at beginning of period
add purchases
less purchase returns
= stock available for resale
less stock at end of period
= cost of goods sold
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.20
 Chapter 5: Inventory transactions

Entries for periodic system

• Purchase of stock from supplier
– Dr Purchases Cost price
– Cr. Accounts Payable Cost price

• Return stock to supplier

– Dr Accounts Payable Cost Price
– Cr. Purchase returns Cost Price

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.21
 Chapter 5: Inventory transactions

Entries for periodic system

• Sale of stock
– Dr Cash/accounts receivable Selling Price
– Cr. Sales Selling Price
– (Note no entry for cost price)
• Return by customer
– Dr Sales Returns Selling Price
– Cr. Accounts Receivable Selling Price
• No entry for stock count - (closing entry)
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.22
 Chapter 5: Inventory transactions

Financial statement
Sales revenue xxx
Less sales returns xx
Cost of goods sold
Inventory at beginning xx
Purchase xx
Freight Inwards x xx
less Purchase returns x
Net purchases xx
Cost of goods available for sale xxx
less inventory at end xx
cost of goods sold xxx
Gross profit xx
Less expenses xx
Net profit x

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.23
 Chapter 5: Inventory transactions

Difference between systems

• Stock loss available under perpetual
• Periodic less time consuming
• Both give the same net profit
• More detail in the periodic profit and loss
statement

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.24
 Chapter 5: Inventory transactions

Closing entries for merchandisers

• In both systems revenue and expense

accounts are closed to the profit and loss
summary account
• Periodic has one extra entry and this is the
stock at end figure which needs to be
entered into the profit and loss account and
the inventory account for the balance sheet

PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.25
 Chapter 5: Inventory transactions

Closing entries
• This entry would be
– Dr. Inventory
– Cr. Profit and loss summary account
(the amount would be the valuation of the stock
as per the stock take)
The closing of the profit and loss to the capital
account would be the same as for a service
firm.
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.26
 Chapter 5: Inventory transactions

Summary
• Merchandise accounting is more complex
than service accounting
• Two methods of recording stock
– perpetual
• continuous method of recording each transaction
– physical
• based upon stock counts
• Closing entries similar to service firm
PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. 5.27