Accounting 3/4 SAC 2 Flashcards
Bad Debts. Recording, Reporting, Valuing and Managing Inventory
Inventory card
a subsidiary accounting record that records each individual transaction involving a particular line of inventory’s movement in and out of a business
Why is inventory counts important? Why is knowing about inventory losses or gains important?
Inventory losses = high theft = review security
Faithful Representation
States we want reports to accurately represent underlying economic events and be accurate/free from error. An inventory account ensures this by ensuring our inventory cards match the inventory we have physically in our store, in order to make sure our reports are accurate.
Inventory Loss - reasons
- theft
- damage/breakages
- undersupply from a supplier, where a supplier has delivered less inventory than has been charged for
- oversupply to a customer, where inventory has been supplied to customers in excess of what they have been charged for
Inventory gain - reasons
oversupply from the supplier from which the business has not bee charged
undersupply to the customer for where the customer has bene charged for inventory not delivered
FIFO pros and cons
- It can be applied to all types of inventory
There will be some occasions when it is not possible, practical or cost effective to use Identified Cost but, in these cases, FIFO can still be used as it does not require individual items of inventory to be marked or labelled.
- It costs less to administer than Identified Cost
FIFO does not require the same investment of time and labour (and therefore money) to label every item of inventory, and then record each code and cost price in the Accounting records. This means lower wages and other administrative costs, and also that staff are able to attend to matters other than inventory costing.
Qualitative characteristics:
As it still uses cost prices that are Verifiable by reference to the source document, FIFO does still provide a Faithful representation of the value of inventory.
However, under FIFO there is no way of knowing if the cost prices allocated at the time of the sale were in fact the same as the price applied at the time of purchase.
This means that, compared with Identified Cost, FIFO will tend to lead to a lower Cost of Sales (and therefore higher profit and higher owner’s equity) and higher value of inventory on hand (assuming prices are rising).
However, if all inventory is sold, it will be the same
Perpetual inventory system
recording inventory transactions in inventory cards, then conducting a physical inventory count at the end of the Period to verify the balances of those inventory cards, in the process detecting any inventory losses or gains
Perpetual inventory system - pros
Identify fast and slow moving lines
Drop slow moving lines
Focus or expand on fast moving lines
(identifies sleep and turnover)
More efficient reordering
can order new inventory when levels are low
Identification of inventory losses or gains
Calculate interim profits can be calculated any time, not just at the time of a stocktake
Perpetual inventory system - cons
Time
We have to record continuously
We have multiple inventory cards
Training
How to use an IC (Identified cost and FIFO)
valuation of inventory
choose the lower of cost price (source documents and product costs) and net realisable value (estimated SP (after damage etc.) -direct selling expenses)
direct selling expenses - (advertising/marketing/complementary products)
the lower of cost and nrv - theory
Faithful representation…
states that reports should faithfully represent the underlying economic events of transactions. Therefore, we must value inventory at the lower of cost and NRV so that we do not overstate that cost price of inventory and accurately represent the future economic benefit we can receive from our inventory.
Going concern…
states that the life of the business is assumed to be continuous and reports should be kept in this manner.
Inventory should be valued at its cost price. It should not be valued at its sales price, which implies the sale will be realised today, but instead we will be able to realise the sale at a future date.
-obsolete
-damaged
-out of season
-superseded
-marketing reasons
discretion and choices in inventory valuation - ethical considerations
Ethical social considerations:
Jeopardises relationships
Stakeholders
Bank
Potential owners
Misleading
Jeopardise relationships
Overstating assets
product vs period cost
was the cost incurred to get the product in a condition or location ready for sale?
no - other expense
can the price be logically allocated to individual units of inventory?
no - period cost
yes to both - product cost
different between product and period cost
if inventory remains unsold or partially sold, allocating a cost as a product cost will result in a higher net profit than a period cost. This is because a product cost will only be recognised as an expense (cost of sales) when sold, whereas a period cost is recognised in full and straight away
Inventory management
- Physically rotating inventory on hand (The older goods should be placed on display so they are sold first).
- Monitoring seasonal products (Towards the end of a season inventory should be run down).
- Monitoring technological obsolescence (It may be unwise to purchase volatile technologies in bulk).
Introducing complementary products - (Improves the chances of selling additional lines of inventory).
- Changing with the times (Managers must always be prepared to change and react to the times I.e.
- The amount and speed of change will be determined by the product and market.)
- Monitoring selling prices (One factor that management might underestimate are selling prices. In particular, by changing the mark-up, a manager can sell inventory more quickly or extract more revenue per sale.
- Ensuring adequate security (Investing in security can decrease theft and fraud).
inventory turnover
ITO = Average Inventory
––––––––––––––––––– x 365
Cost of Goods Sold
Managing accounts receivable
Granting credit to customers - how can a business guarantee they will be paid back?
- Offering discounts to customers (NOT INCREASING DISCOUNT)
- Sending emails to Accounts Receivable.
- Sending regular statements to overdue accounts.
- Threatening/taking legal action.
- Engaging a debt collector.
accounts receivable turnover
ARTO = Average Accounts Receivable
––––––––––––––––––– x 365
Net Credit Sales (Plus GST)
Managing Accounts Payable
Why would a business purchase on credit?
- Gives a business time to sell inventory and turn it into cash.
- Trade credit is basically interest free finance.
strategies to improve APTO
- pay earlier for discount
- pay later to retain more cash
- generate more cash
accounts payable turnover
APTO = Average Accounts Payable
––––––––––––––––––– x 365
Net Credit Purchases (Plus GST)
Bad debt theory
Verifiability: adjustments an estimate, estimating adjustment for bad debts
Relevance : enhances decision making
Faithful rep: more accurate representation of economic benefit
Understandability: formatting the BS, makes it easier to understand, connecting the two numbers
Period assumption:
Matching the revenue and expense for a particular period of time
Balance reflects amount unlikely to be recurred in a future period
Accrual basis: - BDA’s
Revenues earned vs. expenses incurred
We must match and estimate bad debts expense we will incur from a given period’s credit sales (we want to match revenues earned against expenses incurred)
Examples of useful non-financial information
Relationship with customers
Quality of inventory
Relationship with suppliers
Relationship with employees
State of the economy
