Week 6 - Accounting for inventory and credit loss/ bad debts - FINISH

Question 1

What are the problems bookkeeping inventories?

Answer 1

Because the double entry bookkeeping system records:
1. The costs of buying and producing our products
2. The sales revenue from selling these products

Also doesnt usually record flows of inventory or how much inventory we have at any point in time

As the unit purchase price ≠ unit selling price, we cant infer flows or stocks of inventory from the difference between total cost of purchases and total sales revenue

Question 2

What is an expense?

Answer 2

costs consumed in delivering goods/ services to customers

Question 3

What is the matching part of the accruals concept?

Answer 3

all expenses must be matched against the revenue (or income) earned in an accounting period

Question 4

What do the costs of buying/ manufacturing a product have to be recognised as?

Answer 4

an expense in the income statement in the year in which the product is sold

Question 5

What do the costs of buying/ manufacturing a product which havent yet been sold recognised as?

Answer 5

are not treated as expenses until the products are sold

these products are assets (until they are sold), so shown in the balance sheet as current assets: inventory

Question 6

What is the closing inventory equation?

Answer 6

Closing inventory = Opening inventory + Purchases - Cost of Sales

Question 7

What is cost of sales also called and used to calculate?

Answer 7

Cost of Goods sold, and used to calculate gross profit in I/S

Question 8

Which financial statement does closing inventory go in?

Answer 8

the Balance sheet at the end of the year

Question 9

What is the trading account?

Answer 9

In the statement of profit/ loss for the year ended
The Less: Cost of sales
- Inventory at the start of the year
- Purchases of goods for resale
- Less: Inventory at the end of the year

(usually smaller companys or sole traders)

Question 10

Example
Dora Ltd sell foam pillows
1st April 2019, they have opening inventory of 2,200 pillows which cost £3 each
They purchase a further 4,500 pillows at an an average cost of £3.50 during the year, and sell at their opening inventory plus some of their purchases leaving the with 1,800 pillows on 31st March 2020.

How much is the cost of goods sold (cost of sales) for year ended 31st March 2020?

Answer 10

2,200 pillows x £3 = £6,600 cost of opening inventory (asset at 1st April 2019)

+ purchases during the year 4,500 pillows x £3.50 = £15,750

• cost of pillows not sold by 31st March 2020 1,800 x £3.50 = (£6,300)

= Total cost of goods that have been sold during the year £16,050

Question 11

How do you calculate the cost of sales using journals?

Answer 11

From an initial Trial Balance with last year’s closing inventory (this years opening inventory) and purchases of goods for sale recorded. Adjusts inventory at the end of the period and allows the calculate of the cost of sales

Question 12

How do you calculate costs of sales using journals (in terms of debit and credit)?

Answer 12

Debit: Cost of Sales XXX
Credit: Inventory (opening inventory) XXX
(remove opening inventory to cost of sales)

Debit: Cost of sales XXX
Credit: Purchases XXX
(purchases during the year for sales are removed (credited) from the purchases account and added to cost of sales)

Debit: Inventory (closing inventory) XXX
Credit: Cost of sales XXX
(closing inventory has been counted and the value is now included in inventory but removed from cost of sales as it is not sold

Question 13

What is the impact of these journals to figure out cost of sales?

Answer 13

impact of these journals is to include all purchases in cost of sales except those not sold (closing inventory) and to remove opening inventory from the trial balance and replace it with closing inventory
(reflects a periodic inventory system)

Question 14

Example - Inventory adjustment journals

You are the accountant for KwikSell - a chair retailer which has a periodic inventory system. As part of the year end adjustments for the year end 31st October 2020, you are given the following information from the initial trial balance (opening inventory and purchases) and an inventory count (closing inventory)

Inventory per initial trial balance (as at 1st November 2019) £60,000

Purchases of goods for resale in year to 31st October 2020 £550,000

Unsold chairs at year end 31st October 2020 £75,000

Calculate the cost of sales for the statement of profit and loss and show the journals required to adjust the initial trial balance to produce the required numbers for the financial statements

Answer 14

Use T accounts
Journals

Debit: Cost of sales 60,000
Credit: OB Inventory 60,000

Debit: Cost of sales 550,000
Credit: Purchases 550,000

Debit: CB Inventory 75,000
Credit: Cost of sales 75,000

T Account for Cost of Sales
Debit:
OB Inventory 60,000
Purchase 550,000
/ 610,000
Credit:
CB Inventory 75,000
I/S 535,000
/ 610,000

Cost of sales to I/S
Closing balance of inventory to B/S

Explanation: Cost of sales is an expense account which is increased by debits (opening inventory and purchases) and reduced by credits (closing inventory). Closing inventory hasnt been sold so is removed for the cost of sales account because of the matching principle

OR directly work out
Cost of Sales = Opening Inventory + Purchases - Closing Inventory
= 60,000 + 550,000 - 75,000
= 535,000

Question 15

How do we record closing inventory since it is not part of the double entry bookkeeping system?

Answer 15

So we need a separate system to record and value inventory

and record the number of each item of inventory

Question 16

What are the different elements of inventory?

Answer 16

Raw materials
Work-in-progress
Finished goods

Question 17

What are two ways to record the number of each item of inventory?

Answer 17

1. a periodic count
2. a perpetual inventory control system

Question 18

What is a periodic count?

Answer 18

physical count at the end of an accounting period

eg car dealers selling cars

Question 19

What is a perpetual inventory control system?

Answer 19

a computerised recording of all deliveries and usage of each item

Question 20

How is cost of sales recorded in a perpetual inventory system?

Answer 20

in a perpetual inventory system, inventory is recorded as it is bought and as it is sold. This means at the year end, there is a record of all inventory sold during the year and what it originally cost, so cost of sales is calculated by the accounting system automatically

Question 21

What does the initial trial balance only show?

Answer 21

the opening inventory and purchase figure

not cost of sales and closing inventory

Question 22

What will also take place in a perpetual inventory system?

Answer 22

a physical inventory count to check whether he system is recording inventory accurately and to confirm that no theft has taken place (by checking whether the amount of inventory agrees with the inventory in the system)

Question 23

What are the 3 inventory cost flow assumptions?

Answer 23

1. the purchase price may vary over time
2. where possible, the specific cost of a unit of inventory that has been sold should be used (this isnt always possible)
3. in these cases, the company knows the quantity of inventory but not how much each individual item within the inventory cost

Question 24

Why may the purchase price vary over time?

Answer 24

the cost of the same product or raw material purchased at different points of time could be different

Question 25

Why is the specific cost of a unit of inventory that has been sold should be used not always possible

Answer 25

if there isnt a reliable record of each individual item purchased and sold and where costs have varied over the period

fungible inventory refers to idnetical goods where it is not possible to identify the particular batch(es) of purchases in inventory. Items are interchangeable. Examples include high volume, low price items such as goods sold in grocery stores

Question 26

When do entities need to make assumptions about the cost of goods in inventory?

Answer 26

if we cannot trace the specific cost or purchase price of these goods

Question 27

What are the 3 assumptions about the cost of goods in inventory?

Answer 27

1. first in, first out (FIFO)
2. last in, first out (LIFO)
3. weighted average cost (AVCO)

Question 28

What is the first in, first out method (FIFO)?

Answer 28

goods sold (or raw materials used) are assumed to be those which have been in inventory for the longest time

think of this physically as a line where new items are delivered to one end of the line while items sold are taken from the other end of the line

first (oldest) inventory is first to be used, as a result closing inventory will be valued at the cost of the most recent purchases. this assumption is the most commonly used

Question 29

What is the last in, first out method (LIFO)?

Answer 29

goods sold (or raw materials used) are assumed to be those which have been in inventory for the shortest time

closing inventory will consist of the oldest purchases

this of this physically as inventory in stacks on the floor, where new items are added to the top of the stack and items sold are taken from the top of the stack

this may reflect the physical movement of goods in some circumstances (eg coal, iron ore, sand and gravel stored in piles)

Question 30

What two places dont allow the last in, first out method (LIFO)?

Answer 30

IAS 2 or by UK tax auhorities

in times of rising prices, LIFO will lead to a lower inventory valuation than FIFO

Question 31

What is the weighed average method (AVCO)?

Answer 31

goods sold (or materials used) are assumed to consist of a mixture of each batch of purchases (or production)

Question 32

When does weighted average method occur (AVCO)?

Answer 32

where goods are stored together in a single container

eg nuts and bolts stored in bins; liquids and granular substances stored in tanks

also be justified where prices are fluctuating on the grounds that it will give a more representative ‘normal’ price, and thus more comparable cost of sales figure

Question 33

Who is the weighted average method (AVCO) allowed by?

Answer 33

IAS 2

Question 34

Inventory flow assumption example: Last in, first out (FIFO)
1st April 2019 - Opening inventory - 100 units - £8
1st Sept 2019 - Purchases - 60 units - £9
1st Dec 2019 - Sales - 110 units - £15
1st Feb 2020 - Purchases - 80 units - £10
1st March - Sales - 90 - £15

Answer 34

Date - Movement -> Cost of goods sold -> Inventory -> Calc.
1st April 2019 -> Opening -> X -> 100 x £8 -> £800

1st Sept 2019 - In: buy 60 at £9 >- X -> 60 x £9 -> £540
Total (in calc) 160
Calc. £1340

1st Dec 2019 -> Out 110 sold at £15 -> 100 x £8 = £800, 10 x £9 = £90
110 goods £890 -> 50 x £9 (50 because 160-110) -> £450

1st Feb 2020 -> In: buy 80 at £10 -> X -> 80 x £10 ->£800
Total (Inventory) 130
Calc. £1,250

1st March 2020 -> Out 90 sold at £15 -> 50 x £9 = £450, 40 x £10 = £400
90 goods £850 -> 40 x £10 (40 because 130-90) -> £400

Cost of goods sold = £880 + £850 = £1,740
Closing Inventory = £400

Question 35

Inventory flow assumption example: Weighted average cost (AVCO)
1st April 2019 - Opening inventory - 100 units - £8
1st Sept 2019 - Purchases - 60 units - £9
1st Dec 2019 - Sales - 110 units - £15
1st Feb 2020 - Purchases - 80 units - £10
1st March 2020 - Sales - 90 - £15

Answer 35

Date -> Movement -> Cost of goods sold -> Calculation -> Inventory
1st April 2019 -> Opening -> X -> 100 x £8 - £800
1st Sept 2019 -> In: buy 60 at £9 -> X -> 60 x £9 -> £540
Total (in calculation) 160
1340/160 = £8.375
Inventory £1340

1st Dec 2019 - Out 110 sold at £15 - 110 x £8.375 = £921 -> 50 x £8.375 (50 because 160 - 110) -> £419

1st Feb 2020 -> In: buy 80 at £10 -> X -> 80 x £10 -> £800
Total (in calculation) 130
1219/ 130 = £9.377
Inventory - £1219

1st March 2020 -> Out 90 sold at £15 -> 90 x £9.377 =£844, 40 x £9.377 (40 because 130-90) - £375

Cost of good sold = £921 +£844 = £1765
Closing Inventory = £375

Question 36

What is the difference in comparison of COGS and CB inventory under three methods when purchase price is increasing:

Answer 36

when purchase price is increasing (from £8 to £9, then £10):
FIFO: COGS £1740, Closing Inventory £400
Weighted Average