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Accounting

ACCOUNTING FOR INVENTORIES


We have studied the accounting cycle for organizations that render services to their
customers. Merchandising companies in contrast, earn their revenue by selling goods.
The goods that the merchandising companies sell to its customers are called inventory
(or merchandise). Thus, the inventory of an automobile dealership consists of
automobiles and trucks offered for sale, whereas the inventory of a grocery store consists
of a wide variety of food items. In most cases, inventory is a relatively “liquid” asset- that
is; it usually will be sold within a few weeks or months. For this reason, the asset
inventory appears near the top of the balance sheet, immediately below account
receivable.

THE OPERATING CYCLE OF THE


MERCHANDISING COMPANY
The series of transactions through which a business generates its revenue and its cash
receipts from customers is called the operating cycle. The operating cycle of the
merchandising company consists of the following basic transactions:
1. Purchases of merchandise.
2. Sales of the merchandise, often on account.
3. Collection of the account receivables from customers.
As the word cycle suggests, this sequence of transactions repeat continuously. Some of
the cash collected from the customer is used to purchase more merchandise, and a cycle
begins a new.

3.Collection of the receivables 1. Purchase of merchandise


Cash

Account
Inventory
Receivables 2.Sale of merchandise on account
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Accounting

APPROACHES USED IN ACCOUNTING FOR


MERCHANDISING TRANSACTIONS
Either of two approaches may be used in accounting for merchandising transactions:
1. Perpetual inventory system
2. Periodic inventory system
In past decades, both systems were in widespread use. Today, however, most large
businesses (and many smaller ones) use perpetual systems. Periodic systems are used
primarily in small businesses with manual accounting systems.

PERPETUAL INVENTORY SYSTEMS


In a perpetual accounting system, merchandising transactions are recorded as they occur.
The system draws its name from the fact that the accounting records are kept perpetually
up to date. Purchases of merchandise are recorded by debiting an asset account entitled
inventory. When merchandise is sold, two entries are necessary: one to recognize the
revenue earned and the second to recognize the related cost of goods sold. This second
entry also reduces the balance of the inventory account to reflect the sale of some of the
company’s inventory.
A perpetual inventory system includes an inventory subsidiary ledger. This ledger
provides company personnel with up to date information about each type of product that
that the company sells, including the per unit cost and the number of units purchased,
sold and the currently on hand.
To illustrate the perpetual inventory system, we will follow specific items of merchandise
through the operating cycle. The sample transactions comprising following entries:

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Accounting

PURCHASES OF MERCHANDISE
(INVENTORY)
Purchases of inventory are recorded at cost.
Inventory ****
Account Payable ****
The data contained in this entry are posted to general ledger and also to the inventory
subsidiary ledger.

SALE OF INVENTORY
The revenue earned in the sale transaction is equal to the sale price of the inventory and is
credited to a revenue account entitled sales.
Account receivable ****
Sales ****
The matching principle requires that revenue be matched (offset) with all of the cost and
the expenses incurred in producing that revenue. Therefore, a second journal entry is
required at the date of sale to record the cost of goods sold.
Cost of goods sold ****
Inventory ****
This entry will be based upon the cost of the merchandise.

PAYMENT OF ACCOUNT PAYABLE TO SUPPLIERS


The payment to supplier is recorded as follows:
Account payable ****
Cash ****
Both portions of this entry are posted to the general ledger.

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Accounting

COLLECTION OF ACCOUNT RECEIVABLESFROM


CUSTOMERS
The entry to record the collection of account receivables is as follows:
Cash ****
Account receivable ****

Both portions of this entry are posted to the general ledger.

THE INVENTORY SUBSIDIARY LEDGER


An inventory subsidiary ledger includes a separate account (or “Inventory card”) for
each type of product in the company’s inventory. A sample inventory subsidiary ledger is
as follows:

Item …………………... Primary Supplier ……………………..


Description ……………….. Secondary Supplier ……………………
Location …………………. Inventory level: Min …… Max …….

Date Purchased Sold Balance


U UC T U UC CGS U UC T

Where,

U=Units UC=Unit Cost T=Total CGS=Cost Of Goods Sold

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Accounting

PERIODIC INVENTORY SYSTEM


A periodic inventory system is an alternative to a perpetual inventory system. In a
periodic inventory system no effort is made to keep up to date records of either the
inventory or the cost of goods sold. Instead, these amounts are determined only
“periodically”—usually at the end of each year.

OPERATION OF A PERIODIC INVENTORY


SYSTEM
A traditional inventory system operates as follows. When merchandise is purchased, its
cost is debited to an account entitled purchases, rather than to an inventory account.
When merchandise is sold, an entry is made to recognize the sales revenue, but no entry
is made to recognize the cost of goods sold or to reduce the balance of the inventory
account. As the inventory account is not updated as the transaction occurs, there is no
inventory subsidiary ledger.
The foundation of the periodic inventory system is the taking of complete physical
inventory at year-end. This physical count determines the amount of inventory appearing
in the balance sheet. The cost of goods sold for the entire year then is determined by a
short computation.

PURCHASES OF MERCHANDISE (INVENTORY)


Purchases of merchandise under periodic inventory system is as follows:
Purchases ****
Account Payable ****
This entry was posted to purchases and account payable accounts in the general ledger.
The debit to purchases was not “double posted” as there is no inventory subsidiary ledger
in a periodic system.

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Accounting

NOTE Accounting for sale transactions is the same under perpetual and periodic
inventory system, with one notable exception. In a periodic inventory system, no entries
are made transferring costs from the inventory account to the cost of goods sold account.

COMPUTING TE COST OF THE GOODS SOLD


The computation of the cost of the goods sold under periodic inventory system can be
calculated as follows:
Inventory (beginning of the year) ****
Add: Purchases ****
--------------------------
Cost of goods available for sale ****
Less: Inventory (end of the year) ****
-----------------------------
Cost of goods sold ****

SELECTING AN INVENTORY SYSTEM


Accountants and business managers often must select an inventory system appropriate for
a particular situation. Some of the factors usually considered in these decisions are listed
on the next page.

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Accounting

Factors suggesting a perpetual Factors suggesting a periodic


Inventory system Inventory system

1) Large company with professional Small company, run by owner.


management.
2)Management and employees want information . Accounting records of inventories and
about items in inventory and the quantities in specific product sales are not needed in

which specific products are selling. daily operations. Such information is


developed primarily for use in annual

3)Items in inventory have a high per unit cost. income tax returns

Inventory consists of many different


4)Low volumes of sales transactions or a kinds of low cost items.
computerized accounting system.
High volumes of sales transactions and a
manual accounting system. Lack of full

5)Merchandise store in multiple locations or in time accounting personnel.

warehouses separate from the sales sites


All merchandise stored at the sales site
i.e in the store.

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Accounting

CASE STUDY

ALHAMRA PUBLISHING COMPANY


Alhamra Publishing company- based in Islamabad, Pakistan -
publishes and distributes quality books in English and Urdu in various
domains: fiction, poetry, literary criticism, non-fiction, languages,
history, education, religion, children's books, magazines etc. They also
publish Urdu literature in English translation, and foreign literature in
Urdu translation. Classics of Urdu literature, which are out-of-print, are
also published using modern technology. In order to facilitate reading
of classic literature, many of their titles include meanings of difficult
words, which are provided at the bottom of the page as footnotes or in
the form of a glossary at the end of the book. Among their most
important series are:

• Alhamra Afsana Series (Urdu Short Story Series)


• Alhamra Zinda Adab Series (Urdu Living Literature Series)
• Alhamra Shairi Silsila (Urdu Poetry Series)
• Alhamra Junior Series (Children’s Classics in English)
• Alhamra Bilingual Series (Urdu-English; Persian-Urdu, etc.)
• Alhamra International Bestsellers Series ( in English, and in Urdu
translation)
• Alhamra World Classics Series

MISSION
To provide the different kinds literately material to literately
person as per demand of the public.

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Accounting

Perpetual Inventory System of Alhamra


Alhamra Publishing company purchased books on account with invoice
price of 10,000; terms 2/10, n/30 (net cost 9,800), paid in bound
freight charges of 60.Returned to supplier some of these books with
invoice price of 1,000 (net cost 980) due to the defects in some books.
The company has paid the whole amount within the discount period.
Alhamra publishing company also sold some books costing 6,600 on
account for 11,000; terms 2/10, net/30. Customer returned for full
credit books with a sales price of 1,000 and a cost of 600. The
company has collected the whole amount within the discount period.
The company was using perpetual inventory system due to the
wide setup over the country.
Recording of these transactions are as under:

General Journal
Date Account Title And Description Debit Credit
10 Jan Inventory 9,800
Account Payable 9,800
Received books (10,000 * 0.98)

10 Jan Transportation-in 60
Cash 60
Paid freight charges on books received

20 Jan Account Payable 980

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Accounting

Inventory 980
Returned books (1,000 * 0.98)

25 Jan Account Payable 8,820


Cash 8,820
Paid amount within the discount period
(9,800 - 980)

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11 Mar Account Receivable 11,000


Sales 11,000
Sold books on account

11 Mar Cost Of Goods Sold 6,600


Inventory 6,600
To record the cost of the books sold

18 Mar Sales Return And Allowances 1,000


Account Receivable 1,000
Customer returned books sold for 1,000

18 Mar Inventory 600


Cost Of Goods Sold 600
To record the cost of the sales return

28 Mar Cash 9,800


Sales Discount 200
Account Receivable
10,000
Collected amount within the discount period

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Accounting

Merits & Demerits

Merits
• Publish all types of books like novels, study books, poetry books,
magazines etc.
• It has copy rights for any published book or magazine and any
research book.
• Company has complete network for distribution of their books,
magazines.
• Registered under the act of Government of Pakistan.
• Good working capital for operation of the organization.

Demerits
• No proper system for inventory management.
• No computerized system for controlling and maintaining inventory.
• It has good resources but no proper management of resources.
• No proper price list.
• Company is not using promotional tools.

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Conclusion
Alhamra Publishing Company maintaining a heavy inventory of
different books. But in the era of information technology, there is
no computerized system. The company is maintaining their
accounts manually which creates lot of problems for customers, as
well as workers. Even then the search of the book or availability of
the book can not be pin pointed. Company is providing quality
literary material to the common person.

Recommendations
• The company must establish their own outlets for selling of
their product.
• Price and quality should be reasonable.
• Inventory management system should be computerized.
• Computerized database system should be design for keeping
record of all types of publication.
• Price list should be managed properly.

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