Inventory

Inventory is the term for the goods available for sale and raw materials
produce goods available for sale. Inventory represents one of the most asset of
a business because the turnover of inventory represents one of the primary sources
of revenue generation and subsequent earnings for the company's shareholders.

Understanding Inventory
Inventory is the array of finished goods or goods used in production held
by a company. Inventory is classified as a current asset on a company's balance
sheet and it serves as a buffer between manufacturing and order fulfillment.
When an inventory item is sold, its carrying cost transfers to the cost of goods sold
category on the income statement.

Inventory can be valued in three ways. The first-in, first-out (FIFO) method
says that the cost of goods sold is based on the cost of the earliest purchased
materials, while the carrying cost of remaining inventory is based on the cost of
the latest purchased materials. The last-in, first-out (LIFO) method states that the
cost of goods sold is valued using the cost of the latest purchased materials, while
the value of the remaining inventory is based on the earliest purchased materials.
The weighted average method requires valuing both inventory and the cost of
goods sold based on the average cost of all materials bought during the period.

Types of Inventory
Inventory is generally categorized as raw materials, work-in-progress, and
finished goods.  Raw materials are unprocessed materials used to produce a good
Examples of raw materials include aluminum and steel for the manufacture of cars,
flour for bakeries production of bread, and crude oil held by refineries.

Work-in-progress inventory is the partially finished goods waiting for

completion and resale; work-in-progress inventory is otherwise known as inventory
on the production floor. For example, a half-assembled airliner or a partially
completed yacht would be work-in-process.

Finished goods are products that have completed production and are
ready for sale. Retailers typically refer to this inventory as "merchandise.” Common
examples of merchandise include electronics, clothes, and cars held by retailers.
Perpetual Inventory System

Concept
Detailed records are maintained for the purchase cost and sale of every item in
inventory.

All purchases and sales are updated to the general ledger’s Inventory Account as
they occur to provide a running balance of quantity and cost of items.

Whenever a physical count exercise took place, the discrepancies are adjusted
accordingly

Functionality
Cost of goods sold account and balance exist at general ledger level at all times

Inventory account is used to record :

o purchase transactions
o purchase return transactions

Cost of goods sold is directly recorded in cost of goods sold account and inventory
is also directly reduced when a sale is entered

Returns from customers are recorded by reducing the cost of goods sold and
adding back into inventory

Accounting treatment
Scenarios Debit Credit
You purchase inventory Inventory Account A/P – [Supplier]
from supplier GST Recoverable
Freight-in

You return inventory to Debit Credit

supplier A/P – [Supplier] Inventory Account
GST Recoverable

You sell inventory to Debit Credit

customer A/R – [Customer] Sales
Cost of Goods Sold GST Payable
PST Payable (if to end user)
Inventory Account
Shipping (Payable or Revenue)
You get inventory Debit Credit
returned from customer Sales (or Sales Return) A/R – [Customer]
GST Payable Cost of Goods Sold
PST Payable
Inventory Account

You Pay your supplier Debit Credit

A/P – [Supplier] Cash / Bank
Purchase Discount (if paid within
the discount period)

Your customer pays you Debit Credit

Cash / Bank A/R – [Customer]
Sales Discount (if paid
within the discount
period)

Print Financial ✅ the balance in Inventory Account is the Closing Stock

Statements Value

❌ not require to run stock valuation

❌ not require to pass journal for closing stock

Examples:
1. Purchase of Inventory on Account, 100,000
Debit Credit
Inventory 100,000
Accounts Payable 100,000

2. Payment of Freight on Purchases, 10,000

Inventory 10,000
Cash in Bank 10,000

3. Return of goods purchased to supplier, 5,000

Accounts Payable 5,000

Inventory 5,000
4. Sale of inventory on Account for 100,000. Gross profit on selling price is 20%.

Accounts Receivable 100,000

Sales 100,000

Cost of Goods Sold (100,000*80%) 80,000

Inventory 80,000

5. Goods sold for 10,000 was returned by a customer. Gross profit on selling price is
20%.

Sales Return 10,000

Accounts Receivable 10,000

Inventory 8,000
Cost of Goods Sold (10,000*80%) 8,000

6. Physical count of Inventory at the end of period, 35,000. Beginning inventory is

2000

No adjusting entry required. The balace of the inventory account

represents the ending inventory account. Adjusting entry will be made only when
there is a discrepancy between the count and the balance per records.

Inventory
Beg. Balance 2,000
Purchases 100,000 5,000 Purchase Returns
Freight-in 10,000 80,000 COGS
Sales Returns 8,000
35,000

Cost of Goods Sold

COGS 80,000 8,000 Sales Returns

End balace 72,000

Periodic Inventory

Concept
Detailed records are not kept for each item in inventory.

At the end of an accounting period, the ending-inventory is determined by an

actual (physical) count of every item and its cost is computed by using the set
costing method – Standard, FIFO or Average.

This amount is subtracted from the sum of purchases ( or cost of goods

manufactured) and the beginning inventory of the new accounting period to
arrive at the cost of goods sold

Functionality
Inventory and cost of goods sold are nonexistence until the stock valuation run or
or physical count at the end of the period/year

Purchases account is used to record :

o purchase transactions
o purchase return transactions

Cost of goods sold is a calculated value derived from

opening stock + purchases – closing stock in the Profit & Loss report

Returns from customers will not have any inventory entries

Accounting treatment
Scenarios Debit Credit
You purchase inventory Purchases A/P – [Supplier]
from supplier GST Recoverable
Freight-in

You return inventory to Debit Credit

supplier A/P – [Supplier] Purchases (for purchase return)
GST Recoverable

You sell inventory to Debit Credit

customer A/R – [Customer] Sales
GST Payable
PST Payable (if to end user)
Shipping (Payable or Revenue)
You get inventory Debit Credit
returned from customer Sales (or Sales Return) A/R – [Customer]
GST Payable
PST Payable

You Pay your supplier Debit Credit

A/P – [Supplier] Cash / Bank
Purchase Discount (if paid within
the discount period)

Your customer pays you Debit Credit

Cash / Bank A/R – [Customer]
Sales Discount (if paid
within the discount
period)

Print Financial ❌ the balance in Inventory Account is the Closing Stock

Statements Value

✅ not require to run stock valuation

✅ not require to pass journal for closing stock

Examples:
1. Purchase of Inventory on Account, 100,000
Debit Credit
Purchases 100,000
Accounts Payable 100,000

2. Payment of Freight on Purchases, 10,000

Freight-in 10,000
Cash in Bank 10,000

3. Return of goods purchased to supplier, 5,000

Accounts Payable 5,000

Purchase Returns 5,000
4. Sale of inventory on Account for 100,000. Gross profit on selling price is 20%.

Accounts Receivable 100,000

Sales 100,000

5. Goods sold for 10,000 was returned by a customer. Gross profit on selling price is
20%.

Sales Return 10,000

Accounts Receivable 10,000

6. Physical count of Inventory at the end of period, 35,000. Beginning inventory is

2,000

Income Summary 2,000

Inventory Beg. 2,000
to close the beginning balance of the inventory

Income Summary 105,000

Purchase Returns 5,000
Purchases 100,000
Freight-in 10,000
to close nominal accounts

Inventory - end. 35,000

Income Summary 35,000
to adjust the balance of the inventory

The net balance of the income summary account of 72,000 (2,000 +105,000 -35,000)
represents the cost of goods sold.
First-in-first-out (FIFO) Method

First-in-first-out (FIFO) Inventory is valued at the most recent ‘cost’, since the cost
of oldest inventory is charged out first, whether or not this accords with the actual
physical flow.

The FIFO cost formua assumes that the items of inventory that were purchased or
produced first are sold first and, consequently, the items remaining in inventory at
the end of the reporting period are those most recently purchased or produced.

Under FIFO cost of goods sold represents cost from earlier purchases while cost of
ending inventory represents cost from earlier purchases. Therefore FIFO results to
the highest income in period of inflation or rising of prices and the lowest income in
period of depflation or declining prices

Example:
ABC Co. is a wholesaler of guitar picks. The activity for product "Pick X" during
August is shown below:

Date Transaction Units Unit Cost Total Cost

1-Aug Inventory 2,000 36.00 72,000
7-Aug Purchase 3,000 37.2 111,600
12-Aug Sales 4,200
13-Aug Sales Return 600
21-Aug Purchase 4,800 38.00 182,400
22-Aug Sales 3,800
29-Aug Purchase 1,900 38.60 73,340
30-Aug Purchase Return 300 38.60 (11,580)
Total Goods Available for Sale 427,760

Solution:
FIFO Periodic

Beginning Inventory Units 2,000

Net Purchases in Units (3,000 + 4,800 + 1,900 - 300) 9,400
Total Goods Available for sale in units 11,400

Total Goods Available for sale in units 11,400

Quantity of Goods Sold (4,200 - 600 + 3,800) (7,400)
Ending Inventory in Units 4,000
 Unit
Units Cost Total Cost
Ending Inventory to be allocated 4,000
Allocated as follows:
From Aug. 29 net purchases
(1,900 - 300) (1,600) 38.6 61,760
Bal. to be allocated to the next most 2,400
recent purchase date
From Aug. 21 net purchase (2,400) 38 91,200
Ending Inventory at Cost 152,960

Cost of Goods Sold is then computed as follows: 427,760

Total Goods Availablr for Sale in pesos 152,960
Cost of Goods Sold 274,800

FIFO - Perpetual
Date Transaction Units Unit Cost Total Cost
1-Aug Inventory 2,000 36.00 72,000
7-Aug Purchase 3,000 37.20 111,600
12-Aug Net Sales (4,000 - 600) 3,600
Allocation:
from beg. inventory (2,000) 36.00 (72,000)
from Aug. 7 purchase (1,600) 37.20 (59,520)
21-Aug Purchase 4,800 38.00 182,400
22-Aug Sales 3,800
Allocation:
from Aug. 7 Purchase 37.20 (52,080)
from Aug. 21 purchase 38.00 (91,200)
29-Aug Net Purchases
(1,900 - 300) 1,900 38.60 61,760
Ending Inventory at Cost 152,960

Cost of Goods Sold is derived from the table above as follows:

(72,000 + 59,520 +52,080 + 91,200) = 274, 800