ACCT5013 M5 Lecture

ACCT 5013 Intermediate Financial Accounting
Lecture – Module 5
Reporting and Analysing Inventory

Introduction to Accounting Information Systems
Curtin University | Accounting Discipline 1

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Part of this material has been derived or modified from Wiley’s instructor
materials and resources accompanying the adopted textbooks/book chapters.

Learning objectives
 Apply the inventory cost flow methods to determine cost of sales
and ending inventory.
 Explain the financial statement effects of the inventory cost flow
methods.
 Apply the lower of cost and net realisable value basis to account for
and report inventories.
 Understand the process in developing an accounting information

system.
 Understand the basic features of computerised accounting systems.
 Describe the nature and purpose of control accounts and subsidiary
ledgers.
 Use special journals to record transactions.

Inventory cost flow methods
 Specific identification:
 Cost of sales = the actual cost of the items sold
 Ending inventory = the actual cost of the items on hand at the

end of the period
 This is possible when a business sells a limited variety of high

unit cost items that can be clearly identified from the time of
purchase to the time of sale, e.g., jewellery stores, antique
shops.

What about mass products?
 For mass products, we often have on hand different lots of identical
units purchased at different prices.
 For example,
 100 bottles of shampoo purchased on Jan 10 at $4.8 each
 200 bottles of shampoo purchased on Jan 30 at $4.5 each
 50 bottles of shampoo purchased on Feb 14 at $5 each
 A customer purchases 3 bottles. How do we determine the cost? Which

lots of inventory are these 3 bottles from?
 When it is not practical (too costly) to identify the actual unit cost,
the following cost flow assumptions are used.
 First-in, first-out (FIFO)
 Last-in, first-out (LIFO)
 Average cost

Inventory cost flow methods
 First-in, first-out (FIFO)

 Assumes the units which are purchased first are sold first.
 The old units are sold, and the new units are left on hand at the
end of the period.
 Last-in, first-out (LIFO)
 Assumes the units which are purchased last are sold first.
 The new units are sold and the old units are left on hand at the
end of the period.
 Average cost
 Cost of sales and ending inventory are calculated based on
weighted average unit cost.
 Weighted average unit cost = Cost of goods available for sales
No. of units available for sale

Example 1
Date Transactions Quantity Price Amount
Jan 1 Opening Inventory 100 $2 $200
Jan 5 Cash Purchase 200 $2.5 $500
Jan 10 Cash Sale 150 $5 $750
Jan 15 Credit Sale 100 $5 $500
Jan 20 Credit Purchase 200 $2.6 $520
Jan 25 Cash Sale 180 $5 $900
FIFO LIFO Average Cost

Sales (430 units x $5) 2,150 2,150 2,150
Cost of Sales ? ? ?
Gross Profit ? ? ?

Example 1 – FIFO (perpetual)
Purchase Sales Balance
Date Quan. Cost Amt Quan. Cost Amt Quan. Cost Amt
Jan 1 100 $2.0 $200
Jan 5 200 $2.5 $500 100 $2.0 $200
200 $2.5 $500
Jan 10 100 $2.0 $200 150 $2.5 $375
50 $2.5 $125
Jan 15 100 $2.5 $250 50 $2.5 $125
Jan 20 200 $2.6 $520 50 $2.5 $125
200 $2.6 $520
Jan 25 50 $2.5 $125 70 $2.6 $182
130 $2.6 $338
Total 400 $1020 430 $1038 70 $182

Example 1 – LIFO (perpetual)
Jan 1 100 $2.0 $200
Jan 5 200 $2.5 $500 100 $2.0 $200
200 $2.5 $500
Jan 10 150 $2.5 $375 100 $2.0 $200
50 $2.5 $125
Jan 15 50 $2.5 $125 50 $2.0 $100
50 $2.0 $100
Jan 20 200 $2.6 $520 50 $2.0 $100
200 $2.6 $520
Jan 25 180 $2.6 $468 50 $2.0 $100
20 $2.6 $52
Total 400 $1020 430 $1068 70 $152

Example 1 – Average Cost (perpetual)
Jan 1 100 $2.0 $200
Jan 5 200 $2.5 $500 300 $2.333 $700
Jan 10 150 $2.333 350 150 $2.333 $350
Jan 15 100 $2.333 $233 50 $2.333 $117
Jan 20 200 $2.6 $520 250 $2.548 $637
Jan 25 180 $2.548 $459 70 $2.548 $178
Total 400 $1020 430 $1042 70 $178
WA unit cost = Cost of goods available for sales $2.333 = ($200 + $500)/(100+200)
No. of units available for sale $2.548 = ($117 + $520)/(50+200)

Example 1 – FIFO (periodic)
Jan 10 Cash Sale 150 $5 $750
Jan 25 Cash Sale 180 $5 $900
Units Amount
Beginning Inventory 100 200
+ Purchase ($500 + $520) 400 1 020
= Costs of goods available for sales 500 1 220
- Ending Inventory (70 x $2.60) 70 182
= Costs of goods sold 430 $1 038
Example 1 – LIFO (periodic)
Jan 10 Cash Sale 150 $5 $750
Jan 25 Cash Sale 180 $5 $900
Units Amount
+ Purchase ($500 + $520) 400 1 020
= Costs of goods available for sales 500 1 220
Example 1 – Average Cost (periodic)
Jan 10 Cash Sale 150 $5 $750
Jan 25 Cash Sale 180 $5 $900
Units Amount
+ Purchase ($500 + $520) 400 1 020 WA unit cost:
= Costs of goods available for sales 500 1 220 $2.44 = $1220
500 units
Financial statement effects of cost flow
methods
 In a period of increasing prices:
 Cost of sales is lower and Gross profit is higher with FIFO

 Ending inventory is higher with FIFO
 Cost of sales is higher and Gross profit is lower with LIFO

 Ending inventory is lower with LIFO.
 In the period of decreasing prices, the opposite is true.

Example 1
Jan 10 Cash Sale 150 $5 $750
Jan 25 Cash Sale 180 $5 $900
Notice that unit purchase prices are

increasing in this example.

Financial statement effects of cost flow methods
Perpetual FIFO Average LIFO

Cost
Sales (430 x $5) 2 150 2 150 2 150
Notice that unit
Cost of Sales 1 038 1 042 1 068 purchase prices are
Gross Profit $1 112 $1 108 $1 082 increasing in this
example.
Periodic FIFO Average LIFO => Gross Profit is

Cost higher with FIFO!
Sales (430 x $5) 2 150 2 150 2 150
Cost of Sales 1 038 1 049 1 080
Gross Profit $1 112 $1 101 $1 070

Using inventory cash flow methods
consistently
 Consistent application enhances comparability of financial
statements over successive periods.
 If a firm chooses to adopt a new method, it must disclose in

the financial statements:
 the change; and
 the effects of the change on profit.

The lower of cost and NRV rule
 The amount of inventory shown in the statement of financial
position (SFP) should not exceed the future benefits
expected from it.
 This is to comply with conservatism principle.
 The Lower of Cost and Net Realisable Value (LCNRV) rule:

 When the NRV of inventory is lower than its cost, the
inventory is written down to its NRV.
 AASB 102 defines Net Realisable Value (NRV) as the

estimated proceeds of sale less costs incurred in
completing the sale.

Example – applying the LCNRV rule
Cost Market Amount Journal Entry (if any)

price of inven.
in SFP
$100,000 $120,000 100,000 Nil
Dr Inven. Write-Down Expense 10,000

$100,000 $90,000 90,000 Cr Inventory 10,000

Transactions in Foreign Currency and
LCNRV

Transactions in Foreign Currency
 On the transaction date:
 An amount in foreign currency should be translated at the spot
exchange rate at the date of transaction. (AASB121, para 21)
 At the end of the reporting period:

 The cost of a non-monetary item is translated at the spot rate at
the transaction date. (AASB121, para 23)
 The NRV, if in foreign currency, should be translated at the
closing rate, which is the spot exchange rate at the end of the
reporting period. (AASB121, para 25)
 Monetary items (e.g., cash, accounts receivable, and accounts
payable) in foreign currency are to be translated at the closing
rate. (AASB121, para 23)
Example 2 – Journal Entries for Buyer
 The entity is operating in Aus. => AUD is the functional currency.
 Prepare journal entries for the following transactions/events.
 Ignore taxes and GST.
Date Transactions Spot Rates

Jun 10 Purchased inventory on account, USD 1: AUD1.30
n/30, USD1,000.
Jun 30 The NRV was AUD1, 200. USD 1: AUD1.35
Jul 10 Paid for the inventory. USD 1: AUD1.32
 Transaction Date:
 Jun 10 Dr Inventory (USD1,000 x 1.30) 1,300
 Cr Accounts Payable 1,300

Example 2 - Journal Entries for Buyer
 End of Reporting Period (Jun 30):
 Inventory in SFP (Statement of Financial Position) = LCNRV
 Cost = USD1,000 x 1.3 (spot rate at the transaction date)
 NRV = AUD1,200
 LCNRV = AUD1,200 (NRV)
 Jun 30 Dr Inventory Write-Down Expense 100
 Cr Inventory [1,300 – 1,200] 100
 Accounts Payable in SFP = USD1,000 x 1.35 (the closing rate)

 Accounts Payable at transaction date = USD1,000 x 1.30
 June 30 Dr Foreign Exchange Loss 50
Cr Accounts Payable [(1.35-1.30)x1000] 50
Example 2 - Journal Entries for Buyer
 Settlement Date:
 Acc. Payable in SFP (30 June) = USD1,000 x 1.35 (the closing rate)
 Spot rate on Jul 10 => USD 1: AUD1.32
 Jul 10 Dr Accounts Payable [(1.35 - 1.32)x1000] 30

 Cr Foreign Exchange Gain 30
 Jul 10 Dr Accounts Payable 1,320
 Cr Cash (USD1,000 x 1.32) 1,320

 OR
 Jul 10 Dr Accounts Payable 1,350
 Cr Cash 1,320
 Cr Foreign Exchange Gain 30
 Prepare an adjusting entry for inventory on June 30.

Jun 10 Purchased inventory on account, USD 1: AUD1.30
n/30, USD1,000.
Jun 30 The NRV was NZD 1,200. USD 1: AUD1.35
The inventory was to be sold to NZD 1: AUD 0.95
NZ customers in NZD.
=> The NRV was in NZD.

Jul 10 Paid for the inventory. USD 1: AUD1.32

 End of Reporting Period:
 Cost = USD 1,000 x 1.30 (spot rate at the transaction date);
 NRV = NZD 1,200 x 0.95 (closing rate for NZD) = AUD1,140
 LCNRV = AUD1,140 (NRV)
 Jun 30 Dr Inventory Write-Down Expense 160

 Cr Inventory [1,300 – 1,140] 160

Learning Activity – Challenge yourself!
 Please try preparing journal entries for Seller!

Jun 10 Sold inventory on account, n/30, EUR 1: AUD1.65
EUR1,000. (Ignore cost of sales.)
Jun 30 Prepared an adjusting entry for foreign EUR 1: AUD
currency transactions. 1.60
Jul 10 Collected cash from the customer. EUR 1: AUD1.68

Date Account Name Dr Cr
Jun 10 Accounts Receivable (EUR1000 x ____)
Sales Revenue
Jun 30
Accounts Receivable in SFP = EUR1000 x ______
July 10 Cash
Accounts Receivable

Accounting Information System

Accounting information systems
 Accounting information systems involve three phases:
 input
 processing
 output.
 Raw transactions are transformed into financial statements

to provide information for decision making.

Developing an accounting information system
Figure 6.2 Carlon et al. 2022

Computerised accounting information systems
 Computer accounting programs perform the double entry steps in
the accounting cycle i.e. journalising, posting and preparation of
trial balance and reports.
 Advantages:  Disadvantages:
 Ability to process large  Use of inappropriate and/or
number of transactions incompatible software and
quickly. hardware.
 Automatic posting of  Need for reliable back-up
transactions. procedures.
 Error reduction.  Computer viruses and hackers.
 Fast report production.  Fraud and embezzlement.

Control accounts and subsidiary ledgers
 Subsidiary ledgers are groups of accounts with a common

characteristic.
 Details from subsidiary ledgers are summarised in the
general ledger control account.
 Two common subsidiary ledgers are:

 Accounts Receivable (customers) which collects transaction
data of individual customers.
 Accounts Payable (suppliers) which collects transaction data
of individual creditors.

Example 4
Accounts Receivable (Control ) No. 120
Bal. 12,500
Car Carrot No. 120-1

Bal. 6,000
Cel Celery No. 120-2

Bal. 4,000
Broc Broccoli No. 120-3

Bal. 2,500

Accounts receivable - Control NO. 120
JRNL
DATE ITEM . DEBIT CREDI BALANCE
REF.
Jan 5 Collected cash
T
Jan 1 Bal. 12 500 Dr from Carrot,
5 Cash 2 000 10 500 Dr $2,000.
10 Sales 1 000 11 500 Dr
Accounts receivable - Carrot NO. 120-1 Jan 10 Sales on account
JRNL.
REF. DEBIT CREDIT
to Celery, $1,000.
DATE ITEM BALANCE
Jan 1 Bal. 6 000 Dr
5 Cash 2 000 4 000 Dr
Accounts receivable - Celery NO. 120-2

JRNL.
DATE ITEM REF. DEBIT CREDI BALANCE
T
Jan 1 Bal. 4 000 Dr
10 Sales 1 000 5 000 Dr
Accounts receivable - Broccoli NO. 120-2
JRNL.
DATE ITEM REF. DEBIT CREDI BALANCE
T
Jan 1 Bal. 2 500 Dr

Special journals
 Special journals are used to record similar types of
transactions.
 Examples of common special journals are:
 Sales journal – for sales of inventory on account
 Purchases journal – for purchases on account
 Cash receipts journal – for all cash receipts (including cash sales)
 Cash payments journal – for all cash payments (including cash
purchases)
 General journal are used to record infrequent or complicated
transactions, or transactions which cannot be entered in special
journals, e.g.,
 adjusting entries, closing entries, and correcting entries
 owners equity transaction not involving cash

Sales Journal
COST OF
SALES DR.
ACCOUNTS SALES GST
POST. RECEIVABLE REVENUE Payable INVENTORY
DATE REF. ACCOUNT DEBITED REF. DR. CR. CR CR.
Nov. 2 Carrot √ 880 800 80 400
Example: Sold inventory on credit to

Carrot $880 (GST included). Cost of
sales was $400 (net of GST).
Dr AR - Carrot 880
(112) (411) (217) (511/131)
Cr GST payable 80
Cr Sales revenue 800
Dr COS 400
Cr Inventory 400
Curtin University | Accounting Discipline

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ACCT 5013 Intermediate Financial Accounting

Reporting and Analysing Inventory

Curtin University | Accounting Discipline 1

Curtin University | Accounting Discipline 2

 Understand the process in developing an accounting information

Curtin University | Accounting Discipline 3

 Ending inventory = the actual cost of the items on hand at the

 This is possible when a business sells a limited variety of high

Curtin University | Accounting Discipline 4

 A customer purchases 3 bottles. How do we determine the cost? Which

Curtin University | Accounting Discipline 5

 First-in, first-out (FIFO)

Curtin University | Accounting Discipline 6

FIFO LIFO Average Cost

Curtin University | Accounting Discipline 7

Curtin University | Accounting Discipline 8

Curtin University | Accounting Discipline 9

Curtin University | Accounting Discipline 10

 Cost of sales is lower and Gross profit is higher with FIFO

 Cost of sales is higher and Gross profit is lower with LIFO

 In the period of decreasing prices, the opposite is true.

Curtin University | Accounting Discipline 14

Notice that unit purchase prices are

Curtin University | Accounting Discipline 15

Perpetual FIFO Average LIFO

Periodic FIFO Average LIFO => Gross Profit is

Curtin University | Accounting Discipline 16

 If a firm chooses to adopt a new method, it must disclose in

Curtin University | Accounting Discipline 17

 The Lower of Cost and Net Realisable Value (LCNRV) rule:

 AASB 102 defines Net Realisable Value (NRV) as the

Curtin University | Accounting Discipline 18

Cost Market Amount Journal Entry (if any)

$100,000 $120,000 100,000 Nil

Dr Inven. Write-Down Expense 10,000

Curtin University | Accounting Discipline 19

Curtin University | Accounting Discipline 20

 At the end of the reporting period:

Date Transactions Spot Rates

Curtin University | Accounting Discipline 22

 Accounts Payable in SFP = USD1,000 x 1.35 (the closing rate)

 Jul 10 Dr Accounts Payable [(1.35 - 1.32)x1000] 30

Date Transactions Spot Rates

=> The NRV was in NZD.

Curtin University | Accounting Discipline 25

 Jun 30 Dr Inventory Write-Down Expense 160

Curtin University | Accounting Discipline 26

Date Transactions Spot Rates

Curtin University | Accounting Discipline 27

Accounts Receivable in SFP = EUR1000 x ______

Curtin University | Accounting Discipline 28

Curtin University | Accounting Discipline 29

 Raw transactions are transformed into financial statements

Curtin University | Accounting Discipline 30

Figure 6.2 Carlon et al. 2022

Curtin University | Accounting Discipline 31

Curtin University | Accounting Discipline 32

 Subsidiary ledgers are groups of accounts with a common

 Two common subsidiary ledgers are:

Curtin University | Accounting Discipline 33

Car Carrot No. 120-1

Cel Celery No. 120-2

Broc Broccoli No. 120-3