TOPIC 6

ACCOUNTING FOR INVENTORIES

ACCOUNTING FOR INVENTORIES

DEFINITION:FRS 102: Inventory is an asset that owned

by the business for the purpose of selling to the customer.

Managing inventory is done to determine:1. Inventory on hand2. Inventory available for

sale3. Cost of goods sold.

Inventory Control

1. Establishment of responsibility: every inventory counter is accountable by different person.

2. Segregation of duties: a person who records the inventories is not the same as the person who makes a count and also not the same with the person who distributes the inventories.

Inventory Control

3. Independent Internal Verification: make a second count and verify the balance by a different person.

4. Documentation Procedure: numbering tag or barcode is paste to the inventory and each sales is made using on-line basis.

5. Physical, mechanical and electronic control: make a physical stock count frequently.

Inventory Accounting System

There are two basic systems of accounting for inventories:

1. Perpetual Inventory system (Sistem Berterusan)

2. Periodic Inventory System (Sistem Berkala)

Differences between these two systems:

Perpetual Periodic

Detailed records of each inventory purchase and sale are maintained and continuously show inventory in hand

No attempt is made to keep detailed inventory records of goods on hand throughout the period

Keeps track of both quantities and costs

No record kept on both quantities and costs

The cost of goods sold is determined and recorded each time sales occur

The cost of goods sold only can be determined at the end of accounting period when physical stock count is taken.

Valuation of Inventory

1. First In First Out (FIFO)- first items purchase will be sold first.

2. Last In First Out (LIFO)- last item purchase will be sold first.

3. Weighted Average (WA)- make an average cost per unit purchase of the goods.

Example:The information below regarding an inventory

product name AIA for year 2006:

The physical stock counts on 31 Dec 2006 shows a balance of 400 units.

Date Unit Cost per unit (RM)

Selling Price (RM)

1 Jan Bal b/b 100 8 -

7Feb Purchase 400 10 -

3 Jun Sales 300 - 12

3 Aug Purchase 500 12 -

2 Oct Sale 400 - 14

5 Nov Sale 100 - 16

8 Dec Purchase 200 13 -

Total Stock (unit) - total Sales (unit) = Closing stock (unit)

[Opening stock + Purchase] – Total Sales = Closing Stock 100 unit + 1100 unit - 800 unit =

400 unit.

a) FIFO - Periodic:

Cost of Good Sold:Opening Inventory 800Add: Purchase 12,600

13,400Less: Closing Stock 5,000COST OF GOOD SOLD 8,400

Purchase (Aug 8)

200unit RM12 RM2,400

Purchase (Dec 8) 200 unit RM13 RM2, 600

Closing Inventory

400 unit RM5, 000

b) FIFO - PERPETUALFIFO STOCK CARD - AIA

Date Purchasing Selling Balance

2006 Unit Price RM Unit Price RM Unit Price RM

1-Jan 100 8 800

7-Feb

400 10 4000 100 8 800

400 10 4000

3-Jun

100 8 800

200 10 2000

200 10 2000

8-Aug

500 12 6000 200 10 2000

500 12 6000

2-Oct

200 10 2000

200 12 2400

300 12 3600

5-Nov

100 12 1200

200 12 2400

8-Dec

200 13 2600 200 12 2400

200 13 2600

Total Purchase

12600

COGS 8400

Closing Stock

5000

LIFO - Periodic:

Cost of Good Sold:Opening Inventory 800Add: Purchase 12,600

13,400Less: Closing Stock 3,800COST OF GOOD SOLD 9,600

Opening Balance

100 unit RM8 RM800

Purchase (7 Feb)

300 unit RM10 RM3,000

Closing Inventory

400 unit RM3,800

PERPETUAL LIFO – STOCK CARD - AIA

Date Purchasing Selling Balance

2006 Unit Price RM Unit Price RM Unit Price RM

1- Jan

100 8 800

7- Feb

400 10 4000 100 8 800

400 10 4000

3-Jun

300 10 3000 100 8 800

100 10 1000

8-Aug

500 12 6000 100 8 800

100 10 1000

500 12 6000

2-Oct

400 12 4800 100 8 800

100 10 1000

100 12 1200

5-Nov

100 12 1200 100 8 800

100 10 1000

8-Dec

200 13 2600 100 8 800

100 10 1000

200 13 2600

Total Purchase

12600

COGS 9000 Closing Stock

4400

WEIGHTED AVERAGEPeriodic

Weighted Average cost per unit =Opening Inventory + Purchases

Total unit available for sale

RM800 + RM12,600(100 + 1,100) unit

= RM11.17 per unit

Closing Inventory = 400 unit x RM11.17= RM4,468

COGS = 800 unit x RM11.17= RM8,932

Perpetual

Weighted Average – Stock Card - AIA

Date Purchasing Selling Balance

2006 Unit Price

RM Unit Price

RM Unit Price

RM

1-Jan

100 8 800

7-Feb

400 10 4, 000

500 9.6 4,800

3-Jun

300 9.6 2,880

200 9.6 1,920

8 Aug

500 12 6000 700 11.31

7,920

2-Oct

400 11.31

4,526

300 11.31

3,394

5-Nov

100 11.31

1,131

200 11.31

2,263

8-Dec

200 13 2,600

400 12.16

4,863

Total Purchase

12,600

COGS 8,537

Closing Stock

4,863

Effect of using different method:

1. InflationAssume that the purchase price is increasing:

FIFO:The lower price of the inventory will be taken out

first; this will lower down the cost of goods sold of the inventory. Thus

the profit will be increased.

LIFO:The higher price of the inventory will be taken out

first; this will increase the cost of good sold of the inventory. Thus the profit will be decreased.

FIFO LIFO WA

Sales 10,800 10,800 10,800

COGS 8,400 9,000 8,573

PROFIT 2,400 1,800 2,227

2. Deflation:- deflation (lower price of the inventory) will give a reverse situation whilst using either FIFO, LIFO or WA.

• An alternative method of valuing inventory in a situation of declining value of inventory : lower than cost

(e.g due to changes in technology or fashion)

• To comply with accounting principle:Conservatism: the best choice is to

select the method that is least likely to overstate asset and net income.

VALUING INVENTORY AT THE LOWER OF COST OR MARKET (LCM)

The method:

The value of inventory should be written down from the cost price to market price in situations where market is below cost.

Market price:- “Current replacement cost” not

selling price.- A cost of purchasing the same

goods at the present time from the usual supplier.

Reporting in the Financial Statement:Cost of Goods Sold:

Opening Inventory + Cost of Good Available for Sale - Closing

Stock.

Cost Market LCM

Video equipment

48, 000 45, 000 45, 000

Recorders 15, 000 14, 000 14,000

Movies 63, 000 59, 000 59,000

Consoles 60, 000 55, 000 55, 000

Portables 45, 000 52, 000 45, 000

Total Inventory

168, 000 166, 000 159, 000

Income Statement – Periodic System

________________________________________________________ Opening Inventory 2, 000

Add:Purchase 20,000Carriage Inward 2, 500Import Duty 1, 500

24, 000(-) Return Outward (1, 000)

23, 000Cost of Goods Available for sale 25, 000(-) Closing Stock (5, 000)Cost of Good Sold 20, 000

Income Statement - Perpetual System________________________________________________

Sales xxxLess: Cost of Good Sold xxLess: Inventory Shortage xx xx

Gross Profit xxx

• EFFECT ON PROFIT: OVER/UNDERSTATE VALUE OF INVENTORY

Inventory Error COGS Net Profit

Opening Understated

Understated

Overstated

Opening Overstated Overstated Understated

Closing Understated

Overstated Understated

Closing Overstated Understated

Overstated

Journal Entries for Purchasing of Goods

Transaction Periodic Perpetual

Purchase goods on credit/cash

Dt Purchase Cr Trade Creditor/ Cash

Dt Stock Cr Trade Creditor /Cash

Return Outward/ purchase return

Dt Trade Creditor Cr Return Outward/purchase return

Dt Trade Creditor Cr Stock

Carriage Inward/ freight-in

Dt Carriage Inward Cr Cash

Dt Stock Cr Cash

Payment to supplier/ creditor

Dt Trade Creditor Cr Cash

Dt Trade Creditor Cr Cash

Journal Entries for Sales of GoodsTransactions Periodic Perpetual

Sales Goods on Credit / Cash

Dt Debtor/Cash Cr Sales

Dt Debtor / Cash Cr Sales

No entry to be made

Dt Cost of Goods Sold Cr Stock

Return Inward/ sales return

Dt Return Inward Cr Debtor

Dt Return Inward Cr Debtor

No entry to be made

Dt Stock Cr Cost of Good Sold

Collections Dt CashDt Sales Discount Cr Debtor

Dt CashDt Sales Discount Cr Debtor

If there is inventory shortage

No record to be made because it directly charge to COGS

Dt Inventory Shortage expense Cr Inventory

1. SHORT TERM INVESTMENTDefinition:Investment made for a period of less than one year

and very easy tochange or convert it in the cash term.Example: investment in Marketable securities

(Treasury Bill)The objective of investment is to earn interest and

dividends.

Types:- investment in government bond - investment in stock of large corporation

Reasons:Stock and bonds traded on organized securities

markets, such asBursa Malaysia, are readily marketable because can

be bought and sold daily. Therefore, easy to convert into cash when it is needed.

OTHER CURRENT ASSET

2. Accrued Revenue

3. Prepaid Assets/Expenses

Presentation in Financial StatementCurrent AssetCashBankInvestmentAccrued RevenuePrepaid Expenses.

Exercises on Inventory 1. Berikut adalah belian dan jualan Syarikat

Zamani dalam bulan September 20X6.

Dikehendaki:Dengan menggunakan kedua-dua sistem iaitu

berterusan dan berkala, kira nilai stok akhirnya mengikut kaedah:

a) FIFO (MDKD)b) LIFO (MKKD)c) Kos Purata

Tarikh Belian (unit)

Jualan (unit)

RM

1 September

200 - 2.00

8 ‘’ - 50 -

15 “ 60 - 2.50

20 “ - 200 -

30 “ 80 - 3.00