Perpetual Inventory System

- Cost of goods sold is determined and recorded each time a sale occurs -Maintain detailed records of the cost of each inventory purchase
and sale.
-Records continuously show inventory that should be on hand for every item. -Company determines cost of goods sold each time a sale
occurs.
- allows for the determination of cost of goods sold after each sale. Purpose of taking a physical inventory - To check the accuracy of the
perpetual inventory records
A physical count is necessary under the perpetual method in order to adjust the balance of the inventory account for items that have been
lost, stolen, or damaged.
Periodic Inventory System
-Do not keep detailed records of the goods on hand. -requires a physical inventory count to determine the cost of goods on hand -Cost of
goods sold determined by count at the end of the accounting period.
Physical inventory is usually taken when a limited number of goods are being sold or received and at the end of the companys fiscal year.
Purchase Discounts
2/10, n/30
- 2% discount if paid within 10 days, otherwise net amount due within 30 days
1/10 EOM
- 1% discount if paid within first 10 days of next month
n/10 EOM
- Net amount due within the first 10 days of the next month
A customer returns goods for credit, the seller should - debit Merchandise Inventory
A company returned goods for credit to the supplier and perpetual inventory system is used - credit Inventory
Goods are purchased for resale by a company using a periodic inventory system - debit to Purchase
Inventory turnover = Cost of goods sold Average inventory
inventory) 2
Inventory turnover measure how quickly a company sells its goods
Days in inventory = 365 days Inventory turnover

Average inventory = (Beginning inventory + Ending

Inventory turnover a ratio that indicates the liquidity of inventory by measuring the number of times average inventory is sold during the
period
Cost of goods sold and sales - reported on a multiple-step income statement and on a single-step income statement
LIFO reserve - difference between the inventory value under LIFO and FIFO
In periods of rising prices, LIFO will produce - Lower income taxes than FIFO - Lower net income than FIFO.
In periods of declining prices - FIFO will report the lowest net income, - LIFO the highest net income
Company uses LIFO to cost its inventory - company will pay less income taxes in periods of rising prices compared to using FIFO
lower-of-cost-or-market (LCM) method of inventory - LCM is departure from the cost basis of accounting
LCM is an accounting concept of conservatism. LCM is NOT an example of the revenue recognition principle. LCM is defined as current
replacement cost
Sales Returns and Allowances is a contra revenue account to Sales and have a normal debit balance.
Sales discounts and Sales returns and allowances both normally have debit balance
Net Sales = Sales less sales returns and allowances and sales discounts
Gross profit will result if net sales are greater than cost of goods sold
Gross Profit = Net Sales Cost of goods sold
Gross Profit rate = Gross Profit Net Sales
Profit Margin = Net income Net Sales
Finished goods inventoryitems that are completed and ready for sale
Work in processthat portion of manufactured inventory that has been placed into the production process but is not yet complete
Raw materials inventorythe basic goods that will be used in production but have not yet been placed into production
Legal title - factor which determines whether or not goods should be included in a physical count of inventory
If goods in transit are shipped FOB destination the seller has legal title to the goods until they are delivered.
Operating expenses - Items would appear in the income statement of both a merchandising company and a service company
Specific identification - is an inventory costing method. A problem with Specific identification method is management can manipulate
income. Most time consuming
Freight terms of FOB destination mean that the - seller must debit freight out - seller to pay the freight cost
FOB shipping point indicate- seller places the goods free on board the carrier, and the buyer pays for the freight costs
Goods in transit should be included in the inventory of the buyer when the terms are FOB shipping point.
LIFO inventory method assumes that the cost of the latest units purchased are the first to be allocated to cost of goods sold
FIFO inventory costing method that the earliest goods purchased are the first to be sold
Sales discount - incentive for customers to pay their accounts promptly reduction given by seller for prompt payment of a credit sale
Purchase discount cash discount claimed by a buyer for prompt payment of a balance due
Purchase invoice a document that supports each credit purchase
Purchase allowance deduction made to the selling price of merchandise granted by the seller so the buyer will keep the merchandise
Purchase return return of goods from buyer to seller for cash or credit
Consigned goods - Goods held for sale by one party although ownership of the goods is retained by another party
Days in inventory - Measure of the average number of days inventory is held; calculated as 365 divided by inventory turnover ratio.

Current Ratio for LIFO = current assets Current liabilities

for FIFO = (current assets + excess of FIFO costs or LIFO reserve) Current
liabilities
just-in-time inventory methods - Not an advantage is Companies may not have quantities to meet customer demand
Net income will result if gross profit exceeds operating expenses
Two categories of expenses in merchandising companies are cost of goods sold and operating expenses
Inventory becomes part of cost of goods sold when a company sells the inventory
Journal entry to record a credit sale is Accounts Receivable Sales Revenue
Income from operations appears on a multiple-step income statement.
On Jan 14, Menke purchased merchandise inventory at a cost of $45,000. Credit terms were 2/10, n/30. The inventory was sold on account
for $60,000 on Jan 21. Credit terms were 1/10, n/30. The accounts payable was settled on January 23, 2012, and accounts receivables were
settled on Jan 30. Prepare journal entries
Jan 14 Inventory
45000
Accounts Payable
45000
Jan 21 Accounts Receivable
Sales Revenue
Cost of Goods Sold
Inventory

60000
60000
45000

Jan 23 Accounts Payable

Cash
Inventory

45000

Jan 30 Cash
Sales discounts
Accounts Receivable

59400
600

45000
44100

900

60000

COMPANY
Income Statement
For the Year Ended December 31, 2014
Sales revenue ....................................................................
$645,000
Less: Sales returns and allowances ................................ $ 50,000
Sales discounts ......................................................
9,500
59,500
Net sales ...........................................................................
585,500
Cost of goods sold ..............................................................
396,000
Gross profit .........................................................................
189,500
Operating expenses
Salaries and Wages Expense .......................................
$ 84,000
Utilities Expense ...........................................................
23,000
Advertising Expense .....................................................
15,000
Depreciation Expense ..................................................
3,500
Freight-Out ...................................................................
2,000
Total operating expenses ........................................
127,500
Income from operations ......................................................
62,000
Other revenues and gains
Interest revenue ............................................................
25,000
Other expenses and losses
Interest expense ...........................................................
19,000
Net income .........................................................................
$ 68,000
Profit margin = Net income Net Sales = $68,000 $585,500 = 11.6%
Gross profit rate = Gross profit Net Sales = $189,500 $585,500 = 32.4%