ACCY901
Accounting Foundations for Professionals
Topic 6
Chapter 5
Reporting and analysing inventory
Dr Andy Wang
BCom(Hons), MAccg, PhD, CPA
Learning objectives
After studying this presentation, you should be able to:
1. Record purchases and sales of inventory under a periodic inventory system.
2. Determine cost of sales under a periodic inventory system.
3. Describe the steps in determining inventory quantities.
4. Identify the unique features of the statement of profit or loss for a merchandising
business under a periodic inventory system.
5. Explain the basis of accounting for inventories and apply the inventory cost flow methods
under a periodic inventory system.
6. Explain the financial statement effects of each of the inventory cost flow methods.
7. Explain the lower of cost and net realisable value basis of accounting for inventories.
8. Calculate and interpret inventory turnover.
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Periodic inventory system
• Revenues from sale of inventory is recorded when the sale is made.
• Cost of sales is not recorded at date of sale.
• Quantity on hand and cost of sales are determined by a physical inventory
count at the end of the period.
Key difference between periodic and perpetual
inventory systems is the point at which the cost
of sales is calculated
Recording purchases of inventory
• Purchase of inventory:
– Purchases account used to record cost of all inventory purchased.
– Example:
• Sauk Stereo purchases inventory for $3800 from PW Audio Supply
Ltd.
May 5 Purchases 3 800
Accounts Payable 3 800
(To record goods purchased
on account, terms 2/7, n/30)
Recording purchases of inventory
• Purchase returns and allowances:
– Example:
• Sauk Stereo returns goods valued at $300 to PW Audio
Supply as they are incorrect.
May 8 Accounts Payable 300
Purchase Returns and Allowances 300
(To record return of incorrect goods
purchased from PW Audio Supply)
Recording purchases of inventory
• Freight costs:
– Freight costs incurred by purchaser.
– Example:
• Sauk Stereo pays We Deliver Freight Co. $150 for freight
charges on purchases.
May 6 Freight-in (Transportation-in) 150
Cash 150
(To record payment of freight
on goods purchased)
Recording purchases of inventory
• Purchase discounts:
– Example:
• Sauk Stereo pays PW Audio Supply Ltd balance
outstanding and receives a 2% cash discount.
May 12 Accounts Payable ($3800 - $300) 3 500
Cash 3 430
Discount Received ($3500 x 0.02) 70
(To record payment to PW Audio
Supply within the discount period)
Recording sales of inventory
• Sale of inventory:
– Example:
• Sale of inventory to Sauk Stereo by
PW Audio Supply Ltd.
May 5 Accounts Receivable 3 800
Sales 3 800
(To record credit sales per invoice
no. 731 to Sauk Stereo)
Recording sales of inventory
• Sales returns and allowances:
– Example:
• Goods returned to PW Audio Supply Ltd by Sauk Stereo.
May 8 Sales Returns & Allowances 300
Accounts Receivable 300
(To record return of goods from
Sauk Stereo)
Recording sales of inventory
• Sales discounts:
– Example:
• PW Audio Supply Ltd receives cash of $3430 from Sauk
Stereo after allowing 2% discount.
May 12 Cash 3 430
Discount Allowed ($3500 x 0.02) 70
Accounts Receivable ($3800 – $300) 3 500
(To record collection from Sauk
Stereo within discount period)
Comparison of entries:
perpetual vs. periodic
Comparison of entries:
perpetual vs. periodic
Cost of sales
• To calculate Cost of sales (periodic system):
1. Record purchases of inventory.
2. Determine cost of goods purchased.
3. Determine cost of goods on hand at beginning and end of accounting
period.
– To determine Cost of goods on hand:
• Undertake a physical inventory count.
• Apply costs to items counted in the inventory.
Cost of sales
• Determining cost of goods purchased:
– Accounts used to record purchases.
Cost of sales
• Calculation of net purchases:
Cost of sales
• Determining Inventory Quantities:
– Counting the physical inventory:
• Inventory on hand must be determined by a physical inventory
count.
– Determining ownership of goods:
• Who owns goods in transit that are not included in the physical
count?
– FOB shipping point
– FOB destination.
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Cost of sales
• Calculating cost of sales:
– Example: PW Audio Supply Ltd.
Statement of profit or loss
More detail
is required in
the periodic
system.
Inventory cost flow methods –
periodic system
• Specific identification:
– 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. motor vehicle dealerships, jewellery stores, antique shops.
Cost flow assumptions
1. First-in, first-out (FIFO).
2. Last-in, last-out (LIFO).
3. Average cost.
• Example – Dubbo Electronics
– Cost of goods available for sale:
Cost flow assumptions
• During the year 550 units were sold and 450 were in inventory at
the end of year.
1. First-in, first-out (FIFO):
– Assumes first goods purchased are first goods sold.
– Allocation of costs:
Cost flow assumptions
• During the year 550 units were sold and 450 were in inventory at
the end of year.
2. Last-in, first-out (LIFO):
– Assumes last goods purchased are first goods sold.
– Allocation of costs:
Cost flow assumptions
3. Average cost:
– Assumes that goods sold are similar in nature.
– Cost of goods available for sale is calculated on weighted average
unit cost incurred.
– Allocation of costs:
Financial statement effects of
cost flow methods
• Statement of profit or loss effects:
– In periods of increasing prices:
• FIFO reports the highest profit.
• LIFO the lowest.
• Average cost falls in the middle.
– In periods of decreasing prices:
• FIFO will report the lowest profit.
• LIFO the highest.
• Average cost falls in the middle.
Financial statement effects of
cost flow methods
Valuing inventory at the lower of cost
and net realisable value
• When the value of inventory is lower than its cost, the inventory is written
down to its market value by valuing the inventory at the lower of cost and
net realisable (LCNRV) in the period in which the price decline occurs.
• AASB 102 defines net realisable value (NRV) as the estimated proceeds of
sale less costs incurred in completing the sale.
Analysis of inventory
• Two indicators of how quickly inventory is sold:
Analysis of inventory
Appendix 5A
Inventory cost flow methods –
perpetual system
First-in, first out (FIFO)
Last-in, first-out (LIFO)
Average cost
