ACCY901

Accounting Foundations for Professionals

Topic 6
Inventory Chapter 4

Dr Andy Wang
BCom(Hons), MAccg, PhD, CPA
Learning objectives
After studying this presentation, you should be able to:
1. Identify the differences between a service business and a merchandising
business.
2. Explain the recording of purchases under a perpetual inventory system.
3. Explain the recording of sales revenues under a perpetual inventory system.
4. Prepare a fully classified statement of profit or loss.
5. Use ratios to analyse profitability.

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Merchandising operations

• Merchandising businesses buy and

resell inventory.
• Revenues are referred to as sales
revenue.
• Expenses are divided into two
categories:
– cost of sales
– operating expenses.

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Operating cycles

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Inventory systems
• Perpetual System:
– Detailed inventory system in which the cost of inventory is maintained.
– Records continuously show the inventory that should be on hand:
• e.g. car dealerships, furniture stores.
– Use of bar codes and optical scanners has led to wide use:
• e.g. supermarkets, department stores.

• Periodic system:
– Inventory system in which detailed records are not maintained.
– Cost of sales is determined only at end of accounting period by a
physical inventory account.
– Used widely by small businesses:
• e.g. convenience stores, cafes.

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Comparing perpetual and periodic
inventory systems

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Recording purchases of inventories in
a perpetual inventory system
• Example:
– Purchase of inventory on credit from PW Audio Supply Ltd.

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Purchases returns and allowances
• A purchase return is the return of goods by the customer.
• The customer will receive a refund in the form of either credit or cash.
• A purchase allowance occurs where the customer keeps the goods and a
reduction in price is granted.

• Example:
– Goods costing $300 are returned to PW Audio Supply Ltd.

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Freight costs
• Cost of freight is added to the cost of inventory where cost is charged
to buyer.
• Cost is allocated to Freight-in account and is part of cost of sales.

• Example:
– Sauk Stereo pays We Deliver Freight Co. $150 for freight charges.

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Freight costs

• Freight costs incurred by the seller are an operating expense to the seller.
• These costs are included as part of delivery or freight-out expenses.

• Example:
– PW Audio paid freight charges $150 for goods sold.

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Purchase discounts

• Settlement discounts are discounts given for prompt payment of account.

• Example:
– Sauk Stereo settles account outstanding of $3500 and receives
discount of $70.

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Purchase discounts
• Trade discounts are a % reduction in the list price of inventory sold.
• Example:
– List price quoted is $5000 and trade discount given of 10%.

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Recording sales of inventory in a
perpetual inventory system
• Two entries are required:
1. to record the sale of goods
2. to record the cost of sales.
• Example 1:
– PW Audio Supply Ltd made cash sales of $2200.
– Cost of sales was $1400.
• Example 2:
– PW Audio Supply Ltd sold $3800 to Sauk Stereo on credit.
– Cost of sales was $2400.

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Recording sales of inventory

• Example 1:
1. Sale of the goods for $2200 cash.
2. Cost of sales was $1400 reducing inventory on hand.

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Recording sales of inventory

• Example 2:
1. Sale of the goods on credit for $3800.
2. Cost of sales was $2400.

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Sales returns and allowances

• Return of goods by a customer.

• Two entries are required:
1. To record sales return at selling price.
2. To record return to inventory at cost price.
• Example 1:
– PW Audio Supply Ltd records credit for goods returned by customer.
• Example 2:
– Goods returned by customer are faulty.

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Sales returns and allowances

• Example 1:
– Sales return at selling price of $300.
– Return (increase) to inventory at cost price of $140.

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Sales returns and allowances

• Example 2:
– Sales return at selling price of $300.
– Increase in expense account of $140.

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Sales discounts

• Invoice amount less a discount for prompt payment given to customer.

• Example:
– Sauk Stereo pays PW Audio Supply and receives a discount.

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 Statement of profit or loss presentation

• Sales Revenue:

• Gross Profit:

• Other Revenue:

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Operating expenses

• Selling expenses:
– cost of making the sale
– e.g. advertising, delivery expenses.
• Administration expenses:
– cost of operating activities of the general, accounting and personnel
offices
– e.g. salaries, rent.
• Financial expenses:
– costs of financing the business
– e.g. interest expense, discounts allowed.

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Operating expenses

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Operating expenses

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Evaluating profitability
• Gross Profit Rate:
– Gross profit as a percentage of sales.

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Evaluating profitability

• Operating Expenses to Sales Ratio:

– Operating expenses as a % of sales.

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