FINANCIAL ACCOUNTING LEARNING MODULE ATTACHMENT (DO NOT COPY)

ACCOUNTING FOR INVENTORIES

Merchandising Business
• Companies purchase inventory that they will sell to their customers (one that buys and sells goods
without changing their physical form). There are concepts used in merchandising but not to service
business.

Definition/Nature and Measurement:

• Asset that are held for sale in the ordinary course of business, in the process of production such sale, or
in the form of materials or supplies to be consumed in the production process.
• Inventories should be measured at the lower or cost and net realizable value.

Classes of Inventories:
Merchandising Company
• Inventory of Merchandise Inventory

Manufacturing Company
• Finished Goods Inventory
• Goods in Process/ Work in Process Inventory
• Raw Materials Inventory

Inventory System:
• Periodic System
 A separate general ledger account is used for each type of inventory transaction.
 Cost of goods sold transactions are ignored during the period and recorded only at the end of the
period.
 Merchandise inventory balance in the general ledger is not updated until the end of the period
and does NOT represent the value of inventory on hand.
• Perpetual System
 All inventory transactions are recorded in a single merchandise inventory account in the general
ledger.
 Cost of goods sold transactions are recorded as incurred throughout the period.
 All inventory transactions are recorded as incurred, constantly updating the value of inventory in
the general ledger which represents the value of inventory on hand.

Periodic Vs Perpetual System

Periodic
“periodic” means occurring or recurring at
regular intervals (pana-panahon)
Do not track each movement of inventory but
instead determines the inventory balance at the
end of the accounting period or periodically
physical counting.
Inventory/Merchandise Inventory account is
update only when physical count is performed.
Perpetual
“perpetual” means continuing forever (tuloy –
tuloy or walang hanggan)
Constantly track any movements in the
inventory and records all transaction in the
“Inventories or Merchandise Inventory”
Account.

THIS FORM IS FOR INSTITUTIONAL PURPOSES ONLY!

 Thus, the amount of inventory and cost of sold
are determined only periodically.
Do not maintain records.
To determine the physical count of goods on
hand performed periodically (daily, weekly,
monthly or annually)
Commonly used for inventories that are
normally interchangeable, relatively low valued
and fast turnover rate such as groceries items,
medicines, electrical parts and office supplies
Low value but high volume (groceries)
It is updated each time of purchase or sales is
made. Thus, the ““Inventories or Merchandise
Inventory” account shows a continuing or
running balance of goods on hands
Records called “stock cards” and “stock ledger”
are maintained from which the quantities and
balances of goods on hand and good sold can be
determined at any given point of time without
the need of performing physical count.
Summary of inventory inflows and outflows
Commonly used for inventories that are
specifically identifiable and relatively high
value such as cars, machineries, furniture and
heavy equipment
(High Value, Low Volume)

Accounting Treatment:
Periodic Perpetual
➢ Increases and Decreases in inventory during ➢ All increases and decreases are recorded in
the period are recorded in “purchases”, “Inventory” account
“freight-in”, “purchases returns” and
purchases discounts accounts as appropriate
➢ “Cost of Goods Sold” is not recorded ➢ “Cost of Goods Sold” is debited when
inventory is sold and credited for sales returns
➢ Physical count is necessary to determine the ➢ Physical count is performed only to check the
balances of inventory on hand and cost of accuracy of the ledger balances
goods sold
➢ Requires the use of the following formula to ➢ Does not require the use of any formula to
determining the cost of goods: determine cost of goods sold because this
Beginning Inventory xx information is readily available from the
Net Purchases xx ledger.
Total Goods Available for Sales xx
Ending Inventory (Physical Count) xx
Cot of Goods Sold xx

Journal Entries:
Periodic Perpetual
Purchase of Merchandise:
Purchases xx Inventory xx
Accounts Payable xx Accounts Payable xx

Periodic Perpetual
Payment of Freight:
Freight - In xx Inventory xx
Cash xx Cash xx

THIS FORM IS FOR INSTITUTIONAL PURPOSES ONLY!

 Periodic Perpetual
Discount, Return and Allowances:
Accounts Payable xx Accounts Payable xx
Purchase Discount xx Inventory xx

Accounts Payable xx
Purchase Return and Allowances xx

Periodic Perpetual
Sale of Merchandise:
Accounts Receivable xx Accounts Receivable xx
Sales xx Sales xx

Cost of Goods Sold xx

Inventory xx

Periodic Perpetual
Return of Merchandise Sold:
Sales Return xx Sales Return xx
Accounts Receivable xx Accounts Receivable xx

Inventory xx
Cost of Goods Sold xx

Periodic Perpetual
Sales Discount and Allowances
Sales Return and Allowances xx Sales Return and Allowances xx
Accounts Receivable xx Accounts Receivable xx

Periodic Perpetual
Merchandise inventory at the year- end:
Inventory xx No entry unless there is shortage/overage
Income Summary xx
Shortage:
Loss on Inventory xx
Inventory xx

Overage:
Inventory xx
Income or appropriate account xx

Inventory Cost:

THIS FORM IS FOR INSTITUTIONAL PURPOSES ONLY!

• Cost is the total resources given up to acquire inventory and move it to the purchaser’s place of
business.
• Cost may be assigned to units of inventory in one of four ways:
-Specific identification
-First-In, First Out (FIFO)
-Last-In, First-Out (LIFO)
-Weighted Average Cost
• The actual application of these methods will vary depending on whether a perpetual or periodic
inventory system is used.

INVENTORY COST FLOW ASSUMPTIONS:

SPECIFIC IDENTIFICATION
Specific Identification means that each item in inventory is retains its purchase cost throughout the inventory
and cost of goods sold cycle. This inventory method is appropriate for a low volume, high value inventory,
such as a new car dealer or a high-end jewelry store would have. Specific identification is typically
used with the perpetual inventory method. This method provided the “truest” value for both ending inventory
and cost of goods sold, but is too cumbersome for many applications.

FIFO, LIFO AND AVERAGE

Under these three inventory methods, inventory items or units do not retain their unit purchase cost after the
purchase has been recorded. Instead, units sold during the accounting period and units remaining in inventory
at the end of the accounting period are assigned a cost according to the rules of FIFO, LIFO or Average Cost.
In summary:
Under FIFO, unit costs are assigned to units sold in the order in which they were incurred, regardless of
which units were actually sold. The oldest or first-in unit costs are used to calculate cost of goods sold;
remaining unit costs are assigned to the units in ending inventory.
Under LIFO, unit costs are assigned to units sold in the reverse order of which they were incurred,
regardless of which units were actually sold. The most recent or last-in unit costs are used to calculate cost
of goods sold; remaining unit costs are assigned to the units in ending inventory.
Under Average Cost, an average cost for all units cost for all units in inventory is calculated and used to
value the units in both cost of goods sold and ending inventory.

Following are examples of these methods under the periodic inventory method (Examples #1, #2 and #3)
and under the perpetual inventory method (Examples #4, #5 and #6). There are 50 units in ending
inventory.
Transaction Type # of Units Unit Cost
Beginning Inventory 10 P120
Purchased 40 P125
Sold 20
Purchased 50 P130
Sold 20
Sold 30
Purchased 40 P132
Sold 20

THIS FORM IS FOR INSTITUTIONAL PURPOSES ONLY!

Example #1: FIFO/Periodic
Note that the costs of the 50 units purchased at P130 have been split between the units sold and the units
remaining in inventory.
Cost of Goods Sold Ending Inventory
Units Cost/unit Units Cost/unit Total
10 P120 P1,200
40 P125 5,000
40 P130 5,200 10 P130 P1,300
40 132 5,280
P11,400 P6,580
Example #2: LIFO/Periodic
Cost of Goods Sold Ending Inventory
Units Cost/unit Total Units Cost/unit Total
50 P130 P6,500 10 P120 P1,200
40 132 5,280 40 125 5,000
P11,780 P6,200

Example #3: Average Cost/Periodic

Transaction Type # of Units Unit Cost Value
Beginning Inventory 10 P120 P1,200
Purchased 40 125 5,000
Purchased 50 130 6,500
Purchased 40 132 5,280
Total 140 128.43 17,980
***Average Cost: P17,980 / 140 total units = P128.43/unit (rounded). Average cost is calculated at the end of the period.
Cost of Goods Sold Ending Inventory
Units Cost/unit Total Units Cost/unit Total
90 P128.43 P11,558.50 50 P128.43 P6,421.50

Example #4: FIFO/Perpetual

Transaction Type Purchases Cost of Goods Sold Balance
Beginning Inventory 10@P120=P1,200
10@P120=P1,200
Purchased 40@P125=P5,000 40@P125=P5,000
10@P120=P1,200
Sold
10@P125=P1,250 30@P125=P3,750
30@P125=P3,750
Purchased 50@P130=P6,500 50@P130=P6,500
20@P125=P2,500 10@P125=P1,250
Sold
50@P130=P6,500
10@P125=P1,250
Sold
20@P130=P2,600 30@P130=P3,900
30@P130=P3,900
Purchased 40@P132=P5,280 40@P132=P5,280
20@P130=P2,600 10@P130=P1,300
Sold
40@P132=P5,280
Total/Balance P11400 P6580

THIS FORM IS FOR INSTITUTIONAL PURPOSES ONLY!

Example #5: LIFO/Perpetual
Transaction Type Purchases Cost of Goods Sold Balance
Beginning
10@P120=P1,200
Inventory
10@P120=P1,200
Purchased 40@P125=P5,000 40@P125=P5,000
10@P120=P1,200
Sold
20@P125=P2,500 20@P125=P2,500
10@P120=P1,200
20@P125=P2,500
Purchased 50@P130=P6,500 50@P130=P6,500
20@P130=P2,600 10@P120=P1,200
Sold 20@P125=P2,500
30@P130=P3,900
10@P120=P1,200
Sold
30@P130=P3,900 20@P125=P2,500
10@P120=P1,200
20@P125=P2,500
Purchased 40@P132=P5,280 40@P132=P5,280
10@P120=P1,200
Sold 20@P125=P2,500
20@P132=P2,640 20@P132=P2,640
Total/Balance P11640 P6340

Example #6: Average Cost/Perpetual

Transaction Type Purchases Cost of Goods Sold Balance
Beginning
10@P120=P1,200
Inventory
Purchased 40@P125=P5,000 50@P124=P6,200
Sold 20@P124=P2,480 30@P124=P3,720
Purchased 50@P130=P6,500 80@P127.75=P10,220
Sold 20@P127.75=P2,555 60@P127.75=P7,665
Sold 30@P127.75=P3,833 30@P127.75=P3,833
Purchased 40@P132=P5,280 70@P130.19=P9,113
Sold 20@P130.19=P2,603 50@P130.19=P6,509
Total/Balance P11471 P6509
***Average cost (highlighted in red) is calculated after each purchase and is used to value both cost of goods
sold and inventory until the next purchase is made.

Summary of Examples #1 through #6:

Cost of Goods Sold Ending Inventory
Units Value Units Value
Periodic
Example #1 90 P11,400 50 P6,580
Example #2 90 P11,780 50 P6,200
Example #3 90 P11,558 50 P6,422
Perpetual
Example #4 90 P11,400 50 P6,580
Example #5 90 P11,640 50 P6,340
Example #6 90 P11,471 50 P6,509

THIS FORM IS FOR INSTITUTIONAL PURPOSES ONLY!

 LEARNING ACTIVITY #4 – MID-TERM
Name: Score:
Program / Course: Class Schedule:
Year & Section: Contact No. / FB Account:
Residential Address:

Type of Activity (check or choose from below)

Concept Notes Laboratory Report Portfolio
Skills: Exercise / Drill Illustration Others:___________________

Activity Title : __________________________________________________________________

Learning Target : ________________________________________________________________
References (Author, Title, and Pages) :_______________________________________________

Problem Solving:
Transaction # of Units Unit Cost
Beginning Inventory 20 P2,200
Purchase 25 2,250
Sold 10
Sold 14
Purchase 15 P2,300
Sold 26
Purchase 20 P2,350

According to the table above, there are 30 units in the ending inventory.

Required: What is the cost of these units under each of the following assumptions?
a. FIFO/Periodic
b. LIFO/Periodic
c. Average Cost/Periodic
d. FIFO/Perpetual
e. LIFO/Perpetual
f. Average Cost/Perpetual

THIS FORM IS FOR INSTITUTIONAL PURPOSES ONLY!