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Chapter4 Inventory and cost of goods sold SpotlightDanny opened a supermarket named Happy Mall. There are variety kinds of inventories in the supermarket. The merchandise inventory is Happy Mall’s largest asset while the cost of goods sold is the largest expense. How to manage these inventories is the most important issue for the company. However, the cost of the purchase of each batch may be different. The different cost of goods sold may lead to different net income. So how to measure the cost of the inventory sold? How to measure the ending inventory?The management of inventory has significant impact to an entity, especially commercial enterprise. Reasonable inventory management can help the enterprise to calculate the profit and report the assets correctly. Through the control of the inventory, the enterprise can achieve the ultimate goal of inventory management-Improvement of economic benefit.Text1 Classifications of inventoryInventories are also called merchandise inventories. Inventories can include any of the followings:•Finished Goods product•Work in progress being produced•Materials•Purchased goods2 Inventory and cost of goods soldExhibit 4-1Financial statement Account StatusBalance sheet Inventory On handIncome statement Cost of goods sold Sold3 Gross profitFor merchandising firms, an initial step in assessing profitability is gross profit. Gross profit, also called gross margin, is the excess of sales revenue over cost of goods sold. It is the difference between sales revenues and the cost of goods sold.Gross profit= Sales revenue-cost of goods sold4 Accounting for inventoryThere are 2 main types of inventory accounting systems:•Periodic inventory system•Perpetual inventory system4.1 Periodic inventory systemThis system in which the cost of goods sold is computed periodically by relying solely on physical counts without keeping day-to-day records of units sold or on hand.The periodic inventory system does not involve a day-to-day record of inventories or of the cost of goods sold. Instead we compute the cost of goods sold and an updated inventory balance only at the end of an accounting period, when we take a physical count of inventory.Beginning balance+ Newly purchase-Cost of goods sold=Ending balanceCost of goods sold=Beginning balance+ Newly purchase-Ending balanceExhibit 4-2Goods available for sale -Inventory left over = Cost of goods sold 4.2 Perpetual inventory systemIt is a system that keeps a running, continuous record that tracks inventories and the cost of goods sold on a day-to-day basis. The daily record helps managers control inventory levels and prepare interim financial statements. In addition to this continuous record-keeping process, companies periodically physically count and value the inventory.No matter which method a company choose to manage its inventory, it should conduct a physical count at least once a year to check on the accuracy of the continuous record.Journal entry:①Inventory is purchased:Dr: Inventory. . . . . . . . . . . . . . . . . . . . .. . . . . . . . . .XXXCr: Cash. . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . XXX②Inventory is soldDr: Cash. . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . XXXCr: Sales revenue. . . . . . . . . . . . . . . . . . . . .. . . . .XXXDr: Cost of goods sold. . . . . . . . . . . . . . . . . . . . .. .XXXCr: Inventory. . . . . . . . . . . . . . . . . . . . .. . . . . . . . .XXX5 The various inventory costing methodThere is a challenge to recognize the cost of goods sold. Because the unit price is different every time when purchase inventory.There are four accepted inventory method•Specific identification method•Average cost method•First-in, first out•Last in, first out5.1 Specific identification methodIt is also called specific identification method. Specific identification method concentrates on physically linking the particular items sold with the cost of goods sold that we report. Business cost their inventories at the specific cost of the particular unit. This method is relatively easy to use for expensive, low volume。
