INVENTORY VALUATION LECTURE
Inventory refers to goods
1. Held for sale in the ordinary course of business
2. To be (or being) used in the production of finished goods (or services) to be available for sale later.
Merchandising firms have merchandise inventory, which refers to items being held for
sale. Manufacturing firms have raw materials, work in process, and finished goods.
Inventory includes goods in transit and goods out on consignment.
Perpetual and Periodic Systems
Perpetual System
Inventory can be valued using either the perpetual or the periodic system. Perpetual means continuous,
so in theory, the value of inventory on hand and cost of goods sold for the period can be determined
after every transaction involving inventory. Under the perpetual inventory system, the journal entries
are as follows:
When goods are bought:
Debit Inventory
Credit Accounts Payable
When goods are sold:
Debit Accounts Receivable
Credit Sales
and
Debit Cost of Goods Sold
Credit Inventory
One of the difficulties of the perpetual system was that the calculation of inventory values could get
complex very quickly. However, the decrease in the cost of computing power and the widespread use of
computers have led to the increasing use of the perpetual inventory system.
Periodic System
In contrast, under the periodic system, the value of inventory on hand and the cost of goods sold for the
period are determined at the end of each period. Under the periodic inventory system, when goods are
purchased they are recorded in the purchases account. In the perpetual inventory system, the journal
entries are as follows:
When goods are bought:
Debit Purchases
Credit Accounts Payable
When goods are sold:
Debit Accounts Receivable
Credit Sales
At the end of the period, ending inventory is determined by a physical count. The cost of goods sold can
be calculated by using information about the beginning inventory, ending inventory, and purchases.
Inventory Systems:
Periodic -
does not keep a continuous record of inventory on hand
-
physical inventory is required at least once a year
Perpetual - keeps a continuous record of inventory on hand
-
an annual physical inventory is still required
Journal entries for Purchases and Sales of Inventory:
Credit Purchases
Perpetual System
Periodic System
Inventory
Purchases
Accounts Payable
Credit Sales
Accounts Payable
To record sale of merchandise:
Accounts Receivable
Accounts Receivable
Sales
Sales
To record cost of merchandise:
Cost of Goods Sold
No entry required
Inventory
End of Period
Transfer Beg. Inv. Bal. To COGS:
Entries
Cost of Goods Sold
Inventory
No entries required
Record End. Physical Inventory:
Inventory
Cost of Goods Sold
Transfer cost of purchases to
COGS:
Cost of Goods Sold
Purchases