7/29/2019 inst_11.doc

1/4

UNIT # 11 -INVENTORIES

TUTORIAL - INITIAL

TUTORIAL - COMPLETED

7/29/2019 inst_11.doc

2/4

INSTRUCTIONS FOR UNIT # 11

~ In Unit #10 you prepared closing entries to measure profit or loss and the change toequity. At his point we've established the sequence of recording, adjusting, and closingtransactions. Before looking at financial statements, we'll introduce the accountingtreatment of inventory.

~ When inventory is acquired it is an asset; when sold it is an expense. In this tutorialwe will use the perpetual system in which a company has an information system totrack the purchase, sale, and current balance. The sequence ofjournal entries works thisway:

~ When purchased, record to the inventory account and the related accounts payable orcash account. Inventory is recorded at cost.

~ If part of the inventory is returned, reduce the payable and inventory account.~ When selling inventory with credit, record to accounts receivable and sales. Inventory

is sold at price. The difference between price and cost is gross profit ormargin. For

example, if cost is $50 and price is $ 90, $ 40 is gross profit or margin. A business musthave sufficient gross profit to cover it's operating expenses and provide a profit. Asecond entry must happen when a sale occurs; record to an expense account called costof merchandise sold. These two entries comply with the matching principle whichrequires that revenues and expenses be recorded in their proper time period. Therefore, ifa sale occurs the matching expense must also be recorded.

~ When selling inventory for cash, follow the same sequence except record to cash.~ When selling for Visa or Mastercard, record to cash as banks recognize the credit

card slip as a deposit to cash.~ When selling inventory for American Express, record to accounts receivable as

American Express requires the seller to send in the slips and they in turn will mail the

cash less a deduction for their fee; this deduction is recorded as credit card expense bythe seller. For example, on a $ 50 sale, the seller receives $ 45; the $ 5 is treated as creditcard expense.

~ When previously sold merchandise is returned, debit to sales returns and allowancesand credit to accounts receivable. This shows the reduction to the sale and reduces thereceivable.

~ If merchandise is sold at a discount, e.g. 2/10/n30 means 2% discount granted if paidin 10 days; reason: to accelerate cash flow. When this happens, a sales discount accountis setup to record the discounts.

~ If taking a discount on merchandise bought, a purchase discount account is setup.~ Tutorial #11 Initial is setup to record ten entries. Enter the correct accounts( HIT THE

SPACE BAR 3 TIMES FOR CREDITS) and amounts in the columns. The column onthe right, Accounts, will display a response of" Correct" or"Not correct". It willalso display on the left "In balance" or"Not in balance" to assure the equality of debitsand credits. The ten entries are:

1. Buying inventory on credit, $ 525.2. Returning inventory, $ 25.3. Buying inventory with cash, $ 400.

7/29/2019 inst_11.doc

3/4

INSTRUCTIONS FOR UNIT # 11

4. Selling inventory on credit, $ 810; recording the cost of the merchandise sold and

the reduction to inventory, $ 400.5a. Selling inventory for cash, $ $ 100; recording the cost of the merchandise sold andthe reduction to inventory, $ 50.

5b. Selling inventory with Visa or Mastercard, $ 90; recording the cost of merchandisesold and reduction to inventory, $ 45.

6. Selling inventory with American Express, $ 90; recording the cost of merchandiseSold and reduction to inventory, $ 45.

7. Recording sales returns of $ 10. The $ 10 was from a credit sale.8. Collecting cash on a receivable of $ 800; 2% of the $ 800 was a sales discount;

98% was collected as cash.9. Collecting cash from an American Express sale. The receivable was $ 90, $ 5 was

kept by American Express and $ 85 was received as cash.10. Made a payment on accounts payable. The payable was $ 500, 2% was taken asdiscount and 98% was paid.

~ Tutorial # 11 Completed has the correct accounts and amounts to include "Inbalance".

~ These transactions are significant to most companies as they show how buying andselling inventory can change the financial position of a company. With many companiesusing point of sale terminals and computerized sales and inventory systems, these entriesare recorded in "real time", i.e. as they occur. We'll now show the significance of thatchange to financial position.~ When a company sells inventory it has bought, the difference between the price to thecustomer and the cost to the merchant is called gross profit or margin. It is a criticalnumber as the amount of gross profit or margin must be sufficient to cover operatingexpenses and generate a profit. Accordingly, well compute the gross profit from theabove transactions:~ At the bottom of the Tutorial #11 Initial there is a section titled Computing grossprofit or margin and Computing ending inventory. The entries for these computationsare based on the transactions you have entered above. Transactions # 1 and 4 have beenentered for you to demonstrate how this works. Note how the ending inventory has beencomputed. A response of"Reconciled " appears to show that calculation. Also, look atthe two percents, gross profit rate and cost compliment. They show the percentage ofgross profit and product cost (called cost compliment) to net sales. Those percentages arewatched carefully by managers to see if the company is "on target" for goals or budgets.~ When you complete the entering of the ten transactions, look at these computations asthey summarize their financial impact. They appear at the bottom of Tutorial #11Completed.

7/29/2019 inst_11.doc

4/4