List of contents

Chapter 2
1. Definitions

Accounting for Businesses Resources

Part 1: Raw Materials and tools

2. Measurement of materials and tools 3. Recognition of materials and tools

Why is Inventory Control Important?

Inventory is a significant asset and for many companies the largest asset. Inventory is central to the main activity of merchandising and manufacturing companies. Mistakes in determining inventory cost can cause critical errors in financial statements. Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.

Direct Materials Product Costs Direct Labor Factory Overhead

The cost of materials that are an integral part of the product. The cost of labor directly involved in converting material into the product. Manufacturing costs other than direct materials and direct labor.
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Flow of Manufacturing Costs

Direct Labor Factory Overhead

Flow of Manufacturing Costs

MATERIALS STOREROOM

PRINTING PLANT

WAREHOUSE
Job 69

CAMPUS BOOKSTORE

INK

INK

Job 73

Job 70

Materials Inventory

Work in Process Inventory

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Finished Goods Inventory

Cost of Goods Sold

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1. Definitions
Materials
Unfinished goods consumed by a manufacturer in providing finished goods. Classified as inventory in the current assets section of an entitys balance sheet

Classification of materials
Main raw materials Subordinate materials Fuels Spare parts Materials and equipments for capital construction Other materials

Tools
Tools and supplies are assets which do not meet the recognition criteria for fixed assets in terms of their value or usage time

2. Measurement of materials and tools

Perpetual vs. periodic inventory accounting system Principles of valuing materials and tools Initial Measurement Inventory costing methods

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Perpetual vs. Periodic Methods of Accounting

Perpetual vs. Periodic Methods of Accounting

Perpetual Method
Inventory records are updated after each purchase or sale Inventory accounts are used to record the balance and the moving of goods Costs of goods sold/used are calculated based on units of goods sold/used and unit cost assigned to those units

Periodic Method
Inventory records are updated periodically based on physical inventory counts Inventory accounts are only used to reflect the balance of goods, the moving of goods during the period is recorded in purchase account Costs of goods sold/used are calculated by taking cost of goods available for sale/use less cost of ending inventory Cost of ending inventory are determined by taking the units of ending inventory (found by physical count) and unit cost assigned to those units 12

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Principles of valuing materials and tools

Cost: Inventories (materials and tools) are determined at cost Prudence: Where the net realizable value is lower than cost, inventories are measured at the net realizable value Consistency: Inventory costing methods should be applied consistently
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Net realizable value

Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale

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Initial measurement
Materials and tools are initially measured at cost
The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing inventories to their present location and condition

Initial measurement
Materials and tools are initially measured at cost
The cost of purchase of materials and tools comprise the purchase price, non reimbursable taxes and duties, and transportation, handling and other costs directly attributable to the purchase. Trade discounts and purchase returns and allowances are deducted from the costs of purchase
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Non- reimbursable taxes and duties

Customs duties Excise duties VAT (in case the entity calculating VAT under direct method or the inventories are used for activities free from VAT)

Trade discounts
A trade discount is the decrease of the quoted price offered to the buyer for their large orders

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Purchases Returns and Allowances

A purchases return involves actually returning merchandise that is damaged or does not meet the specifications of the order. When the defective or incorrect merchandise is kept by the buyer and the vendor makes a price adjustment, this is a purchases allowance.
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CostofGoodsPurchased
Costofinventorypurchased(invoiceprice excludedVAT):
Less: Purchasereturnsandallowances Tradediscounts Plus: Nonrefundabletaxesandduties Transportation,handlingcosts
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Cost of Goods Purchased

Purchased 100 units of materials A on credit from Alden Company: 22,000,000 dong, including 2,000,000 dong of VAT. Transportation costs paid by cash: 500,000 dong. All materials are brought to the store. What is the cost of this amount of materials at time of recognition?
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Inventory costing methods

Used for calculating the value of materials and tools at the time of being issued from the store Four costing methods available
Specific identification Weighted average First in, first- out (FIFO) Last in, first out (LIFO)
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SpecificIdentificationMethod
Being used mainly for items of inventory that differ from unit to unit, such as used cars This method tracks the actual physical flow of the good. Each item of inventory is marked, tagged or coded with its specific unit cost This method is possible when a business has a limited variety of high-unit-cost items that can be clearly identified
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Weightedaveragemethod
The weighted average method assumes that the goods available for sale/use have the same (average) cost per unit. Under this method, the cost of goods available for sale/use is allocated on the basis of the weighted average unit cost.

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Weightedaveragemethod
Cost of goods sold/used Units of goods sold/used Weighted * -average unit cost

Weightedaveragemethod
Cost of beginning goods

Cost of goods purchased

Weighted -average = unit cost

Units of beginning goods

Units of goods purchased

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First in,first out

The FIFO method assumes that the earliest goods purchased are the first to be sold/used. Under this method, the costs of the earliest goods purchased are the first to be recognized as cost of goods sold/used

Last in,first out

The LIFO method assumes that the latest goods purchased are the first to be sold/used. Under this method, the costs of the latest goods purchased are the first to be assigned to cost of goods sold/used

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Inventory Cost Flow Assumptions

Purchased goods

Inventory Cost Flow Assumptions

Purchased goods

Sold goods

Sold goods
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Inventory Cost Flow Assumptions

Perpetual Inventory Costs

Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems
Item 127B Units 10 7 8 4 2 10 Cost $20 $30 21 31 32 22 Price Jan. 1 Inventory 4 Sale Cost of 10 Mdse.Purchase Sold 22 Sale 28 Sale 30 Purchase

Sold Purchased goods goods

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FIFO Perpetual Inventory Account

Item 127B Purchases Unit Cost Total Cost Cost of Mdse. Sold Unit Cost Total Cost Inventory Balance Unit Total Cost Cost 20 200

Date Jan. 1

Qty.

Qty.

Qty. 10

The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

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FIFO Perpetual Inventory Account

Item 127B

FIFO Perpetual Inventory Account

Purchases Date Jan. 1 4 Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. 7 Unit Cost 20 Total Cost 140 Inventory Balance Qty. 10 3 Unit Total Cost Cost 20 20 200 60

Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems

Item 127B Jan. 1 Inventory 4 Sale Cost of 10 Mdse.Purchase Sold 22 Sale 28 Sale 30 Purchase Units 10 7 8 4 2 10 Cost $20 $30 21 31 32 22 Price

The sale of 7 units leaves a balance of 3 units.

On January 4, 7 units of Item 127B are sold at $30 each.

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On January 4, 7 units of Item 127B are sold at $30 each.

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FIFO Perpetual Inventory Account

Item 127B

FIFO Perpetual Inventory Account

Purchases Date Jan. 1 4 10 Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. 7 8 21 168 Unit Cost 20 Total Cost 140 Inventory Balance Qty. 10 3 3 8 Unit Total Cost Cost 20 20 20 21 200 60 60 168

Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems

Item 127B Jan. 1 Inventory 4 Sale Cost of 10 Mdse.Purchase Sold 22 Sale 28 Sale 30 Purchase Units 10 7 8 4 2 10 Cost $20 $30 21 31 32 22 Price

On January 10, the firm purchased eight units at $21 each.

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purchased eight units at $21 each.

Because the purchase price of $21 is different than the cost of the previous 3 units Onhand, the inventory balance of on January 10, the firm 11 units is accounted for separately.

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FIFO Perpetual Inventory Account

Item 127B

FIFO Perpetual Inventory Account

Purchases On January 22, the Cost of Mdse. Sold Unit Total Unit Total firm sold four units Date Qty. Cost Cost Qty. Cost Cost for $31 each. Jan. 1 4 10 22 7 8 21 168 3 1 20 21 60 21 20 140 Inventory Balance Qty. 10 3 3 8 7 Unit Total Cost Cost 20 20 20 21 21 200 60 60 168 147

Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems

Item 127B Jan. 1 Inventory 4 Sale Cost of 10 Mdse.Purchase Sold 22 Sale 28 Sale 30 Purchase Units 10 7 8 4 2 10 Cost $20 $30 21 31 32 22 Price

On January 22, the firm sold four units for $31 each.

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Of the four units sold, three are from the first units in (fifo) at a cost of $20.

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FIFO Perpetual Inventory Account

Item 127B

FIFO Perpetual Inventory Account

Purchases Date Jan. 1 4 10 22 28 Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. 7 8 21 168 3 1 2 20 21 21 60 21 42 Unit Cost 20 Total Cost 140 Inventory Balance Qty. 10 3 3 8 7 5 Unit Total Cost Cost 20 20 20 21 21 21 200 60 60 168 147 105

Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems

Item 127B Jan. 1 Inventory 4 Sale Cost of 10 Mdse.Purchase Sold 22 Sale 28 Sale 30 Purchase Units 10 7 8 4 2 10 Cost $20 $30 21 31 32 22 Price

On January 28, the firm sold two units at $32.

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On January 28, the firm sold two units at $32.

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FIFO Perpetual Inventory Account

Item 127B

FIFO Perpetual Inventory Account

Purchases Date Jan. 1 4 10 22 28 30 Totals
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Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems

Item 127B Jan. 1 Inventory 4 Sale Cost of 10 Mdse.Purchase Sold 22 Sale 28 Sale 30 Purchase Units 10 7 8 4 2 10 Cost $20 $30 21 31 32 22 Price
Qty.

Cost of Mdse. Sold Total Cost Qty. Unit Cost Total Cost 140

Inventory Balance Qty. 10 3 3 8 7 5 5 10 15 Unit Total Cost Cost 20 20 20 21 21 21 21 22 200 60 60 168 147 105 105 220 $325
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Unit Cost

On January 30, purchased 7 20 8 ten additional units of 21 168 Item 127B at $22 each. 3 20
1 2 10 18 22 220 $388 13 21 21

60 21 42

On January 30, purchased ten additional units of Item 127B at $22 each.

$263

FIFO Perpetual Inventory Account

Item 127B Purchases Date Jan. 1 4 10 22 28 30 Totals Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. 7 8 21 168 3 1 2 10 18 22 220 $388 13 $263 20 21 21 60 21 42 Unit Cost 20 Total Cost 140 Inventory Balance Qty. 10 3 3 8 7 5 5 10 15 Unit Total Cost Cost 20 20 20 21 21 21 21 22 200 60 60 168 147 105 105 220 $325
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LIFO Perpetual Inventory Account

Item 127B Purchases Unit Cost Total Cost Cost of Mdse. Sold Unit Cost Total Cost Inventory Balance Unit Total Cost Cost 20 200 Item 127B

LIFO Perpetual Inventory Account

Purchases Unit Cost Total Cost Cost of Mdse. Sold Unit Cost 20 Total Cost 140 Inventory Balance Unit Total Cost Cost 20 20 200 60

Date Jan. 1

Qty.

Qty.

Qty. 10

Date Jan. 1 4

Qty.

Qty. 7

Qty. 10 3

The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.
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On January 4, the firm sold 7 units at $30 each.

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LIFO Perpetual Inventory Account

Item 127B Purchases Unit Cost Total Cost Cost of Mdse. Sold Unit Cost 20 Total Cost 140 Inventory Balance Unit Total Cost Cost 20 20 20 21 200 60 60 168 Item 127B

LIFO Perpetual Inventory Account

Purchases Unit Cost Total Cost Cost of Mdse. Sold Unit Cost 20 Total Cost 140 Inventory Balance Unit Total Cost Cost 20 20 20 21 20 21 200 60 60 168 60 84

Date Jan. 1 4 10

Qty.

Qty. 7

Qty. 10 3 3 8

Date Jan. 1 4 10 22

Qty.

Qty. 7

Qty. 10 3 3 8 3 4

21

168

21

168 4 21 84

On January 10, the firm purchased eight units at $21 each.

Note that a new layer is formed.

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On January 22,sold, all come Of the 4 units the firm sells four from the most recent purchase units at $31 each. each. at a cost of $21
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LIFO Perpetual Inventory Account

Item 127B Purchases Unit Cost Total Cost Cost of Mdse. Sold Unit Cost 20 Total Cost 140 Inventory Balance Unit Total Cost Cost 20 20 20 21 20 21 20 21 200 60 60 168 60 84 60 42 Item 127B

LIFO Perpetual Inventory Account

Purchases Unit Cost Total Cost Cost of Mdse. Sold Unit Cost 20 Total Cost 140 Inventory Balance Unit Total Cost Cost 20 20 20 21 20 21 20 21 20 21 22 200 60 60 168 60 84 60 42 60 42 220

Date Jan. 1 4 10 22 28

Qty.

Qty. 7

Qty. 10 3 3 8 3 4 3 2

Date Jan. 1 4 10 22 28 30

Qty.

Qty. 7

Qty. 10 3 3 8 3 4 3 2 3 2 10

21

168 4 2 21 21 84 42

21

168 4 2 21 21 84 42

10

22

220

On January 28, sold two units at $32 each.

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On January 30, purchase 10 units at $22 each.

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LIFO Perpetual Inventory Account

Item 127B Purchases Unit Cost Total Cost Cost of Mdse. Sold Unit Cost 20 Total Cost 140 Inventory Balance Unit Total Cost Cost 20 20 20 21 20 21 20 21 20 21 22 200 60 60 168 60 84 60 42 60 42 220 53 $322

Date Jan. 1 4 10 22 28 30

Qty.

Qty. 7

Qty. 10 3 3 8 3 4 3 2 3 2 10 15

21

168 4 2 21 21 84 42

Fifo Periodic

10

22

220

Totals

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$388

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$266

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Fifo Periodic
200 units @ $9 300 units @ $10 400 units @ $11 100 units @ $12 1,000 units available for sale during year Jan. 1 Beginning Inventory Mar. 10 Purchase Sept. 21 Purchase Nov. 18 Purchase

Fifo Periodic
200 units @ $9 300 units @ $10 400 units @ $11 100 units @ $12 = $1,800 = = = 3,000 4,400 1,200 Jan. 1 Mar. 10 Sept. 21 Nov. 18

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1,000 units available $10,400 for sale during Cost of merchandise year
available for sale

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Fifo Periodic
A physical count on December 31 reveals that ending units of inventory is 300. The cost of the ending inventory is found by taking the unit cost of the most recent purchased and working backward until all units of inventory are costed
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Fifo Periodic
Sold these 200 200 units @ $9 Sold these $10 300 units @300 Sold unitsof these 400 200 @ $11 200 100 units @ $12 $1,800 = $ 0 = = = 3,000 0 4,400 2,200 1,200 Jan. 1 Mar. 10 Sept. 21 Nov. 18

1,000 units available $10,400 $ 3,400 for sale during year Ending inventory

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Fifo Periodic
Cost of merchandise available for sale $10,400 Less ending inventory 3,400 Cost of merchandise sold $ 7,000

Summary of Fifo Periodic

Purchases
Jan. 1 200 units at $9 Mar. 10 300 units at $10 Sep. 21 400 units at $11 Nov. 18 100 units at $12

Merchandise Available for Sale

$1,800 $3,000

Cost of Merchandise Sold

$7,000

700 units

$4,400 $1,200 $10,400

Merchandise Inventory
$2,200 $1,200 $3,400 200 units at $11 100 units at $12

1,000 units

300 units
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Lifo Periodic
200 units @ $9 Jan. 1 Beginning Inventory Mar. 10 Purchase Sept. 21 Purchase Nov. 18 Purchase

Lifo Periodic

300 units @ $10 400 units @ $11 100 units @ $12 1,000 units available for sale during year

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Lifo Periodic
200 units @ $9 300 units @ $10 400 units @ $11 100 units @ $12 Jan. 1 Beginning Inventory Mar. 10 Purchase Sept. 21 Purchase Nov. 18 Purchase

Lifo Periodic
A physical count on December 31 reveals that ending units of inventory is 300 The cost of the ending inventory is found by taking the unit cost of the oldest goods and working forward until all units of inventory are costed
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1,000 units lifo, the most recent batch Using available for sale during purchased is considered the first year of merchandise sold. batch

Lifo Periodic
200 units @ $9 Sold unitsof these 100 200 @ $10 300 400 units @400 Sold these $11 100 units @100 Sold these $12 = $1,800 = = = 3,000 1,000 4,400 0 1,200 0 Jan. 1 Mar. 10 Sept. 21 Nov. 18

Lifo Periodic
Cost of merchandise available for sale $10,400 Less ending inventory 2,800 Cost of merchandise sold $ 7,600

1,000 units available $10,400 $2,800 for sale during year Ending Inventory

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Summary of Lifo Periodic

Purchases
Jan. 1 200 units at $9 Mar. 10 300 units at $10 Sep. 21 400 units at $11 Nov. 18 100 units at $12

Average Cost Periodic

200 units @ $9 300 units @ $10 400 units @ $11 100 units @ $12 Jan. 1 Beginning Inventory Mar. 10 Purchase Sept. 21 Purchase Nov. 18 Purchase

Merchandise Available for Sale

$1,800 $3,000

Merchandise Inventory
$1,800 $1,000 $2,800 Cost of Merchandise Sold 200 units at $9 100 units at $10

300 units

$4,400 $1,200 $10,400 $7,600

700 units

1,000 units

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1,000 units available for sale during year

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Average Cost Periodic

200 units @ $9 300 units @ $10 400 units @ $11 100 units @ $11 1,000 units available for sale during year = $ 1,800 = $ 3,000 = $ 4,400 = $ 1,200 $10,400 Cost of merchandise available for sale sale 69

Average Cost Periodic

Cost of Merchandise Available for Sale = Average Unit Cost Units Available for Sale During Year $10,400 1,000 Units = $10.40 per Unit

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Average Cost Periodic

Cost of merchandise available for sale $10,400 Less ending inventory ($10.40 x 300) 3,120 Cost of merchandise sold $ 7,280 To verify this amount, multiply 700 units sold times $10.40 to get the same $7,280.
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3. Accounting for materials and tools

Source documents Accounts used Journal entries for some basic transactions (according to perpetual accounting system)

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Source documents
Receiving Report No. 196

Source documents
Receiving Report No. 196

Materials received are inspected by the Receiving Department. Once inspected, a receiving report is prepared showing the quantity received and its condition.
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Invoice

The receiving report and the invoice are used to record the receipt of the merchandise and to control the payment.

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Source documents
Receiving Report No. 196

Accounts used
Acc 151 - Goods in transit Acc 152 Materials Acc 153 Tools and supplies Acc 133 Deductible VAT

Invoice

a. Materials Accounts Payable Materials purchased during December.

10 500 00 10 500 00

Acc 331 Account payable Acc 111, 112 Cash on hand, in bank Acc 621,627,641,642 Expenses Acc 142, 242 Prepaid expenses
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Account 151 Goods in transit

Value of goods owned by the entity in transit at the end of the period Value of goods in transit at the end of the period transferred from acc 611 Value of goods in transit which is received by the entity Transferring the beginning balance to acc 611

Account 152 Materials

Cost of materials increased by Receiving (from purchase, production) Revaluation Stock- taking Cost of materials inventory at the end of the period transferred from acc 611 Cost of materials decreased by Issuing for use in business activities Deducting purchase returns and allowances, trade discounts Revaluation Stock taking Transferring the beginning balance to acc 611

Balance

Balance: cost of materials at a point of time

Account 611 Purchase

Receiving the beginning balance of acc 151,152,153 Cost of materials, tools increased during the period Transferring materials, tools inventory, goods in transit at the end of the period to 152, 153,151 Cost of materials and tools used for different purposes during the period Revaluation

Common transactions
1. Materials and tools received by purchase
Goods in transit

2. Materials issued for use in business activities 3. Tools issued for use in business activities

Subsidiary accounts:

Acc 6111: Materials and tools purchase

Acc 6112: Goods purchase

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1. Materials and tools received by purchase Source documents: purchase invoices and receiving notes: Journal entry (perpetual method)
Dr acc 152 cost of materials and tools received Dr acc 133 deductible VAT (if any) Cr acc 111, 112 total amount paid Cr acc 331 total amount payable
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1. Materials and tools received by purchase

Example:
Purchased 100 units of materials A on credit from Alden Company: 22,000,000 dong, including 2,000,000 dong of VAT. Transportation costs paid by cash: 500,000 dong. All materials are brought to the store (both receiving notes and invoice are received by accountant) Using the perpetual system of accounting, provide the journal entry for the above transactions

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1. Materials and tools received by purchase

1. Materials and tools received by purchase

Example:
If VAT is deductible then Journal entry
Dr acc 152 20,000,000 Dr acc 133 2,000,000 Cr acc 331 22,000,000 (payable to Alden Co.,) and Dr acc 152 500,000 Cr acc 111 500,000
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Example:
If VAT is not deductible then Journal entry
Dr acc 152 22,000,000 Cr acc 331 22,000,000 (payable to Alden Co.,) and Dr acc 152 500,000 Cr acc 111 500,000
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1. Materials and tools received by purchase Goods in transit Source documents: purchase invoices only Journal entry (made at the end of the period - perpetual method):
Dr acc 151 Value of materials and tools in transit Dr acc 133 deductible VAT (if any) Cr acc 331 total amount payable

1. Materials and tools received by purchase Goods in transit Whenever the accountant receives the receiving note of this purchase, then the following journal entry is made (perpetual method):
Dr acc 152, 153 Value of materials and tools received Cr acc 1511 value of materials and tools in transit

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1. Materials and tools received by purchase Goods in transit - Example Purchased 100 units of materials A on credit from Alden Company: 22,000,000 dong, including 2,000,000 dong of VAT according to the invoice dated Sep 15. At the end of the month, the accountant has not received the receiving note of this purchase Suppose VAT is deductible. Using the perpetual system of accounting, provide the journal entry for the above transactions

1. Materials and tools received by purchase Goods in transit - Example Journal entry on Sep 30:
Dr acc 151 20,000,000 Dr acc 133 2,000,000 Cr acc 331 22,000,000 (payable to Alden Co.,)

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1. Materials and tools received by purchase Goods in transit - Example Suppose on Oct 2, receiving note of this purchase is received by accountant Journal entry on Oct 2:
Dr acc 152 Cr acc 151 20,000,000 20,000,000

2. Materials issued for use in business activities Source documents: Goods issuing notes Journal entry (perpetual method) :
Dr acc 621,627,641,642 cost of materials issued Cr acc 152 Cost of materials issued

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2. Materials issued for use in business activities Example Issuing 15,000,000 dong for direct use in production, 2,000,000 for use in sales department Journal entry (perpetual method) :
Dr acc 621 Dr acc 641 Cr acc 152 15,000,000 2,000,000 17,000,000

3. Tools issued for use in business activities Source documents: Goods issuing notes Journal entry (perpetual method) :
Dr acc 621,627,641,642 cost of tools issued if it is small Dr acc 142, 242 if it is quite large and needed to allocate for more than 1 period Cr acc 153 Cost of materials issued

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3. Tools issued for use in business activities Example Issuing 100 tools with the value of 15,000,000 dong for use in production department. These tools have the useful life of 12 months Provide the journal entry for the above transaction if
The accounting period is 1 month The accounting period is 1 year
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3. Tools issued for use in business activities Example If the accounting period is 1 month, then The journal entry (perpetual method) made on the issued day
Dr acc 142/242 Cr acc 153 15,000,000 15,000,000

At the end of each month from the issued month, an adjusting entry is made to allocate the value of tools issued to the expense of the period Dr acc 627 1,250,000 94 Cr acc 142/242 1,250,000

3. Tools issued for use in business activities Example If the accounting period is 1 year, then The journal entry (perpetual method) made on the issued day
Dr acc 627 Cr acc 153 15,000,000 15,000,000

Chapter 2 Continue

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