INVENTORY INFO FOR CLASS:
Merchandisers, Manufacturers, and Inventory Transactions
A merchandiser is simply a company who buys a finished product from a manufacturer and sells the product directly to the consumer. Common examples of merchandisers are Walmart, Target, Kmart, and grocery stores. They buy products from companies like Proctor & Gamble, Keebler, and Johnson & Johnson. Then they turn around and sell those products to consumers like you and me.
Both merchandisers and manufacturers must purchase, manage, and sell merchandise inventory.
When we record a cash sale, we will record a debit to cash and a credit sales. At the same time we also need to record an entry ...view middle of the document...
Periodic vs Perpetual Inventory
Under the periodic inventory system, we only update the inventory account in our accounting records when we physically count the inventory. Under the perpetual system, our inventory account is continuously updated – it is updated each time we make a sale or a purchase.
Inventory Costing Methods
Now, we already know that when we make a sale, we post two entries to the general ledger. The first entry is a debit to accounts receivable and a credit to revenue – assuming we made the sale on credit. The second entry is a debit to cost of merchandise sold and a credit to inventory. Remember that the cost of merchandise sold will be an expense shown on the income statement. The inventory account is an asset and will be found on the balance sheet.
Now, let’s say that we are a merchandiser. We start the period with some amount of inventory in our warehouse. During the month, we make some more purchases – all at different costs. Now, also during the month, we are continuously selling this inventory. So we have to determine which inventory is going to go into our cost of goods sold. Whatever does not go into cost of goods sold will be left on our balance sheet in our inventory account.
Okay, in order to determine what will go into cost of goods sold and ending inventory, we will have to make some cost flow assumptions. Before we discuss them, let’s talk about why we have to make them. In reality, most companies cannot track each individual piece of merchandise. It just would not be cost effective to do so. Very few companies will track each individual piece of merchandise. Usually only companies dealing with very expensive inventory will do this such as car dealerships or expensive jewelry dealers. For companies who do track each item, this is called the specific identification method. They always know exactly which items they have sold and exactly which items are still sitting in ending inventory.
Now, let’s talk about why this would not be practical for other merchandisers. Let’s say for example that we are Walmart or a big grocery store chain. Obviously, we sell thousands of different items every day. Let’s think about one item in particular. Let’s say canned green beans for example. Walmart may start the month with 50,000 cans of green beans sitting in one of their warehouses. Then during the month, they might purchase another 200,000 cans of green beans (let’s say that they make one purchase a week during the month – the first purchase was made for $0.32 per can, the second was made at $0.33 per can, the third was made at $0.35 per can, and the final purchase was made at $0.36 per can. At the same time, during the month, they might sell 180,000 cans of green beans. So, how does Walmart know which can of green beans they sold??? How do they know if they sold a can that costs them $0.32 or a can that costs them $0.35??? The answer is: they don’t!!! It would not be practical for...