Inventory affiliated transactions

Remember that, in illustration one, inventory item was introduced whereby it was treated as a current asset. However, this balance sheet item is different from the rest of the ledger accounts for it is governed by the International Accounting Standards number two (IAS-2). The standard require that a demarcation between the quantitative and monetary aspect of inventory be considered when recording inventory affiliated transactions. That is, the monetary value of goods sold be determined by the selling price whereas, the monetary value of the unsold inventory be determined by either:-

1. Cost

2. Market price

Whichever is lower

The challenge which an entrepreneur faces is how to adjust inventory value to represent its two dimensions when all or part of the inventory units is sold. This is because the following scenarios may occur;

The Purchase price may be less than selling price

The Purchase price may be greater than selling price

The Purchase price may be equal to selling price

The same Accounting standard provides different methods/approaches of determining the price to be used to value inventory during stock taking process. This includes;

1. First in First Out (FIFO)

2. Last in Last Out (LIFO)

3. Highest price in First Out (HIFO)

4. Simple average Method

5. Weighted Average Method

The details on how those methodologies apply are not provided at this tutorial level. The entrepreneur/learner needs to consult a professional accountant to value his or her inventory for his business.

Inventory Transactions

There are four transactions which affect inventory item. These are;

1. Purchase of inventory

2. Sale of goods/inventory

3. Goods returned by the customers

4. Goods returned by the business to the suppliers

Purchase of Inventory

When goods are bought for reselling purpose, the quantity and monetary aspect of inventory increases. However, the inventory account is replaced with purchases account to avoid the quantity-monetary mismatch. This is because the purchases account takes care of the monetary changes of the inventory (keeps track) whereas, stock/inventory taking which is a physical counting of the inventory units acquired represents the quantitative changes occurring on the inventory. Case 1 demonstrates the accounting treatment for such transactions.

Case-1

Suppose on 6th/1/2018, Zack purchased 1000 units of inventory in cash amounting to $75,000. The accounts affected will be;

Cash a/c (asset)-decrease in value (CR)

Purchases a/c (trading expense)    (DR)

The accounting entries are as shown below

Sale of Inventory/goods

Once goods have been bought for re-selling purposes, the next step is the actual selling. Two accounting challenges that may arise are;

1. Some or all goods bought can either be sold at a higher price than purchase price, hence making some profits or can be sold at same price as the purchase price hence making zero profits or at a lower price than purchase price resulting to losses.

2. All units of goods bought can be sold at a go or some units may remain unsold at the end of the period given.

   The question that arises is how to account for case “a” and “b” aforementioned.

   For case (a), the accounts affected will be sales and cash account (if goods were sold on cash) or if goods were sold on credit, trade debtor account will replace cash account. For case (b) if some of the goods were sold, then it is only the units sold which will be considered as sales hence the transaction will be recorded in sales and cash/debtors accounts respectively. The following case-2 will assume that all the 1000 units of inventory were sold as shown below;

Case-2

Suppose on 6th/1/2018, Zack sold all the 1000 units of the inventory/goods previously bought for $100,000 in cash. The accounts affected are;

Sales a/c (income) increase in value (CR)

Cash a/c (asset) increase in value     (DR)

The accounting entries are as shown below

Case-3

Let us re-visit case 2 and assume that on 6th/1/2018, Zack sold only 900 units of inventory for $90,000 on cash basis. The accounts affected are;

Cash a/c (asset) increase in value        (DR)

Sales a/c (income) increase in value   (CR)

The accounting entries are as shown below

On sale of inventory, the transaction is recorded in the cash and sales accounts at market price (ie $100) whereas the unsold inventory of 100 units were valued at $7,500 for the IAS no-2 requires that the inventory be valued at cost or market net realizable price whichever is lower. From this illustration, it is clear that inventory account is not suitable to keep track of all business transaction affecting inventory as it is with other accounts.

Goods/inventory returned by customer

Sometimes goods sold by the firm to the customer may have some discrepancies such as physical damage during transfer from the seller’s destination to the customer’s area of operation. Other discrepancies could be goods with wrong specifications etc. such goods are returned to the business hence have some financial implication. This type of transaction is also known as return inwards. When this transaction occurs, the accounts affected are;

Debtor account and returns inwards account

Case-4

Assume 6th/1/2018, Our co. ltd sold goods on credit to “Y” company ltd for $200,000 and on;

      7th/1/2018, “Y” co. ltd returned goods worth $15,000 for they were of low quality   

The accounting entries were as follows; 

 Goods/inventory returned to Supplier

Just as it is in the case of return inwards, the goods bought by the firm in question may be returned to the supplier due to some discrepancies such as physical damage during transfer from the supplier destination to the firm premises. The goods bought by the firm may also have discrepancies such as wrong specifications etc. such goods are returned by the business to the supplier, hence will have some financial implication to the firm. When this transaction occurs, the accounts affected are;

Creditor account and

Return outwards account

Case-5

Assume that 6th/1/2018, Our co. ltd bought goods on credit from “T” co. ltd. for $105,000 and on;

              7/1/2018, Our co. ltd returned goods worth $5,000 for they were damaged

The accounting entries were as follows;