Question

Case Background

A sole proprietor (the owner) has established a service business specializing in recruitment for businesses needing specialized Tool Industry staff. The trail balance at the end of the first three months of operations is provided below. Part of the service is to train people before they are placed with companies. The owner has asked, you, the accountant for HR, to prepare the answers to the questions below considering the notes provided.

Trial Balance

Accounts	Debits	Credits
Cash	24,500
Accounts Receivable	10,000
Inventories / Supplies	3.500
Equipment	50,000
Accounts Payable		1,500
Notes Payable		50,000
Capital		15,000
Withdrawals	10,000
Sales		50,000
Salaries	15,000
Advertising	2,000
Accountants Fees	1,500
Total	116,500	116,500

Notes

1. The owner issued a cheque for $2,000 for insurance for the next three month after discovering there was no insurance in place. The cheque has not been recorded as a reduction of cash to-date. There is no insurance expense for the first three months.

2. The equipment must be depreciated for three months. The equipment has a service life of 5 years and monthly depreciation is estimated to be $833 a month.

3. Recorded revenue of $5,000 is unearned and was an advance from a client. This revenue will be earned in the next three months.

4. Salaries of $15,000 were paid in the first three months. However, $1,000 of salaries should be accrued as employees earned these salaries but will not be paid until the 4th month.

5. The owner provided services of $2,500, which were not invoiced or billed to clients in the 3rd month but were earned in accordance with the Revenue Principle.

6. Interest expense (Debit) needs to be recorded at the end of three months. The amount is $750 and should be recorded as a liability in Interest Payable (Credit) on the balance sheet. None of the $50,000 note has been paid to lenders yet. This note will be paid back at the end of 5 years.

7. Supplies of $1,500 must be expensed to Cost of Goods Sold (i.e., moved out of inventory) and a new accrual of Accounts Payable should be established for $2,000 for supplies ordered at the end of the 3rd month, and not booked to-date.

Questions

1. Which inventory system (perpetual or periodic) would provide the most cost-benefit to the owner?

Answer 1

Two types of inventory record system:

There are two principal systems of determining the physical quantities and monetary value of inventories sold and in hand. One system is known as ‘ Periodic Inventory System’ and the other as the ‘Perpetual Inventory System’. The periodic system is less expensive to use than the perpetual method.

Periodic inventory system is a method of ascertaining inventory by taking an actual physical count (or measure or weight) of all the inventory items on hand at a particular date on which inventory is valued. Here inventory ledger is not maintained to record all the inward and outward transactions.

Perpetual inventory system is a system of recording inventory balances after each receipt and issue. In order to ensure accuracy of perpetual inventory records, physical inventory should be checked and compared with recorded balances. Under this system, cost of goods issued is directly determined and inventory of goods is taken as residual figure with the help of inventory ledger in which flow of goods is recorded on continuous basis.

Conclusion

As in the present scenario, the sole proprietor is in service business of recruitment. So, its inventory is relatively low in volume and value. In this case, periodic inventory system will be a better option than perpetual inventory system, as it does not involve ledger keeping on a day to day basis and recording all the inward and outward of inventory at a very detail level.