Question

As part of the calculation for cost of goods sold it is necessary to determine the value of goods on hand, termed merchandise inventory. Accountants use two basic methods for determining the amount of merchandise inventory. Identify the two methods and describe the circumstances (including examples of users of each method) under which each method would be used. Describe the computation necessary to arrive at the cost of goods sold figure on a merchandising company's income statement.

Answer 1

There are basically two methods of recording the value of goods in hand or merchandise inventory. These are

1. Perpetual Inventory System; this method is useful for large business houses .Perpetual Inventory system does not keep the inventory balance same till the end as it was in the beginning. The perpetual inventory system provides a continuous record of the balance of the inventory. Under Perpetual Inventory system Cost of Goods sold is recorded whenever goods are sold and current balance of inventory and cost of goods sold is recorded. There is no need to do ending inventory adjustment under Perpetual Inventory system because continuous record is maintained.

For example; the companies which sell inventories of high individual net values and can afford computer for recording the transactions.

1. Periodic Inventory System; this method is useful for large small business houses. The closing inventories in a periodic inventory system are more complicated because it requires recording of inventory purchases to a purchases account and inventory records are updated only during the closing process that is at the end of the year and these results are based on the physical count. At the time of sales or purchases of inventory no entries are passed and no adjustments are therefore done during the sale or purchase of such inventory.

For example; the companies which sell inventories of low individual net values and cannot afford computer for recording the transactions.

Describe the computation necessary to arrive at the cost of goods sold figure on a merchandising company's income statement.

The cost of goods sold has been calculated by applying the following formula;

Beginning Inventory + Net Purchases – Ending Inventory

Beginning Inventory is the inventory which the company already has at the beginning of the accounting period. In the beginning inventory we will add net purchases which have been calculated as gross purchases less discounts and returns. The ending inventory is the inventory which has been not sold during the year and carried over to the next year as beginning inventory .