Trading Firms and Inventory

• Trading firms


  A business that aims to generate profit by purchasing goods and then selling them at a higher price
• Inventory


  Goods purchased by a trading firm for the purpose of resale at a profit
• Importance of inventory


  • Sale of inventory is the main source of revenue for a trading firm, and this the key to its ability to earn profit
  • Inventory is likely to be one of the most significant assets in the balance sheet of a trading business
• It is important that the owner has useful information relating to inventory
• Inventory


  The term inventory is only used to describe goods that are purchased expressly for the purpose of resale
• Inventory


  It is a present economic resource controlled by the business that has the potential to provide future economic benefits within the next 12 months
• Inventory


  Inventory is the main source of revenue and profit for a trading firm<|>Profit is earned as inventory is bought and sold
• Careful records need to be kept

  1. Work out the value of inventory on hand

  2. Monitor inventory levels and ensure sufficient quantities of the right of the right inventory item are on hand to meet customer demands
• There are implication of too much or too little inventory on hand so we should aim to have a minimum quantity just enough to satisfy demand until delivery arrives and a maximum quantity
• Ethical considerations regarding inventory

  • Purchasing from local suppliers and supporting the local community or economy
  • Ensuring products are of a particular quality and do what has been advertised
  • Ensuring products are sourced from suppliers that provide safe working conditions and fair wages
  • Ensuring products meet minimum required safety standards in terms of performance, composition, components, packaging, flammability and labelling
  • Ensuring products are actually organic, sustainably sourced, not genetically modified, and grown in Australia
  • Not distorting profit or loss figures and reducing tax payable
  • Not providing misleading financial information to decision makers
• Perpetual inventory system


  A system of accounting for inventory that involves the continuous recording of inventory movement in inventory cards
• Perpetual inventory system


  1. Record all inventory transactions in inventory cards

  2. Conduct a physical count to verify inventory cards are accurate and detect any inventory losses or gains

  3. Change income statement presentation to show gross profit and net profit
• Why use perpetual inventory system

  • Greater control over inventory is possible because up to date timely information is available
  • Management should make better decisions in relation to inventory
  • Can identify slow moving and fast moving inventory
  • Automates the recording of inventory which is more efficient
  • Can prepare interim reports without doing inventory take
  • Inventory on hand in the balance sheet is available from inventory cards
  • Inventory loss and gain can be measured when a physical inventory take is done
• Sales


  The revenue earned by a trading firm from the sales of inventory
• Purchase


  The inventory bought by a trading firm for the purpose of resale
• Cash purchase of inventory


  Swaps one current asset (bank) for another (inventory), GST paid is not part of inventory valuation
• Credit purchase of inventory

  Increases assets (inventory) and increases liabilities (accounts payable), GST owing is not part of inventory valuation
• Cash sale of inventory

  Increases assets (bank), increases revenue, decreases inventory, increases cost of sales
• Credit sale of inventory

  Increases assets (accounts receivable), increases revenue, decreases inventory, increases cost of sales
• Purchase returns


  Decreases assets (inventory), decreases liabilities (accounts payable), increases liabilities (GST payable)
• Sales returns


  Decreases assets (accounts receivable, increases inventory), decreases liabilities (GST payable), decreases owner's equity (sales, cost of sales)
• Drawings of inventory


  Decreases assets (inventory), decreases owner's equity (drawings)
• Advertising using inventory


  Decreases assets (inventory), decreases owner's equity (advertising expense, profit)
• FIFO


  First In First Out assumption for cost allocation and recording of sales, does not necessarily relate to actual physical flow of inventory
• Recording transactions in inventory cards

  Purchases - record quantity and cost price in IN column, increasing balance

  Sales, drawings, advertising, inventory loss - record quantity and cost price in OUT column using FIFO

  Purchase returns - record quantity and identified cost price in OUT column

  Sales returns - record quantity and reverse FIFO cost price in IN column

  Inventory gain - record quantity and most recent cost price in IN column
• Inventory cards


  • Top portion shows non-financial details like item description, code, cost method, location, supplier

  Bottom portion records transactions in IN, OUT and BALANCE columns
• IN, OUT and BALANCE columns

  IN column records all inventory coming into the business<|>OUT column records all inventory leaving the business<|>BALANCE column shows the inventory on hand available for sales (totalled at cost price)
• Purchases


  Inventory coming into the business, recorded in the IN column at cost price<|>Increases the number of items on hand in the BALANCE column
• Sales


  Inventory leaving the business, recorded in the OUT column at cost price<|>The selling price is not recorded in the inventory card to protect the Gross Profit
• Cost prices changing


  Differing cost prices must be recorded separately in the BALANCE column of the inventory card
• Recording transactions in inventory cards

  1. Purchases

  2. Sales
• Identified cost


  Identifies the actual cost of the inventory item when it is purchased and when it is sold
• First In, First Out (FIFO)


  Assumes the first inventory in (purchased) will be the first out of the store (sold)
• Recording transactions using FIFO

  1. Purchases

  2. Sales

  3. Drawings

  4. Advertising

  5. Credit sale

  6. Sales return

  7. Purchase return
• Inventory loss


  Physical inventory count reveals less inventory on hand than shown in the inventory cards
• Inventory gain


  Physical inventory count reveals more inventory on hand than shown in the inventory cards
• The physical count: Identified cost


  Verify accuracy of inventory cards by conducting a physical count
• The physical count: FIFO

  1. Calculate value of inventory loss using oldest cost price

  2. Calculate value of inventory gain using latest cost price
• Inventory loss is an expense that decreases assets (inventory) and decreases owner's equity (profit)
• Inventory gain is revenue that increases assets (inventory) and increases owner's equity (profit)