RECORDING AND MEASURING INVENTORY
TYPES OF INVENTORY There are two types of inventories depending on the kind of business operation.
A merchandising concern buys and resells inventory in the ordinary course of business. Merchandise inventory is reported in the balance sheet as a current asset.
A manufacturing concern purchases raw materials (Raw Materials Inventory), combines it with labor and factory overhead (Work in Process Inventory) and then sells the finished product (Finished Goods Inventory) to its customers. At the end of each accounting period each category of inventory is reported as a current asset in the balance sheet.
CONTROL There are two types of inventory systems that are used in maintain accounting records and report inventory in the financial statements.
Under the perpetual inventory system the entity maintains a continuous record of the balance in the Inventory account and the Cost of Goods Sold account through out the accounting period.
Raw materials or merchandise purchases are charged to Raw Materials or Merchandise Inventory respectively as the purchases are made.
Freight-in, purchase returns and allowances and purchase discounts are recorded in the inventory account.
As each sales transaction is recorded the Inventory account is credited for the cost of the item and the Cost of Goods Sold account is debited.
Inventory is a control account, which is supported by a detailed subsidiary ledger.
Under the periodic inventory system the inventory account reflects the beginning balance of inventory. Throughout the accounting period purchases, freight-in, purchase returns and allowances and purchase discounts are recorded in separate expense accounts. At the end of the accounting period a physical inventory is taken and the inventory account is adjusted to reflect the correct ending inventory.
Example of the year-end adjusting journal entries:
End of year Income summary
Debit Beginning inventory
To remove beginning inventory from general ledger inventory account.