How does the periodic inventory accounting method track inventory and cost of goods sold?
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Inventory is a key current asset for retailers, distributors, and manufacturers. Inventory consists of goods (products, merchandise) awaiting to be sold to customers as well as a manufacturers' raw materials and work-in-process that will become finished goods. Inventory is recorded and reported on a company's balance sheet at its cost. When an inventory item is sold, the item's cost is removed from inventory and the cost is reported on the company's income statement as the cost of goods sold. Cost of goods sold is likely the largest expense reported on the income statement. When the cost of goods sold is subtracted from sales, the remainder is the company's gross profit. It is critical that the items in inventory get sold relatively quickly at a price larger than its cost. Without sales the company's cash remains in inventory and unavailable to pay the company's expenses such as wages, salaries, rent, advertising, etc. It is common for a company to experience rising costs for the goods it purchases. As a result, the company's costs may be different for the same products purchased during its accounting year. When this occurs, the company must decide which costs should be matched with its sales and which costs should remain in inventory. In the U.S., three of the cost flow methods for removing costs from inventory and reporting them as the cost of goods sold include:
In addition to selecting a cost flow method, the company selects one of the following inventory systems for recording amounts in its general ledger Inventory account(s):
It is time consuming and costly for companies to physically count the items in inventory, determine their unit costs, and calculate the total cost in inventory. There may also be times when it is necessary to determine the cost of inventory that was destroyed by fire or stolen. To meet these problems, accountants often use the gross profit method for estimating the cost of a company's ending inventory. We will illustrate the FIFO, LIFO, and weighted-average cost flows along with the period and perpetual inventory systems. This will be done with simple, easy-to-understand, instructive examples involving a hypothetical retailer Corner Bookstore. Inventory Is Reported at CostInventory items are recorded at their cost. Cost is defined as all costs necessary to get the goods in place and ready for sale. For instance, if a bookstore purchases a college textbook from a publisher for $80 and pays $5 to get the book delivered to its store, the bookstore will record the cost of $85 in its Inventory account. The recorded cost will not be increased even if the publisher announces that additional copies will cost $100. When the textbook is sold, the bookstore removes the cost of $85 from its inventory and reports the $85 as the cost of goods sold on the income statement that reports the sale of the textbook. The recorded cost for the goods remaining in inventory at the end of the accounting year are reported as a current asset on the company's balance sheet. Periodic vs Perpetual Inventory SystemsEach cost flow assumptions can be used in either of the following inventory systems:
Under the periodic inventory system:
Under the perpetual inventory system:
How do you find cost of goods sold using the periodic inventory system?The cost of goods sold formula is calculated by adding purchases for the period to the beginning inventory and subtracting the ending inventory for the period.
What is periodic inventory system in cost accounting?A periodic inventory system is a form of inventory valuation where the inventory account is updated at the end of an accounting period rather than after every sale and purchase. The method allows a business to track its beginning inventory and ending inventory within an accounting period.
How do you record inventory using the periodic inventory system?Under the periodic inventory system, all purchases made between physical inventory counts are recorded in a purchases account. When a physical inventory count is done, the balance in the purchases account is then shifted into the inventory account, which in turn is adjusted to match the cost of the ending inventory.
What is the method of accounting for inventory in which the cost of goods sold is recorded each time a sale is made?The periodic inventory system uses an occasional physical count to measure the level of inventory and the cost of goods sold. The perpetual system keeps track of inventory balances continuously, with updates made automatically whenever a product is received or sold.
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