 In this presentation we will discuss the weighted average inventory method using a periodic system. The weighted average method as opposed to a first in first out or last in first out method, the periodic system as opposed to a perpetual system. We want to keep the other systems in mind as we work through this comparing and contrasting. We're going to be working with this worksheet entering this information here. It's important to note that this worksheet is a worksheet that can typically be used with any of these inventory flow type problems of which there are many. We have first in first out, last in first out, the average method. And then we have a perpetual and periodic system which can be used with any of those methods. It's also possible for questions to ask for just one component such as cost of goods sold or ending inventory. And therefore it can seem like there's more types of problems that we can have in that format as well. If we set up everything in a standard way, even if that weighs a little bit longer for some types of problems, it may be easier because we can just memorize that one format to set things up. This would be a format to do that. This would be breaking up the information into three components. Purchases, cost of merchandise sold, and inventory or ending inventory. Within those three components we're going to have the quantity, the unit cost, and then the total cost in each of these three sections. And then we'll enter the data through this worksheet as we go starting this time with the beginning inventory. So this is where we started at the beginning of the month, in this case the month of March. We're going to say the beginning inventory is 100 units costing $50, 100 times 50 being $5,000. We're going to put that same $5,000 out to the total column just to give an indication as we go through this worksheet of what the total is in its own distinct column out in the total section. So there we have that, 5,000 units, that's where we start. If we look at our trial balance, it will be in order, assets, liabilities, equity, revenue, and expenses, debits, non-bracketed or positive numbers, credits bracketed or negative numbers, the debits minus the credits equaling this zero. So we have net loss in this case, meaning revenue of zero minus these expenses 5,3 and 9,920 giving us a loss of 10,720. We're focusing here, of course, this time being the inventory on inventory. This 5,000 matching what we just put into our worksheet, that is our beginning balance, that's where we start. Next, we will have a purchase of 400 units at $55. We're going to put that into our worksheet in the purchasing section. Remember that the purchases will not differ no matter what method we will be making, whether that's FIFO, LIFO, AVERAGE, PERPETUAL or PERIODIC. It will be what it is in March. It was 400 units that we purchased at $55. Notice the rising prices from 50 to 55 for the inventory units we are purchasing, same units, costs going up. That's going to be the standard assumption that will happen. You want to just remember it going one way as if cost increase would be the norm. And then if it goes the other way, then we can kind of just reverse some of the effects that would happen. So in other words, as costs rise, what's going to be the effect on ending inventory and cost of goods sold under the three methods, LIFO, FIFO and AVERAGE, and then reverse the effects, obviously, when costs then fall. So we're going to have the 400 times the 55, that'll be the 22,000. Then we're going to do our average calculation. Now, it's possible since we're doing a periodic system to just do all of the purchases and then calculate the average at the end. But we're going to calculate the average as we go to get practice calculating the average. It can be something that people find a little bit more confusing because of the weighted average that we will be using. So what we're going to do is we're going to calculate our average by putting the calculation all under this line, under this date line. Again, moving this amount down. So there's our 100 units at 50 or 5,000. Then we're going to move this column over and there's our 400 units at 55. So we started at 100 units at 50. We got 400 units at 55. What we want to do now is create the average. Now, I'm going to show the wrong way to do this first of all and then we'll calculate the weighted average. So the normal average of just the two prices would be 50 plus 55. Those two numbers divided by two would give us an amount right in the middle of them at 52.50. Which seems reasonable. 52.50 seems reasonable. However, it's not exactly right because there's a lot more of the 55 units, 400, than the 50 units, 100. And therefore the weighted average taking that into account would be closer to the 55 than to the 50. So that's the mistake we just have to kind of avoid. How are we going to do this? We're going to take the total here, the total dollar we've spent, and the total units and then divide those out. So it can look a little bit confusing on the worksheet because we're first going to calculate or sum up the units, 100 and 400. We're not going to sum up the unit cost. That doesn't really make any sense because it's the unit cost. We can sum up the total here, 5,000 and 22,000 for 27,000 and then take this 27,000 divided by 500. So now we're simply taking the 27,000 divided by 500 and that gives us the 54 which is closer to this number that's the weighted at the 400 units. So we get 54 as our total. If we pull that out to the outer column then the 27,000 what is what should be on our financial statements in ending inventory and our trial balance. We're going to record the journal entry here now. Here's going to be our new thing that happened. We purchased another 400 units for 22. We're going to adjust inventory. Inventory has a debit balance. We're going to make it to go up by doing the same thing to it. This is another debit of 22,000. Then the other side is not decreasing cash but increasing the liability accounts payable. Therefore we will increase accounts payable by the 22,000 posting this out then. We have the inventory. Inventory is up here. It started at 5,000. It's going to go up by the 22,000 to 27,000. Then we have the accounts payable. Counts payable 12,150 going up by 22,000 to 34,150. Note once again this transaction is going to be the same no matter what method we are using. If we see everything here we're going to say that we're still in balance. No effect on net income. The purchase of inventory was not expensed at the time of purchase. It will be expensed but not till it's used in order to generate revenue in accordance with the matching principle. That will be when we sell it in the form of cost of goods sold. However, under a periodic system we're not going to get around to recording that cost of goods sold until the end of the time period until we do a physical count the end of the month, the end of March in this case. Next transaction we're going to say that there's a sale of 420 units at $85. Now if we were using a perpetual inventory system we would have to record the reduction of inventory and the cost of goods sold along with the sale into our worksheet. We're not looking at the worksheet here because we're in a periodic system and we're not going to record that component until the end of the period with a physical count. What we will record is just the journal entry just to demonstrate this journal entry, the sales journal entry which will be the same under the two methods a periodic and perpetual the second piece being the difference. So remember that if we make a sale on a merchandising company we typically assume that it's going to be a perpetual system and we often break out that journal entry and thinking about it into two journal entries meaning we have the sale side and then we have the inventory or cost of goods sold side of the journal entry. The sale side we can think of as similar as if we were a merchandising company and we can just eliminate the inventory and say hey what would happen if we had a sale or did services and got paid or on account meaning we got an accounts receivable what would be the journal entry. This is not affected. Accounts receivable has a debit balance we got more of it people OS money therefore accounts receivable will go up with another debit so we're going to debit accounts receivable and then we're going to credit something and something will be revenue that revenue for a service company might be fees earned or it might be revenue or income and it could be called sales for a merchandising company but it's all just a revenue account. So it's going to go up in the credit direction of the normal journal entry that we see whenever we make a sale whether it be merchandise or a service type business accounts receivable going up revenue going up. Then we have the second component that we typically think of when we make a sale as a merchandiser meaning we sold merchandise inventory should be going down and the related cost of goods sold should be going up. We're not going to record this under a periodic system that's the difference between a periodic system and perpetual system for the decrease in inventory and related cost of goods sold expense at the point at the end of the period the end of the month in this case the end of March after we do a physical count. Why? Why would we do that? Why would we not decrease the inventory? We know the inventory went down and it's probably just the sophistication of the system. If we have a clerk or someone recording these sales it's easy to know what the sales price is but this sales price has nothing to do with the cost of goods sold or in other words the cost of goods sold might have been used to make that sales price but there's no direct relationship between these two things. The sales price is known when we make the sale so 420 times 85 that's the 35 700. That's what we want to focus on collecting the revenue and making the sale at the point of sale. We don't want to spend all of our time training people how to record the cost of goods sold or inventory if they have to do it manually because that could take some time especially if there's multiple products that we are selling. If however it's an electronic scanner system that does it at that point in time without us even needing to know what the cost is then that makes it a lot more doable to do a perpetual system which would be better from an accounting standpoint. If we don't have that sophistication we may be using a periodic system which will simplify the process but we know that it won't be entirely accurate until the end of the time period. So if we post this out then accounts receivable debit balance we're posting this 35,000 to it going from 44,900 up by 35,700 to 80,600 then the revenue is going up from zero we're posting this revenue up from zero by 35,700 to 35,700 if we look at our full transaction we're back in balance net income is going up drastically went up a lot went up by 35,700 so 35,700 minus these expenses is 24,980 so that's going to be our net income note it's really not exactly correct now of course because we haven't recorded the cost of goods sold and that's going to be substantial expense that we haven't recorded we haven't recorded the decrease in inventory so our assets are overstated we will do so at the end of the time period the end of the month the end of March. Next we have on 3,18 purchased 120 units at $60 per unit so once again we'll be in the purchases column this will be the same as in any method first in first out last in first out average perpetual periodic these purchases are what they are this is what we will actually pay for the inventory we're going to have the 120 units at $60 note the rising prices from 50 to 55 to 60 that's not because the units got better that's not because we're buying better widgets or better inventory the prices just going up and that's going to be the standard prices increasing the standard for these types of problems the standard for practice as well due to inflation if nothing else the 120 times the 60 will give us the 7,200 now we're going to calculate the average once again remember that if we're doing a periodic system we could calculate the average basically at the end and sum up all of them but I want to calculate the average each time we make a new step because this is the most complex component typically what we're going to do is draw a line here we're going to bring this amount down so this is what we had before we had 500 units at $54 that's $27,000 then we're going to pull over the new information here's the new information what we are not going to do when calculating the average what you want to avoid be careful of is to just take the amounts the 54 plus the 60 the 54 being the old average plus what our new inventory costs and taking that and dividing it by 2 what's the problem with that it looks like a reasonable number but it's not taken into account the weighted average it's not taken into account that we have 500 units at $54 and only $120 at $60 and therefore this number should not be right in the middle but leaning towards the $54 so instead what we're going to do is sum up the total units we have the $500 and the $120 then sum up the total amount that we paid for those units $34,200 and then we'll do the division problem that division problem being the $34 $200 divided by the $620 units giving us a number of $55,16 note it's not going to round specifically to the penny that's okay that happens in practice we're going to round it to the penny because we're talking about dollars and cents here so we're going to say that calculate that that number here is going to be this number divided by this number or the total dollar amount divided by the quantity so that's going to give us the $34,200 that we want to get to on our trial balance now in our financial statements we're going to do that recording the journal entry the journal entry will be the same under any method FIFO, LIFO, AVERAGE because it is a purchase that's not the side that differs the side that's differing is when we make the sale so we're going to say that inventory has a debit balance we need to make it to go up so we're going to do the same thing to it another debit so here's the debit to inventory the other side is not going to be paid with cash we're going to increase the liability so the liability has a credit balance we're going to increase the accounts payable therefore by a credit of $7,200 posting this out then we have the inventory in the journal entry the inventory up here in the assets we started with $27,000 it's going to go up by $7,200 to $34,200 then we have the accounts payable we have the accounts payable here it's at $34,150 we're going to increase it in the credit direction $7,200 to $41,350 so there's going to be our transaction this $34,200 matches what we just calculated on our worksheet the $34,200 the inventory worksheet supporting the inventory amount reported on the trial balance or the balance sheet here's going to be the full transaction we still have the $34,200 or back in balance indicated by the green zeros no effect on net income no effect on these accounts the revenue or expense accounts we will be affecting the revenue expense accounts by the inventory that we purchased not at the point of purchase but at the time we sell the inventory in the form of cost of goods sold however under the periodic system we won't be recording that until the end of the period when we do the physical account we're going to do another purchase here purchase 200 units at $62 so we are going to be in the purchases column once again the $200 unit purchase at $62 note the rising prices going from 50 to 55 to 60 to 62 same units, unit cost going up because of if nothing else inflation that will be the norm you want to think that it can go down but you probably want to think the norm will be increasing prices and then reverse your thought process for it to go down the 200 times to 62 gives us $12,400 we're going to calculate our average now and we could do this at the end of the time period under a periodic system for the average method we're going to do it as we go, this being the key component to the average system calculating that average cost to do so we're going to draw a line under our last date line and we're going to be putting this new information here taking this $620 down just copying that down and then we're going to pull over our new information and once again we're going to say what not to do which is a common common error in calculating this and that's going to be taking the 55.16 plus the 62 or the two prices and just dividing by two that's an average but it's not the weighted average because it's right in the middle of those two costs and it should be leaning towards the $620 it being weighted higher it having more inventory in it so what we're going to do instead is we'll sum up the $620 and the $200 to get the $820 then we'll sum up the $34,200 and the $12,400 amount to get to the $46,600 and then we can do our average, we're going to take the total dollar amount the $46,600 divided by the $820 units giving us an average of $56,83 rounding up not worrying about the fact that we have all these decimals we're going to use it rounding to the pennies talking dollars and cents so that's going to give us the $56,83 that's going to be this number divided by this number, there's the total that we are going to be reporting on the financial statements we will now record the journal entry for that new purchase, the purchase of the $12,400 remember that the journal entry will be the same under LIFO, FIFO average, periodic, perpetual all of them, this is not an estimate we're going to say that the inventory started at the debit balance and we're going to increase it, we bought more inventory with a debit of that $12,400, we're going to credit not cash, but the liability of accounts payable increasing the accounts payable posting this out, we have the inventory here going to the inventory there starting at $34,200 increasing by $12,400 going to a total of $46,600 here's the accounts payable there that's going to be posted here, we've got a credit balance starting at $41,350 increasing $12,400 to $53,750 noting that the inventory that we end up with is supported by our inventory worksheet, now we're going to do the inventory count at the end of the time period this is what we're going to do in a periodic system in order to record the cost of goods sold for the entire period what we have not been doing for the entire period and record the related reduction in inventory something we haven't done so you'll note that as we go in our worksheet we've just been doing purchases and we've been increasing and increasing with purchases not recording the decrease in the inventory for the sales and we're going to do that at the end of the time period due to and with the help of a physical count and the cost of goods sold calculation cost of goods sold calculation a mandatory calculation something we really have to know both in terms of units and in terms of dollars the format will look like this beginning inventory plus purchases gives us goods available for sale or mount available for sale minus the ending inventory will give us cost of goods sold that's going to be our calculation now note that a multiple choice question might ask you for any component just give you three one unknown for this formula they might give you the beginning of the unknown for example or the purchases as the unknown now you could write this formula as beginning inventory plus purchases skip the subtotal beginning inventory plus purchases minus ending inventory equals cost of goods sold and write it out as an algebraic equation giving any of these unknowns then as long as we only have one we would then be able to find out any of these amounts so keep that in mind you don't want to remember multiple different equations to figure out for example purchases or beginning inventory you want to remember one equation cost of goods sold that can answer any of those types of questions you do need to know the subtotal however by name even if you don't use it in the equation if you pull it out for an equation because some problems will refer to it as well as in practice we're going to do this calculation first for the units and then we'll do the same calculation in terms of dollars we started with a hundred units that's what we began with we purchased 720 units 400 plus 120 plus the 200 in the purchases section that gives us 820 available that doesn't mean we had 820 at any given time in our warehouse but within the widget warehouse we had 820 go through it meaning we started with 100 we purchased 720 we may have sold items throughout here we don't know what we sold but we know what we purchased and therefore had available for sale hence the name, goods available for sale and that's 820 then we're going to do the physical count so we're going to say there's 240 widgets left in the widget warehouse so there's 240 left so if we had 820 we could have sold 240 are still there given our physical count then the difference between the two is 580 that's what we sold in terms of the widgets it is possible that we had shrinkage or theft or spoiler or something as well which is why the perpetual system would be nice to use because it can verify or better verify that type of problem but our assumption is it's sold and the assumption is that the shrinkage of any kind breakage, theft is in material and in relation to it and therefore we're going to record this entire amount to cost of goods sold so note what we did here we just basically said hey this is the amount we had available and then allocated it out between either what's still left in Indian inventory and what has been sold we're going to do that same thing with dollars it would be a very easy conversion if the dollar amount were the same throughout the entire period but very often it is not even though we're talking about the same widgets we're not buying different types of things it's all the same but the dollar amounts are increasing so that makes it a little bit difficult if we see this then we're going to say well we started with $5,000 that's our beginning balance we know that we purchased 720 and we purchased them for $41,600 we can't convert from $720 to $416 easily because of the different dollar amounts but we know what we purchased we can just look at the GL and say hey we increase inventory that's how much we're going to pay it's not an estimate this is what we're going to pay $22,000 plus $7,200 plus $12,400 that's a given that's not an estimate and so if we add those two up we're at $46,600 that's where we stop now we're going to allocate that out between ending inventory and cost of goods sold however we know that there's 240 units that we're still in ending inventory but now we have to figure out our conversion here because we need to know which of those units we purchased some for $50 some for $50 some for $60 some for $62 that's what we'll do now in the average method and the average method because we've been calculating it as we go is nice and easy right now we're just going to say well yeah some of them cost $50 $55, $52, $60 whatever but they all cost around about an average if we average them all out a weighted average of $56 and $63 so we're going to say whatever we sold in this case 580 units those 580 we sold for this $56.83 about if we multiply 580 times $56.83 we get $32,960 $93 and that's our cost of goods sold this is the cost of goods sold we haven't been recording the entire time period it's the cost of goods sold that we would record every time we make a sale under a perpetual system the cost of goods sold we are now recording for all sales happening during the time period in our case the month the month of March month of March so we have 820 units that we had before minus the 580 means we still have left 240 so we did this allocation of the 820 units 580 have been sold and 240 are still left they are at $56.83 if we multiply 240 times the $56.83 we get $13,639 $02 so now we can fill out the rest of this form we can say okay the ending inventory is $13,939 $639 $02 and we could subtract this out then and notice we did take off the rounding here so here we have the pennies here we remove the pennies it's just rounding so if we take off the $46,600 minus $13,639 we get the $32,961 which is also matching this amount $32,960 rounding $961 that ties out we're going to do our final journal entry now this would be the journal entry that we would see under a perpetual system every time we record a sale or similar one at least one that would be reducing inventory and recording cost of goods sold but under a periodic system as we are doing now we will only see it one time at the end of the period whatever period that may be for our case the month the month of March so we're going to record the reduction of the inventory for the entire time period we're going to make it go down by doing the opposite thing a credit and the related cost of goods sold cost of goods sold is an expense it's going to go up in the debit direction bringing net income down so here's the cost of goods sold and there's the inventory so once again this is the journal entry we would see each time under a periodic system as we record sales it's going to be the second half of the sales transaction but under a perpetual under a periodic under a perpetual under a perpetual system but under a periodic system we're only going to record it for the entire sales all sales made during the period at the end so if we record this here's cost of goods sold here's cost of goods sold here it's going to go from zero way up by the 32,961 to 32,961 here's inventory here's inventory it's at 46,600 it's going to go way down by 32,961 to 46,639 this number now matching the 13,000 in Indian inventory this number now matching our cost of goods sold calculation so note that before we did this transaction our net income was way too high and now it's way lower so that's going to be the case for the periodic system our net income cannot be trusted until we do this transaction the cost of goods sold being huge for a merchandising company typically also our assets will be way overstated until we do this end of period adjustment because once again the inventory is typically a fairly large asset and it's not being reduced as we make the sales so we gotta wait till the end of the period to have an accurate number there if we look at the comparisons here's our calculation here's our worksheet here's our trial balance we can see that we have the ending inventory here we have the ending inventory on the trial balance which would be on the financial statement we have the ending inventory on our worksheet we have the cost of goods sold here on the cost of goods sold calculation on our merchandise cost of goods sold worksheet and then we have the cost of goods sold here on our trial balance as well which would also be on the income statement