 Hello and welcome to the session in which we will introduce inventory. Specifically we're going to be introducing the concept of periodic versus perpetual inventory system. Inventory is a major topic in intermediate accounting as well as the CPA exam. This is the first session of a multiple session that's going to discuss the inventory. It could be 10 to 12 sessions discussing this topic because it's an important topic whether you are an accounting student or studying for the CPA exam. Whether you are an accounting student or studying for the CPA exam I strongly suggest you take a look at my website farhatlectures.com. I don't replace your CPA review course. I am a useful addition to your CPA review course. I provide you alternative explanation. I will show you the theory behind the concept of understanding the material which in turn will help you add 10 to 15 points to your CPA exam. Your risk is one month of subscription, your potential gain is passing the exam. This is a list of my course catalog. I have intermediate accounting, auditing, governmental accounting, advanced accounting. I have a lot of resources, multiple choice, through faults, exercises. My CPA supplemental resources are aligned with your Becker, Wiley, Roger, Gleam or any other CPA course you are taking so it's very easy to switch between to go back and forth between your CPA review course and my supplemental material. I also give you access to all the AI CPA previously released questions. Almost 1500 questions with detailed solution in addition to thousands of CPA questions. If you have not connected with me on LinkedIn please do so. Take a look at my LinkedIn recommendation like this recording. Share it with other. Connect with me on Instagram, Facebook, Twitter and Reddit. So what is inventory? Well inventory are items held for sale in the normal course of operation. Simply put inventory is something that usually you would buy or you would manufacture and you present for the customers for sale. So it's an asset. Specifically it's a current asset. Why is it an asset? Well when you sell it the assumption is you're going to be making a profit. Well it's an asset because assets the definition of an asset is something that's going to provide you future benefit. The assumption is you will sell it at a higher than its cost. Also it's a current asset because you expect to sell it in the near future. So when you have an asset like inventory you don't want to sit on it for any period of time. You want to sell it immediately if you can. So that's why it's a current asset. Inventory can be purchased and if it's a purchase it's very easy to account for. You have one account called usually merchandise inventory or for short just inventory or inventory could be manufactured for manufacturing companies. We could see three types of inventory accounts and those are raw material work and process and finished goods and I have no doubt you looked at those accounts when you studied either cost accounting or managerial accounting and companies like Ford Motor Company or companies that that that that is manufacturing in nature will have those accounts. What is raw material? Raw material is for example for a Ford Motor Company raw material will be the tires that are sitting in the warehouse. It'll be the batteries that they're going to be installing in their cars. It will be the radios that are going to be installing in each vehicles. So that's raw material. They have not started the process yet. It's sitting in the warehouse. Work and process are not completed manufactured cars so they are partially completed. So for example at the end of the period they will have a car that's 70 percent completed. Well that's part of their inventory but it's not completed. Finished goods are finished inventory cars ready to be sold. So the inventory for a company like Ford Motor Company will involve raw material work and process and notice here they add supplies which is usually it's part of raw material and finished goods. But for a company like Walmart they usually have one line which is inventory. As we are starting to learn about inventory we need to understand something called inventory cost flow. How does the inventory cost flow from a grand perspective? Well let's assume a company that already existed. If a company is already existed at the beginning of the period they might have some beginning inventory. So for simplicity I'm going to be using units to illustrate this concept not dollar amount because we're going to get to this later on. Okay we're going to get to the dollar amount in future session. I want to make sure you understand this picture very well because it's a powerful powerful concept. So at the beginning let's assume you open the store and from the prior periods you are selling calculators. You had 10 calculators in beginning inventory. Then throughout the year you purchased more calculators. Then you purchased an additional 90 calculator throughout the year. Well what you started with is 10. Then you purchased another 90 units. Simply put you had 100 units available for sale. 100 units available for sale which is which are the calculator you started with then purchase 90 you have 900 units available. At the end of the period what's going to happen is this some of these units will stay in ending inventory so if you did not sell those calculators they're going to stay in ending inventory. So we're going to assume that your ending inventory consists of 20 units and if your ending inventory consists of 20 units we would assume that you sold the remainder was sold and you sold 80 units. A few things I want to point out here. One the first thing your beginning inventory plus your purchases will give you something cost of goods available for sale. Here what I did I did not use the dollar amount because I don't want to complicate matter yet. I just want to use units. Simply put you had 100 units now if you assuming each unit for 10 dollars you can multiply it by 10 dollars but it doesn't matter. So those are the goods so we can eliminate the cost here because we're using unit goods available for sale you had 100 unit. When you counted your inventory you find out you had 20 units remaining if you have 20 units remaining it means 80 were sold when you sell inventory it becomes cost of goods sold. Now the other thing I want to point out is this if you had 25 unit remaining it means you sold 75. If you had 10 units remaining it means you sold 90. So notice what's happening the relationship between those ending inventory and cost of goods sold there's a negative relationship between those two. If ending inventory is higher cost of goods sold is lower. If ending inventory is lower it's going to be in cost of goods sold there's a negative relationship and it's this is an important concept that we need to understand for later it's a negative relationship and simply put ending inventory plus cost of goods sold they can go backward and they will give us also cost of goods available for sale. So whatever we sold and whatever we have left is what we had in total available. So notice beginning inventory and purchases gives you this number cost of goods available for sale also ending inventory and cost of goods sold can we work can we can work with it backward. This is an important concept important computation here that we are going to be using later when we deal with FIFO, LIFA, weighted average and other inventory cost flow method. Now let's dive into perpetual versus periodic what is the difference between perpetual versus periodic work. Well there are two ways to account for your inventory as you're selling inventory we're going to look at the perpetual first then we'll look at the periodic then we'll work a short example perpetual perpetual means you are continuously updating the inventory record think of a perpetual as a computerized system or a smart system where you are using technology to keep track of all your purchases of all your sales of all your purchase discounts of all your purchase return so simply put when you make a purchase you debit the purchase to inventory so everything is accounted for in an inventory account simply put so you will have an inventory account and when you purchase something you debit inventory for the cost of that inventory if you paid for transportation if you paid for transportation to transport this inventory you would also add it to the inventory so transportation freight in transportation it's added to the inventory if you have any purchase returns and allowances there are a reduction in your inventory you would credit inventory so everything is is updated through inventory it's a smart system cost of goods sold is updated with each sales while reducing inventory so simply put when you make a sale you would reduce your inventory and it goes from inventory wherever you reduce an inventory it becomes cost of goods sold so simply put it goes into cost of goods sold and you're accounting for cost of goods sold also perpetually also life as you are selling and you're going to keep a sub ledger of each individual inventory item on hand so you also have a you would have a sub ledger to keep track of this this is a perpetual inventory system and don't worry we're going to be working examples short example next then more examples later periodic inventory system is inventory recorded or updated periodically as the word periodic it means every once in a while it's a manual system when do you update the inventory is when you do account when you do account periodically this is why it's called periodically when you make a purchase you're going to be debiting an account called purchases so rather than inventory what's going to happen is when you make a purchase when you make a purchase you would keep track of those purchases and a purchase account rather than inventory if you have any purchase discounts and returns you will have another account called purchase discount and you will have another account called purchase return i'm writing very small purchase return so you'll have you'll have these accounts separately so you'll have more accounts to account for those purchase discounts and return versus in the perpetual you increase and decrease inventory purchases and beginning inventory at the end are closed you close them and specifically you sum them all and you close them to cost of goods sold so how do we compute cost of goods sold under the periodic inventory system will take all our purchases plus our beginning inventory then will deduct ending inventory and that's going to give us cost of goods sold something similar to what we looked at in the prior in the prior slide on the prior slide if you remember we looked at this relationship between those accounts and this is basically how it works but the concept is the same cost of goods available for sale whether it's periodic or perpetual it has to be split between ending inventory and cost of goods sold now the best way to kind of make some sense of this method is to actually work in a quick example short example illustrating the main concept we're going to be diving more into this concept later on so let's take a look at this simple example to illustrate the perpetual how to account for these transaction perpetual versus periodic our beginning inventory happens to be 200 unit and we purchased them at six dollars and our total beginning inventory is 1200 that's fine that's our beginning inventory we're starting with that then we made a purchase we purchased 700 units also at six dollars well under a perpetual inventory system we will debit inventory and we will credit accounts payable under the periodic inventory system we'll debit an account called purchases and we credit accounts payable so notice the difference and remember periodic purchases so if it's if you want to remember which account to debit then we made a sale we sold 800 units at ten dollars well we're going to debit account receivable for eight thousand dollar we're going to credit sales for eight thousand dollar then we're going to reduce our our inventory we sold 800 units and we only have the cost I kept it simple the cost of all the units is six dollars therefore we reduce our unit 800 unit which is four thousand eight hundred and what we do this 800 and the 800 unit that are sold they become we debit cost of goods sold so notice what happened is we are matching the cost to the sale so as we make a sale we are matching the related cost under the periodic inventory system we only have one entry and what I mean by one entry only the sale we debit account receivable we credit sales we don't have the second entry why because under the perpetual we have two entries the sale and the cost of the sale under the periodic we are not keeping track of our inventory nor our cost of goods sold but perpetual we are periodic is you don't worry about this later we'll account for this later ending period at the end of the period we had 100 unit remaining simply put we started with 200 we purchased 700 200 plus 700 is 900 then we sold 800 we still have 100 units left well if we have 100 units left under the perpetual inventory system we can easily account for our inventory we started with 1200 this is what we started with we purchased 4200 it's right here then we reduce our inventory by 4800 so everything is accounted for cost ending inventory is 600 there's no journal entry to be made because we are keeping track of our ending inventory and cost of goods sold also we don't need to do anything because cost of goods sold we are keeping track of our cost of goods sold under the periodic inventory system it's going to be different under the periodic inventory system we're going to count inventory and it's going to tell us we have 100 unit and the cost of those 100 unit is six dollars the first thing we do is the we establish ending inventory so we establish ending inventory at 600 now we need to remove purchases and beginning inventory because those are temporary account we need to get rid of them so we credit purchases 4200 so to get rid of purchases we credit beginning inventory which the 1200 coming from here beginning inventory we have to get rid of those cost of goods sold becomes a plug and basically all what we did is we took to compute cost of goods sold we took beginning inventory we can do it going through beginning inventory 1200 plus purchases the purchases were 4000 200 uh mine uh this is going to give us 5400 minus uh 5000 400 minus uh minus ending inventory ending inventory is 600 ending inventory is 600 and that's going to give us 4800 which is the same as perpetual but we account for it differently under the perpetual cost of goods sold was accounted for as we are processing the transaction now one more thing I want to mention in this session is inventory adjustment when the inventory count differ from the perpetual inventory system yes although we have a perpetual inventory system we are still going to count the inventory and differences could occur due to theft breakage shrinkage incorrect record keeping so we could have we could have a difference so the best way is to illustrate this concept let's assume the perpetual inventory record which is the computer system show a balance of 85600 but the inventory count established the inventory balance to be 85000 well the computer system is saying we should have 85600 we did the count and it's only 85000 well what do we have to do we have to reduce our inventory by by 600 so what we do is we debit an account called inventory inventory not cash inventory over and short inventory over short for $600 and we credit inventory for $600 to reduce inventory now we could also close it to cost of goods sold if the amount is not material if the amount is not material we usually close it to cost of goods sold most tax book close it to cost of goods sold now even if you did this inventory cash over and short you might also close it to cost of goods sold but if the amount is material what you have to do is you have to have a separate line if the amount is material and the amount should not be material you should not have those inventory shortage that's going to be a large amount that would require its own line or be reported separately under other revenues or other losses and expenses it should not in a periodic inventory system this number is berries and buried in cost of goods sold so periodic inventory system varies the shortage whatever shortage you have into cost of goods sold and the simple is you're not when you do the count under the periodic inventory system you are not comparing your count to anything else you're just doing the count therefore you have nothing to compare to therefore you just debit so simply put under a periodic inventory system you will debit automatically cost of goods sold most likely in your tax book most likely on the CPA exam you will close it to cost of goods sold because the amount usually is not material is not material now in the next session what we would look at is determining the cost of goods sold what goes into the not sorry what goes into the cost of inventory not cost of goods sold at the end of this recording i'm going to remind you whether you are an accounting student or a CPA candidate to take a look at my website farhatlectures.com i can help you increase your score i can help you increase your CPA exam score along working with your CPA review review course i don't replace your CPA review course give me 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