Question

Question 1 (10 marks)
Retail operations and retail inventory
Spottie Ltd began business on 1 January 2018. The business will sell ‘Spot the dog’ soft toys via an online store. The business is not registered for GST. The following transactions occurred during January 2018:
Date:    Details:
1 Jan    Spottie Ltd issued 10,000 x $2 shares to Mr Spot and Mrs Spot. $20,000 received from the share issue was deposited into the business bank account.
3 Jan    Inventory purchase (400 soft toys) from Plush Toys Ltd on account for $2,400 on terms of n/30.
6 Jan    Sale of inventory (160 soft toys) to Rainbow Preschool on account for $1,600 on terms of n/30.
9 Jan    Inventory purchase (300 soft toys) from Plush Toys Ltd via EFT for $2,100.
12 Jan Paid Plush Toys Ltd for purchases made on 3 January, via EFT.
15 Jan Received $1,600 from Rainbow Preschool in payment of their account.
20 Jan Sale of inventory (200 soft toys) to Sydney Children’s Hospital for $2,000 on terms of n/30.
22 Jan Inventory purchase (150 soft toys) from Plush Toys Ltd on account for $1,050 on terms of 2/10, n/30.
24 Jan Paid Plush Toys Ltd for purchases made on 22 January, via EFT.

25 Jan Sale of inventory (200 soft toys) for $2,400 to online customers, with customers paying via EFT.

31 Jan Mr & Mrs Spot completed a stocktake, and the number of soft toys on hand was 290.
Required:
i) Mr and Mrs Spot have heard of the two inventory methods – periodic and perpetual methods, and they have also heard of the terms ‘First-in-first-out’ and ‘Weighted average cost’, but don’t really know anything more about them. Prepare a memo to Mr and Mrs Spot explaining each of these methods/terms.
ii) After Mr and Mrs Spot received your memo above, they both agree that the ‘First-in-first-out’ method suits their business. They are still undecided about which inventory method should be used (either the perpetual or periodic methods), and have asked you to prepare journal entries for all of the company’s transactions for January using the two different methods (using the ‘First-in-first-out’ basis), so that they can see how the journal entries differ. Show workings where necessary.

Answer 1

Answer (i)

Explanation of two inventory methods:

Periodic method: In this method, the inventory value cannot be determined directly by looking at the books of accounts. The inventory account stays a constant figure until the inventory value is determined at the end of a period (usually once a year, or a quarter or a month). Meanwhile all the inventory purchase movements are recorded in purchases account and sales are recorded in sales account. Hence the term periodic, since the inventory amount is determined periodically either as an estimate or by carrying out physical inventory count together with the use of a cost flow assumption - FIFO/Weighted Average

Perpetual method: In this method, the inventory value can be determined directly by looking into the books of account or ledger. The inventory account changes perpetually with each transaction posting and posting takes place in inventory accounts and cost of goods sold account. All the inventory related postings are immediately impacted in the inventory ledgers and hence the term perpetual. The value is determined based on the cost flow assumption - FIFO/Weighted Average and might require a physical inventory to make any stock corrections.

Stock flow terms:

First in First out Stock: This stock flow means that the stock which came in first will first move out or will be consumed first. It is more applicable to industries where the stock in hand can be identified by date and the one which came in first needs to be consumed first else they may expire over time. For eg: In a potato chips factory, potatoes will be maintained in potato lots and the potatoes which came in before will be consumed first else they may spoil. The amounts for goods issue is also taken accordingly and the old rates are applied for old stock quantity issued. The stock which remains in hand are valued a latest rates, since the old stock with old rates are consumed.

Weighted Average: This stock flow means that the stock which came in first or which came in last cannot be determined and a weighted average cost needs to be determined for the mixed stock. It is more applicable to industries where the new stock has to be mixed with the old stock and cannot be kept separate from each other. For eg: In a manufacturing unit, the old oil gets mixed with the new oil, since the production is going on continuously and the materials are continuously moving. Hence a mixed rate or a weighted average rate is calculated for the mixed stock and accordingly stock movement is accounted for.

Answer (ii)

Please see the entire journal entry chart, side by side for easy understanding and a clear concept. All required calculations have been provided in transactions. Also for perpetual inventory, the stock running balance is shown additionally, so that the concept is crystal clear.

												Balance inventory
	Periodic Inventory system						Perpetual inventory system					Qty	Rate	Amount
1-Jan-18	Bank	Dr	20000			1-Jan-18	Bank	Dr	20000
	Share Capital	Cr		20000			Share Capital	Cr		20000
3-Jan-18	Purchases account	Dr	2400			3-Jan-18	Inventory of toys (400 x 6)	Dr	2400			400	6	2400
	Plush Toys Ltd	Cr		2400			Plush Toys Ltd	Cr		2400
3-Jan-18	Rainbow Preschool	Dr	1600			3-Jan-18	Rainbow Preschool	Dr	1600
	Sales Account	Cr		1600			Sales Account	Cr		1600
							Cost of Goods Sold (160x6)	Dr	960			240	6	1440
							Inventory of toys	Cr		960
9-Jan-18	Purchases account	Dr	2100			9-Jan-18	Inventory of toys (300 x 7)	Dr	2100			240	6	1440
	Bank	Cr		2100			Plush Toys Ltd	Cr		2100		300	7	2100
12-Jan-18	Plush Toys Ltd	Dr	2400			12-Jan-18	Plush Toys Ltd	Dr	2400
	Bank	Cr		2400			Bank	Cr		2400
15-Jan-18	Bank	Dr	1600			15-Jan-18	Bank	Dr	1600
	Rainbow Preschool	Cr		1600			Rainbow Preschool	Cr		1600
20-Jan-18	Sydney Chilren Hospital	Dr	2000			20-Jan-18	Sydney Chilren Hospital	Dr	2000
	Sales Account	Cr.		2000			Sales Account	Cr.		2000
							Cost of Goods Sold (200x6)	Dr	1200			40	6	240
							Inventory of toys	Cr		1200		300	7	2100
22-Jan-18	Purchases account	Dr	1050			22-Jan-18	Inventory of toys (150 x 7)	Dr	1050			40	6	240
	Plush Toys Ltd	Cr		1050			Plush Toys Ltd	Cr		1050		300	7	2100
												150	7	1050
24-Jan-18	Plush Toys Ltd	Dr	1050			24-Jan-18	Plush Toys Ltd	Dr	1050			40	6	240
	Bank	Cr		1029			Bank	Cr		1029		300	7	2100
	Cash Discount	Cr		21			Inventory of toys	Cr		21		150	6.86	1029	disc adjusted
25-Jan-18	Bank	Dr	2400			25-Jan-18	Bank	Dr	2400
	Sales Account	Cr		2400			Sales Account	Cr		2400
							Cost of Goods Sold (40x6+160x7)	Dr	1360			140	7	980
							Inventory of toys	Cr		1360		150	6.86	1029
												290		2009
31-Jan-18	Stock in hand	Dr	2009			31-Jan-18	No entry required, since no
	Cost of Goods Sold (Balance figure)	Dr	3520				change in physical stock as
	Cash Discount	Dr	21				compared to book stock
	Purchases A/c	Cr		5550

Hope this helps!