Chapter 3 PA II - Copy.docx - Fundamental of Accounting II...

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Fundamentalof Accounting IICHAPTER ONE:INVENTORIESIntroductionIn the last section of Principles of Accounting I, you have learned about the principles and practices ofaccounting for receivables – one of the current asset items in the balance sheet of a retail business. In thischapter you will learn and discuss the concepts in accounting for inventories in addition to the concepts thatyou have learned in chapter three and four (Accounting for merchandising and manufacturing companies)1.1.Control of InventoryTwo primary objectives of control over inventory are as follows:1. Safeguarding the inventory from damage or theft.2. Reporting inventory in the financial statements.Safeguarding InventoryControls for safeguarding inventory begin as soon as the inventory is ordered. The following documents areoften used for inventory control:Purchase orderReceiving reportVendor’s invoiceThepurchase orderauthorizes the purchase of the inventory from an approved vendor. As soon as theinventory is received, a receiving report is completed. Thereceivingreportestablishes an initial record ofthe receipt of the inventory. To make sure the received is what was ordered, the receiving report iscompared with the company’s purchase order. The price, quantity, and description of the item on thepurchase order and receiving report are then compared to the vendor’s invoice. If the receiving report,purchase order, and vendor’s invoice agree, the inventory is recorded in the accounting records.Finally, controls for safeguarding inventory should include security measures to prevent damage andcustomer or employee theft. Some examples of security measures include the following:Storing inventory in areas that are restricted to only authorized employees.Locking high-priced inventory in cabinets.Using two-way mirrors, cameras, security tags, and guards.Importance of dealing with the inventoriesMerchandise purchased and sold is the most active elements in merchandising business, i.e. in wholesaleand retail type of businesses. This is due to the following reasons:a.The sale of merchandise is the principal source of revenue for them.b.The cost of merchandise sold is the largest deductions from sales.c.Inventories (ending inventories) are the largest of the current assets or those firms.Because of the above reasons inventories, have effects on the current and the following period’s financialstatements. If inventories are misstated (understated of overstated), the financial statements will bedistorted.1.2The Effects of Inventories on Current and Following Period’s Financial Statements.I.Effect of ending inventory on current period’s financial statementsEnding inventory is the cost of merchandise on hand at the end of accounting period. Let us see its effect oncurrent period’s financial statements.1.Income statementa.Cost of goods (merchandise) sold =Beginning inventory + Net purchase – Ending inventory

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Cost Of Merchandise

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