ACC1AIS Business Activity Statement (BAS) Contra Revenue Account Cost of Sales Discount Allowed Discount Received Freight-­‐In Freight-­‐Out Goods & Services Tax (GST) Gross Profit Gross Profit Ratio GST-­‐Free Supplies Input Tax Credit Input Taxed Supplies Inventory Inventory Write-­‐
Down Net Sales Operating Expenses to Sales Ratio Other Revenue Periodic Inventory System Perpetual Inventory System Sales Invoice Sales Returns & Allowances Sales Revenue Suppliers Invoice Taxable Supply Taxation Authority CHAPTER 4 INVENTORIES A report filed at regular intervals (monthly, quarterly or yearly) by a business with the taxation authority. It details the amount of GST collected by a business on taxable supplies, the amount of GST paid on purchases and the amount owing to or the refund due from the taxation authority. An account that is offset against a revenue account on the income statement, eg. sales returns and allowances. The total cost of inventories sold during the period. A settlement discount given by a seller for prompt payment of balance due. A settlement discount claimed by a buyer for prompt payment of balance due. An expense incurred by the buyer of inventory, which is considered part of the cost of inventory. An expense incurred by the seller of inventory, which is classified as a selling expense. A broad-­‐based indirect tax levied on most supplies of goods and services. 10% The excess of net sales revenue over the cost of sales. Gross profit expressed as a percentage by dividing the amount of gross profit by net sales. Goods and services that do not attract GST under GST legislation, such as basic food, education, health services and exported goods. The credit received by registered suppliers from the taxation authority for the amount of GST paid on all goods and services purchased in the supply chains. Goods and services that do not attract GST under GST legislation such as residential rants and financial supplies. Goods acquired by a retail business for the purposes of resale in the ordinary course of business activities. An expense account used to record damaged, stole, obsolete or lost inventory as well as inventory shrinkage or waste that occurs. Sales less sales returns and allowances. The ratio of operating expenses to net sales, measured by dividing operating expenses by net sales. Revenue items other than sales revenue, such as interest revenue and rent revenue. An inventory system in which detailed records are not maintained and the cost of sales and inventory on hand is determined only at the end of an accounting period. An inventory system in which the cost of each inventory item is maintained and the records continuously show the cost of sales and inventory that should be on hand. A document prepared by the seller evidencing a claim for payment for goods or services provided to a customer. Cash refunds or credit notes recorded in the books of the seller for merchandise returned or discounted if faulty of incorrect. Revenue generated from the sale of inventory. A document prepared by the supplier, evidencing a claim for payment of goods and services provided. Goods and services that have GST included in the selling price. The body that administers tax legislation (ATO). ACC1AIS Trade Discount Value-­‐Added Tax CHAPTER 4 INVENTORIES A reduction in the list price granted to certain customers. The discount is shown as a reduction from the list price on the invoice but is not recorded in the accounts of either the buyer or the seller. An indirect tax levied on the value added by a business at each stage of the production and distribution chain, ie. from the purchase of raw materials to the sale of the finished product or supply of the service to the final consumer. GST is a value added tax. ACC1AIS CHAPTER 4 INVENTORIES MERCHANDISING OPERATIONS Merchandising businesses buy and resell stock. The main source of revenue is the sale of inventory, often referred to simply as ‘sales revenue’ or sales. Expenses are divided into two categories: the cost of sales and operating expenses. The cost of sales is the total cost of inventory sold during the period. Cost of sales and gross profit are unique to merchandising businesses; they are not used by service businesses. OPERATING CYCLES The operating cycle of a merchandising business is longer than that of a services business; the purchase of inventory and its eventual sale lengthen the cycle. INVENTORY SYSTEMS PERPETUAL INVENTORY SYSTEM: Detailed records of the cost of each inventory purchase are maintained. The accounting records continuously – ie. perpetually – show the quantity and the cost of inventory that should be on hand at any time. The cost of sales is determined each time a sale occurs. PERIODIC INVENTORY SYSTEM: Detailed inventory records of the goods on hand are NOT kept throughout the period. The cost of sales is determined only at the end of the accounting period – ie. periodically – when a physical inventory count (stock take) is taken to determine the quantity and cost of goods on hand. Three steps to determine the cost of sales figure: 1. Determine the cost of goods on hand at the beginning of the accounting period 2. Add to it the cost of goods purchased 3. Subtract the cost of goods on hand at the end of the accounting period ACC1AIS CHAPTER 4 INVENTORIES COMPUTERISED INVENTORY SYSTEMS: Keeps up-­‐to-­‐the-­‐minute records, allowing managers to access the most current inventory information at any time. ADDITIONAL CONSIDERATIONS: A perpetual system provides better control over inventories than a periodic system – it shows the quantity of stock that should be on hand and can therefore be counted to see if a physical count matches the inventory records. Any shortages uncovered can be investigated immediately whereas a periodical inventory system will not know until the end of the period and if these amounts are true or not, ie wont know if stock has been stolen. A perpetual inventory system requires additional clerical work and additional cost to maintain the records. ACC1AIS CHAPTER 4 INVENTORIES RECORDING PURCHASES OF INVENTORIES Cash purchases refer to those that were made at the time of delivery. These include cash, cheque, credit card or electronic funds transfer. Credit purchases are those that are paid for after the delivery of the goods, ie. the purchase is on credit terms. Common credit terms are 30 days and 7 days. If the purchases are on 7-­‐day terms, the supplier allows the purchaser up to 7 days to pay for the goods. Purchases are normally recorded when the goods are received from the seller. Every purchase should be supported by source documents that provide written evidence of the transaction. Cash purchases are recorded by an increase in inventory and a decrease in cash. Credit purchases are recorded by an increase in inventory and an increase in accounts payable. Important elements on an invoice: -­‐ The seller (supplier) -­‐ The purchaser -­‐ The date (to determine if the purchases receives a discount upon payment) -­‐ The salesperson -­‐ The credit terms of the transaction -­‐ The freight terms -­‐ The details of the goods -­‐ The total invoice amount PURCHASE RETURNS & ALLOWANCES A purchaser may be dissatisfied with the inventory received because the goods are damaged or defective, of inferior quality, or do not meet the purchaser’s specifications. If so, the purchaser may return the goods to the seller for credit if the sale was made on credit, or for a cash refund if the purchase was for cash. Alternatively, the purchaser may keep the inventory of the seller is willing to grant an allowance (deduction) from the purchase price (known as a purchase allowance). ACC1AIS CHAPTER 4 INVENTORIES FREIGHT COSTS A sales invoice will indicate whether the seller or the buyer pays the cost of transporting the goods to the buyer’s place of business. When the freight charges are paid by the seller, the seller may establish a higher invoice price to cover the delivery costs. When the buyer pays the transport costs, these are considered part of the cost of purchasing inventory and are called freight-­‐in. Freight costs will be recorded as cost of sales if they are included on the invoice and can be allocated to each individual inventory. If not, they will be recorded as freight-­‐in in a separate account because of the difficulty of allocating freight costs to each inventory items. In contrast, freight costs incurred by the seller on outgoing inventory are called freight-­‐out and are operating expenses to the seller. These costs increase an expense account called either ‘freight-­‐out’ or ‘delivery expense’. PURCHASE DISCOUNTS SETTLEMENT DISCOUNTS: The credit terms of a purchase on account may permit the buyer the claim a discount for prompt payment. The buyer called this settlement a ‘discount received’. The incentive offers advantage to both parties – the purchaser saves money and the seller is able to shorten the operating cycle by converting the accounts receivable into cash earlier. The credit terms specify the amount of cash discount and the time period during which the discount is offered. They also indicate the time within which the purchaser is expected to pay the full invoice price. Example; credit terms are 2/7, n/30. This reads as ‘two-­‐seven, net thirty’. This means that a 2% discount may be taken invoice price, less (’net of’) any returns or allowances, if payment is made within 7 days of the invoice period (discount period); otherwise, the invoice price is due 30 days from the invoice date. If no discount period is offered, credit terms will specify the maximum time period for paying the balance due, eg. n/30. When an invoice is paid within the discount period, the amount of the discount is credited to ‘discount received’. Discounts are recorded by the buyer as revenue, as a discount represents a saving in outflows and a reduction in liabilities and increase in equity. ACC1AIS CHAPTER 4 INVENTORIES TRADE DISCOUNTS: Trade discounts unlike settlement discounts, do not depend on early payment of the amount due and are not recorded in the records of either the buyer or the seller. Trade discounts are disclosed on the sales invoice as a percentage reduction in the list price of the inventory sold. This means that the discount price becomes the new cost of the inventory that is to be recorded. Example; List price of $500 per item and allows a trade discount of 10% for buyers who purchase in large quantities of 8 or more. ACC1AIS CHAPTER 4 INVENTORIES RECORDING SALES OF INVENTORIES Sales revenues (like service revenues) are recognised/recorded when the inflow of economic benefits is probable and can be measured reliably. Sales can be made on credit or cash, and every sales transaction should be supported by a source document that provides written evidence of the sale. A sales copy provides support for a credit sale; the original copy will go to the customer and a copy is kept by the seller for recording purposes. Under a perpetual inventory system, two entries are made for each sale. 1. The first entry records the sale, either increasing cash or accounts payable and increasing sales revenue. SELLING PRICE 2. The second entry records the cost of the inventory sold, increasing cost of sales and decreasing inventory. COST PRICE For internal decision-­‐making purposes, business may use more than one account. For example, if they sell phones and computers they may have a ‘sales revenue – phones’ account and a ‘sales revenue – computers’ account. By using separate accounts for major product lines, management can monitor sales trends more closely and respond in a more appropriate strategic manner to changes in sales patterns. SALES RETURNS & ALLOWANCES When a customer returns goods, the seller may give a cash refund or a credit note. A credit note reduces the amount owing by the customer. Cash refunds and credit notes are recorded as sales returns and allowances. If goods are returned because they are faulty or damaged, they cannot be returned to inventory for resale. The entries would be the same for a sales return, but an increase in the expense account called ‘inventory write down’ and a decrease in cost of sales. ACC1AIS CHAPTER 4 INVENTORIES The inventory write down account can also be used to record inventory shrinkage, inventory waste, inventory obsolescence or inventory that has been lost or stolen. Sales returns and allowances is a contra revenue account to sales. A contra account is used to separately identify in the accounts and the income statement the amount of sales returns and allowances. Excessive returns and allowances may indicate inferior inventories, inefficiencies in filing orders, errors in invoicing customers or mistakes in delivery and shipment of goods. SALES DISCOUNTS Discount allowed is reported as an expense in the income statement and provides information to management on the amount of discount taken by customer. Sellers offer customer discounts to encourage early payment and hence decrease the operating cycle. ACC1AIS CHAPTER 4 INVENTORIES INCOME STATEMENT PRESENTATION SALES REVENUE Sales return and allowances, a contra revenue account, is deducted from sales in the income statement to arrive at net sales. GROSS PROFIT Cost of sales is deducted from sales revenue to determine gross profit. Gross profit is the surplus of sales revenue over cost of sales. It is NOT a measure of the overall profit of a business because operating expenses have not been deducted. OTHER REVENUE Revenue items other than sales revenue are included after gross profit. Other revenue includes items such as rent revenue and discount received. OPERATING EXPENSES SUBGROUPING OF OPERATING EXPENSES In a fully classified income statement, operating expenses are subdivided into selling, administrative and financial expenses. Selling expenses are those associated with making sales. Administrative expenses relate to the operating activities of the general, accounting and personnel offices. Financial expenses are those associated with the financing of the firms operations and debt collection. ACC1AIS CHAPTER 4 INVENTORIES EVALUATING PROFITABILITY GROSS PROFIT RATIO Gross profit is expresses as a percentage by dividing the amount of gross profit by net sales. The gross profit ratio is generally more informative than the gross profit amount, because it expresses a more meaningful relationship between gross profit and net sales. A higher ratio is a favourable as more sales dollar is being retained as gross profit. A decline in a business’s gross profit ratio can be caused by selling products with a lower mark up. This may be caused by a higher purchase price or a lower selling price. Or a higher one of each but an increase in the purchase price proportionally more than a higher selling price. An increase in the gross profit ratio would be due to a lower purchase price or higher selling price, or those in proportion. OPERATING EXPENSES TO SALES RATIO Indicates how much of net sales is being consumed by operating expenses. A decrease in this ratio is favourable as it indicates better expense control. ACC1AIS CHAPTER 4 INVENTORIES OVERVIEW OF THE GST PROCESS The tax is levied on the value added by a business at each stage in the production and distribution chain. GST is a broad tax. Goods and services which attract GST are referred to as taxable supplies. There are two exemptions where the customer does not pay GST – GST free supplies and input taxes supplies. With these, the supplier can obtain an input tax credit form the taxation authority for GST free supplies but cannot obtain a credit for input taxed supplies. In relation to taxable supplies, registered suppliers receive a credit (input tax credit) for all the GST paid on goods and services purchased in the commercial chain. The difference between the total amount of GST the business collects 0n sales and the total amount it pays on purchases is remitted to the taxation authority at regular intervals along with the BAS. ACCOUNTING FOR GST PURCHASING INVENTORY SELLING INVENTORY REMITTING GST TO THE TAXATION AUTHORITY The journal entry to pay the liability is a debit to ST collected for the total amount of GST collected during the period, a credit to the GST paid account for the total GST paid during the period, and a credit to cash, which is the amount paid to the ATO. The amount paid to the ATO is the difference between the GST collected and GST paid. ACC1AIS CHAPTER 4 INVENTORIES SUMMARY OF LEARNING OBJECTIVES Identify the differences between a service business and a merchandising business Because of the presence of inventory, a retail business has sales revenue, cost of sales and gross profit. To account for inventory, a retail business must choose between a perpetual inventory system and a periodic inventory system. Explain the recording of purchases under a perpetual inventory systems The inventory account is debited for all purchases of inventories, and it is credited for purchase returns and allowances. Explain the recording of sales revenue under a perpetual inventory system When inventory is sold, accounts receivable (or cash) is debited and sales is credited for the selling price of the inventory. At the same time, cost of sales is debited and inventory is credited for the cost of inventories sold. Prepare a fully classified income statement A fully classified income statement is an internal report which shows numerous steps in determining profit including the calculation of gross profit, other revenue, expenses classified by function into three categories – selling, administrative and financial expenses – and profit before and after income tax expense. Use ratios to analyse profitability Profitability is affected by gross profit, as measured by the gross profit ratio, and by management ability to control costs, as measured by the ratio of operating expenses to sales. Understand the basic process and main features of the goods and service tax (GST) The GST is essentially a 10% value added tax imposed on most goods and services. The tax is paid at each stage in the production and supply change, but it is the final consumer who bears the cost. Businesses that supply goods and services are generally eligible for a credit from the taxation authority on the tax paid. Suppliers essentially act as tax collectors for the taxation authority. The difference between how much GST a business has collected and paid determines whether the business has a GST liability to pay to the ATO or will receive a refund from the taxation authority. Complete journal entries to record GST GST included in amounts paid to suppliers is debited to a GST paid account (an asset account). GST collected from customers is credited to a GST collected account (a liability account). At the end of the reporting period, if the amount of GST collected exceeds the amount paid, the business pays the net amount to the taxation authority. The payment is recorded as a credit to cash to discharge the GST liability with the taxation authority. If the amount of GST paid exceeds the GST collected, the business will receive a refund from the taxation authority. This is recorded as a debit to cash, a debit to GST collected and a credit to GST paid. ACC1AIS CHAPTER 4 INVENTORIES