🔹Periodic vs. Perpetual Inventory
- Overview: Continuous, real-time recording of inventory costs.
- Features:
- Inventory updated instantly after every transaction.
- COGS recognized immediately after each sale.
- Often integrated with tech like Point of Sale (POS) systems.
- Pros:
- Provides current inventory and cost data.
- Swift identification of discrepancies, theft, etc.
- Enhanced inventory management due to real-time stock updates.
- Cons:
- Can be technologically complex and costly.
- Overview: Updates inventory periodically, typically at accounting period ends — such as quarterly or annually.
- Features:
- Sales recorded, but not immediate COGS tracking.
- Physical counts needed for ending inventory.
- COGS calculation involves:
- Beginning Inventory + Net Purchases = Goods Available for Sale (GAFS) - Ending Inventory = Cost of Goods Sold (COGS)
- Pros:
- Simplified, suitable for small businesses.
- Reduced daily record-keeping.
- Cons:
- Doesn't offer real-time financial data.
- Delayed recognition of theft or losses.
🔹The “Holy Grail” Inventory Formula
Beginning Inventory + Net Purchases = Goods Available for Sale (GAFS) - Ending Inventory = Cost of Goods Sold (COGS)
1. Understand this Formula Conceptually
Understanding this formula is crucial, not just for memorization but to grasp its underlying logic. Let's dive into an analogy:
Imagine you're organizing a party and you're responsible for the drinks.
- “Beginning Inventory” — like the initial bottles of alcohol you already have at home.
- “Plus Net Purchases” — the additional drinks you buy for the party.
- “Goods Available for Sale (GAFS)” — Combine what you already had with what you just bought, and you get the total number of bottles available for the party.
Now, post-party, only two things could have happened with the drinks:
- They were consumed (equivalent to goods being sold).
- They remain unconsumed (equivalent to ending inventory).
Beginning Inventory + Net Purchases = Goods Available for Sale (GAFS) - Ending Inventory = Cost of Goods Sold (COGS)
- The formula captures this simple reality. What's not consumed (Ending Inventory) when subtracted from what was available (GAFS) gives you what was consumed (COGS).
2. Visualize the Formula Using an Example
From the example:
- You began with an inventory worth $47,000.
- Purchased additional inventory worth $62,200.
- Giving a total of $109,200 available for sale.
- At the period's end, assume that inventory worth $17,000 remains.
- Therefore, inventory worth $92,200* was sold. 109,200 - 17,000 = $92,200
3. Another Perspective: Units of Inventory
Exam questions can show inventory in terms of total $ value or in terms of # of units. Luckily, the same formula works for both! Beginning Inventory + Net Purchases = Goods Available for Sale - Ending Inventory = COGS
For instance, explore this hypothetical scenario:
- Beginning Inventory: 500 units.
- Net Purchases: Another 700 units.
- Equals GAFS of 1200 units.
If 300 units are left remaining by the period's end, this means 900* units were sold. 1200 - 300 = 900
Key Takeaway: Just like the drinks at your party, all inventory has two potential fates – it’s either sold (Cost of Goods Sold) or it remains unsold (Ending Inventory). Knowing your beginning inventory and what you've added to it (net purchases) provides clarity on what was available for sale in the first place. The subtraction simply indicates the outcome: sold or unsold. This concept, understood deeply, becomes a foundational tool for handling merchandising questions in exams.
🔹Credit Terms (aka Discount Codes)
- Throughout your merchandising chapter, "credit terms" and "discount codes" will frequently come up. Remember, they mean the same thing. At their core, they represent structured incentives sellers provide to buyers for more prompt payments.
- The world of credit terms can be viewed through two lenses: the buyer's perspective and the seller's perspective. Regardless of the viewpoint:
- Buyers: Look to maximize their savings.
- Sellers: Utilize discounts as a carrot to get their cash sooner.
- Typical Format: % / Days, n / Days
- Example 1:
1/10, n/60 - 1% is the discount offered.
- 10 days is the window to avail this discount.
- 60 days is the overall period granted for full payment.
- Example 2:
2/15, n/45 - 2% is the discount offered.
- 15 days is the window within which you can get the discount.
- 45 days is the total duration granted for the complete payment.
By thoroughly understanding and memorizing this format, you'll be equipped to decode and handle any variation of credit terms that your exam throws at you.
- For Buyers: Recognize that early payment not only helps conserve cash but also directly reduces expenses.
- For Sellers: Realize that while discounts may reduce incoming cash slightly, the trade-off often involves accelerating cash flow, which is invaluable.
🔹FOB Shipping Point vs. Destination
FOB (Free On Board): Determines when the ownership of inventory transfers from the seller to the buyer during shipment.
- FOB Shipping Point:
- Ownership & Risk: Transfers to the Buyer when the goods leave the Seller Warehouse (the moment they're on the truck).
- Shipping Costs: Typically covered by the buyer.
- FOB Destination:
- Ownership & Risk: Remains with the Seller until goods arrive and offload at the Buyer Warehouse.
- Shipping Costs: Typically covered by the seller.
Remember: FOB type decides "Who owns (and risks) the goods during transit?"
🔹Multi-Step Income Statement
Breaking this down into digestible chunks is way easier than trying to memorize the whole thing. Remember each step, and know you might be tasked with creating a full statement on your exam. (Always consult your professor on the exact requirements.)
🔍 STEP 1: Calculate Net Sales
📌 This helps you figure out the total sales after considering returns and discounts.
- Gross Sales
- Less: Sales Discounts
- Less: Sales Returns & Allowances
- Equals: 🌟 Net Sales
- Gross Sales: $50,000
- Less: Sales Discounts: $2,000
- Less: Sales Returns & Allowances: $3,000
- Equals: 🌟 Net Sales: $45,000 If you sold goods worth $50,000, but gave discounts worth $2,000 and had returns of $3,000, your Net Sales would be $45,000.
🔍 STEP 2: Determine Gross Profit
📌 Find out the profit after subtracting the cost of producing or buying your goods.
- Net Sales (from Step 1)
- Less: COGS* (use the Holy Grail Inventory Formula!)
- Equals: 🌟 Gross Profit
- Net Sales (from Step 1): $45,000
- Less: COGS* (use the Holy Grail Inventory Formula!): $20,000
- Equals: 🌟 Gross Profit: $25,000 Hypothetically, if your beginning inventory was $15,000 and you made net purchases of $10,000, you had $25,000 goods available for sale. If ending inventory is $5,000, then COGS is $20,000.
🔍 STEP 3: Find Net Income
📌 Now, figure out your total net income or loss after all other expenses.
- Gross Profit (from Step 2)
- Less: Selling Expenses
- Less: General & Admin Expenses
- Equals: 🌟 Net Income or Loss
🔽 Toggle to see example calculation.
🌟 The Holy Grail: COGS Calculation
- Beginning Inventory
- + Net Purchases
- = Goods Available for Sale (GAFS)
- - Ending Inventory
- Equals: 🌟 Cost of Goods Sold (COGS)
🚀 Pro Tip: Practice each step until you can write it down without looking. Make sample income statements, and test yourself regularly.