Chapter 9 - Inventory

 Inventory - every companies need inventory be it a manufacturing or trading one😊. A Service company may need inventory but inventory costs will not be a high porportion of its total costs, a hair saloon may have shampoo or clips but its main costs will still be the hairdressers wages.👩

When a business purchase inventory, the double entry are as such: -

Dr Inventory                                                           XX

Cr Cash at bank/ Trade payable                                                         XX

When a business returns inventory 

Dr Cash at bank/trade payable                       XX 

Cr Inventory                                                                          XX

☝Question: - 

☝ Question - When a customer returns goods why isn't the Cost of sales and inventory account affected? 

Ans: Its because the business like the prev example above has purchases of 200 squids and also sale pf 200 squids which has already take place and cannot be reversed/adjusted.

 Instead we Debit Sales returns when a customer returns goods as, it will reflect a reduction to the business sales as such in the income statement: -

 

☝Question - When do we adjust the inventory account?

Ans: when we return goods back to Suppliers, the double entry is as follow:- 

Dr Trade Creditor/Supplier     $XX

Cr Inventory                                           $XX 

💨Which brings us to the next point, what are the items inside inventory account other than the cost of the product?

1. Freight/transport costs of bringing the good to the company 

2. Import duties or custom duties 

3. Insurance 

4. Packing materials 

5. Salaries paid to workers to process the goods to finished product

💨FIFO - First In First Out    

What is FIFO, it means First In First Out - it is a method to calculate the cost/product as part of the cost of sales. A business say for example that buys & sell Squid -- I like squid lah haha, the purchase price cannot always be the same right? Henceforth how do we determine the cost of the squid everytime we sell? The FIFO method assumes that the cost of the squid that is sold will be based on the earliest purchase  batch of the squid, until the earliest batch of  purchase is finish, then it will move to the 2nd batch of earliest purchase as its cost price.

☝Question - 

The total inventory at month end is $300.

Impairment/loss/Fire

💨Whenver we are asked to value stock, people always say "Lower of cost or Net book value lor, so easy"

But exactly whats that huh?

Let me explain - Cost refers to the initial/historical purchase price that is the price that was sold by supplier to you ;

Net book value would refers to Selling price less additional costs to bring the stock to its current condition. The selling price could be a market price, i.e.  the price that the stock can fetch at current market condition less selling cost.

See if either the costs is lower or the Net Book Value is lower then we will apply the lower of the 2 values.

For e.g. our stock costs is $500 current however its net book value( Selling price - selling costs) is $450, we will have to choose $450.

Henceforth impairment has occured because our stock in our balance sheet current asset is still $500 while the net book value is $450 , a reduction of $50.

we will need to pass our impairment journals : -

Dr  Impairment loss( Income Statement)                  $50 

Cr  Inventory/Stock( Balance sheet)                                        $50

☝Why is impairment needed?

Ans: it is because we need to fulfil the prudence accounting principle in that we should not overstate assets and undervalue our liabilities as this will present a wrong balance sheet information to user of our financial statements. 

☝Ok, what happens when we don't pass impairment losses above? 

Ans: Our profit and inventory values will be overstated by $50.

Test your understanding - try doing this question

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Chapter 8 - Prepayments and Accural

 Lets start on prepayment & accrual:)  Prepayment & Accruals is an important topic, it will definitely come out as part of the income statement adjustment and/or a question on its own. 

💥Why do we need all these accruals & prepayments? 

 If you can recall in earlier topics, when we prepare the income statement & Balance sheet, it was prepared based on an earned/incurred basis in the financial period. 

For income/expenses which are Outside of the period or which are not earned/incurred, we will therefore have to exclude them. This is to satisfy the accrual accounting concept as well as the Matching accounting concept.

💨FYI, matching accounting concept refers to matching the income earned with the expenses incurred for the financial period. 

Expenses first, there are 2 types of expenses namely: (i) Accrued Expenses & (ii) Prepaid Expenses 

(i) Accrued expenses refer to an expense that is incurred in the current financial period which will be paid in the next accounting period. No invoice for this expenses has been received yet however the business has incurred this expenses in the current financial period.

☝Question-  A business financial year end is from 1 Jan 20X1 to 31 Dec 20x1 however the electricity bills is received half yearly from 1st April 20X1 to 30 Sept 20X1. How about the Electricity expenses from 1st Oct 20X1 to 31 Dec 20X1? 

Ans: Accrue the Electricity for this period 

Using the electricity bill from  1st April 20X1 to 30 Sept 20X1 as a proxy for e.g. $600 for 6 mths and accrue them:

Accrue Elect from 1st Oct 20X1 to 31 Dec 20X1: 3/6 mths X $600 = $300

Therefore , we  Dr Electricity Expenses $300 & Cr Accrued Electricity Exp $300 

The electricity expenses will lower the profit and accrued electricity will increase liability in the balance sheet. 

(ii)Prepaid Expenses refers to expenses whereby we paid for the expenses which we have not yet incurred in the financial period. 

☝Question- Company ABC whose financial year is between 1 Jan 20X1 to 31 Dec 20X1 paid for 15 months club membership from Jan X1 to Mar X2 in Jan X1 for $1,500. 

Since from Jan X2 to Mar X2 are considered outside of the financial period, the 3 months payment are therefore prepaid club membership expenses.

Therefore, to record the payment of the club Membership 

Jan X1 : Dr Club Membership Exp $1,500 Cr Cash at Bank $1,50

To remove Jan X2 to Mar X2 expenses 

Dec X1: Dr Prepaid Membership $300 Cr Club Membership Exp $300

The total club membership expenses would be $1,200 while prepaid club membership would be $300. 

Now lets go on to Income, there are 2 types of namely: (iii) Income Receivables & (iv) Income Received in advance

(iii) Income Receivables refers to income which has been earned in the current financial period but will only be received in the next financial period. This could be due to invoicing not done to customer yet which result in the late collection. The revenue for the current financial period should still be recorded. 

☝Question - ABC Ltd earns $100/mth for the rental of tables and chairs to Bebe Restaurant. For the year ended 31 Dec 20X1, the rental income of Nov X1 and Dec X2 had not been received . ABC Ltd has not billed Bebe Restaurant and no records exist.

(iv) Income Received in advance refers to income which has not been earned but received in advance. 

☝Question- ABC Ltd earns $100/mth for the rental of tables and chairs to Bebe Restaurant. For the year ended 31 Dec 20X1, ABC Ltd received 13 months of rental income from Jan X1. 

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Chapter 7 - Trial Balance

 Once all source documents has been recorded in the journals and the journals has been posted to the ledgers, the business can start to prepare the trial balance. 

The trial balance is a balance of all accounts ledger with amount balances at a given date.  

The purpose of a Trial balance is :- 

💥 To check for any arithmetic errors &

💥 Assist in the preparation of financial statements

Lets do a question and do up the trial balance: -

1. Owner Fittbitt contributed $10,000 cash to the business

2. The company purchased stock at $50,000 list price and obtained a trade discount of 10% for hope of continued patronage and larger quantities purchase from supplier TB.

3. Sales of $2,000 were made to Customer C on credit.

4. Rental and electricity of $5,000 each is accrued on a monthly basis. 

1st Step: Prepare the individual ledger accounts : -

Based on the ending balance of the ledger above, we prepare the Trial balance: -

The Debits and Credits has to be equal otherwise, a check have to be made to investigate the reason.

There you go, a trial balance:)

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Chapter 6 - Cash Book

 Lets start on chapter 6- Cash book & Petty cash book. First on Cash book, the cash book may refer to the cash in hand that is being held by the business or the cash inside the bank account. 

Whenver a customer pays up, the double entry will be: -

Dr Cash at bank      $XX

Cr Customer A                   $XX

However, when we introduce cash discount allowed to customer, the double entry changes, for e.g. Customer A pays us $90 for a debt owning of $100 to us, meaning we allowed customer A to enjoy a discount of $10. ($100 - $90). The double entry will be as such: -

Dr Cash at bank                  $90

Dr Discount allowed(Exp) $10

Cr Customer A                                 $100

Lets move onto Supplier next, for supplier, since we will be the one paying them, the discount will be termed as discount received.

Whever we pay a supplier, the double entry will be :- 

Dr Supplier B      $XX

Cr Cash at bank                  $XX

 However, when we introduce cash discount received from Supplier B, the double entry changes, for e.g. when we pay Supplier B for a debt owning of $100 to them, meaning we received a cash discount of $10 from supplier B. (Note: its a Discount received for payment to suppliers & Discount allowed for payment received from customers).The double entry will be as below:-

Dr Trade Creditor - Supplier B     $100

Cr Cash at bank                                                                 $90

Cr Discount Received(income)                                         $10

You may ask what's the difference between a trade discount and a cash discount?

1. Purpose - A cash discount is offered to encourage its credit customer to settle their debts within a shorter time than the credit period given. A Trade discount is given to encourage customer to buy in larger quantities.

2. Calculated - A cash discount is a discount off the invoice price while trade discount are not shown on invoices. For e.g. A cash discount of 20% given to early payment, the original invoice amount is $100. The invoice will still shows $100. 

If a trade discount of 20% given to encourage increase quantities purchase of $100 original price, the invoice will not state $100, instead it will shows $80 in the invoice. 

3. Recording in ledger: - Cash discount are recorded as discount received/allowed while trade discount are not recorded.  

4. Discount given: - Cash discount arises when the customer pays up earlier than his credit terms while a trade discount is given at the sale/purchase of goods, before the invoice is issued. 

Dishonoured cheques 

Dishonoured cheques are cheques that are received from customers which are rejected by the bank, that is no funds inflow. The reasons why a cheque is dishonoured can be found below: -

1. The Cheque has expired - issued more than 6 months ago and no longer valid. 

2. The information on the cheque is incomplete or inconsistent, e.g. no date or signature is not consistent with the authorised version. 

3. Insufficient funds - Supplier who issues the cheque might not have sufficient funds in the bank account.

For e.g. On Receipt of a cheque by customer C for $$40 for a original debt owning of $50, we will pass  the below entries: -

Dr Bank $40

Dr Discount allowed $10

Cr Trade Receivable - Cust C $50

Having informed by the bank that the cheque was dishonoured, we reverse the transaction :- 

Dr Trade Receivable - Cust C $50 

Cr Bank                                                  $40

Cr Discount allowed                               $10

Lets move onto cash book: -

A cash book normally has 3 columns on each side of debit/credit: - Discount allowed/cash in bank/cash in hand on the debit side and Discount received/cash in bank/cash in hand on the credit side.

Normally a payment voucher needs to be filled in before a business can issue out funds to supplier/staff, for receipt of funds, a receipt will normally be issued after funds has been received ----> Source documents.

Questions

On 30 Jun 20X1,an amount received from Customer A of $90 for settlement of an amount owning of $100, the recording to cashbook will be as such: 

** Notice the discount allowed of $10 which will not be entered to bank balance, instead it will be Charged to Discount Allowed Acc @ Dr Discount Allowed $10 at the month end. 

Lets try payment to supplier: -

On 30 Jun 20X1, we made a payment  of $90 to supplier B  for settlement of an amount owning of $100, the recording to cashbook will be as such: 

The double entry will be Dr Supplier B $100 , Cr Discount received $10 & Cr Bank $90

Since we only need to pay $90 for an original owning of $100, the $10 is hence a discount received for the business.  The $10 discount received is also not added to the cash at bank balance but instead is charged off the discount received account Cr Discount received at the month end. 

💥Question: assuming a sales of $100 was made to Customer D, we gave customer D a cash discount of $20 for early repayment, how much sales revenue does the business records in its book?

Answer: $100, since the cash discount was given after invoice has been received, the discount will impact discount allowed - $20 which will be shown as a separate account from the Sales Revenue account. 

Petty Cash fund 

A business sometime keep some sum of money for low value expenditures such as refreshments, transport or toiletries such as toilet paper. 

The amount paid from the fund plus the amount remaining in the fund has to be equal to a fixed sum called the imprest amount or float.

(Float here doesnt refers to A & W float, although it is very tasty to drink)

For e.g. a petty cash fund of $100 paid out $60, the amount remaining of $40 + Paid out amount of $60 will be $100, which is the imprest amount.

The $60 paid out will be reimbursed to the fund such that the imprest amount of $100 is maintained. 

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Chapter 5 - Bank Reconciliation

 Next Chapter Bank Reconciliation, if a question on bank reconciliation were to appear in my O levels, I will be so happy and grinding teeth to teeth😁 That is provided I know how to do!

There are basically 4 steps in a bank reconciliation : -

Step 1. Compare the opening balance of the bank statement and the cash at bank account. Both opening balance  has to be correct in order to start your matching. 

    

The 2 items on the bank statement 1.chq no. 118 and 2.Trfr to supplier A amount has been taken in by the business in their Cash at bank account, whereas the opening balance of the Bank Statement - $5,550 Cr has yet to take in the effect of these 2 transactions. 

This could be due to customer for chq 118 telling the account clerk beforehand and the account clerk posting the trfr to Supplier A in the accounting system before actually processing the payment. 

Nevertheless, by adjusting these 2 entries in the bank statement, the opening balance of the bank statement is the same as the opening balance of the cash at bank account.

Step 2: 

Compare the transactions in the debit column of the cash at bank account against the Credit(Deposit) column of the bank statement &

Compare the transactions in the credit column of the cash at bank account against the Debit(Withdrawal) column of the bank statement. 

The cells highlighted in green were used to adjust the opening balance of the bank statement, henceforth they are considered to be non - reconciling/Ok.  For the cells which are not in green or crossed, we will have to adjust them in later steps.

Step 3: Draw up a revised bank account 

The purpose is to update the cash at bank account with items which appear in the bank statement which are not taken in yet by the business cash at bank account. The interest expense of $50 & Direct deduction - car instalment of $1000 appears in the bank statement but does not appear in the cash at bank account which is why we have to adjust in our cash at bank acc.

Step 4: Prepare a Bank Reconciliation Statement 

Having cleared the items in the bank statement, now the only outstanding are items in the cash at bank account which has not been reconciled or not slash at Step 2. 

Take note that the Credit balance as per bank statement means that your bank statement is positive and that you are taking up items which has been passed in the cash at bank account but not at the bank statement to tie to your revised bank account balance of $3,450.

Done, your bank reconciliation is finished :)

Remenber,  different format applies depending when your bank statement balance is Debit or Credit balance, it is the direct opposite of each other.

Chapter 4 - Special Journals

 Having understand the various elements of financial statements as well as double entry , lets go on to the next topic : - Special Journals 

There are 4 types of Special Journals namely: -

1. Purchase Journal;  

2. Purchase Return Journal; 

3. Sales Journal ; & 

4. Sales Return Journal 

Purchase Journal & Purchase Return Journal

An example of a Purchase Journal, contains all the individual Credit purchases: - 

Example of Purchase Journal 

Example of Purchase return Journal 

At the end a periodic period, which may be 5 days or 10 days, the account staff will post the amounts in the purchase journal and purchase return journal to the ledger : - namely the Inventory and Trade Payable ledger as per following: - 

Ps: recall where inventory and trade payable belongs to which part of financial statement, is it debit or credit in nature?

Inventory A/c (Extract) 

Trade Payable A/c (Extract)

What happen if we dont have special journal- purchase journal ?

Inventory a/c without special journal totals 

• Does it look more cluttered and messy? If your finance manager wants to know nett puchases from Supplier A, is the inventory acc (w/o Special journal) or the Purchase journal + Purchase return journal easier to retrieve? 

Ans: The Purchase journal + Purchase return journal

Lets move on to the other type of special journal:- namely the Sales Journal and Sales Return journal.

Sales Journal & Sales Return Journal

The Sales and Sales return journal are used to record sales to customer on credit and Sales returns. It is a compilations of all credit sales & credit sales returns.

Transactions are recorded using source document ---> Sales invoice or Credit Notes

  

Example of Sales Journal 

Example of Sales Returns Journal - let say both Strawberry & Blueberry returns $100 worth of goods: -

Similar to purchase journal, the posting to the Sales Revenue and Trade Debtor ledger which are part of the General ledger will be done periodically , 5 or 10 days once: -

Ps: recall where Sales revenue and trade debtor belongs to which part of financial statement, is it debit or credit in nature?

Sales Revenue acc (Extract) 

Trade debtor Acc (Extract)

What happen if we dont have special journal- Sales journal ?

This is how our Sales revenue acc will looks like: - 

• Does it look more cluttered and messy? If your finance manager wants to know nett Sales revenue from Strawberry, is the Sale revenue acc above (w/o Special journal) or the Sales journal + Sales return journal easier to retrieve? 

Ans: The Sales journal + Sales  return journal

There are a few reasons why we need to have these special journals: -

1. Ease of retrieve of information- for E.g. when we want to know the current outstanding amount owed to Supplier A, we just need to refer to the purchase journal and find Supplier A amount;

2. The periodical posting to Ledger instead of every single purchase/sales/returns to ledger will avoid overcrowding of the General ledger, this makes the preparation of financial statement easier;

3. Segregation of duties - instead of 1 staff to handle the ledger such as sales revenue/purchases/return, having the special journal allows allocation of staff to handle the Sales revenue + Trade debtor ledger and another staff to handle the Stock/inventory + Trade Payable ledger. This will increase productivity and avoid confusion. 

** Remenber to exclude any trade discount when posting to ledger from special journals!

Test your understanding - Question

 Squid Ltd purchases goods on credit from 001 Pte Ltd, A trade discount of 10% is given by 001 Pte Ltd to Squid Ltd out of goodwill the following transactions occured in the month of Jun 2021: -

2021

June 1 Purchase Goods at list price of $1,000. An invoice for carriage inward amounting to $100 was               separately received

        12 Returned damage goods purchased on 1st June with a list price of $500

        31 Made a partial payment of $150 by cheque

Required

(I) Prepare the account of 001 Pte Ltd in Squid Ltd's ledger for the month of Jun 2021, showing the balance on 1 July 2021. The outstanding amount owed to 001 Pte Ltd on 31 May 2021 was $1500.

(II) Why does a business needs to maintain a separate Sales & Purchase ledger when it has already have a general ledger?

    

Answer for 1(II)

1. When a business has numerous credit suppliers & credit customers, their individual trade payable and receivables account are kept separately in the sales and purchases ledger. 

2. This is to prevent flooding of the general ledger and thereafter ease of preparation for financial statements/retrieve of information regarding particular trade debtor or creditor.  

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Chap 3:Accounting Equation and Financial statements elements

 All right, after the accounting information system, lets us embark on another section, which is the Accounting equation:) : -

Balance Sheet

Assets = Liabilities + Equities 

A business needs assets such as job equipment, cash and stock in order to operate. Asset are resources owned by the company.

While on the other side liabilities can be further split to Non- Current liab such as Long Term Borrowings and Current liab such as creditors. Liabilities are funds borrowed from other people, they can be bank or natural person.

Equities are resources or funds contributed to the business by its owner.

Income Statement 

Profit/(loss) = Total Income -Total expenses

Income could be in the form of  trading/service/Sales revenue. Other income such as scrap proceed, bank interest income could be another form too.

Expenses are outflow of funds of the business such as depreciation/rental/electricity expenses to name a few.

All right, having known the 5 major elements of the financial, lets us get to know the impact transaction will have on the elements.

1. Cash sales of goods worth $1,000 for $1,500 

Dr Cash (Balance sheet-current asset increase)     $1,500

Cr Sales revenue (Income statement - revenue increase) $1,500

& for the cost of goods

Dr Cost of goods (Income statement - Cost of Goods sold increase) $1,000

Cr Inventory (Balance sheet - current asset reduces) $1,000 

We need to account for the sales of $1,500 in revenue in income statement and also cash/bank in balance sheet. The $1,000 will need to be reduced from inventory and increase to the Cost of goods sold account in income statement. 

2. Purchase of Goods on Credit for $2,000 from Mr POA

Dr Inventory (Balance sheet - Current asset increases)  $2,000

Cr Trade Creditor - Mr POA (Balance sheet - Current Liab increases) $2,000

When a business purchase goods, inventory will increase, correspondingly Trade creditor or cash will increase/reduce correspondingly depending if the purchase is paid on credit or in cash.

3. Return of Goods worth $500 to Mr POA 

Dr Trade Creditor - Mr POA (Balance sheet - current liability (reduces)  

Cr Return Outwards( Income statment - reduces expenses/purchases)

Upon return of goods to Mr POA, the business inventory/purchases reduces, how do we reflect it?

We reflect it by increasing Return outwards account, the return outwards is shown below in the income statement: -

Income Statement as at 31 Dec 20X2

                                                $

Total Purchases                2,000

Less:Return Outwards    (500)

Net purchases.                  1,500

From all 3 transactions,notice 2 things:-

i. The bal sheet & income statement still balances after each transaction:-

In the case of payment to a trade creditor,If I reduces cash which is an current asset,I also reduces trade creditor which is a current liab.....and since 

Total Assets = Total Liab + Total Equity 

By reducing asset & Liab,the equation will ⚖️ balance:)

2. It will have a Debit & Credit entry,no Debit only or Credit only entry.

Test your understanding by trying out the double entries for these transactions:

Example

1. Accrual of rental Exp $1,500

Dr.              ....Total Exp/Rev increase/decrease......               $1,500

Cr               ....Total assst/liab increase/decrease......                         $1,500

2.Payment to trade debtor Mr B $500

3. Owner,Mr POA adds $10,000 of cash to the business

4. Return of goods by customer Mr B $100

5. Depreciation of Machinery $1,000 for the year of 20X1

6.Owner take out $3,000 of cash for personal usages

7.Purchase of $700 of goods on credit from supplier,Mr D

8.Dividend payment of $0.01/share or $1,000 declared for the year ended 31 Dec 20X2.

Do these above and think of the transactions impact on each part of the financial statement same as the example for (a):)

Feel free to leave a msg shld you need any assistance:)

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