Inventory Management and Adjustments Quiz

Balance Day Adjustments

• Businesses need to determine operating efficiency and future prospects
• Accounting periods (e.g., financial year) divide the business life into arbitrary periods
• Financial statements use the matching concept traditionally to match expenses to revenues, ensuring accuracy—matching concept
• Now, the emphasis is on conceptually determining if an item is revenue or expense and then subtracting expenses from revenues
• Financial statements are broadened to recognize relevant assets, liabilities, revenues, and expenses for the period
• Adjustments are necessary when daily transactions aren't fully recorded during the accounting period

Adjusting Entries

• Adjusting entries needed if general ledger isn't complete for the accounting period
• Daily activities might occur but not be recorded daily (e.g., paying employees, using supplies)
• External party transactions might not be recorded immediately (e.g., interest earned, electricity)
• Time-dependent events impact future economic benefits (e.g., insurance, asset cost)
• Current assets, like accounts receivable, need realistic values (e.g., estimated bad debts, inventory)

Inventory Adjustments

• Inventories can be adjusted for two reasons: Item records showing incorrect inventory values and yearly stocktakes to reflect inventory losses
• Stock on hand differs from recorded inventory after stocktake
• The inventory shortage is a cost of sales expense, decreasing gross profit
• Inventory shortage amount reduces the Inventories Control account
• Adjustment entry is a debit to Inventory Adjustment and credit to Inventories Control to reflect inventory loss
• The opposite happens when stock exceeds recorded values

Cost of Goods Sold (COGS)

• Inventory valuation is generally at historical cost.
• If net realizable value is lower than cost, the lower amount is used.
• Net realizable value (NRV) is estimated selling price minus selling/distribution costs
• Methods for determining cost include specific identification, FIFO (First-In, First-Out), and weighted average
• Cost and NRV are compared to determine inventory value
• If NRV is lower than cost, it represents a loss that needs adjustment

Accrued Expenses

• Accrued expenses are expenses incurred but not yet paid during an accounting period
• Expense account increases to reflect expenses incurred
• Accrued Expenses liability account is created

Accrued Revenues

• Accrued revenues are revenues earned but not yet received during the accounting period
• Asset Accrued Revenues is created
• Revenue account is increased to its correct amount

Prepaid Expenses

• Prepaid expenses are expenses paid in advance, recorded as assets until used
• Expense account increases
• Prepaid Expenses asset account decreases

Unearned Revenues

• Unearned revenues are received in advance but earned in a future period
• Revenues decrease
• Unearned Revenues liability account increases

Provision for Doubtful Debts

• Provision for doubtful debts estimates the amount of accounts receivable unlikely to be collected
• Transfer of bad debts to a provision account sets up a provision
• Adjusting entries for bad debts decrease the Bad and Doubtful Debts account and decrease the provision account to the correct amount

Depreciation

• Depreciation allocates the cost of a long-term asset over its useful life
• Depreciation expense account increases to match the depreciation expense
• Accumulated depreciation is a contra account that increases to reflect the total depreciation
• Depreciation recorded reduces the asset value in the balance sheet

GST Clearing

• Adjusts GST collected and GST credits received to the payable account
• Removes GST liability and decreases GST Collected account simultaneously
• GST clearing payable account appears as liability in the statement of financial position