ACCOUNTING FOR INVENTORIES
 
1.   Inventories
 
      So far we have studied current assets. Current assets that we have studied are cash and cash equivalents (cash, demand deposit and time deposit bank accounts in local and foreign currencies), trade receivables, prepaid expenses, advance payments, accrued revenues, and VAT carried forward. In this chapter we will study another type of current assets that are inventories.
 
      Inventories are assets that are:
      a.   Manufactured and held for sale,
      b.   Being manufactured for sale,
      c.   Held for resale,
      d.   Materials to be used in production of goods, providing services or carrying out other business activities.
 
      Here, we have defined four types of inventories. The first type is called finished goods. They are goods manufactured by the firm but have not been shipped to the customers. The firm is holding these manufactured goods for sale to the customers. The second type is called work-in process. They are the goods that are still in the production process. In other words, they are the goods that have not been completed yet. They are still being manufactured inside the factory. When they are completed they become finished goods. Until they are completed they are called work-in process. The third type is called merchandise. They are the goods that the firm bought manufactured (the firm did not manufacture them. Another firm manufactured these goods and the firm bought them manufactured) for the purpose of reselling them. The fourth type is called materials. They are the materials to be used in production such as raw materials and components, materials to be used in providing services, and materials to be used in other business activities such as office supplies, packaging materials etc. Accordingly, we define four types of inventories, which are finished goods inventory, work-in process inventory, merchandise inventory, and materials inventory.
 
2.   Inventory records when they are purchased
 
      In this section, the subject is related to materials and merchandise inventories. Finished goods inventory and work-in process inventory are the subject of another course. Although the subject is related to both materials and merchandise inventories, our focus will be on merchandise inventory.
 
      When inventories (materials and merchandise) are purchased they are recorded at total cost. Total cost of the inventories include the following items:
 
      a.   Purchase price,
      b.   Transportation and handling costs (if they are not included in the purchase price),
      c.   Taxes and import duties (other than VAT. VAT is not included in inventory costs),
      d.   Repackaging costs,
      e.   All other costs incurred in bringing the inventories to their present location and condition. Other costs may include bank transfer fees (paid before receiving the inventories), custom brokerage firm fees, funds etc.
 
 Example-1
 
A firm bought materials costing 50,000 TL + 18 % VAT (including transportation) on account payable in 60 days.
 
50,000 * 0.18 = 9,000 TL (VAT)
 
 
Debit
Credit
Materials inventory
50,000
 
VAT deductible
9,000
 
 Accounts payable
 
59,000
 
Here, there is only one cost item that is the purchase price (including the transportation). So, the inventories recorded with this cost. Do not forget: VAT is not included in the cost. It is debited as VAT deductible.
 
Example-2
 
A firm bought 300 units of merchandise inventory on account payable in 45 days. Unit cost is 50 TL + 18 % VAT (excluding transportation). The firm also paid 300 TL + 18 % VAT for transportation in cash.
 
      a.   Make the accounting record.
      b.   What is the unit cost?
 
300 * 50 = 15,000 TL (purchase price)
15,000 * 0.18 = 2,700 TL (VAT of the merchandise)
300 * 0.18 = 54 TL (VAT of the transportation)
 
In this example total cost includes two items. One of them is the purchase price (15,000 TL), another one is the transportation cost (300 TL).
 
Total cost = 15,000 + 300 = 15,300 TL
 
As usual VAT (value added tax) is not included in the total cost. Total VAT (2,700 + 54 = 2,754) will be debited as VAT deductible. Accounting record:
 
 
Debit
Credit
Merchandise inventory
15,300
 
VAT deductible
2,754
 
 Cash
 
354
 Accounts payable
 
17,700
 
      The firm paid 300 TL + 54 TL (VAT) to the transportation firm in cash. So, 354 TL credited to cash. Purchase price + VAT (15,000 + 2,700 = 17,700) will be paid later. So, it is credited to accounts payable.
 
      Unit cost = Total cost / Number of units
 
      Total cost = 15,300, number of units = 300
 
      Unit cost = 15,300 / 300 = 51 TL
 
Example-3
 
A firm bought 200 units of merchandise inventory. Unit cost is 80 TL (including transportation). The firm must also pay 3,200 TL excise tax and 3,460 TL VAT. The firm gave a forward-dated check for the total amount.
 
      a.   Make the accounting record.
      b.   What is the unit cost?
 
Excise tax is another tax that is collected on deliveries. Unlike value added tax, excise tax is collected only once when the producer delivers the goods and when the imported goods are received from the customs. Buyer pays the excise tax, seller (producer) receives the excise tax. Excise tax is accrued when the goods are delivered regardless the cash receipts or payments. It is not a deductible tax. Seller must transfer the whole amount to the government. Since it is not deductible, buyer includes the excise tax in the total cost of the goods. Excise tax is collected on the delivery of certain goods. These goods are: petroleum products, motor vehicles, alcoholic beverages, beverages made with cola, tobacco products, and other goods (such as fragrances, deodorants, after shave lotions, shaving foams, air conditioners, refrigerators, dish washers, washing machines, shaving machines, vacuum cleaners, etc.)
 
Value added tax (VAT) is calculated by adding the excise tax to total purchase price.
 
VAT = (Total purchase price + excise tax) * VAT rate
 
 
Debit
Credit
Merchandise inventory
19,200
 
VAT deductible
3,460
 
 Notes payable
 
22,660
 
Here the total cost includes purchase price (200 * 80 = 16,000) and the excise tax (3,200 TL). VAT is debited as VAT deductible.
 
Unit cost = 19,200 / 200 = 96 TL.
 
Example-4
The firm imported 250 units of materials. Unit cost is 120 USD (including transportation).
 
      a. The firm paid the purchase price in advance. 1 USD = 1.75 TL. The bank charged 525 TL for transfer fee.
      b.   The firm received the goods. The firm paid 3,530 TL import duty, 11,260 TL excise tax, 12,160 TL VAT.
      c.   The firm paid 1,000 TL + 18 % VAT to a customs brokerage firm.
 
      All payments are made from the bank account.
 
Required:
      a.   Make the accounting records at each step,
      b.   What is the unit cost?
 
At the first step the firm transferred the purchase price (250 * 120 = 30,000 USD) and paid the bank’s transfer fee (525 TL).
 
The TL equivalent of the purchase price = 30,000 * 1.75 = 52,500 TL
 
Bank’s fee is also related to the inventories and it is an inventory cost (other costs). So, total cost at the first step is 52,500 TL (purchase rice) + 525 TL (bank’s fee) = 53,025 TL. Accounting record:
 
 
Debit
Credit
Advance payments
53,025
 
 Bank accounts
 
53,025
 
53,025 is debited to advance payments. Because the firm paid this amount before receiving the goods.
 
At the second step the firm received the goods from the customs. The firm paid the import duty, excise tax and VAT to receive the goods.
 
Import duty is calculated by multiplying the TL equivalent of the purchase price (30,000 USD * the exchange rate prevailing on the day when the goods are received) with import duty rate. Excise tax is calculated as follows:
 
      (TL equivalent of the purchase price + import duty) * excise tax rate.
 
VAT is calculated as follows:
 
(TL equivalent of the purchase price + import duty + excise tax) * VAT rate.
 
The firm must pay the taxes in order to receive the goods from the customs. As explained before, import duty and excise tax are part of the total cost. So, 3,530 + 11,260 = 14,790 TL is part of the total cost. VAT (12,160 TL) is debited as VAT deductible. The accounting record:
 
 
Debit
Credit
Materials inventory
67,815
 
VAT deductible
12,160
 
 Advance payments
 
53,025
 Bank accounts
 
26,950
 
Since the goods are received 53,025 TL paid in advance is transferred to materials inventory. Materials inventory (67,815 TL) reflects the total cost so far. This total cost includes:
 
      52, 500 TL , purchase price,
      525 TL , bank’s transfer fee,
      3,530 TL, import duty,
      11,260 TL, excise tax.       
 
Because the firm received the goods, 53,025 TL advance payments is closed by a credit entry.
 
At the third step the firm made the payment to the customs brokerage firm. The accounting record:
 
 
Debit
Credit
Materials inventory
1,000
 
VAT deductible
180
 
 Bank accounts
 
1,180
 
Since custom brokerage firm payment is related to the inventories, it is also part of the total inventory cost.
 
Total cost = 67,815 + 100 = 68,815
 
Unit cost = 68,815 / 250 = 275.26 TL.
 
Example-5
The firm imported 150 units of merchandise on account payable in 60 days. Unit cost is 200 Euro (including transportation).
 
      a.  The firm paid 4,190 TL fund before receiving the goods.
      b.   The firm received the goods. The firm paid 4,620 TL import duty, 14,720 TL excise tax, 15,900 TL VAT. 1 Euro = 2.30 TL.
      c.   The firm paid 1,200 TL + 18 % VAT to a customs brokerage firm.
 
      All payments are made from the bank account.
 
Required:
      a.   Make the accounting records at each step,
      b.    What is the unit cost?
 
At the first step the firm paid the fund. This fund is called “resource utilization support fund”. The funds rate is 6 %. Amount of the fund is calculated as follows:
 
Amount of the fund = TL equivalent of the purchase price (invoice price) calculated by using the exchange rate on the day when the fund is paid * 0.06
 
The fund is paid only if the payment to the exporter is made after receiving the goods. If the payment is made before receiving the goods the fund does not have to be paid. Since the firm in this example will make the payment to the exporter after receiving the goods, it must pay the fund in order to receive the goods from the customs. The accounting record:
 
 
Debit
Credit
Advance payments
4,190
 
 Bank accounts
 
4,190
 
Since the fund is paid before receiving the goods it is debited as advance payments.
 
At the second step the firm received the goods from the customs. The firm paid the import duty, excise tax and VAT to receive the goods. Total cost at this stage:
 
Purchase price = 150*200*2.3 = 69,000
Import duty      = 4,620
Excise tax         = 14,720
Fund                = 4,190 (fund was paid in advance)
Total Cost        = 92,530 TL (This amount is debited as merchandise inventory)
 
 
Debit
Credit
Merchandise inventory
92,530
 
VAT deductible
15,900
 
 Advance payments
 
4,190
 Bank accounts
 
35,240
 Accounts payable
 
69,000
 
4,190 TL advance payments is closed with a credit record. The firm paid the import duty, excise tax, and the VAT to receive the goods from the customs. Total payment:
 
Import duty      = 4,620
Excise tax         = 14,720
VAT                = 15,900
Total                = 35,240 TL (This amount is credited as bank accounts)
 
The firm will pay the purchase price in (69,000 TL) in 60 days. Since it is open account, it is credited as accounts payable.
 
At the third step the firm made the payment to the customs brokerage firm. The accounting record:
 
 
Debit
Credit
Merchandise inventory
1,200
 
VAT deductible
216
 
 Bank accounts
 
1,416
 
Total cost = 92,530 + 1,200 = 93,730 TL
 
Unit cost = 93,730 / 150 = 624.87 TL
 
Example-6
 
The firm imported 250 units of materials. Unit cost is 150 Euro (including transportation).
 
      a. The firm paid 5,290 TL fund before receiving the goods.
      b. The firm accepted a draft sent by the exporter (the bank also gave a guarantee) and received the goods. The firm paid 5,850 TL import duty, 18,640 TL excise tax, 20,130 TL VAT. The bank also charged 900 TL fee for its service. 1 Euro = 2.33 TL.
      c.   The firm paid 1,000 TL + 18 % VAT to a customs brokerage firm.
 
      All payments are made from the bank account.
 
Required:
      a.   Make the accounting records at each step,
      b.    What is the unit cost?
 
At the first step the firm paid the fund before receiving the goods. Accounting record:
 
 
Debit
Credit
Advance payments
5,290
 
 Bank accounts
 
5,290
 
At the second step the firm accepted the draft and received the goods from the customs. The firm paid the import duty, excise tax and VAT to receive the goods. The firm also paid bank’s fee. Total cost at this stage:
 
Purchase price = 250*150*2.33 = 87,375
Import duty      = 5,850
Excise tax         = 18,640
Bank’s fee        = 900
Fund                = 5,290 (fund was paid in advance)
Total Cost        = 118,055 TL (This amount is debited as materials inventory)
 
 
Debit
Credit
Materials inventory
118,055
 
VAT deductible
20,130
 
 Advance payments
 
5,290
 Bank accounts
 
45,520
 Notes payable
 
87,375
 
5,290 TL advance payments is closed with a credit record. The firm paid the import duty, excise tax, and the VAT to receive the goods from the customs. The firm also paid the bank’s fee. Total payment:
 
Import duty      = 5,850
Excise tax         = 18,640
VAT                = 20,130
Bank’s fee        = 900
Total                = 45,520 TL (This amount is credited as bank accounts)
 
The firm will pay the purchase price in (87,375 TL) in the future. Since it is backed by a draft, it is credited as notes payable.
 
At the third step the firm made the payment to the customs brokerage firm. The accounting record:
 
 
Debit
Credit
Materials inventory
1,000
 
VAT deductible
118
 
 Bank accounts
 
1,118
 
Total cost = 118,055 + 1,000 = 119,055 TL
 
Unit cost = 119,055 / 250 = 476.22 TL
 
3.   Calculating the cost of inventories when they are sold
 
      As you remember from the previous subjects, when the inventories (merchandise inventory or finished goods inventory) are sold two records are made. The first one records the revenue (domestic or foreign sales) along with VAT payable; the second one records the cost of merchandise sold (or cost of goods sold) and the reduction in inventories. In order to make the second record, cost of the inventories sold must be calculated. This subject is explained by taking the following example.
 
Example:
 
The inventory transactions of an item are presented below:
 
Beginning inventory, 500 units at a cost of 20 TL per unit.
Purchased 300 units at 18 TL per unit
Sold 600 units
Purchased 250 units at 22 TL per unit
Sold 300 units
Purchased 200 units at 23 TL per unit
Purchased 170 units at 19 TL per unit
Sold 400 units
 
Calculate the cost of merchandise sold in each sales transaction.
 
There are two methods to calculate the cost of merchandise sold. One of them is called first in first out (FIFO), the other one is called weighted average. Both methods are acceptable for tax accounting and financial accounting.
 
FIFO assumes that units sold come from the party that entered the firm first. Weighted average method calculates an average cost. We will calculate cost of merchandise sold by using both methods.
 
FIFO
 
No
Purchased
Units sold
 
Unit cost
Cost of merchandise sold
Balance
1
Beginning inventory
 
 
 
500*20=10,000
2
300
 
 
 
500*20=10,000
300*18=5,400
3
 
600
500*20=10,000
100*18=1,800
11,800
200*18=3,600
4
250
 
 
 
200*18=3,600
250*22=5,500
5
 
300
200*18=3,600
100*22=2,200
5,800
150*22=3,300
6
200
 
 
 
150*22=3,300
200*23=4,600
7
170
 
 
 
150*22=3,300
200*23=4,600
170*19=3,230
8
 
400
150*22=3,300
200*23=4,600
50*19=950
8,850
120*19=2,280
 
At the beginning of the period the firm has 500 units that transferred from the previous period (No: 1). Then the firm purchased 300 units (No: 2). After this purchase the firm has two parties of goods; the party (500 units) that is transferred from the previous period and the party (300 units) that is purchased. No: 3 is a sales transaction. The firm sold 600 units. These 600 units come from two parties (a total of 800 units). But we don’t know the actual flow of units. In another words we don’t know how many units come from the first party, how many units come from the second party. But, according to FIFO method, we assume that the units sold first come from the oldest party (from the beginning 500 units), the remaining 100 units come from the second party (party of 300 units purchased). Unit cost column shows this calculation. Total cost of merchandise sold is 11,800 TL. After this sale, all the units in the first party (all 500 units) left the firm, and 100 units from the second party also left the firm. Balance column shows the number of units at hand after this sale (number of units that are still in the firm). As you see from this column, there are 200 units at a cost of 18 TL per units (units remaining from the second party) are still in the firm. The transactions continue in this manner. At the end of the period, the firm has 120 units of inventory still at hand. These 120 units will transfer to the next period. Total cost of these 120 units is 2,280 TL.
 
 Weighted Average
 
No
Purchased
Units sold
 
Unit cost
Cost of merchandise sold
Balance
1
Beginning inventory
 
 
 
500*20=10,000
2
300
 
 
 
500*20=10,000
300*18=5,400
3
 
600
19.25
600*19.25
= 11,550
200*19.25=3,850
4
250
 
 
 
200*19.25=3,850
250*22=5,500
5
 
300
20.78
300*20.78
= 6,234
150*20.78=3,117
6
200
 
 
 
150*20.78=3,117
200*23=4,600
7
170
 
 
 
150*20.78=3,117
200*23=4,600
170*19=3,230
8
 
400
21.05
400*21.05=
8,420
120*21.05=2,526
 
Here, in the first sales transaction an average cost is calculated. 600 units sold come from the 800 units (from two parties). Total cost of these two parties is (10,000 + 5,400) 15,400 TL. Average cost is (15,400/800 = 19.25 TL). So, cost of merchandise sold is 600*19.25 = 11,550. After this sale, 200 units left. We value these 200 units at the average cost. The total cost of the units at hand is (200*19.25) 3,850 TL.
 
In the 5th transaction average cost = 3,850 + 5,500 / 450 = 20.78 TL.
 
In the 8th transaction average cost = 3,117 + 4,600 + 3,230 / 520 = 21.05 TL.
 
Glossary:
 
Finished goods: Mamuller
Ship: Sevk etmek
Work-in process: Yar覺 mamuller
Merchandise: Ticari mallar
Materials: 襤lk madde ve malzeme
Import duty: Gümrük vergisi
Excise tax: Özel tüketim vergisi
Alcoholic beverages: Alkollü içecekler
Beverages made with cola: Kolal覺 içecekler
Tobacco products: Tütün ürünleri
Fragrances: Parfümler
Customs: Gümrük
Customs brokerage firm: Gümrük müavirlik firmas覺
The exchange rate prevailing on the day when the goods are received: Mallar覺n gümrükten çekildii gün geçerli olan döviz kuru
Fund: Fon
Resource utilization support fund: Kaynak kullan覺m覺 destekleme fonu
Invoice price: Fatura tutar覺
Draft: Poliçe