Physical Inventory Count, Ownership of Goods, and Consigned Goods: Videos & Practice Problems

At the end of an accounting period, companies must determine their inventory levels to accurately report them on their balance sheets. This process involves conducting a physical count of the inventory on hand, which may include counting, measuring, or weighing goods in the warehouse. Regardless of whether a company uses a perpetual or periodic inventory system, this physical count is essential.

In a perpetual inventory system, inventory records are continuously updated with each transaction. Therefore, the physical count should ideally confirm the inventory balance recorded in the accounting system. Any discrepancies found during the count may indicate issues such as waste, theft, or errors in record-keeping. While the course does not delve into the specifics of addressing these discrepancies, it is important for businesses to investigate and resolve them.

Conversely, a periodic inventory system only updates the inventory account at the end of the accounting period. In this system, the physical count is crucial, as it serves as the basis for calculating the cost of goods sold (COGS). Companies track purchases and other relevant data throughout the period, but the actual inventory count at the end is necessary to determine the ending inventory. Therefore, when solving problems related to periodic inventory, the ending inventory figure will always be provided as a result of this physical count.

Understanding the differences between these two systems and the role of physical inventory counts is vital for accurate financial reporting and inventory management.

When managing inventory at the end of a period, it's crucial to determine ownership of goods, particularly for items in transit. This is where the shipping terms "FOB" (Free On Board) come into play, specifically distinguishing between FOB shipping point and FOB destination.

With FOB shipping point, ownership of the goods transfers at the shipping point. This means that once the supplier ships the goods, the buyer assumes ownership, even if the items are still in transit. Therefore, if a purchase made under FOB shipping point is still on its way to the warehouse on the last day of the year, it should be included in the buyer's inventory. This is because the buyer legally owns the goods during transit.

Conversely, FOB destination indicates that ownership changes hands only when the goods reach their final destination, typically the buyer's location. In this scenario, if a sale is made under FOB destination terms and the goods have not yet arrived at the customer’s location by the end of the year, the seller retains ownership. Consequently, these goods must still be included in the seller's inventory, as they have not yet been transferred to the customer, and revenue cannot be recognized until the transfer occurs.

To summarize, the key to understanding inventory ownership during transit lies in recognizing whether the terms are FOB shipping point or FOB destination. For purchases, if the goods are in transit under FOB shipping point, they belong to the buyer. For sales, if the goods are in transit under FOB destination, they remain the seller's property until delivery is completed. This understanding is essential for accurate inventory management and financial reporting.

Consigned goods refer to items that are held for sale by one party (the seller) but are owned by another party (the supplier). This arrangement is common in boutique shops, where the store displays products from suppliers without taking ownership of them. The seller earns a commission only when the goods are sold, and if the items do not sell, they remain the property of the supplier.

In accounting for consigned goods, it is crucial to note that these items do not appear in the seller's inventory. The seller only records transactions related to sales and the revenue generated from those sales. For instance, if a boutique sells dresses on consignment, the seller will not include these dresses in their inventory records. Instead, they will recognize revenue only when a sale occurs.

Consider a scenario where Jan's boutique sells dresses for Sophie. If Jan receives $1,000 for each dress sold and earns a commission of $100 per dress, the accounting entries would reflect this. If Jan sells two dresses, she collects $2,000 in cash but must pay Sophie the majority of that amount. The journal entries would be as follows:

1. **Debit Cash** for $2,000, reflecting the total cash received from the sale.

2. **Credit Revenue** for $200, representing Jan's commission from the sale (2 dresses x $100 commission).

3. **Credit Payable to Sophie** for $1,800, indicating the amount owed to Sophie for the dresses sold (total cash received - commission).

In this case, Jan's inventory balance remains at $0, as the dresses are not her property. Her revenue from the commission is $200, while her liabilities reflect the $1,800 owed to Sophie. This example illustrates the key principles of accounting for consigned goods, emphasizing that the seller does not own the goods and only earns a commission upon sale.