Ordering Inventory - balance sheet

CFA Level I FRA
#1

A company order’s $1000 of goods. They will pay on delivery. At the time of the ordering do they:

  1. do nothing, OR

  2. increase Accounts Receivable by $1000, increase Accounts Payable by $1000?

Similarly, if they order $1000 of goods and pay $500 at ordering, and will pay $500 on delivery, at the time of ordering do they:

  1. reduce cash by $500, increase accounts receivable by $500, OR

  2. reduce cash by $500, increase accounts receivable by $1000, increase accounts payable bt $500

Also, in this case, is “Accounts receivable” the correct word, or is that reserved for expected financial payments? I know “prepaid expenses” is for expected services. Is there a specific word reserved for expected physical items or assets?

#2

Account receivable has nothing with solely purchasing goods unless you are not seller in transit (in case you just connect wholesallers and customers and don’t hold any inventory).

So, when you purchase goods on credit for further distribution you have this situation:

Incerase account inventory for 1000 (Debit)

Incresase account payable for 1000 (Credit)

when you make paymment for goods above you have:

Decrease account payable (Debit)

Decrease cash on bank account (Credit)

When you sell those goods to another customer

Than:

Solution - sell all inventory on credit

Inventory

Decrease Inventory 1000 (Credit)

Account receivable 1500 (Debit) let’s assume that 500 $ is your mark-up

Paid invoice by customer

Account receivable 1500 (Credit)

Cash on bank account 1500 (Debit)

Solution - sell part (f.ex a half) inventory on credit

Decrease Inventory 500 (Credit) - here you use one of the inventory method, LIFO, FIFO, weighted average cost etc.

Account receivable 750 (Debit)

Paid invoice by customer

Account receivable 750 (Credit)

Cash on bank account 750 (Debit)

Solution - sell all inventory for cash

Decrease Inventory 1000 (Credit)

Cash on hand 1500 (Debit) let’s assume that 500 $ is your mark-up

#3

Thanks for the quick and detailed answer but that’s not what I’m asking about :frowning:

#4

Could you be concrete? I am quite sure that I gave you a correct aswer.

If you made purchase on credit terms, simply you have balance on account payable until you settled that to 0.00 by

making the last paymnet. Account receivable and prepaid expense account has nothing with this situation. This is only method of payments agreed with supplier, the effect on revenues/costs will be the same (ignoring discount/interest effects for deffered payment or payment prior agreed terms).

#5

Not ordering on credit. Ordering on debit, or partially on debit:

I’m not asking for business strategies. I’m asking for balance sheet treatment:

  1. What is the Balance Sheet account called when you have given a down-payment for inventory that has not yet been delivered (“Prepaid Expenses” and “Accounts Receivable” are similar in effect, but I think there might be another account name).

The other question… I don’t think there’s a simpler way to ask. I think all the information is there:

And change the words “accounts receivable” to whatever the correct term is (answer to the first question)

For the record, I think (1) is correct, but I want to check.

#6

Do you mean from seller aspect or from buyer aspect? Sorry for confusion. Just want to avoid discussing wrong situation.

1.There may be or may be not an additional analitical Inventory account for Inventory drawn-down. Since here we are not accountants than analyists, consider there is only one Inventory account which increases by new purchasement of goods and decreases by selling or writting-off goods, so all changes are done on same Inventory account and expresses total Inventory position on balance sheet date.

Furthermore, as you look from seller aspect, according to IFRS (as I found simillar situation is according to USGAAP), goods that are paid by customer but not yet delivered are shown as liabilty account - received cash advance from customer. Since goods are not delivered, all risk are not yet been transfered to customer and revenue cannot yet be recognized. Once, when you deliver goods, bill customer, you may recognize a revenue, create account receiveble to customer and than offset open receivable account with prior received cash booked as liability to this customer.

If you look same situation as a buyer, all of above is just opposite. You book given cash advance as an asset account, once when you receive goods and invoice for goods, you book cost of purchased goods and liability to supplier which is offset and closed with prior advance payment booked on given cash advance asset account.

  1. Who are “they” sellers or buyers? If buyer order goods and pay 500 at ordering and 500 on delivery you have 2 situation with likely timing distance (what mean that each situation has its cutoff date and it could be watch separetly).

First and second situation at Q. 2 above considered by buyer side, you may book it as given advance (situation described above) or otherwise seller can send you 2 different invoices for each payment and you book it as liability each time.

Each time and ever when you make any payment you reduces your cash. If you receive payments as a seller your cash position increases.

First and second situation at Q. 2 above considered by seller side. Everything remain same but just opposite. You may issue 2 invoices as a seller (which is simplier) or just use received advance payment and show it as temporary liability to customer as decribed above. Once, when you issue invoice, you recignize revenue and debit account receivable which was offset (deducted) by 500 $ paid prior as advance.

I hope this helps to better understand the process.

#7

I know you are trying hard to help. But if you don’t know the answer, please stop posting as it stops other people from reading and reduces my chanse of getting the answer.

I don’t know how to say the question more simply.

  1. A comapy orders some goods from a supplier.

  2. They pay some or all of the bill at the time of ordering / pre-paiying / down-payment / deposit

  3. The goods have not yet been delivered.

How is this recorded on the balance sheet of the company that is buying?

  1. Cash decreases

  2. An asset account increases, what is it called?

Yes! What is the name of this asset account?

#8

Possible that I’m getting confused by the walls of text here, however this would be my expectation:

Initially: Cash decreases, accounts receivable increases.

Upon delivery: Cash decreases, accounts receivable decreases, inventory increases.

#9

This is what I thought. But “Accounts Receivable” is for uncollected revenue.

“Prepaid Expenses” is also similar (paid for but not used), but I’m pretty sure that’s not it either.

There must be another account for goods that are paid for but not delivered.

#10

Got ya, not sure in that case. There’s probably something along the lines of “Prepaid Inventory”, but I don’t remember encountering it in the text.

#11

I have a degree in accounting, and teach accounting at a local university.

If you’ve ordered inventory but it hasn’t been delivered, you certainly wouldn’t debit Accounts Receivable; that’s an account for transactions with your customers, not your suppliers.

I’ve never seen it done, but you might have a Prepaid Inventory account in that situation. It would be odd, but conceivable. If you used such an account, you’d debit it when you pay, then credit it (and debit Inventory) when the inventory is delivered.

Personally, I’d debit Inventory when you pay and be done with it.

The rest of this stuff is just plain weird.

#12

Thanks! So you would account for it as though it had been delivered?

Yes, going off examples I read in accounting books, it seems an uncommon situation. But looking at small businesses, it seems to happen all the time:

  • inventory: give a down payment when ordering
  • fixed assets: give a deposit when ordering
  • immediate expenses (not assets), e.g. just buying printer ink off amazon.com… you pay first, and delivery is a day or two later.

All of these are between the company and their suppliers, but the only account I’ve ever seen in this regard is “Prepaid Expenses”, which I believe is for insurance, rent and services… (not physical items) …?

#13

On the seller side since all goods has not been delivered to Customer thus

all risks have not been transferred to customer, it can be used unearned (deffered) revenue

liability account not prepaid expense which is an asset account. Same situation is with selling goods

with warranty in contracted terms.

Consider often situation if good has not been delivered yet but received payments from customer. Goods are

still placed in a seller’s warehouse. Than warehouse burns with paid goods by customer inside. Risk

remained on seller’ side.

#14

Correct. Prepaid expense account has been used for paid costs related with goods such

as insurance premium paid in advance for further 1Y period, costs of transports paid to cooperates in advance etc.

#15

OK, let other people help you. I would like you to know there is always more than one solution for booking certain events in ledgers. But almost only one is correct under accounting standards.

#16

Hey guys

Chartered accountant, former auditor.

S2000 essentially gave the right answer. In practice, companies that pre-pay for goods have a “Goods In Transit” subledger account that rolls up into Inventory on the balance sheet, so the entry is a debit to GIT and a credit to Cash.

Also - Flash, your journal entires aren’t correct for when you sell inventory, you forgot COGS and Revenue. Debits and Credits have to be equal.

Cheers.

#17

Hi

I did not forget. Just tried to explain entries in a simple manner without explaining certain booking schemes to simplfy a process to non-accountants but no avail. Obviously I’m not good in explaining. I also mentioned additional analytical accounts such as “inventory in transit” but I think it is not a crucial thing here. I make jourrnal and GL entries 365 days in year.