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

At the end of an accounting period, companies must determine their inventory through a physical count, which confirms records in a perpetual system or adjusts them in a periodic system. Ownership of goods during transit is crucial; under FOB shipping point, goods in transit belong to the buyer, while under FOB destination, they remain with the seller until delivery. Additionally, consigned goods, which are sold on behalf of another party, do not appear in the seller's inventory. Only the commission from sales is recorded as revenue, emphasizing the importance of understanding inventory ownership and accounting principles.

Physical Inventory Count

Alright. Now let's discuss a couple more issues with inventory at the end of an accounting period. Let's check it out. Alright. So whether you're using a perpetual system or a periodic system, all companies are going to have to determine inventory at the end of the period, right? They're going to have to know how much inventory is on hand to put it on their balance sheet and report it. So, what do they do? Well, we're going to have a physical count. They're literally going to go into the warehouse and physically count the inventory and see what's there, right, and this is the inventory count that happens at the end of the period. So they're going to count the goods, measure the goods, if they have to weigh the goods to see how much weight they have left of that good, whatever it might be.

So in the perpetual system, we're going to see that the count should confirm our inventory balance in the accounting records. Right? Because in a perpetual system, we're constantly updating inventory. We're perpetually updating it. So when we count the inventory in the warehouse, it should match up with the records, right? And we could adjust any discrepancies, right? Maybe we count and there's something missing. Well, that could be some waste, it could be shoplifting or maybe even employees stealing from you, right? And there's going to be ways to deal with all of that, but we don't really talk about it in this course. And then in a periodic system, the physical count is necessary. Remember that a periodic system, they only update the inventory account at the end of the period, right? They keep track of how much they purchased, they keep track of all sorts of things like that, but then at the end of the period, they physically count the inventory and back into the cost of goods sold. Okay? So in a periodic system, this physical count is necessary. Every time you see a problem about a periodic inventory, they have to tell you the ending inventory because of this physical count. Okay? So that's the physical count right there.

Why don't we pause right here and then we'll talk about the next issue related to the end of period inventory, alright? Let's check that out in the next.

Ownership of Goods

Alright, another issue that we come across when we're dealing with inventory at the end of the period is whether or not we own inventory that's in the warehouse or inventory that's on the way to the warehouse that's being delivered. Maybe we own some of that stuff. Alright. So let's see what could happen. We might have talked about this before already, the FOB shipping point. FOB stands for free on board and this is discussing shipping terms where you make a contract with the other person who's going to own the shipment while it's being delivered, okay? So when we have FOB shipping point, this means that the ownership of the goods, it's going to change hands at the shipping point. Okay? So look what we’ve got here. We've got the supplier and then the supplier is going to give the delivery or the ownership is going to change hands right here, right? It's going to change hands here because that’s the shipping point, right? Here is the shipping point, right? FOB shipping point. So what does that mean? That if we have a purchase in transit, well, it belongs to the company. That means that if we purchase something and on the day the last day of the year, it's still on the way to the warehouse, well, in this situation, we own these goods and they should be included in our inventory, okay? So if there were any purchases we made that were FOB shipping point and they're still in transit, well they belong to us and we include those in inventory, okay?

So let's look at the opposite, an FOB destination right down here, okay? So still free on board FOB, this is where the ownership of the goods, well, this time it changes hands at the destination, right? So now, it's going to change who owns it after it's been delivered, that’s when it gets changed hands. So let's see in this situation, we're going to have a situation where we were going from our warehouse and then we put it on the shipping truck and then it gets to a customer, okay? So notice in the first situation that was when we were purchasing something. This is a situation where we're selling, so notice how this sale is going to still belong to us, right? Because in an FOB destination, well this is the destination, right? The destination is the customer in this case, right? So we own it during shipment, right? When we sell something FOB destination, we own it during shipment. So any FOB destination sales in transit belong to the company, right? So on the last day of the year, if we had sold something, but it hasn't gotten to the customer yet and the terms were FOB destination, well, we have to include that in our inventory still. We haven’t transferred it to the customer and we can't even take the revenue yet because it still belongs to us, okay? So that’s the deal with FOB shipping point and FOB destination. Obviously, in this first situation, if we were purchasing something, right? Where we have the supplier, shipping company and our warehouse up here and if we were purchasing it FOB destination, well, in that case, right? What would happen here if this was FOB destination, it would still belong to the supplier and we wouldn't include it in our inventory. So the main trick is to think about do you own it during transit, right? Whether it's a purchase or a sale, just try and focus on is it ours based on this kind of flow with the delivery, alright?

So there we go. Let's move on to one more topic related to ownership of goods, alright? Let's do that now.

Consignment

Alright, so the last topic here is consigned goods. This could be goods that are in our warehouse or in our store, but they don't belong to us, okay? So consigned goods, this is when you're selling goods for someone else, but they own them. This happens a lot in boutique shops or something similar from the supplier. They just put them in their store and once they sell, well that's when they give money to the person who made the dress and they keep their cut, their commission of the sale, but if the dress doesn't sell, it still belongs to the supplier, to the person who made the dress, okay? So that's a consigned good. You do not own consigned goods, so they are not part of your inventory, okay? You never put them into your inventory. The only time that matters is when you actually make the sale and you get some revenue, okay? So that's usually what happens. You're going to get some sort of commission when you sell the goods and that's going to be revenue, but there's never an inventory transaction here. Okay?

So let's see what a journal entry might look like here. Jan's boutique sells Sophie's dresses on consignment. Sophie pays Jan $100 for each dress sold. So that's the commission there, right? $100 for each dress sold. At the beginning of the month, Jan's store displayed 5 of Sophie's dresses with a cost of $250 each. Jan sold 2 dresses. So she sold 2 dresses during the month for $1,000 each, right? Record Jan's journal entries related to the consigned goods. So remember, these are consigned goods, so they're not going to be in her inventory. She would never have made an entry to include in her inventory these 5 dresses. She would have never debited inventory for this, okay? What entry she does make is when she finally makes a sale.

When she sells the goods, she's going to make an entry for the revenue and the cash received, okay? So let's see what happened here. She sold 2 dresses during the month for $1,000 each, right? So 2 dresses times the $1,000 well, that's $2,000 right? That's the amount of cash that she received from the customers, right? She received $2,000 in cash, but she doesn't own all that cash, right? That's not all her cash. Most of that cash belongs to Sophie in this case, right? Because those are her dresses. So what does belong to Jan is her commission, right? She earned a commission in this case and what was her commission? She gets a $100 for each dress sold, so she sold 2 dresses and she gets a $100 commission on each dress, so $200 of it was her revenue, right? That was what she earned from selling these dresses, but she received $2,000 right? So the trick is that although she received $2,000, a lot of that money she has to pay to Sophie, okay? So a lot of that money is going to go to Sophie. So this is how the journal entry would look.

Yes, she received cash, right? She did receive cash of $2,000 when she sold these dresses, so we're going to debit cash for $2,000 because she's holding $2,000 worth of cash, but what we have to do is we're going to credit our revenue, right, Because we did earn some revenue, so we're going to earn revenue of $200 from those sales, but now we have to take a liability, right? Because we owe the rest of that money we collected, we owe that to Sophie. So we could have some sort of payable to Sophie, right? It could be like an account payable or something like that. We'll say payable to Sophie just so we're super clear here in our example and that would be a liability, right? Because we're eventually, we collected this money, but we have to give it to Sophie. The only part that's ours is the $200.

So in this case, what is Jan's inventory balance in this question down below in the little boxes? Well, her inventory is 0, right? This is not her inventory. Sophie would have this inventory on her books. Jan would not have any of this inventory on her books. Her revenue is the $200 from the commission, right? And she's going to have liabilities of $1800 and that's the money that she has to give to Sophie. Cool? Alright. So that's about it for consigned goods. It's not so tricky, you just have to remember that you don't own the goods, all you get is your commission. Alright? Let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What is the difference between a perpetual and periodic inventory system?

A perpetual inventory system continuously updates inventory records for each purchase and sale, providing real-time inventory levels. This system helps in maintaining accurate inventory records and detecting discrepancies like theft or waste. In contrast, a periodic inventory system updates inventory records only at the end of an accounting period. Companies using this system perform a physical inventory count to determine the ending inventory and calculate the cost of goods sold. While perpetual systems offer more timely information, periodic systems are simpler and less costly to implement.

How do FOB shipping point and FOB destination affect inventory ownership?

FOB (Free on Board) shipping point and FOB destination are terms that determine when ownership of goods transfers during transit. Under FOB shipping point, ownership transfers to the buyer once the goods leave the seller's shipping dock. Therefore, goods in transit are included in the buyer's inventory. Conversely, under FOB destination, ownership transfers to the buyer only when the goods reach their destination. Thus, goods in transit remain in the seller's inventory until delivery. Understanding these terms is crucial for accurate inventory and financial reporting.

What are consigned goods, and how are they accounted for?

Consigned goods are items that a company sells on behalf of another party but does not own. These goods are not included in the seller's inventory. Instead, the seller records a liability for the proceeds owed to the consignor (the owner of the goods) and recognizes revenue only for the commission earned from the sale. For example, if a boutique sells dresses on consignment, it records the cash received, the commission as revenue, and the amount owed to the consignor as a liability. The dresses remain in the consignor's inventory until sold.

Why is a physical inventory count necessary in a periodic inventory system?

A physical inventory count is essential in a periodic inventory system because it provides the actual quantity of inventory on hand at the end of an accounting period. This count is used to determine the ending inventory balance, which is crucial for calculating the cost of goods sold (COGS). Since periodic systems do not continuously update inventory records, the physical count ensures that the financial statements reflect accurate inventory levels and COGS, helping in proper financial reporting and decision-making.

How do companies handle discrepancies found during a physical inventory count?

When discrepancies are found during a physical inventory count, companies must investigate the causes, which could include theft, waste, or recording errors. In a perpetual inventory system, the count should match the records, and any differences are adjusted in the accounting records. For example, if inventory is missing, the company may record an expense for inventory shrinkage. In a periodic system, the physical count directly determines the ending inventory, and discrepancies are inherently adjusted when calculating the cost of goods sold. Proper internal controls and regular counts help minimize discrepancies.