Direct Approach:
The system automatically calculates the actual Cost of Goods Sold as a result of transactions that are processed.
When the Inventory is received, the costs of Freight, Duties, etc. are added to the value of the Inventory Items that are received. This “Landed Value” is the figure that is posted to the General Ledger. The Standard Cost can be used to record the raw cost of the merchandise. The Standard Cost does not affect the General Ledger.
Receipt:
When the Inventory is received, the accounting transaction that is completed is to Debit Inventory (for the total Landed Value) and Credit Accounts Payables.
Post A/P:
When the Invoices are received from the various Vendors, the accounting entry would be to Debit Accrued Payables and Credit Accounts Payable.
Sell Inventory:
When the Inventory is sold, the accounting transaction that is automatically generated by the system is as follows: Debit Cost of Goods Sold, Credit Inventory, Debit Accounts Receivable, Credit Sales, Sales Tax Payable, Invoice Freight, etc.
Advantages:
The Direct Approach minimizes errors since all Inventory transactions are processed through the same Accounts. All other parts of the transaction are handled automatically within the system.
Disadvantages:
The Direct Approach will not provide breakdowns of Purchases by Vendor or General Ledger Account in the General Ledger. The Purchasing System does have a complete Purchases Journal that will provide a detailed breakdown by Vendor. If all Inventory Vendor Invoices are being posted to Accrued Payables, however, there will be no way to breakdown the Purchase by General Ledger Account.
Traditional Approach:
When the Inventory is received, the Cost of Freight, Duties, etc. are added to the value of the Inventory Items that are received. This “Landed Value” is the figure that is posted to the General Ledger. The Standard Cost can be used to record the raw cost of the merchandise. The Standard Cost does not affect the General Ledger. This procedure is the same as in the Direct Approach.
The system automatically calculates the actual Cost of Goods Sold as a result of transactions that are processed.
Receipt:
When the Inventory is received, the accounting transaction that is completed is to Debit Inventory (for the total Landed Value) and Credit Accrued Payables. This procedure is also the same as in the Direct Approach.
Post A/P:
When the Invoices are received from the various Vendors, the accounting entry would be to Debit the Traditional Purchases Accounts and Credit Accounts Payable.
Sell Inventory:
When the Inventory is sold, the accounting transaction that is automatically generated by the system is as follows. Debit Cost of Goods Sold, Credit Inventory. Debit Accounts Receivable, Credit Sales, Sales Tax Payable, Invoice Freight, etc.
End of Month:
At the end of the month, Accrued Payables must be cleared out. The transaction to clear out Accrued Payables is to Debit Accrued Payables and Credit the Inventory Over and Under Account. Additionally, the actual Cost of Goods Sold Accounts need to be cleared to this Inventory Over and Under Account. The transaction to accomplish this would be to Credit each of the Cost of Goods Sold Accounts (one for each Division) and Debit the Inventory Over and Under Account. This entry will have no effect on the Profitability, but it will allow you to present a Financial Statement that looks very much like the one that you have used in the past.
Advantages:
The Traditional Approach requires additional month end adjustments, but all the information is at your fingertips and the entry is not complicated. Accrued Payables must be cleared out and you must clear out the Cost of Goods Sold Accounts. This method will give you the complete breakdown of Purchases by Vendor and by General Ledger Account Number. The resulting Financial Statement will be a traditional one. All other parts of the transaction are handled automatically within the system.
Disadvantages:
The traditional Approach will require you to provide breakdowns of Purchases by General Ledger Purchases account at the time that you receive the Vendors’ Invoices.