Solution 3.4

Identify the four accounts that record inventory transactions and explain why the asset of inventory is accounted for through these accounts

For businesses buying and selling products the selling price is normally set at a price above the cost price – otherwise the business would not make a profit. Inventory is bought at one price, the purchase price, and sold at another price (normally higher), the selling price. It makes no sense to have one account for inventory as goods are purchased and sold at different prices. Thus the actual inventory account is divided into four separate accounts as follows.

• Sales account - Detailing all inventory sold at selling price

• Sales returns account - detailing all inventory returned at selling price Inventory

• Purchases account - detailing all inventory purchased at cost price.

• Purchases returns account - detailing all inventory returned at cost price

These four accounts record all inventory going into the business (either through purchases or sales returns) and going out of the business (either through sales or purchases returns).