10.1 Merchandise Inventory, Cost Elements, FOB Terms & Title

Why inventory is Part 3 of the Certified Bookkeeper path

The American Institute of Professional Bookkeepers (AIPB) tests inventory as Part 3 of the Certified Bookkeeper (CB) credential: an untimed, open-book final in the Mastering Inventory workbook, passing grade 70%, with no extra Prometric fee. AIPB’s published workbook outline opens with merchandise inventory, then the perpetual method, then the periodic method, then cost-flow methods. This independent OpenExamPrep chapter covers merchandise cost, FOB title, perpetual entries, periodic entries, and first-in, first-out (FIFO). Weighted-average, moving-average, last-in, first-out (LIFO), and lower of cost or net realizable value (LCNRV) stay in Chapter 11. This is not an AIPB publication and does not claim official approval, review, partnership, or exact equivalence with AIPB, the CB exam, or any workbook.

Inventory is the merchandiser’s working asset. A cutoff error or a freight account parked in the wrong place misstates the balance sheet (ending inventory) and the income statement (cost of goods sold, or COGS) in opposite directions. Gross profit, current assets, and working capital all move when the bookkeeper includes the wrong truckload or omits freight-in.

Merchandise inventory is not every box in the building

Merchandise inventory is goods a company holds for sale in the ordinary course of business. A retailer or wholesaler mostly sees finished goods on shelves, in the warehouse, on a truck, or at a consignee. A manufacturer also inventories raw materials, work in process, and finished goods; CB inventory work in this chapter is the merchandiser’s merchandise account, because that is what the workbook sections named above teach first.

Compare three piles that can sit on the same receiving dock:

Consignment is a title rule, not a location rule. Goods out on consignment (your merchandise at someone else’s store) remain in your inventory until sold to an end customer. Goods in on consignment (someone else’s merchandise in your store) stay off your books. Counting consigned-in goods in the year-end physical inventory inflates assets. Omitting consigned-out goods understates assets and can overstate COGS when the count looks “short.”

If Pine & Parcel ships 20 of its own stoves to a lodge gift shop on consignment, those 20 units stay on Pine & Parcel’s inventory records at cost. If Alpine leaves 15 stoves on Pine & Parcel’s floor, Pine & Parcel records nothing in Inventory. A commission receivable appears only when Alpine’s stove sells.

What amount goes into the Inventory account?

U.S. GAAP inventory cost is the expenditure to acquire the goods and bring them to their present location and condition. For a merchandiser, the working formula is:

Merchandise cost = invoice price + freight-in and other ready-for-sale costs − purchase returns − purchase allowances − purchase discounts taken

Invoice price is the amount after trade discounts. A trade discount is a catalog reduction (for example, list $12,000 less 20% = $9,600 recorded). Trade discounts never appear in a ledger account. Cash discounts (for example, 2/10, n/30) are different: they are a reward for paying the invoice quickly, and they may be recorded under the gross method or the net method.

Freight-in (transportation-in) is a product cost when the buyer is responsible for the carrier. Freight-out (delivery expense) is a selling expense when the seller pays to ship to customers. Import duties, nonrecoverable sales tax on the purchase, and in-transit insurance the buyer pays are typically added to merchandise cost. Unloading and inspection that are necessary to get goods onto the selling floor can also be added when they are incremental and documented. Costs to ship goods to customers, sales commissions, and storage after the goods are ready for sale are not inventory.

Work Pine & Parcel’s stove lot:

The $420 freight bill is not usually discounted under 2/10 terms, because those terms sit on the merchandise invoice, not on the common-carrier invoice. Unless the problem says the freight is billed by the same vendor on the same invoice and is subject to the cash discount, compute the 2% on merchandise only.

If Pine & Parcel had forgotten freight-in, cost would be $8,820 and inventory would be understated by $420. If it had forgotten the cash discount taken, cost would be $9,420 and inventory would be overstated by $180. Those two traps show up constantly on inventory quizzes: freight-in in, cash discount taken out.

Gross method versus net method (concept)

Both methods can produce the same inventory cost when the company takes every cash discount. They differ in when the discount shows up and in what account captures a missed discount.

Under the gross method, the bookkeeper records the payable at the full invoice amount after trade discounts (here $9,600, later reduced by the $480 return and $120 allowance to $9,000 still on the books). If Pine & Parcel pays inside 10 days, it reduces the recorded cost by $180. If it misses the window, Inventory (perpetual) or Purchases (periodic) simply stays at the gross amount; there is no separate “discounts lost” account unless the firm adds one for analysis.

Under the net method, the bookkeeper records the payable at the discounted amount from day one ($9,000 × 0.98 = $8,820 on the remaining invoice after returns and allowances, plus $420 freight-in). If Pine & Parcel pays on time, Cash simply clears the payable. If it misses the 2% window, the extra $180 is Purchase Discounts Lost, an other expense (or interest-like cost of keeping the vendor’s money), not extra merchandise cost. Net method makes a missed discount visible. Gross method buries a missed discount inside a higher inventory cost.

Section 10.2 journals the same ideas on perpetual books. Section 10.3 journals them on periodic books. The conceptual split belongs here because FOB and discounts both change the dollar amount that later FIFO layers will carry.

FOB terms, title, and the December 31 truck

FOB means free on board. The word after FOB names the point where title (and, usually, the freight bill) transfers.

FOB shipping point (FOB origin): title passes when the seller delivers the goods to the carrier. The buyer owns the goods in transit, includes them in inventory at year-end even if the truck has not arrived, and records the carrier bill as freight-in. The seller records the sale at shipment.

FOB destination: title passes when the buyer receives the goods. The seller owns the goods in transit, keeps them in the seller’s inventory until delivery, and records the carrier bill as freight-out, a selling expense, never inventory. The buyer does not record a purchase until arrival.

Pine & Parcel orders stoves on December 29, FOB shipping point. The seller delivers the order to the carrier on December 30. On December 31 the truck is in Nebraska. Pine & Parcel includes those stoves in December 31 inventory and accrues or records the $420 freight-in. If the terms had been FOB destination, Pine & Parcel would omit the stoves until January receipt, and the seller would keep them in the seller’s inventory and expense the freight as freight-out.

Cutoff is a two-sided problem. If the seller uses FOB shipping point and ships on December 31, the seller records Sales and removes (perpetual) or leaves (periodic, until the count) the goods. If the buyer’s receiving log is used as the only cutoff tool, the buyer might omit in-transit FOB shipping-point goods and both companies could drop the same units. The document that governs title is the FOB term on the invoice or purchase order, not the warehouse door.

Exam traps for section 10.1

• Recording freight-out in Inventory. Freight-out is a selling expense. Only freight-in on purchases belongs in merchandise cost.
• Treating supplies as merchandise because they were delivered by the same truck.
• Including consigned-in goods in the physical count “because they are in our store.”
• Excluding consigned-out goods “because they left the building.”
• Computing the 2% cash discount on freight-in when the carrier is a separate invoice.
• Using the list price before the trade discount as the recorded purchase.
• Assuming goods in transit are always the buyer’s. Read FOB first, then decide title.