The company used the average cost formula to determine that the cost of merchandise inventory at december 31 was $65,000. on December 31, it would have cost $80,000 to replace the merchandise inventory, so the following entry was made
Dr. Merchandise inventory 15000
Cr. Cost of Goods Sold 15000
To understand why this entry was made, you need to have a basic understanding of the average cost method for valuing merchandise inventory.
The average cost method calculates the cost of goods sold (COGS) and the ending inventory by taking the weighted average of the costs of all similar items available for sale during the accounting period.
In this case, the company used the average cost formula to determine that the cost of the merchandise inventory as of December 31 was $65,000. This means that the weighted average cost of all the goods available for sale up to that point was $65,000.
However, the replacement cost of the merchandise inventory was determined to be $80,000 on December 31. This means that if the company had to purchase the same items on that day, it would have cost them $80,000.
To adjust for the difference between the calculated average cost and the replacement cost, the following entry was made:
Dr. Merchandise Inventory (increase) - $15,000
Cr. Cost of Goods Sold (decrease) - $15,000
This entry reduces the merchandise inventory by $15,000 and increases the cost of goods sold by the same amount. This adjustment reflects the higher replacement cost of the goods compared to their average cost.
It is important to note that this adjustment is typically made at the end of the accounting period to ensure that the inventory is stated at its most current and relevant cost. This adjustment allows the financial statements to reflect the economic reality of the business's inventory valuation.