This is a simulation from Becker. I can't understand subdivision 2 in it. This deals with freight out and safety stock. I can understand that freight out has been capitalized as product cost whereas it should have been expensed. But I can't understand the safety stock part. What is the journal entry behind maintaining a safety stock.

Only the amount capitalised -safety stock(50%) has been recorded as correction.

any explanations?

Per my understanding, There is no JE for safety stock. Safety stock is just a level of stock to be maintained in the physical inventory records. It is a buffer against unexpected increases in demand, uncertainty about lead time, and unavailability of stock from suppliers. So, a level of safety stock is calculated and stock is ordered well in time accordingly.

Now, if we look at the question, let's take the first year - 2001. Freight-out was $50,000. It should have been expensed as a selling expense in the same year itself. However, we capitalized it to Inventory just like the purchases.

DR Inventory 50,000

Cr Cash  50,000

We are following FIFO here and safety stock, i.e., buffer stock is maintained at 50% of the current year purchases. Since freight-out was capitalized just like a purchase, we first capitalized $50,000 and at the end of the year, expensed 50% of it as COGS.

DR COGS

CR Inventory

Thus, now we would correct remaining 50% freight-out in the inventory for 2001:-

DR Freight -out 50,000

CR Inventory 25,000

In 2002 again, we are posting the similar JE as above for $75,000. However, $25,000 which was to be expensed in 2001 as freight-out was expensed as COGS in 2002 which we now reverse. Thus, net effect only $50,000.

Hope that clears your doubt !

agarcia255 wrote: Can you post the entire problem? Thanks.

It's in Becker Simulations and Final exam software as "Financial 2 - Revenue and Expense Recognition"

That's a great explanation. Got it now.Thanks!