inventory & cost of goods sold

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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Inventory & Cost of Goods SoldChapter 6


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Show how to account for inventory


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Merchandise Inventory

Balance Sheet (partial)

Current assets:

Cash $XXX

Accounts receivable XXX

Inventory (1 chair @ cost of $300)

$300

Income Statement (partial)

Sales (2 chairs @ $500 selling price) $1,000

Cost of goods sold (2 chairs @ $300 cost)

600

Gross profit $400


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The cost of inventory on

hand = Inventory

The cost of inventory on

hand = Inventory

The cost of inventory

that’s been sold =

Cost of Goods Sold

The cost of inventory

that’s been sold =

Cost of Goods Sold

Asset on the Balance SheetAsset on the

Balance Sheet

Expense on the Income

Statement

Expense on the Income

Statement


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Sales Price vs. Cost of Inventory•Sales revenue based on sales price of

inventory sold•Cost of goods sold based on cost of

inventory sold•Inventory based on cost of inventory on

hand•Gross profit, also called gross margin

▫Sales revenue minus cost of goods sold


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Number of Units of Inventory

•Determined from accounting records•Evidenced by physical count at year-end•Consigned goods:

▫Does not include those held for another company

▫Does include those out on consignment•In transit goods

▫Depends on shipping terms


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FOB Shipping Point FOB Destination

• Legal title passes to purchaser when items leave seller’s place of business

• Purchaser owns good while in transit▫ Included in purchaser’s

inventory count

• Purchaser pays transportation costs

• Legal title passes to purchaser when items arrive at purchaser’s receiving dock

• Seller owns goods while in transit▫ Included in seller’s

inventory count

• Seller pays transportation costs

Shipping terms


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Inventory Accounting Systems

Perpetual Inventory System

Periodic Inventory System

Used for all types of goods

Used for inexpensive goods

Keeps a running total of all goods bought, sold, and on hand

Does not keep a running total of all goods bought, sold, and on hand

Inventory counted at least once a year

Inventory counted at least once a year


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Perpetual Inventory

•Bar codes on products provide information to record▫Sale of item▫Update of inventory record

•Two entries needed for each sale▫Record revenue and asset received (cash or

receivables)▫Record cost of sale and reduction of

inventory


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Recording Inventory (Amounts Assumed)

JOURNAL

Date

Accounts and explanation Debit Credit

Inventory 560,000

Accounts payable 560,000

Purchased inventory on account

Accounts receivable 900,000

Sales 900,000

Sold inventory on account

Cost of goods sold 540,000

Inventory 540,000

Recorded cost of goods sold


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Recording Inventory (Amounts Assumed)

Inventory

Cost of Goods Sold

100,000Beginning balance

Purchases 560,000 Cost of goods sold 540,000


Ending balance 120,000


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Reporting in the Financial Statements

Balance Sheet (partial)

Current assets:

Cash $ XXX

Accounts receivable XXX

Inventory 120,000

Prepaid expenses XXX

Income Statement (partial)

Sales $900,000


Gross profit $360,000


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Cost of Net Purchases

Purchase price of the inventory

$600,000

+ Freight-in 4,000

− Purchase returns (25,000)

− Purchase allowances (5,000)

− Purchase discounts (14,000)

= Net purchases of inventory $ 560,000


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Net Sales

Sales revenue− Sales returns and

allowances− Sales discounts= Net sales


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Apply and compare various inventory cost methods


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Inventory Costing Methods


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Specific Unit Cost

•Used for businesses with unique inventory items▫Automobiles, antique furniture, jewels, and

real estate•Businesses cost their inventories at the

specific cost of the particular unit•Too expensive for inventories with

common characteristics


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Average Cost

Average cost per

unit

Cost of goods available *

Number of units available*

*Goods available = Beginning inventory + Purchases

Cost of goods sold

Number of units sold

Average cost per

unit

Average cost per

unit

Ending inventory

Number of units on

hand

Average cost per

unit

Average cost per

unit


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First-in, First-out (FIFO)

•Oldest items assumed to be sold first•Ending inventory consists of most recent

purchase costs


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Last-in, First-out (LIFO)

•Most recent items purchased are assumed to be sold first

•Oldest costs in ending inventory


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Problem 6-60A

Date Units Cost per unit

Total cost

Beg. inventory

75 tents $16 $1,200

March 3 95 tents 18 1,710

March 17 165 tents 20 3,300

March 23 36 tents 21 756


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Problem 6-60A Average Cost

Average cost per

unit

Cost of goods available *

Number of units available*

*Goods available = Beginning inventory + Purchases

$1,200 + $1,710 +$3,300 + $756

$1,200 + $1,710 +$3,300 + $756

75 +95 +165 + 3675 +95 +165 + 36

$6,966$6,966

371 units371 units

$18.78(rounded)$18.78

(rounded)


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Cost of goods sold

Number of units sold

Average cost per

unit

Average cost per

unit

Ending inventory

Number of units on

hand

Average cost per

unit

Average cost per

unit

318 tents318 tents $18.78(rounded)$18.78

(rounded)$5,972$5,972

53 tents53 tents$18.78

(rounded)$18.78

(rounded)$995$995

Problem 6-60A Average Cost


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Problem 6-60A FIFO

Cost of goods sold

75 tents $16 $1,200

95 tents 18 1,710

148 tents

20 2,960

318 tents

$5,870

Ending inventory

36 tents $21 $756

17 tents 20 340

53 tents $1,096

Oldest items sold first

Oldest items sold first

Newest items on hand

Newest items on hand


Total cost

Beg. inventory 75 tents

$16 $1,200

March 3 95 tents

18 1,710

March 17 165 tents

20 3,300

March 23 36 tents

21 756


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Cost of goods sold

36 $21 $756

165 20 3,300

95 18 1,710

22 16 352

318 tents

$6,118

Ending inventory

53 tents $16 $848

Problem 6-60A LIFO

Newest items sold first

Newest items sold first

Oldest items on hand

Oldest items on hand


Total cost

Beg. inventory 75 tents

$16 $1,200

March 3 95 tents

18 1,710

March 17 165 tents

20 3,300

March 23 36 tents

21 756


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Impact of Inventory Methods on Financial Statements

Increasing inventory prices

Cost of goods sold

Ending inventory

FIFO Lowest because based on older costs, which are less expensive

Highest because based on more recent and expensive costs

LIFO Highest because based on more recent costs, which are more expensive

Lowest because based on older costs, which are less expensive


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Impact of Inventory Methods on Financial Statements

Decreasing inventory prices

Cost of goods sold

Ending inventory

FIFO Highest because based on older costs, which are more expensive

Lowest because based on more recent, less expensive costs

LIFO Lowest because based on more recent costs which are less expensive

Highest because based on older, more expensive costs


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Tax Advantage of LIFOIn periods of increasing

prices

In periods of increasing

prices


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Cost of Goods Sold Ending Inventory

•LIFO provides a better matching of expense to revenue▫More recent costs

included in Cost of Goods Sold

•FIFO provides a more up-to-date inventory cost ▫More recent costs

on the Balance Sheet

Comparison of Inventory Methods


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LIFO Issues

•Allows manipulation of net income▫When inventory prices are rising, large

quantities purchased at end of year to lower taxes

•Liquidation can occur▫Quantities decrease from last year,

companies must “dip into” older inventory layers

•Not allowed under International Financial Reporting Standards (IFRS)


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Explain and apply underlying GAAP for inventory


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Principles Related to Inventories


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Disclosure Principle

•Financial statement should disclose enough information for users to make informed decisions▫Information should be relevant and

representationally faithful•Examples:

▫Accounting methods used▫Substance of material transactions


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Lower-of-Cost-or-Market Rule

•Inventory is reported at the lower of:▫Cost or▫Market

Usually replacement cost•If market is lower, inventory is written

down JOURNAL

Date

Accounts and explanation Debit Credit

Cost of Goods Sold

Inventory

Wrote inventory down to market value


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Compute and evaluate gross profit (margin) and inventory turnover


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Gross Profit Percentage

Gross profitGross profit

Net sales revenueNet sales revenue


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Inventory Turnover

Cost of Goods Sold

Cost of Goods Sold

Average InventoryAverage

Inventory

(Beginning Inventory + Ending Inventory)/2


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Use the COGS model to make management decisions


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Use the COGS Model to Make Management Decisions

Cost of Goods Sold:Beginning Inventory

+ Purchases

=

Cost of goods available for sale

− Ending Inventory

= Cost of goods sold


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Computing Budgeted Purchases


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Rearranging the Cost of Goods Sold Model

Cost of goods sold (based on plan for next period)

+ Ending inventory (based on plan for next period)

= Goods available as planned

− Beginning inventory (actual amount)

= Purchases (amount manager should buy)


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Estimating Inventory by the Gross Profit Method

Beginning inventory $XXX

Purchases XXX

Goods available for sale XXX

Estimated cost of goods sold:

Net sales revenue $XXX

Less estimated gross profit (XXX)

Estimated cost of goods sold XXX

Estimated cost of ending inventory lost

$XXX


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Exercise 6-26A

Beginning inventory $45,300

Purchases 33,300

Goods available for sale 78,600

Estimated cost of goods sold:

Net sales revenue $61,600

Less estimated gross profit

Estimated cost of goods sold

Estimated cost of ending inventory cost

45% × $61,600

$27,720 33,88

0$44,720


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Analyze effects of inventory errors


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Effects of Inventory Errors

Period 1 Period 2

Inventory Error

Cost of Goods Sold

Gross Profit

and Net Income

Cost of Goods Sold

Gross Profit

and Net Income

Period 1

Ending inventory overstated

Understated

Overstated Overstated Understated

Period 1

Ending inventory understated

Overstated Understated

Understated

Overstated


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4848

inventory & cost of goods sold

Business

prentice hall

pearson education

recorded cost of goods

cost of goodsasset

cost of goodssoldsoldasset

beginning inventory

purchased inventory

reduction of inventory