merchandise inventory chapter 6 copyright ©2014 pearson education, inc. publishing as prentice...
TRANSCRIPT
Merchandise Inventory
Chapter 6
Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall 6-1
Learning Objectives
1. Identify accounting principles and controls related to merchandise inventory
2. Account for merchandise inventory costs under a perpetual inventory system
3. Compare the effects on the financial statements when using the different inventory costing methods
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Learning Objectives
4. Apply the lower-of-cost-or-market rule to merchandise inventory
5. Measure the effects of merchandise inventory errors on the financial statements
6. Use inventory turnover and days’ sales in inventory to evaluate business performance
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Learning Objectives
7. Account for merchandise inventory costs under a periodic inventory system (Appendix 6A)
8. Estimate the cost of ending merchandise inventory using the gross profit method and the retail method (Appendix 6B)
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Learning Objective 1
Identify accounting principles and
controls related to merchandise
inventory
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Consistency Principle
• Businesses should use the same accounting methods and procedures from period to period.
• Consistency helps users of financial statement information to compare financial statements from one period to the next.
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A change in the accounting
methods, must be reported to the investors and
creditors in the Notes to the
Financial Statements.
Disclosure Principle
A company should report enough information to allow users to make knowledgeable decisions about the company. Information should be relevant and have
faithful representation.
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Source: Green Mountain Coffee Roasters, Inc., 2011 Financial Statements, Note 1.
Materiality Concept
• A company must follow strictly proper accounting only for significant items.
• Information is significant when it would cause someone to change a decision.
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Many large companies report their financial numbers in millions. Cash on the balance
sheet of $7,500 might be $7,500,000,000 because the last six zeroes have been left off. Anything
below $1,000,000 is considered to be immaterial.
Conservatism
• A company should report the least favorable figures in the financial statements when two or more possible options are presented.
• Goal: Never overstate assets or net income.
• Anticipate no gains• Provide for probable
losses• Conservatively report
assets and liabilities• When in doubt record an
expense instead of an asset
• Choose options that undervalue the business
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Learning Objective 2
Account for merchandise
inventory costs under a perpetual inventory
system
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Recording Merchandise Inventory
• At the end of the period, count the units in ending inventory and assign dollars to the account.
• At the end of the period, determine the units sold during the period and assign dollars to Cost of Goods Sold.
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• Each unit originally cost $350• Ending Inventory = 3 units * $350 per unit = $1,050• COGS = 14 units * $350 per unit = $4,900
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When the costs are different for different groups of inventory, it is more difficult to decide which
dollars to assign to the ending inventory.
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Inventory Costing Methods
There are four basic GAAP-acceptable
approaches to assigning cost to inventory
1. Specific Identification
2. First-in, first-out (FIFO)
3. Last-in, last-out (LIFO)
4. Weighted-Average
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4
Perpetual Specific Identification
• Used when the specific cost for each unit of inventory can be tracked.
• As each unit is sold, its specific cost is transferred from inventory to Cost of Goods Sold.
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Used for inventories that
include:AutomobilesUnique Artwork
JewelsReal Estate
Perpetual Inventory RecordSpecific Identification
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Perpetual FIFO
• As inventory is sold, the cost of the oldest item in inventory is assigned to each unit as it is sold.
• Ending inventory closely reflects current replacement cost.
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Compared to LIFO, FIFO will result in lower
COGS and higher Net Income when
costs are constantly increasing.
Perpetual Inventory RecordFIFO
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Perpetual LIFO
• As inventory is sold, the cost of the newest item in inventory is assigned to each unit as it is sold.
• Cost of Goods Sold closely reflects current replacement cost.
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Compared to FIFO, LIFO will result in higher
COGS and lower Net Income when
costs are constantly increasing.
Perpetual Inventory RecordLIFO
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Perpetual Weighted-Average
• After each purchase, the average cost of the inventory on hand is computed.
• Sold inventory is costed using the average cost at the time of the sale.
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Average cost BEFORE the
sale and AFTER the sale should be the
same.
Perpetual Weighted-Average
Average cost is computed as:
Dollars in Inventory
÷ Units on Hand
= Average Cost per Unit
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On August 20, a company has $27,900
in inventory and 12,400 units. The Average Cost =
$27,900 ÷ 12,400 =
$2.25 per unit
Perpetual Inventory RecordWeighted-Average
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Learning Objective 3
Compare the effects on the financial
statements when using the different inventory costing
methods
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Note that FIFO results in the highest Gross Profit, while LIFO shows the highest Cost of
Goods Sold.Copyright ©2014 Pearson Education, Inc. publishing as Prentice Hall 6-25
Learning Objective 4
Apply the lower-of-cost-or-market rule to
merchandise inventory
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Lower-of-Cost-or-Market
The LCM rule requires that
inventory should be reported in the
financial statements at the
lower of the inventory’s original cost or its market
value.
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Big Inc. is holding inventory that cost $2
million. However, due to technological
developments, the market value of that inventory is
only $1.2 million.
The inventory should be written down to $1.2
million.
Adjusting Inventory for Lower-of-Cost-or-Market
Smart Touch Learning paid $3,000 for its TAB0503 inventory. By December 31, it can
be replaced for only $2,200.
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Date Accounts and Explanation Debit Credit
Dec. 31 Cost of Goods Sold 800 Merchandise Inventory 800 To write merchandise inventorydown to market value.
Learning Objective 5
Measure the effects of merchandise
inventory errors on the financial statements
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Effect of Inventory Errors
• An error in inventory can lead to errors in other accounts.
• Because the ending inventory number is used in other computations, when ending inventory is incorrect, other numbers will also be incorrect.
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Smart Touch Learning reported
$5,000 more ending inventory than it
actually had.
How does this error impact other
numbers?
Effect of Inventory Errors
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Ending InventoryOverstated $5,000
Sales revenue CorrectCost of Good Sold:
Beginning Inventory CorrectNet Purchases CorrectCost of Goods Available for Sale CorrectEnding Inventory ERROR: Overstated $5,000Cost of Goods Sold Understated $5,000
Gross Profit Overstated $5,000Operating Expenses CorrectNet Income Overstated $5,000
Effect of Inventory Errors
• A common fraud is for a company to intentionally overstate ending inventory, because it leads to higher Net Income.
• Sometimes ending inventory is understated.
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Suppose that Smart Touch Learning
understated inventory by $1,200.
How does this error impact other
numbers?
Effect of Inventory Errors
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Ending InventoryUnderstated $1,200
Sales revenue CorrectCost of Good Sold:
Beginning Inventory CorrectNet Purchases CorrectCost of Goods Available for Sale CorrectEnding Inventory ERROR: Understated $1,200Cost of Goods Sold Overstated $1,200
Gross Profit Understated $1,200Operating Expenses CorrectNet Income Understated $1,200
Learning Objective 6
Use inventory turnover and days’
sales in inventory to evaluate business
performance
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Inventory Turnover
• Measures how rapidly inventory is sold.• Inventory turnover should be evaluated
against industry averages.– A high turnover rate indicates ease of selling.– A low turnover rate indicates difficulty of
selling.
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Days’ Sales in Inventory
• Measures average number of days inventory is held by the company.
• Different types of inventory will move faster.
• For inventory with an expiration date, this measure is very important.
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Learning Objective 7
Account for merchandise
inventory costs under a periodic inventory
system (Appendix 6A)
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Periodic Inventory Accounting
• Inventory is not tracked in the accounting system continuously.
• Beginning inventory balance is carried until the end of the period.
• Purchases are accumulated during the period.• Ending inventory balance replaces the beginning
inventory balance.
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Beginning Inventory + Net Purchase
=Cost of Goods Available for Sale
- Ending Inventory = Cost of Goods Sold
Inventory Costing Methods
Let’s look at three approaches to assigning
cost to inventory in a periodic system.
1. First-in, first-out (FIFO)
2. Last-in, last-out (LIFO)
3. Weighted-Average
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3
Using the information below, let’s see how we would apply a periodic system to
determine Cost of Goods Sold.
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Periodic Inventory—FIFO
• Ending Inventory will be costed out using the NEWEST items in inventory.
• Cost of Goods Sold will include the OLDEST costs.
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Periodic Inventory—LIFO
• Ending Inventory will be costed out using the OLDEST items in inventory.
• Cost of Goods Sold will include the NEWEST costs.
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Periodic Inventory—Weighted Average
• Ending Inventory is costed using the AVERAGE cost of inventory.
• Cost of Goods Sold will also be costed using AVERAGE cost of inventory.
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Learning Objective 8
Estimate the cost of ending merchandise inventory using the gross profit method
and the retail method (Appendix 6B)
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Gross Profit Method
• If the ending inventory cannot be counted, it can be estimated.
• Cost of Goods Sold can be estimated using Sales Revenue and the Gross Profit percent.
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Beginning Inventory + Net Purchases
=Cost of Goods Available for Sale
- Cost of Goods Sold = Ending Inventory
Gross Profit Method
• Suppose Smart Touch Learning’s ending inventory was destroyed.
• Assume:1. Beginning
Inventory was $14,000.
2. Purchases for the period were $66,000.
3. Sales for the period were $100,000 and the gross profit percent = 40%.
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Beginning Inventory + Net Purchase
=Cost of Goods Available for Sale
- Cost of Goods Sold = Ending Inventory
Gross Profit Method
• To estimate Cost of Goods Sold, subtract the normal gross profit from sales.
• $100,000 – $40,000 = $60,000• This will allow you to estimate Ending
Inventory.
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Beg. Inven. $14,000 + Purchases $66,000 = Cost of Goods Avail. - Cost of Goods Sold = Ending Inventory
Gross Profit Method
• To estimate Cost of Goods Sold, subtract the normal gross profit from sales.
• $100,000 – $40,000 = $60,000• This will allow you to estimate Ending
Inventory.
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Beg. Inv. $14,000 + Purchases $66,000 = COGA $80,000 - COGS $60,000 = End. Inv. $20,000
Retail Method
• If the ending inventory cannot be counted, it can be estimated.
• Ending Inventoryis estimated usingthe ratio of Goods Available for Sale at Cost to Goods Available for Sale at Retail.
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Goods Available for Sale at Cost
÷ Goods Available for Sale at Retail
= Cost to Retail Ratio
Retail Method
• Business X has Sales Revenue for the period of $40,000.
• In addition, they have the following information available for inventory:
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Cost RetailBeginning Inventory 20,000$ 34,000$ Plus: Net Purchases 80,000 136,000 Goods Available for Sale 100,000$ 170,000$
Cost to Retail Ratio 59%
Retail Method
Using the Cost to Retail Ratio, we can “back into” the ending inventory.
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Cost RetailBeginning Inventory 20,000$ 34,000$ Plus: Net Purchases 80,000 136,000 Goods Available for Sale 100,000$ 170,000$ Net Sales Revenue (40,000)$ Ending Inventory @ Retail 130,000$ Estimated Ending Inventory @ Cost = $130,000 * 59% 76,700$