Chapter 6

Report
Ch.5
Accounting for Inventories
and Cost of Goods Sold
Prof. J. Wang
Chapter 5, Slide #1
Part I
Introduction
Chapter 5, Slide #2
• 1. merchandise inventory
• 2. I/S of a merchandise company
• 3. how companies keep track of their
inventory: perpetual v. periodic systems
• 4. purchase of inventory on account
• 5. shipping cost
Chapter 5, Slide #3
1.1 Inventory of Wholesalers and
Retailers
 Purchased in finished form
 Resold without transformation
 Classified as “Merchandise Inventory”
on balance sheet
Chapter 5, Slide #4
LO1
1.2 Condensed Income Statement for
a Merchandiser
Net sales
Cost of goods sold
Gross profit
Selling and administrative expenses
Net income before tax
Income tax expense
Net income
Chapter 5, Slide #5
$100,000
60,000
$ 40,000
29,300
$ 10,700
4,280
$ 6,420
1.3 how companies keep track of
their inventory
• Perpetual inventory system
• Periodic inventory system
Chapter 5, Slide #6
Perpetual Inventory Systems
Inventory records are
updated after each
purchase or sale
 Point-of-sale terminals have improved the ability
of mass merchandisers to maintain perpetual
systems
 Company knows the cost of sales and ending
inventory figure from their books
Chapter 5, Slide #7
Periodic Inventory Systems
Inventory records are
updated periodically
based on physical
inventory counts
 Reduces record keeping but also decreases the
ability to track theft, breakage, etc., and prepare
interim financial statements
Chapter 5, Slide #8
The Cost of Goods Sold Model
Beginning inventory
+ Cost of goods purchased
= Cost of goods available for sale
– Ending inventory
= Cost of goods sold
“Pool” of goods
available to sell
during the period
Chapter 5, Slide #9
$ 15,000
63,000
78,000
(18,000)
$ 60,000
An increase in ending
inventory means more
was bought than sold
1.4 Purchase of inventory on account
• Cash discount
Chapter 5, Slide #10
Credit Terms and Sales Discounts
n/30
Payment due 30 days from invoice date
1/10, n/30
Deduct 1% of invoice amount if
paid within 10 days; otherwise full
invoice amount is due in 30 days
2/10, n/30
Deduct 2% of invoice amount if
paid within 10 days; otherwise full
invoice amount is due in 30 days
Chapter 5, Slide #11
• On July 16, the company purchased
merchandise inventory on account for $500.
Term: 1/10, n/30.
Dr. Purchases
Cr. A/P
Chapter 5, Slide #12
500
500
Recording Purchase Discounts
On July 25, the company paid for the purchase, less
discount.
Accounts Payable
500
Cash
495
Purchase Discounts
5
To record payment within discount period to
supplier who offers 1% purchase discount.
($ 500 × 1% = $5 discount)
Chapter 5, Slide #13
Cost of Goods Purchased
 Includes invoice price:
Less:
Purchase returns and
allowances
Purchase discounts
Plus:
Transportation-in
Chapter 5, Slide #14
Inventory Costs Included
 Any freight costs incurred by buyer
 Cost of insurance for inventory in transit
 Cost of storing inventory before selling
 Excise and sales taxes
Chapter 5, Slide #15
1.5 Shipping cost:
FOB Destination Point
Seller
Buyer
Title
passes at
destination
 No sale or purchase until inventory reaches its destination
 Seller responsible for inventory while in transit
Chapter 5, Slide #16
1.5 Shipping cost:
FOB Shipping Point
Seller
Buyer
Title
passes when
shipped
 Both sale and purchase recorded upon shipment
 Buyer responsible for inventory while in transit
Chapter 5, Slide #17
Analysis of Profitability
Of
particular
interest
to current and
potential
investors
Gross
Profit %
Chapter 5, Slide #18
LO4
Daisy’s Profitability
Net sales
Cost of goods sold
Gross profit
Gross profit ratio
Gross Profit Ratio =
$100,000
60,000
$ 40,000
=
40%
Gross Profit
Net Sales
(How many cents on every $ of sales are left
over after covering the cost of the product)
Chapter 5, Slide #19
Part II
Inventory Costing Method
How to determine the cost of inventory left on hand
and cost of inventory sold in a period of inflation
Chapter 5, Slide #20
Inventory Valuation and Income
Measurement
Value
assigned to
inventory
on balance
sheet
Chapter 5, Slide #21
When Sold =
Value
expensed
as cost of
goods sold
on income
statement
LO5
Detailed Costing Method Example
What’re the cost of goods sold and ending inventory?
Beginning inventory, Jan. 1: 500 units (unit cost $10)
Inventory purchases:
Date
Units
1/20
300
4/8
400
9/5
200
12/12
100
Total purchases
1,000 units
Ending inventory, Dec. 31: 600 units
Unit Cost
$ 11
12
13
14
Inventory Costing Methods
(in a period of inflation)
Four costing methods available:
Specific
Identification
Weighted
Average
First-in, First-out
(FIFO)
Last-in, First-out
(LIFO)
Chapter 5, Slide #23
LO6
Specific Identification Method
Step 1:
Chapter 5, Slide #24
Identify the specific units in
inventory at the end of the year
and their costs.
Specific Identification Method
Units in ending inventory:
Date purchased
Units Cost Total Cost
1/20
100
$11
$1,100
4/8
300
12
3,600
9/5
200
13
2,600
Ending inventory
600
$7,300
Units × Cost = Total cost
Chapter 5, Slide #25
Specific Identification Method
Step 2:
cost of goods sold = cost of goods available
for sale – ending inventory
= 17,100 – 7,300 = 9,800
* Few companies use this method
Chapter 5, Slide #26
Weighted Average Method
Step 1:
Chapter 5, Slide #27
Calculate the cost of goods
available for sale.
Weighted Average Method
Date purchased
Units Cost Total cost
Beg. inventory
500
$10
$ 5,000
1/20
300
11
3,300
4/8
400
12
4,800
9/5
200
13
2,600
12/12
100
14
1,400
Cost of goods
available for sale 1,500
Chapter 5, Slide #28
$17,100
Weighted Average Method
Step 2:
Divide the cost of goods available
for sale by the total units to
determine the weighted average
cost per unit.
:
Chapter 5, Slide #29
Weighted Average Method
Cost of Goods Available for Sale
Units Available for Sale
$17,100
= $11.40/unit
1,500
Chapter 5, Slide #30
Weighted Average Method
Step 3: Calculate ending inventory and
cost of goods sold by multiplying
the weighted average cost per unit
by the number of units in ending
inventory and the number of units
sold.
Avg.
Cost
Chapter 5, Slide #31
×
# of
Units
Weighted Average Method
Units on hand
Units sold
Weighted average cost
×
Total cost of goods
available of $17,100 allocated:
Chapter 5, Slide #32
ALLOCATE TO
Ending
Cost of
Inventory Goods Sold
600
900
$11.40
$ 11.40
$6,840
$10,260
First-in, First-out (FIFO) Method
Step 1:
1st
in
Chapter 5, Slide #33
Assign the cost of the beginning
inventory to cost of goods sold.
First-in, First-out (FIFO) Method
Units
Cost
1/1
500
$10
1/20
300
$11
4/8
400
$12
9/5
200
$13
12/12
100
$14
Chapter 5, Slide #34
ALLOCATE TO
Ending
Cost of
Inventory Goods Sold
$5,000
First-in, First-out (FIFO) Method
Step 2:
Continue to work forward until you
assign the total number of units sold
during the period to cost of goods sold.
Allocate the remaining costs to ending
inventory.
2nd
Chapter 5, Slide #35
3rd
etc.
First-in, First-out (FIFO) Method
ALLOCATE TO
Ending
Cost of
Inventory Goods Sold
Units
Cost
1/1
500
$10
$5,000
1/20
300
$11
3,300
4/8
300 / 100
$12
$3,600
9/5
200
$13
2,600
12/12
100
$14
1,400
TOTALS
Chapter 5, Slide #36
$7,600
1,200
$9,500
Last-in, First-out (LIFO) Method
Step 1:
1st
in
Chapter 5, Slide #37
Assign the cost of the last units
purchased to cost of goods sold.
Last-in, First-out (LIFO) Method
Units
Cost
1/1
500
$10
1/20
300
$11
4/8
400
$12
9/5
200
$13
12/12
100
$14
Chapter 5, Slide #38
ALLOCATE TO
Ending
Cost of
Inventory Goods Sold
$1,400
Last-in, First-out (LIFO) Method
Step 2:
1st
in
Chapter 5, Slide #39
Work backwards until you assign the
total number of units sold during the
period to cost of goods sold (allocate
the remaining costs to ending
inventory).
Last-in, First-out (LIFO) Method
ALLOCATE TO
Ending
Cost of
Inventory Goods Sold
Units
Cost
1/1
500
$10
$5,000
1/20
100 / 200
$11
1,100
4/8
400
$12
4,800
9/5
200
$13
2,600
12/12
100
$14
1,400
TOTALS
Chapter 5, Slide #40
$6,100
$ 2,200
$11,000
Comparison of Costing Methods
Specific
Identification
Weighted
Average
FIFO
LIFO
Chapter 5, Slide #41
Ending
Inventory
Cost of
Goods
Sold
Goods
Available
for Sale
$7,300
$ 9,800
$17,100
6,840
10,260
17,100
7,600
9,500
17,000
6,100
11,000
17,100
Chapter 5, Slide #42
Comparison of Costing Methods
Weighted
Average FIFO LIFO
In periods of rising prices:
Highest cost of goods sold?
Lowest cost of goods sold?
Highest gross profit?
Lowest net income?
Lowest income taxes?
Chapter 5, Slide #43
X
X
X
X
X
LO7
LIFO Conformity Rule
 LIFO conformity rule
• If used for tax, LIFO must also be
used for books
• In general, companies can use one
accounting method for financial reporting
purpose and use a different method for tax
purpose. Accounting choice should be
made based on which method produces
most useful information.
Chapter 5, Slide #44
Lower of Cost or Market
(for your information only)
• If inventory’s market value has fallen below
the cost, the inventory must be reported at
the lower market value, and a loss must be
recorded.
Chapter 5, Slide #45

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