Ch+6+outline-2 - Chapter 6 Inventory and Cost of Goods Sold...

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Unformatted text preview: Chapter 6 Inventory and Cost of Goods Sold Inventory • Items held by the company for re-sale – Current asset on the Balance Sheet • Items sold shifted to Cost of Goods Sold – Expense on the Income Statement • Sales revenue based on retail price of inventory • Cost of Goods Sold based on cost of inventory Gross Profit • • • • Sales Revenue minus Cost of Goods Sold Also called Gross Margin Represents markup on products “Gross” because expenses have not been deducted Income Statement Format Multi-Step Income Statement Sales revenues – Cost of goods sold Gross profit – Selling and administrative expenses = Operating income Add: Other revenues and gains Less: Other expenses and losses Income Statement Format Multi-Step Income Statement Earnings before taxes – Income taxes = Net earnings Manufacturing and Merchandising Companies Inventory Merchandise company Wholesaler Retailer Manufacturing company Raw material Work in Progress Finished goods Two Systems • • • • Periodic Count items to determine quantity on hand Used for inexpensive items Used by small businesses Low cost Perpetual • Running record of inventory kept by computer program • Used by large businesses • Scanners and bar codes used to record transactions Net cost of purchases Purchase price + Freight-in Transportation costs - Purchase returns Unsuitable goods returned to seller - Purchase allowances Reduction in amount owed - Purchase Discounts For early payment = Net cost of purchases Perpetual Entries To record purchases of inventory on account JOURNAL Date Accounts Inventory Accounts payable Debit Credit Perpetual Entries • To record sale of inventory on account • Two entries required JOURNAL Date Accounts Accounts receivable Sales Cost of goods sold Inventory Debit Credit Retail price Cost Periodic Inventory System • Does not continually modify inventory amounts • Periodically adjust for purchases and sales of inventory – At the end of the reporting period – Based on a physical count of inventory on hand Periodic Method Formula Formula Alternate Formula Beginning Inventory Beginning Inventory + Purchases + Purchases = Goods available = Goods available - Ending inventory - Cost of Goods sold = Cost of Goods sold = Ending inventory Periodic Entries To record purchases of inventory on account JOURNAL Date Accounts Purchases Accounts payable Debit Credit Periodic Entries • To record sale of inventory on account • One entry required JOURNAL Date Accounts Accounts receivable Sales Debit Credit Retail price Periodic Entries • To record CGS at period end JOURNAL Date Accounts Inventory (ending) Cost of Goods Sold Purchases Debit Credit Inventory (beginning) Any other inventory accounts created “Purchase returns”, “Purchase Discounts”, “Freight-in” are also closed out into inventory Inventory Costing Methods • To determine the cost of inventory sold or on hand, the units are multiplied by the unit cost • Inventory items are often purchased at different prices throughout the year • Company selects a costing method to determine which unit cost to use Inventory Costing Methods • • • • Specific-unit-cost Average cost First-in, first-out (FIFO) Last-in, first-out (LIFO) Specific-unit-cost • Each item in inventory can be separately identified • Used for unique items – Cars, fine jewelry • Too expensive for homogeneous items Average-cost • An average of inventory costs Cost of goods available Number of units available = Average cost per unit Average cost per unit x units sold = Cost of goods sold Average cost per unit x units on hand = Ending inventory FIFO • Oldest items assumed to be sold first • Ending inventory will consist of most recent items purchased LIFO • Newest items are assumed to be sold first • Ending inventory consists of oldest items in inventory Illustrative Data Beginning inventory (10 units @ $8) $ 80 No. 1 (15 units @ $12 per unit) 180 No. 2 (15 units @ $15 per unit) 225 Total purchases $ 405 Cost of goods available for sale $ 485 Ending inventory: 10 units Cost of goods sold: 30 units Specific Unit Cost 5 Units @ $8 Cost of Goods Sold $ 40 180 150 $370 $485 – $370 = $115 15 Units @ $12 10 Units @ $15 Weighted-Average $485 total cost ÷ 40 units = $12.13/unit Ending inventory = 10 × $12.13 = $121.30 Cost of goods sold = 30 × $12.13 = $363.70 First-In, First-Out Less units sold Ending inventory 40 units 30 10 units 10 units × $15 per unit = $150 First-In, First-Out 10 Units @ $8 Cost of Goods Sold $ 80 180 75 $335 15 Units @ $12 5 Units @ $15 Last-In, First-Out Less units sold Ending inventory 10 units × 8 = 40 units 30 10 units $80 Last-In, First-Out Cost of Goods Sold $180 225 $405 15 Units @ $12 15 Units @ $15 Income Effects of Inventory Methods Ending Inventory Specific unit cost Weighted-average FIFO LIFO $115.00 $121.30 $150.00 $ 80.00 Income Effects of Inventory Methods Cost of Goods Sold Specific unit cost Weighted-average FIFO LIFO $370.00 $363.70 $335.00 $405.00 Income Effects of Inventory Methods Assumed Sales Revenue Specific unit cost Weighted-average FIFO LIFO $1,000 $1,000 $1,000 $1,000 Cost of Goods Sold – – – – 370 364 335 405 Gross Profit = = = = $630 $636 $665 $595 Use of the Various Inventory Methods Increasing Costs Cost of goods sold • FIFO lowest – Based on older costs • LIFO highest – Based on recent costs Ending inventory • FIFO highest – Based on recent costs • LIFO lowest – Based on older costs Opposite relationships exist when costs are decreasing Tax Advantage of LIFO Assuming inventory costs are increasing LIFO results in higher COGS Higher COGS results in lower net income Lower net income results in lower taxes Lower taxes results in greater cash flow Comparison of Inventory Methods FIFO • Balance sheet – More recent costs • Income Statement – Does not match current costs with revenue LIFO • Balance Sheet – Old, outdated costs • Income Statement – Matches current costs with revenue Accounting Principles Related to Inventory • Consistency – Companies should use same inventory method from period to period • Disclosure – Companies should disclosed inventory method used • Conservatism – Companies should “write down” inventory if market price falls below cost Lower-of-Cost-or-Market (LCM) • Inventory should be reported at whichever is lower – cost or market – Market = current replacement cost • If cost is lower, no adjustment needed • If market is lower, – Inventory is decreased to market value – Cost of goods sold is increased Effects of Inventory Errors • Error in ending inventory impacts two periods • First period – Cost of goods sold – Gross Profit & Net Income • Second period – Beginning inventory – Costs of Goods sold – Gross Profit & Net Income Effects of Inventory Errors Period 1 Inventory error Period 2 COGS GP & Net Inc COGS GP & Net Inc U O O U O U U O Example 1 Ending inventory overstated Example 2 Ending inventory understated O = Overstated U = Understated Effects of Inventory Errors Period 1 Ending Inventory Overstated by $10,000 Period 1 Beginning Inventory Overstated by $10,000 Period 1 Correct Sales revenue $120,000 $120,000 $120,000 Cost of goods sold: Beg. inventory $10,000 $20,000 $10,000 Purchases 50,000 50,000 50,000 Cost of goods available for sale $60,000 $70,000 $60,000 Ending inventory (20,000) (10,000) (10,000) Cost of goods sold 40,000 60,000 50,000 Gross profit $ 80,000 $ 60,000 $ 70,000 ...
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