bus30000lect5 2017 - Inventory and Cost of Goods Sold BUS...

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Inventory and Cost of Goods Sold BUS 30000 Financial Accounting – Lecture 5 Joao Granja – Winter 2017 2 Inventory Definitions ! Definition: Items held for sale (or further processing prior to sale) as part of the firm’s business operations. 1. Merchandise Inventory – goods held for sale by a merchandising firm. 2. Manufacturing Inventory – items used in the production of products that will be sold in the normal course of business and the final products. ! raw materials, ! work-in-process (work-in-progress), ! finished goods. ! Cost of goods sold – inventory that has left the balance sheet and has become an expense on the income statement by the end of an accounting period. Note: What may constitute inventory for one firm might not be considered inventory for another firm. Example: Computers are an inventory item for Best Buy, but not for McDonald’s.
3 Full Absorption Costing ! The primary basis of accounting for inventory is acquisition cost. ! Inventory should include all costs incurred to acquire goods and prepare them for sale. ! The acquisition costs for a retailer could include costs of ordering goods , receiving , unpacking , inspecting and recording the purchase , transportation , special handling , and shelving . ! Adjustments may be made directly to the inventory account or made to supplemental accounts, provided the balance sheet amount includes these. ! Materiality constraint means that in practice many firms don’t allocate all these costs to the inventory. 4 Inventory Cost Flows – Retailer Inventory (A) Cost of Goods Sold (RE) SG&A Expenses (RE) Purchases Selling Costs Admin. Costs Purchases Acquisition of Merchandise and related costs I ncome Statement Accounts Goods Sold Goods Sold Selling Costs Admin. Costs Note that Merchandise inventory includes transportation and special handling, shelving, cash discounts, returns and other adjustments are part of costs included in inventory Cash(A) / Payable (L)
5 Costs Included in the Manufacturing Firm Inventory ! Firms will try to trace all the costs that can be directly related to manufacturing of their products, i.e., product costs , and absorb them on inventory accounts ! A manufacturing firm incurs three types of costs to convert raw materials into finished goods. 1. Direct materials such as raw materials that can easily be identified in the finished product 2. Direct labor of workers who work on the product, and 3. Manufacturing overhead , costs which are not easily identified with the product but are easily identified with the production facility (depreciation, repairs, maintenance, factory rent and utilities, indirect labor). ! Period costs are costs that are not related to production, they will not enter inventory and COGS but will become period expenses in the income statement 6 Inventory Cost Flows – Manufacturer Raw Materials (A) Work in Process (A) Finished Goods (A) Cost of Goods Sold (RE) SG&A Expenses (RE) Purchases Direct Labor Overhead Selling Costs Admin. Costs Purchases Acquisition of Materials and Services Inventory Accounts (balance sheet) Income Statement Accounts Direct Labor Overhead

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