chap007 - Reporting and Interpreting Cost of Goods Sold and...

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Unformatted text preview: Reporting and Interpreting Cost of Goods Sold and Inventory Chapter 7 7-2 Items Included in Inventory Inventory Tangible Held for Sale Merchandise Inventory Raw Materials Inventory Work in Process Inventory Finished Goods Inventory Used to Produce Goods or Services 7-3 Costs Included in Inventory Purchases The cost principle requires that cost inventory be recorded at the price paid or the consideration given. Invoice Price Freight Inspection Costs Preparation Costs 7-4 Nature of Cost of Goods Sold Beginning Inventory Purchases for the Period Goods available for Sale Ending Inventory Cost of Goods Sold (Balance Sheet) (Income Statement) Beginning inventory + Purchases = Goods Available for Sale Goods Available for Sale – Ending inventory = Cost of goods sold 7-5 Flow of Inventory Costs Merchandiser Merchandise Purchases Manufacturer Raw Materials Direct Labor Factory Overhead Merchandise Inventory Raw Materials Inventory Work in Process Inventory Cost of Goods Sold Finished Goods Inventory Cost of Goods Sold 7-6 Inventory Costing Methods Specific Specific Identification Identification FIFO LIFO Weighted Weighted Average Average 7-7 Inventory Costing Methods Total Dollar Amount of Goods Total Available for Sale Available Inventory Costing Method Ending Inventory Cost of Goods Sold 7-8 First-In, First-Out Method Oldest Costs Cost of Cost Goods Sold Goods Recent Costs Ending Ending Inventory Inventory 7-9 First-In, First-Out Now, we have allocated the cost to all Now, 1,200 units in ending inventory. 1,200 Given Information Ending Inventory Beg. Inv. 1,000 @ $ 5.25 Jan. 3 500 @ 5.30 450 @ $5.30 June 20 300 @ 5.60 300 @ $5.60 Sept. 15 250 @ 5.80 250 @ $5.80 Nov. 29 200 @ 5.90 200 @ $5.90 1,200 Units $ 6,695 Cost Cost of Goods Sold 1,000 @ $ 5.25 50 @ 5.30 1,050 Units $ 5,515 Cost Now, we have allocated the cost to all Now, 1,050 units sold. 1,050 7-10 Last-In, First-Out Method Oldest Costs Ending Ending Inventory Inventory Recent Costs Cost of Cost Goods Sold Goods 7-11 Last-In, First-Out Now, we have allocated the cost to all 1,200 Now, units in ending inventory. units Given Information Ending Inventory Beg. Inv. 1,000 @ $ 5.25 1,000 @ $5.25 Jan. 3 500 @ 5.30 200 @ 5.30 June 20 300 @ 5.60 Sept. 15 250 @ 5.80 Nov. 29 200 @ 5.90 1,200 Units $ 6,310 Cost Cost of Goods Sold 300 300 250 200 1,050 @ $ 5.30 @ 5.60 @ 5.80 @ 5.90 Units $ 5,900 Cost Now, we have allocated the cost to all Now, 1,050 units sold. 1,050 7-12 Average Cost Method When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. Cost of Goods Available for ÷ Sale Number of Units Available for Sale 7-13 Average Cost Method Date Beginning Inventory Purchases: Jan. 3 June 20 Sept. 15 Nov. 29 Goods Available for Sale Computers, Inc. Mouse Pad Inventory Units $/Unit 1,000 500 300 250 200 $ 5.25 Total $ 5.30 5.60 5.80 5.90 5,250.00 2,650.00 1,680.00 1,450.00 1,180.00 Weighted Average Cost $ 12,210 = $5.42667 2,250 2,250 $ 12,210.00 Ending Inventory 1,200 $ 6,512.00 1,200 × $ 5.42667 Cost of Goods Sold 1,050 $ 5,698.00 1,050 × $ 5.42667 7-14 Comparison of Methods Computers, Inc. Income Statement For Year Ended December 31, 2006 Net sales Cost of goods sold: Merchandise inventory, beginning Net purchases Goods available for sale Merchandise inventory, ending Cost of goods sold Gross profit Operating expenses I ncome before taxes I ncome taxes expense (30%)* Net income FIFO $ 25,000 LIFO $ 25,000 W eighted Average $ 25,000 $ $ $ $ $ $ $ $ * Tax expense amounts were rounded. 5,250 6,960 12,210 6,695 5,515 19,485 750 18,735 5,621 13,114 $ $ $ $ $ 5,250 6,960 12,210 6,310 5,900 19,100 750 18,350 5,505 12,845 $ $ $ $ $ 5,250 6,960 12,210 6,512 5,698 19,302 750 18,552 5,566 12,986 7-15 Financial Statement Effects of Costing Methods Advantages of Methods First-In, First-In, First-Out First-Out Last-In, Last-In, First-Out First-Out Weighted Weighted Average Average Ending inventory Ending approximates current replacement cost. replacement Better matches Better current costs in cost of goods sold with revenues. with Smoothes out Smoothes price changes. price 7-16 Managers Choice of Inventory Methods Net Income Effects Managers prefer to report Managers higher earnings for their companies. companies. Income Tax Effects Managers prefer to pay the Managers least amount of taxes allowed by law as late as possible. possible. 7-17 Valuation at Lower of Cost or Market Ending inventory is reported at the Ending lower of cost or market (LCM). Replacement Cost The current purchase The price for identical goods. price The company will recognize a “holding” loss in the current period rather than the period in which the item is sold. This practice is conservative. 7-18 Inventory Turnover Inventory = Turnover Cost of Goods Sold Average Inventory Average Inventory is . . . (Beginning Inventory + Ending Inventory) ÷ 2 This ratio reflects how many times This average inventory was produced and sold during the period. A higher ratio indicates that inventory moves more quickly thus reducing storage and obsolescence costs. 7-19 LIFO and International Comparisons No LIFO Permitted? Singapore China Canada Australia Great Britain Yes 7-20 Perpetual and Periodic Inventory Systems Provides up-to-date Provides inventory records. inventory Perpetual System System Provides up-to-date Provides cost of sales records. In a periodic inventory system, ending inventory and cost of goods sold are determined at the end of the accounting period based on a physical count. 7-21 LIFO Liquidations When a LIFO company sells more inventory than it purchases or manufactures, items from beginning inventory become part of cost of goods sold. This is called a LIFO liquidation. When inventory costs are rising, these lower cost items in beginning inventory produce a higher gross profit, higher taxable income, and higher taxes when they are sold. 7-22 LIFO Liquidations Companies must disclose the effects of LIFO liquidations in the notes when they are material. Many companies avoid LIFO liquidations and the accompanying increase in tax expense by purchasing sufficient quantities of inventory at year-end to ensure that ending inventory quantities are greater than or equal to beginning inventory quantities. 7-23 The End of Chapter 7 ...
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