ch7_sp11 - CH 7 Reporting and Interpreting BCOR 2000 Cost...

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Unformatted text preview: CH 7 Reporting and Interpreting BCOR 2000 Cost of Goods Sold and Inventory Merchandiser Merchandise Merchandise Purchases Purchases Flow of Inventory Costs Merchandise Merchandise Inventory Inventory Cost of Cost of Goods Sold Goods Sold Manufacturer Raw Raw Materials Materials Direct Direct Labor Labor Factory Factory Overhead Overhead Raw Materials Raw Materials Inventory Inventory Work in Process Work in Process Inventory Inventory Finished Goods Finished Goods Inventory Inventory Cost of Cost of Goods Sold Goods Sold Nature of Cost of Goods Sold Beginning Beginning Inventory Inventory Purchases Purchases for the Period for the Period Goods available Goods available for Sale for Sale Ending Inventory Ending Inventory (Balance Sheet) (Balance Sheet) Cost of Goods Sold Cost of Goods Sold (Income Statement) (Income Statement) Beginning inventory + Purchases = Goods Available for Sale Beginning inventory + Purchases = Goods Available for Sale Goods Available for Sale Ending inventory = Cost of goods sold Goods Available for Sale Ending inventory = Cost of goods sold Inventory Costing Methods Specific Identification Rarely used Easy to manipulate net income if homogeneous goods Cost Flow Assumptions: First-in, First-Out (FIFO) Last-in, First-Out (LIFO) Weighted Average FirstIn, FirstOut (FIFO) Method Oldest Costs Oldest Costs Cost of Cost of Goods Sold Goods Sold Recent Costs Recent Costs Ending Ending Inventory Inventory Example: Inventory Data Ending Inventory: 450 units FIFO LastIn, FirstOut Method Oldest Costs Oldest Costs Ending Ending Inventory Inventory Recent Costs Recent Costs Cost of Cost of Goods Sold Goods Sold LIFO WeightedAverage Cost The average cost per unit is assigned to both units sold and those remaining in inventory. Weighted Average Comparison of Inventory Valuation Methods FIFO Sales Beg. Inventory Purchases COGAS Ending Inventory Cost of Goods Sold Gross Profit Operating Exps IB Income Taxes Inc. Tax. Exp. (30%) Net Income $11,500 1,000 +11,000 12,000 -5,800 -6,200 5,300 -2,000 3,300 -990 $2,300 LIFO $11,500 1,000 +11,000 12,000 -5,000 -7,000 4,500 -2,000 2,500 -750 $1,750 W-A Cost $11,500 1,000 +11,000 12,000 -5,400 -6,600 4,900 -2,000 2,900 -870 $2,030 Income Statement Effects In periods of rising prices FIFO reports the highest net income LIFO the lowest net income W-A Cost between In periods of falling prices FIFO reports the lowest net income LIFO the highest net income W-A Cost between Additional Financial Statement Considerations of Costing Methods First-In, First-Out Last-In, First-Out Weighted Average Ending inventory Ending inventory approximates approximates current current replacement cost replacement cost B/S Amount more B/S Amount more Accurate Accurate Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with revenues I/S revenues I/S Amount more Amount more Accurate Accurate Smoothes out Smoothes out price changes, price changes, but both B/S, I/S but both B/S, I/S can be off can be off Why do companies use LIFO when prices are generally rising? If FIFO used, NI would be higher. But, Income Taxes would be higher as well. Unlike other method choices, IRS has LIFO Conformity Rule "if LIFO is used for Tax purposes, it must be used for Financial Reporting also" Managers opt to have higher Cash Flows Exception: if unit sales > purchases / production, eat into "old" LIFO layers ... LIFO Liquidation IFRS does not permit LIFO Lower of Cost or Market Recognize a loss when replacement cost or net realizable value drops below cost Replacement Cost = current purchase price for identical goods Net Realizable Value = Expected sales price less selling costs Departure from cost principle based on Conservatism Impacts timing of Income recognition Perpetual and Periodic Inventory Systems Inventory System Periodic System Carried over Beginning Inventory from prior period Accumulated in Add: Purchases the Purchases account Measured at end of period by Less: Ending Inventory physical inventory count Computed as a residual amount Cost of Goods Sold at end of period Item Perpetual System Carried over from prior period Accumulated in the Inventory account Perpetual record updated at every sale Measured at every sale based on perpetual record Impacts of Inventory Errors Direct inverse relation between COGS and Ending Inventory: if EI is overstated, then COGS in Current Year is understated and Net Income is overstated in next year, BI would be overstated, so COGAS is overstated, and if EI is correct, then COGS is overstated, and Net Income is understated Errors offset across the two years Self-Correct Numerical Example -> Impacts of Inventory Errors Assume that an inventory is errantly taken at the end of YR1 = $40,000; but is actually $50,000. What are the impacts? Note EI is understated YR1 Mistake Beg Inv Purchases COGAS End Inv COGS $30,000 250,000 280,000 40,000 $240,000 YR1 Accurate $30,000 250,000 280,000 50,000 $230,000 YR2 Mistake $40,000 300,000 340,000 60,000 $280,000 YR2 Accurate $50,000 300,000 350,000 60,000 $290,000 Impacts of Inventory Errors Balance Sheet YR YR1 YR2 A $10K U/S NE L NE NE SE $10K U/S NE Income Statement Rev NE NE Exp $10K O/S $10K U/S NI $10K U/S $10K O/S Ratio from CH 7 Inventory Turnover = Cost of Goods Sold Average Inventory The 2009 Inventory Turnover for Harley-Davidson was: $2,901 ($323 + $379) 2 = 9.75 The ratio indicates how quickly inventory is processed and shipped to customers an indicator of production and selling efficiency Application Exercises and Problems CH 7 Handout problem E13, P4 ...
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