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Unformatted text preview: Introduction To Financial Accounting HKUST Chapter 7 p Reporting and Interpreting Cost of Goods Sold and Inventory ACCT 101 Fall 2010 Allen Huang Chapter Seven Slide 1 of 54 Chapter 6 Review Introduction To Financial Accounting HKUST Reporting net sales Sales discount, credit card discount, sales returns and allowance are contra-revenue accounts. Accounting for bad debt expenses Record bad debt expense Bad debt exp (+E, -SE) XXX Allowance for doubtful accounts (+XA, -A) Bad debt write-off XXX XXX Allowance for doubtful accounts (-XA, +A) A/R( A) A/R(-A) XXX Bad debt expense estimation methods I/S approach percentage of credit net sales B/S approach aging schedule Chapter Seven Slide 2 of 54 Learning Objectives for Ch 7 Importance of inventories Some basics about inventory T Terminology i l Physical and accounting flow Introduction To Financial Accounting HKUST Methods of accounting for inventory FIFO, LIFO, weighted average, specific Financial statement effects of different inventory method Footnote disclosure Inventory write downs (Lower of Cost or Market) Allowance for obsolescence Chapter Seven Slide 3 of 54 Importance of Inventories Introduction To Financial Accounting HKUST Definition: Inventory is tangible property held for sale in the normal course of business or will be used in producing goods or services for sale sale. Inventory / Total assets = ? HSBC Accenture (Consulting) Toyota Walmart Boeing Lukfook Jewellery ~0 ~0 5.0% 5 0% 21.1% 29.0% 66.7% Chapter Seven Slide 4 of 54 Costs Included in Inventory Purchases The cost principle requires that inventory be recorded at the price paid or the consideration given. Introduction To Financial Accounting HKUST Invoice Price Freight Inspection Costs Chapter Seven Preparation Costs Slide 5 of 54 Flow of Inventory Costs Merchandiser Merchandise Purchases Merchandise Inventory Introduction To Financial Accounting HKUST Cost of Goods Sold G S Manufacturer Raw Raw Materials Inventory Materials Direct Labor Factory Overhead Chapter Seven Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Slide 6 of 54 Nature of Cost of Goods Sold Beginning Inventory Introduction To Financial Accounting HKUST Purchases for the Period Goods available for Sale Ending Inventory (Balance Sheet) Cost of Goods Sold (Income Statement) Beginning inventory + Purchases = Goods Available for Sale Goods Available for Sale Ending inventory = Cost of goods sold Chapter Seven Slide 7 of 54 E7-3 Income Statement Relation Introduction To Financial Accounting HKUST Supple the missing dollar amounts for the 2012 income statement for each of the following independent cases: Sales Revenue A B C D E $ 650 900 ? 800 1,000 Beg. Inventory $100 200 150 ? ? Purchase Total Available $? ? ? ? 1,100 End. Inventory $ 500 ? 300 300 ? COGS Gross Profits $? ? 400 ? 500 Expense Pretax Income or Loss $? 50 ? 200 (50) $700 800 ? 550 900 $? ? 200 ? ? $ 200 150 100 200 ? Chapter Seven Slide 8 of 54 Inventory Costing Methods Total Dollar Amount of Goods Available for Sale Introduction To Financial Accounting HKUST Inventory Costing Method Ending Inventory Cost of Goods Sold Inventory Costing Methods 1. Specific Identification 2. First-in, First-out 3. Last-in, First-out 4. Weighted Average Chapter Seven Slide 9 of 54 Specific Identification Introduction To Financial Accounting HKUST When units are sold, the specific cost of the unit sold is added to cost of goods sold. Chapter Seven Slide 10 of 54 Cost Flow Assumptions Introduction To Financial Accounting HKUST The choice of an inventory costing method is not based on the physical flow of goods on and off the shelves. FIFO LIFO Chapter Seven Weighted Average Slide 11 of 54 First-In, First-Out Method Introduction To Financial Accounting HKUST Oldest C t Old t Costs Cost of Goods Sold Recent Costs Ending Inventory Chapter Seven Slide 12 of 54 First-In, First-Out Method Introduction To Financial Accounting HKUST Chapter Seven Slide 13 of 54 First-In, First-Out Computers, Inc. Mouse Pad Inventory Units $/Unit 1,000 500 300 250 200 $ 5.25 5.30 5.60 5.80 5.90 Introduction To Financial Accounting HKUST Date g g Beginning Inventory Purchases: Jan. 3 June 20 Sept. 15 Nov. 29 Goods Available A il bl for Sale Ending Inventory Total $ 5,250.00 2,650.00 1,680.00 1,450.00 1,180.00 2,250 1,200 1,050 $ 12,210.00 ? ? Cost of Goods Sold Chapter Seven Remember: The costs of most recent purchases are in ending inventory. Start with Nov. 29 and add units purchased until you reach the number in ending inventory. Slide 14 of 54 First-In, First-Out Introduction To Financial Accounting HKUST Given Information Ending Inventory Beg. I B Inv. 1 000 @ $ 5 25 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 Units Now, we have allocated the cost to all 1,200 units in ending inventory. Chapter Seven Slide 15 of 54 First-In, First-Out Introduction To Financial Accounting HKUST Given Information Ending Inventory Beg. I B Inv. 1 000 @ $ 5 25 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 1 000 @ $ 5 25 5.25 50 @ 5.30 1,050 Units $ 5,515 Cost Now, we have allocated the cost to all 1,050 units sold. Chapter Seven Slide 16 of 54 First-In, First-Out Computers, Inc. Mouse Pad Inventory Units $/Unit 1,000 500 300 250 200 $ 5.25 5.30 5.60 5.80 5.90 $ Introduction To Financial Accounting HKUST Date Beginning g g Inventory Purchases: Jan. 3 June 20 Sept. 15 Nov. 29 Goods Available A il bl for Sale Ending Inventory Cost of Goods Sold Chapter Seven Total 5,250.00 2,650.00 1,680.00 1,450.00 1,180.00 2,250 1,200 1,050 $ 12,210.00 $ $ 6,695.00 5,515.00 Here is the cost of ending inventory and cost of goods sold using FIFO. Slide 17 of 54 Last-In, First-Out Method Introduction To Financial Accounting HKUST Oldest C t Old t Costs Ending g Inventory Recent Costs Cost of Goods Sold Chapter Seven Slide 18 of 54 Last-In, First-Out Method Introduction To Financial Accounting HKUST Chapter Seven Slide 19 of 54 Last-In, First-Out Computers, Inc. Mouse Pad Inventory Units $/Unit 1,000 500 300 250 200 $ 5.25 5.30 5.60 5.80 5.90 Introduction To Financial Accounting HKUST Date g g Beginning Inventory Purchases: Jan. 3 June 20 Sept. 15 Nov. 29 Goods Available A il bl for Sale Ending Inventory Total $ 5,250.00 2,650.00 1,680.00 1,450.00 1,180.00 2,250 1,200 1,050 $ 12,210.00 ? ? Remember: The costs of the oldest purchases are in ending inventory. Start with beginning inventory and add units purchased until you reach the number in ending inventory. Slide 20 of 54 Cost of Goods Sold Chapter Seven Last-In, First-Out Introduction To Financial Accounting HKUST Given Information Ending Inventory Beg. I B Inv. 1 000 @ $ 5 25 1,000 5.25 1,000 1 000 @ $5 25 $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 Units Now, we have allocated the cost to all 1,200 units in ending inventory. Chapter Seven Slide 21 of 54 Last-In, First-Out Introduction To Financial Accounting HKUST Given Information Ending Inventory Beg. I B Inv. 1 000 @ $ 5 25 1,000 5.25 1,000 1 000 @ $5 25 $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 1,050 units sold. Chapter Seven Slide 22 of 54 Last-In, First-Out Computers, Inc. Mouse Pad Inventory Units $/Unit 1,000 500 300 250 200 $ 5.25 5.30 5.60 5.80 5.90 $ Introduction To Financial Accounting HKUST Date Beginning g g Inventory Purchases: Jan. 3 June 20 Sept. 15 Nov. 29 Goods Available for Sale Ending Inventory Cost of Goods Sold Chapter Seven Total 5,250.00 2,650.00 1,680.00 1,450.00 1,180.00 2,250 1,200 1,050 $ 12,210.00 $ $ 6,310.00 5,900.00 Here is the cost of ending inventory and cost of goods sold using LIFO. Slide 23 of 54 Average Cost Method Introduction To Financial Accounting HKUST Chapter Seven Slide 24 of 54 Average Cost Method Computers, Inc. Mouse Pad Inventory Units $/Unit 1,000 500 300 250 200 $ 5.25 5.30 5.60 5.80 5.90 $ Introduction To Financial Accounting HKUST Date Beginning Inventory Purchases: Jan. 3 June 20 Sept. 15 Nov. 29 Goods Available A il bl for Sale Ending Inventory Cost of Goods Sold Chapter Seven Total 5,250.00 2,650.00 1,680.00 1,450.00 1,180.00 Weighted Average Cost 2,250 1,200 1,050 $ $ $ $ 12 210 12,210 = $5.42667 2,250 12,210.00 6,512.00 5,698.00 1,200 $ 5.42667 1,050 $ 5.42667 Slide 25 of 54 Comparison of Methods Computers, Inc. Income Statement For Year Ended December 31, 2009 FIFO $ 25,000 $ $ $ $ $ $ 5,250 6,960 12,210 6,695 5,515 19,485 750 18,735 5,621 13,114 Introduction To Financial Accounting HKUST 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 Income before taxes Income taxes expense (30%) Net income Chapter Seven LIFO $ 25,000 $ $ $ $ $ $ 5,250 6,960 12,210 6,310 5,900 19,100 750 18,350 5,505 12,845 Weighted Average $ 25,000 $ $ $ $ $ $ 5,250 6,960 12,210 6,512 5,698 19,302 750 18,552 5,566 12,986 Slide 26 of 54 Example Year 1 Begin with 0 units 1/1 Buy 1 unit @ $5 2/1 Buy 1 unit @ $8 4/1 Buy 1 unit @ $13 6/1 Buy 1 unit @ $14 12/1 Sell 2 units 12/1 Sell 2 units 4/1 Buy 2 units @ $12 Year 2 Year 3 Introduction To Financial Accounting HKUST 12/1 Sell 2 units Method 1. FIFO: Year 1 Year 2 Year 3 Chapter Seven COGS 5 + 8 = 13 13 + 14 = 27 12 + 12 = 24 Ending Inventory 13 + 14 = 27 12 + 12 = 24 0 Slide 27 of 54 Example Year 1 Begin with 0 units 1/1 Buy 1 unit @ $5 2/1 Buy 1 unit @ $8 4/1 Buy 1 unit @ $13 6/1 Buy 1 unit @ $14 12/1 Sell 2 units 12/1 Sell 2 units 4/1 Buy 2 units @ $12 Year 2 Year 3 Introduction To Financial Accounting HKUST 12/1 Sell 2 units Method 2. LIFO: Year 1 Year 2 Year 3 Chapter Seven COGS 13 + 14 = 27 12 + 12 = 24 5 + 8 = 13 Ending Inventory 5 + 8 = 13 5 + 8 = 13 0 Slide 28 of 54 Example Year 1 Begin with 0 units 1/1 Buy 1 unit @ $5 2/1 Buy 1 unit @ $8 4/1 Buy 1 unit @ $13 6/1 Buy 1 unit @ $14 12/1 Sell 2 units 12/1 Sell 2 units 4/1 Buy 2 units @ $12 Year 2 Year 3 Introduction To Financial Accounting HKUST 12/1 Sell 2 units Method 3. Weighted Average: Year 1 Year 2 Year 3 Chapter Seven COGS Ending Inventory (5+8+13+14)/4 * 2 = 20 (5+8+13+14)/4*2 = 20 (20+12*2)/4*2 = 22 22 (20+12*2)/4*2 = 22 0 Slide 29 of 54 P7-2 Alternative Inventory Methods Introduction To Financial Accounting HKUST Given the following data, compute the amount of (a) goods available for sale, (b) ending inventory, and (c) COGS under each for the following three inventory costing methods. Transactions Beg. Inventory, January 1, 2012 Transactions during 2012: a. Purchase, January 30 b. Purchase, May 1 c. Sale c Sale, ($5 each) d. Sale, ($5 each) 600 460 (130) (700) 3.20 3.50 Units 400 Unit Cost $3.00 1. Weighted average cost 2. FIFO 3. LIFO Chapter Seven Slide 30 of 54 Comparison of Methods Introduction To Financial Accounting HKUST In periods of rising prices, FIFO results in the highest Computers, Inc. Income Statement ending inventory, gross For profit, profit tax expense andEnded December 31, 2009 expense, Year net income, and the lowest cost FIFO LIFO Netof goods sold. sales $ 25,000 $ 25,000 Cost of goods sold: Merchandise inventory, beginning Net purchases Goods available for sale Merchandise inventory ending inventory, Cost of goods sold Gross profit Operating expenses Income before taxes Income taxes expense (30%) Net income Chapter Seven Weighted Average $ 25,000 $ $ $ $ $ $ 5,250 6,960 12,210 6,512 6 512 5,698 19,302 750 18,552 5,566 12,986 Slide 31 of 54 $ $ $ $ $ $ 5,250 6,960 12,210 6,695 6 695 5,515 19,485 750 18,735 5,621 13,114 $ $ $ $ $ $ 5,250 6,960 12,210 6,310 6 310 5,900 19,100 750 18,350 5,505 12,845 Comparison of Methods Introduction To Financial Accounting HKUST In periods of rising prices, LIFO results in the lowest Computers, Inc. Income ending inventory, gross Statement For profit, profit tax expense andEnded December 31, 2009 expense, Year net income, and the highest cost FIFO LIFO Netof goods sold. sales $ 25,000 $ 25,000 Cost of goods sold: Merchandise inventory, beginning Net purchases Goods available for sale Merchandise inventory ending inventory, Cost of goods sold Gross profit Operating expenses Income before taxes Income taxes expense (30%) Net income Chapter Seven Weighted Average $ 25,000 $ $ $ $ $ $ 5,250 6,960 12,210 6,512 6 512 5,698 19,302 750 18,552 5,566 12,986 Slide 32 of 54 $ $ $ $ $ $ 5,250 6,960 12,210 6,695 6 695 5,515 19,485 750 18,735 5,621 13,114 $ $ $ $ $ $ 5,250 6,960 12,210 6,310 6 310 5,900 19,100 750 18,350 5,505 12,845 Summary: Effects of Changes in Input Prices on COGS and NI LIFO versus FIFO COGS Net Income If input prices If input prices Introduction To Financial Accounting HKUST COGSLIFO > COGSFIFO COGSLIFO < COGSFIFO NILIFO < NIFIFO NILIFO > NIFIFO If input prices If input prices Question: If input prices are increasing, which method would most firms want to use if their decision was solely motivated by financial reporting objectives? Chapter Seven Slide 33 of 54 Managers Choice of Inventory Methods Introduction To Financial Accounting HKUST LIFO Conformity Rule If last-in, first-out is used on the income tax return, it must also be used to calculate t t l b dt l l t inventory and cost of goods sold for financial statements. Note: This is one of the rare times that tax laws affect financial accounting. Net Income Effects Managers prefer to report higher earnings for their companies. Income Tax Effects Managers prefer to pay the least amount of taxes allowed by law as late as possible. Slide 34 of 54 Chapter Seven Inventory Write-down Introduction To Financial Accounting HKUST It is not unusual for inventory to lose value, relative to what it cost to make: Inventory can get lost or "misplaced" by employees misplaced employees. Perishable products Industries that compete on technology innovation Lower-of-cost-or-market (LCM) rule Lower-of-cost-or If market value < cost, we must write down the inventory to the lower market value. If market value > cost, we NEVER write up the value of k l i h l f the inventory. In this case, the value stays at cost. Chapter Seven Slide 35 of 54 Accounting for Inventory Write-down Introduction To Financial Accounting HKUST If write-downs are NOT a normal part of the writebusiness: Inventory write down or COGS (+E -SE) (+E, Inventory (-A) (-A) XXX XXX If write-downs are a normal part of the business write(e.g., obsolescence) We set up an Allowance account for inventory (XA) We estimate and recognize a Provision for Inventory g y Obsolescence (Expense) (Expense) Provision for inv. Obsolescence (+E, -SE) XXX Allowance for inv. Obsolescence (+XA, -A) XXX We write off the inventory when realized Allowance for inv. Obsolescence (-XA, +A) Inventory (-A) (-A) Chapter Seven XXX XXX Slide 36 of 54 Valuation at Lower of Cost or Market Introduction To Financial Accounting HKUST Item Pentium chips Disk drives Q Quantity y 1,000 400 Cost $ 250 100 Replacement Cost $ 200 110 $ LCM 200 100 Total LCM $ 200,000 40,000 GENERAL JOURNAL Date Description Cost of goods sold (+E, -SE) Inventory (-A) Debit 50,000 Credit 50,000 Chapter Seven Slide 37 of 54 P7-6 Lower of Cost or Market Introduction To Financial Accounting HKUST Smart Company prepared its annual financial statements dated Dec 31, 2010. The company applies the FIFO inventory costing method; however, the company neglected to apply LCM to the ending inventory. The preliminary 2010 I/S follows. Assume that you have been asked to restate 2010 I/S to incorporate LCM. You have developed the following data relating to the 2010 ending inventory. Sales Revenue Cost of goods sold Beginning inventory Purchases $31,000 184,000 Goods available for sale 215,000 Ending inventory (FIFO cost) Cost of goods sold Gross profit Operating expenses Pretax income Income tax expense (30%) Net income Chapter Seven $280,000 Acquisition Cost Item A B C D Quantity 3,050 1,500 1 500 7,100 3,200 Unit $3 5 1.5 6 Total $9,150 7,500 7 500 10,650 19,200 $46,500 Current Replacement Unit Cost (Market) $4 3.5 3 5 3.5 4 46,500 168,500 111,500 62,000 49,500 14,850 $34,650 Slide 38 of 54 P7-6 Lower of Cost or Market Introduction To Financial Accounting HKUST Restate this income statement to reflect LCM valuation of the 2010 ending inventory. Apply LCM on an item-by-item basis. Acquisition Cost Current Replacement Unit Cost Replacement LCM Valuation (Market) Cost (Market) $4 3.5 3.5 4 Item Quantity Unit Total A B C D 3,050 1,500 7,100 3,200 $3 5 1.5 6 $9,150 7,500 10,650 19,200 $46,500 Chapter Seven Slide 39 of 54 P7-6 Lower of Cost or Market Introduction To Financial Accounting HKUST Restate this income statement to reflect LCM valuation of the 2010 ending inventory. Apply LCM on an item-by-item basis. Sales Revenue Cost of goods sold Beginning inventory Purchases Goods available for sale Ending inventory (FIFO cost) Cost of goods sold Gross profit Operating expenses Pretax income Income tax expense (30%) Net income Chapter Seven Slide 40 of 54 Perpetual and Periodic Inventory Systems Introduction To Financial Accounting HKUST Periodic inventory system: Ending inventory and cost of goods sold are determined at the end of the accounting acco nting period based on a ph sical co nt physical count. Provides up-to-date inventory records. Perpetual System Provides up-to-date cost of sales records. Chapter Seven Slide 41 of 54 Perpetual and Periodic Inventory Systems Item Introduction To Financial Accounting HKUST Inventory System Periodic System Perpetual System Carried over Carried over from Beginning Inventory In entor from prior period prior period Accumulated in Accumulated in Add: Purchases the Purchases the Inventory account account Measured at end Perpetual of period by Inventory record Less: Ending Inventory physical updated at every inventory count sale Computed from Measured at the above three every sale based Cost of Goods Sold accounts at the on perpetual end of period record Chapter Seven Slide 42 of 54 Errors in Measuring Inventory Errors in Measuring Inventory Beginning Inventory Effect on Income Statement Goods Available for Sale Cost of Goods Sold Gross Profit Net Income Effect on Balance Sheet Inventory (12/31) Retained Earnings No effect No effect Introduction To Financial Accounting HKUST Ending Inventory Overstated Understated Overstated Understated + + - - - - + + No effect No effect - + + + + + - - - - - + Beg. Inv. + Purchase - End. Inv. = COGS Goods available for sale Chapter Seven Slide 43 of 54 Question Introduction To Financial Accounting HKUST If the 2002 ending inventory is understated by $3 000 hi h f h f ll i i b $3,000, which of the following is true for 2002? a. Beginning Inventory was understated. b. Cost of Goods Sold will be understated. c. Gross Profit will be overstated. d. Net Income will be understated. Chapter Seven Slide 44 of 54 Question Introduction To Financial Accounting HKUST If the 2002 ending inventory is understated by $3 000 hi h f h following i b $3,000, which of the Errors in Measuring is true f ll i Inventory for 2002? Ending Inventory Overstated Understated No effect No effect a. Beginning Inventory was understated. - - b. Cost of Goods Sold will be understated. - + - c. Gross Profit will be overstated. + d. Net Income will be understated. Gross Profit Net Income Effect on Income Statement Goods Available for Sale Cost of Goods Sold - + + + Effect on Balance Sheet Inventory (12/31) Retained Earnings Chapter Seven Slide 45 of 54 Question Introduction To Financial Accounting HKUST If the 2002 ending inventory is understated by $3,000, which of the following is true for 2003? a. Beginning Inventory was understated. b. Cost of Goods Sold will be understated. c. Gross Profit will be overstated. d. All of the above. Chapter Seven Slide 46 of 54 Question Introduction To Financial Accounting HKUST If the 2002 ending inventory is understated by $3,000, which of the following is true for 2003? a. Beginning Inventory was understated. b. Cost of Goods Sold will be understated. c. Gross Profit will be overstated. d. All of the above. Remember: The ending inventory for 2002 becomes the beginning inventory for 2003. Chapter Seven Slide 47 of 54 Inventory Turnover Inventory Turnover Introduction To Financial Accounting HKUST Cost of Goods Sold = Average Inventory Average Inventory is . . . (Beginning Inventory + Ending Inventory) 2 This ratio reflects how many times average inventory was produced and sold during the period. A higher ratio indicates that inventory moves more quickly thus reducing storage and obsolescence costs. Chapter Seven Slide 48 of 54 Measuring Efficiency in Inventory Management Introduction To Financial Accounting HKUST Inventory turnover = COGS / Average Inventory Examples: Toyota Boeing Yum Brand Walmart Lukfook Jewellery 10.9 10 9 4 91.1 7.84 2.36 times times times times times Days Inventory = 365 / Inventory turnover Examples: p Chapter Seven Toyota Boeing Yum Brand Walmart Lukfook Jewellery 33 91 4 47 155 days days days days days Slide 49 of 54 ...
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