Chapter 06

Chapter 06 - INVENTORIES AND COST OF SALES Chapter 6...

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Unformatted text preview: INVENTORIES AND COST OF SALES Chapter 6 ACCOUNTING FOR INVENTORY Items included in inventory and their costs Costing method a) specific identification; b) FIFO; c) LIFO; or d) weighted average Inventory system (perpetual or periodic) Use McGraw-Hill/Irwin McGraw-Hill/Irwin of market values or other estimates Slide 2 DETERMINING INVENTORY ITEMS Merchandise inventory includes all goods that a Merchandise company owns and holds for sale, regardless of where the goods are located when inventory is counted. Items requiring special attention include: Items requiring special attention include: Goods in Transit McGraw-Hill/Irwin McGraw-Hill/Irwin Goods on Consignment Goods Damaged or Obsolete Slide 3 GOODS IN TRANSIT FOB Shipping Point Public Carrier Seller Buyer Ownership passes to the buyer here. Public Carrier Seller McGraw-Hill/Irwin McGraw-Hill/Irwin FOB Destination Point Buyer Slide 4 GOODS ON CONSIGNMENT Merchandise is included in the inventory of the Merchandise consignor, the owner of the inventory. consignor, Consignee Thanks for selling my inventory in your store. Consignor McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 5 GOODS DAMAGED OR OBSOLETE Damaged or obsolete goods are not counted in Damaged inventory if they cannot be sold. inventory Cost should be reduced to net realizable Cost value if they can be sold. value McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 6 DETERMINING INVENTORY COSTS Include all expenditures necessary to bring an item to Include a salable condition and location. salable Minus Minus Discounts Discounts and and Allowances Allowances Plus Import Plus Import Duties Duties McGraw-Hill/Irwin McGraw-Hill/Irwin Invoice Cost Plus Plus Freight Freight Plus Plus IInsurance nsurance Plus Plus Storage Storage Slide 7 THE CONCEPT OF MATERIALITY Accounting principles prescribe that incidental costs be added to inventory The matching principle states that inventory costs should be recorded against revenue in the period when inventory is sold. However, some companies use the materiality constraints (cost-to-benefit constraints) to avoid assigning some incidental costs of acquiring merchandise to inventory. McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 8 THE CONCEPT OF MATERIALITY An item is “material” if knowledge of the An item is “material” if knowledge of the iitem might reasonably iinfluence the tem might reasonably nfluence the decisions off users of financial statements. decisions o users of financial statements. Many companies immediately charge the cost of immaterial items to expense. McGraw-Hill/Irwin McGraw-Hill/Irwin Lightbulbs Supplies Slide 9 INTERNAL CONTROLS AND TAKING A PHYSICAL COUNT Most companies take a physical count of inventory at least once each year. When the physical count does not match the Merchandise Inventory account, an adjustment must be made. McGraw-Hill/Irwin McGraw-Hill/Irwin Good internal controls over count include: Good internal controls over count include: 1.Pre-numbered inventory tickets. 1.Pre-numbered inventory tickets. 2.Counters have no inventory responsibility. 2.Counters have no inventory responsibility. 3.Counts confirm existence, amount, and 3.Counts confirm existence, amount, and quality of inventory item. quality of inventory item. 4.Second count is taken. 4.Second count is taken. 5.Manager confirms all items counted. 5.Manager confirms all items counted. Slide 10 WHICH UNIT DID WE SELL? When identical units of inventory have different unit costs, a question naturally arises as to which of these costs should be used in recording a sale of inventory. McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 11 INVENTORY SUBSIDIARY LEDGER A separate subsidiary account is maintained for each A separate subsidiary account is maintained for each iitem in inventory. tem in inventory. Item LL002 Description Laser Light Location S toreroom 2 Purchased Date Sept. 5 Sept. 9 Sept. 10 Total $ 3,000 3,750 Units Unit Cost 10 Units 100 75 Unit Cost $ 30 50 Sold ? Primary supplier Electronic City Secondary supplier Electric Company Inventory level: Min: 25 Max: 200 Balance Cost of Goods Unit Sold Units Cost Total 100 $ 30 $ 3,000 100 30 3,000 75 50 3,750 ? ? ? ? ? ? ? How can we determine the unit cost for the Sept. 10 sale? McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 12 SPECIFIC IDENTIFICATION Each time a sale occurs, the actual invoice cost of the units sold is identified and charged to cost of goods sold. This method requires to identify which items were sold and when. If each unit is unique, specific identification method should be chosen. McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 13 COST FLOW ASSUMPTIONS If the items in inventory are homogenous in nature, companies normally adopt a more convenient practice of using a cost flow assumption to determine cost of goods sold and the ending inventory account balance. The actual physical flow of inventory need not correspond to these assumptions. McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 14 INVENTORY COST FLOW ASSUMPTIONS First-In, First-Out (FIFO) The Earliest costs to COGS, The leaving costs of most recent purchases in inventory. Last-In, First-Out Last-In, (LIFO) Most recent costs to COGS, Most leaving costs of earliest purchases in inventory. purchases Weighted Weighted Average Average Each time a sale occurs, the weighted average cost per unit is determined the average cost of each unit in inventory is assigned to COGS and ending inventory. McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 15 INVENTORY COSTING ILLUSTRATION Here is information about the mountain bike inventory of Trekking for the month of August. Date Activity Units Acquired at Cost =$ Units Sold at Retail Unit Inv. Aug. 1 Beg. Inventory 10 units @ $ 91 910 10 Aug. 3 Purchased 15 units @ $ 106 = $ 1,590 25 Aug. 14 Sales Aug. 17 Purchased 20 units @ $ 115 = $ 2,300 25 Aug. 28 Purchased 10 units @ $ 119 = $ 1,190 35 Aug. 31 Sales Totals McGraw-Hill/Irwin McGraw-Hill/Irwin 20 units @ $130 23 units @ $150 55 $5,990 5 12 43 Slide 16 SPECIFIC IDENTIFICATION When units are sold, the specific cost of the units sold is added to cost of goods sold. Trekking sold 20 bikes on August 14th with the following costs: $ 8 bikes @ $ 91 = 728 12 bikes @ 106 31 1,272 The 23 bikes sold on August = st had the following costs: Cost of goods sold= $ 2 bikes @ $ 91 = $ 2,000 182 3 bikes @ 106 = 318 15 bikes @ 115 = 1,725 3 bikes @ 119 = 357 Cost of goods sold = $ 2,582 McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 17 SPECIFIC IDENTIFICATION Income Statement Income Statement Cost of Goods Sold Cost of Goods Sold McGraw-Hill/Irwin McGraw-Hill/Irwin Balance Sheet Balance Sheet IInventory nventory Slide 18 FIRST-IN, FIRST-OUT (FIFO) Cost of Goods Sold for August 31 = $ Cost of Goods Sold for August 31 = $ On August 31st,, there are 12 units in inventory at $ On August 31st there are 12 units in inventory at $ McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 19 FIRST-IN, FIRST-OUT (FIFO) Cost of Goods Sold for August 31 = $2,600 Cost of Goods Sold for August 31 = $2,600 On August 31st,, there are 12 units in inventory at $1,420 (2 @ $115 + 10 On August 31st there are 12 units in inventory at $1,420 (2 @ $115 + 10 @ $119). @ $119). McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 20 LAST-IN, FIRST-OUT (LIFO) Cost of Goods Sold for August 31 = $ Cost of Goods Sold for August 31 = $ On August 31st,, there are 12 units in inventory at $ On August 31st there are 12 units in inventory at $ McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 21 LAST-IN, FIRST-OUT (LIFO) Cost of Goods Sold for August 31 = Cost of Goods Sold for August 31 = $2,685 $2,685 On August 31st,, there are 12 units in inventory at $1,260: (5 @ $91 +,7 @ On August 31st there are 12 units in inventory at $1,260: (5 @ $91 +,7 @ $115). $115). McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 22 WEIGHTED AVERAGE Cost of Goods Sold for August 31 = $ Cost of Goods Sold for August 31 = $ After the August 31 sale, there are 12 units in inventory at $ After the August 31 sale, there are 12 units in inventory at $ McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 23 WEIGHTED AVERAGE Cost of Goods Sold for August 31 = $2,622 Cost of Goods Sold for August 31 = $2,622 After the August 31 sale, there are 12 units in inventory at $1,368: (12 @ After the August 31 sale, there are 12 units in inventory at $1,368: (12 @ $114) $114) McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 24 FINANCIAL STATEMENT EFFECTS OF COSTING METHODS Because prices change, inventory methods nearly always assign different cost amounts. McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 25 FINANCIAL STATEMENT EFFECTS OF COSTING METHODS Advantages of Methods Advantages of Methods Weighted Weighted Average Average First-In, First-In, First-Out First-Out Last-In, Last-In, First-Out First-Out Smoothes out Smoothes out price changes. price changes. Ending inventory Ending inventory approximates approximates current current replacement cost. replacement cost. Better matches Better matches current costs in cost current costs in cost off goods sold with o goods sold with revenues. revenues. McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 26 TAX EFFECTS OF COSTING METHODS The Internal Revenue Service (IRS) identifies several The acceptable methods for inventory costing for reporting taxable income. reporting If LIFO is used for ttax If LIFO is used for ax purposes,, the IRS requires purposes the IRS requires iitt be used in financial be used in financial statements. statements. McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 27 CONSISTENCY IN USING COSTING METHODS The consistency principle requires a consistency company to use the same accounting methods period after period so that financial statements are comparable across periods. statements McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 28 LOWER OF COST OR MARKET Requires the use of historical cost in accounting for inventory unless its market value has dropped below that cost. However, inventory should never be written up to market value if it exceeds cost. Lower-of-Cost-or-Market (LCM) shows accounting conservatism principle in action, i.e., all possible losses and costs should be recognized as soon as apparent, but gains should only be recognized when clearly realizable. McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 29 LOWER OF COST OR MARKET Inventory must be reported at market value Inventory when market is lower than cost. market lower than Defined as current Defined as current replacement cost replacement cost (not sales price). (not sales price). Consistent with Consistent with the conservatism the conservatism principle. principle. McGraw-Hill/Irwin McGraw-Hill/Irwin Can be applied three ways: Can be applied three ways: (1) (1) (2) (2) (3) (3) separately to each separately to each individual item. individual item. to major categories of to major categories of assets. assets. to the whole inventory. to the whole inventory. Slide 30 LOWER OF COST OR MARKET A motorsports retailer has the following items motorsports in inventory: in McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 31 LOWER OF COST OR MARKET McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 32 GAAP VERSUS. IFRS Use of the LIFO method is prohibited under IFRS. Under IFRS, if inventory that previously had been written down to market subsequently increases in value, the write-down is reversed. GAAP: Generally Accepted Accounting Principles IFRS: International Financial Reporting Standards McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 33 INVENTORY ERRORS: AN EXAMPLE Period 1 Period 2 Ending Inventory Beginning Inventory Overstated Overstated by 5,000 by 5,000 100,000 100,000 Sales Revenue Cost of goods sold Beginning inventory 10,000 Net purchases 50,000 Cost of goods available for sale 60,000 Ending inventory (15,000) Cost of goods sold 45,000 Gross profit 55,000 Period 3 Correct 100,000 15,000 50,000 10,000 50,000 65,000 (10,000) 60,000 (10,000) 55,000 45,000 50,000 50,000 te: The correct gross profit is 50,000 for each period McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 34 McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 35 INVENTORY TURNOVER Shows how many times a company turns over its inventory during a period. Indicator of how well management is controlling the amount of inventory available. Inventory Turnover Turnover Average Inventory McGraw-Hill/Irwin McGraw-Hill/Irwin = = Cost of goods sold Cost Avg. inventory Avg. (Beg. Inv. + End Inv.) ÷ 2 Slide 36 DAYS’ SALES IN INVENTORY Reveals how much inventory is available in Reveals how much inventory is available in terms of the number of days’ sales. terms of the number of days’ sales. Days' Sales in Days' Inventory Inventory McGraw-Hill/Irwin McGraw-Hill/Irwin = Ending Inventory Ending Cost of goods sold Cost × 365 Slide 37 END OF CHAPTER 6 McGraw-Hill/Irwin McGraw-Hill/Irwin Slide 38 ...
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This note was uploaded on 03/12/2012 for the course BUSI 1002 taught by Professor Liu during the Winter '10 term at HKU.

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