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![Page 1: 7/e PowerPoint Author: Catherine Lumbattis 5 COPYRIGHT © 2011 South-Western/Cengage Learning Inventories and Cost of Goods Sold.](https://reader036.fdocuments.us/reader036/viewer/2022062323/56649ec55503460f94bd02ad/html5/thumbnails/1.jpg)
7/e
PowerPoint Author: Catherine Lumbattis
5
COPYRIGHT © 2011 South-Western/Cengage Learning
Inventories and Cost of Goods
Sold
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Inventory of Wholesalers and Retailers
Purchased in finished formResold without transformationClassified as “Merchandise Inventory” on
balance sheet
LO1
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CURRENT ASSETS:Cash and cash equivalents $ 1,715 $ 1,724Short term investments ---- 177
Restricted cash 41 38Merchandise inventory 1,506 1,575Other 743 572TOTAL CURRENT ASSETS 4,005 4,086
Gap, Inc.Consolidated Balance Sheets
[Partial] January 31, February 2, 2009 2008ASSETS (in millions)
More than
1/3 of currentassets
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Inventory of Manufacturers
Manufacturingoverhead
Direct materials
Direct labor
Costs Included in Inventory
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Inventory of Manufacturers
Manufacturingoverhead
Direct materials
Direct labor
Manufactureproducts Work in
process
Finishedgoods
Raw materials
Costs Includedin Inventory
Balance SheetClassifications
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Current assets: Inventories: Raw materials $ 3,356
Work in progress 1,107Finished goods 4,022
Supplies 296 Total inventories $ 8,781
IBMConsolidated Balance Sheets
[Partial]
2008ASSETS (in millions)
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Condensed Income Statement for a Merchandiser
Net sales $100,000Cost of goods sold 60,000Gross profit $ 40,000Selling and administrative expenses 29,300Net income before tax $ 10,700Income tax expense 4,280
Net income $ 6,420
LO2
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Contra-Sales AccountsSales
normalcredit
balance
Sales Discounts
Sales AllowancesSales Returns
normaldebit
balance
normaldebit
balance
normaldebit
balance
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Credit Terms and Sales Discounts
n/30 Payment due 30 days from invoice
1/10, n/30 Deduct 1% of invoice amount if paid within 10 days; otherwise full
invoice amount is due in 30 days
2/10, n/30 Deduct 2% of invoice amount if paid within 10 days; otherwise full
invoice amount is due in 30 days
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Purchases of merchandise
Beginninginventory
The Cost of Goods Sold Model
Cost of goods
sold
=Goods Available
for Sale
Less: Ending inventory
LO3
+
=
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An increase in ending inventory means more was bought than sold
The Cost of Goods Sold ModelBeginning inventory $ 15,000
+ Cost of goods purchased 63,000= Cost of goods available for sale 78,000– Ending inventory (18,000)= Cost of goods sold $ 60,000
“Pool” of goodsavailable to sell
during the period
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Perpetual Inventory Systems
Point-of-sale terminals have improved the ability of mass merchandisers to maintain perpetual systems
Inventory records are updated after each purchase or sale
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Periodic Inventory Systems
Reduces record keeping but also decreases the ability to track theft, breakage, etc., and prepare interim financial statements
Inventory records are updated periodically based on physical
inventory counts
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Cost of Goods Purchased Cost of inventory purchased (invoice price):
Less:Purchase returns and allowancesPurchase discounts
Plus:Transportation-in
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Recording Purchases
Purchases 4,000 Accounts Payable 4,000
To record purchase of inventory on account
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Recording Purchase Returns
Accounts Payable 850Purchase Returns and Allowances 850
To record inventory returned to supplier
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Recording Purchase DiscountsAccounts Payable 500
Cash 495Purchase Discounts 5
To record payment within discount period to
supplier who offers 1% purchase discount.
($ 500 × 1% = $5 discount)
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FOB Destination Point
No sale or purchase until inventory reaches its destination
Seller responsible for inventory while in transit
Title passes at destination
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FOB Shipping Point
Both sale and purchase recorded upon shipment Buyer responsible for inventory while in transit
Title passes when shipped
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Recording Shipping Costs
Transportation-In 300 Cash 300
To record shipping costs on inventory purchased
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Analysis of Profitability
Gross Profit %
Of particular interest
to current and potentialinvestors
LO4
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Gross Profit Ratio = Gross Profit Net Sales
(How many cents on every $ of sales are left over after covering the cost of the product)
Daisy’s Profitability Net sales $100,000 Cost of goods sold 60,000 Gross profit $ 40,000
Gross profit ratio = 40%
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Inventory Valuation and Income Measurement
Value assigned toinventory on balance
sheet
Valueexpensedas cost of goods soldon incomestatement
When Sold =
LO5
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Inventory Costs IncludedAny freight costs incurred by buyerCost of insurance for inventory in transitCost of storing inventory before sellingExcise and sales taxes
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Inventory Costing Methods Four costing methods available:
SpecificIdentification
WeightedAverage
First-in, First-out(FIFO)
Last-in, First-out(LIFO)
LO6
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Beginning inventory, Jan. 1: 500 units (unit cost $10)
Inventory purchases:Date Units Unit Cost1/20 300 $ 114/8 400 129/5 200 1312/12 100 14Total purchases 1,000 units
Ending inventory, Dec. 31: 600 units
Detailed Costing Method Example
Calculate the Cost of Goods Sold and Ending Inventory under each cost
flow method
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Specific Identification Method
Step 1: Identify the specific units in inventory at the end of the year and their costs.
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Specific Identification Method Units in ending inventory:
Date purchased Units Cost Total Cost
1/20 100 $11 $ 1,100
4/8 300 12 3,600
9/5 200 13 2,600
Ending inventory 600 $ 7,300
Units × Cost = Total cost
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Specific Identification Method
Step 2: Identify the units sold and calculate the cost of goods
sold.
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Specific Identification Method Date purchased Units Cost Total Cost
Beg. inventory 500 $10 $5,000
1/20 200 11 2,200
4/8 100 12 1,200
12/12 100 14 1,400
Cost of goods sold 900 $9,800
Units × Cost = Total cost
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Weighted Average Method
Step 1: Calculate the cost of goods available for sale.
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Weighted Average Method Date purchased Units Cost Total cost
Beg. inventory 500 $10 $ 5,000
1/20 300 11 3,300
4/8 400 12 4,800
9/5 200 13 2,600
12/12 100 14 1,400 Cost of goods available for sale 1,500 $17,100
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Weighted Average Method
Step 2: Divide the cost of goods availablefor sale by the total units todetermine the weighted averagecost per unit.
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Weighted Average MethodCost of Goods Available for Sale
Units Available for Sale
$17,100 1,500 = $11.40/unit
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Weighted Average Method Step 3: Calculate ending inventory and
cost of goods sold by multiplying the weighted average cost per unit by the number of units in ending inventory and the number of units sold.
×Avg.Cost
# ofUnits
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Weighted Average Method ALLOCATE TO Ending Cost of Inventory Goods
SoldUnits on hand 600 Units sold 900Weighted average cost $11.40 $ 11.40
× Total cost of goods available of $17,100 allocated: $6,840 $10,260
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First-in, First-out (FIFO) Method
Step 1: Assign the cost of the beginning inventory to cost of goods sold.
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First-in, First-out (FIFO) Method ALLOCATE TO Ending Cost of
Units Cost Inventory Goods Sold
1/1 500 $10 $5,000
1/20 300 $11
4/8 400 $12
9/5 200 $13
12/12 100 $14
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First-in, First-out (FIFO) Method
Step 2: Continue to work forward until you assign the total number of units sold during the period to cost of goods sold. Allocate the remaining costs to ending inventory.
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First-in, First-out (FIFO) Method
ALLOCATE TO Ending Cost of
Units Cost Inventory Goods Sold
1/1 500 $10 $5,000
1/20 300 $11 3,300
4/8 300 / 100 $12 $3,600 1,200
9/5 200 $13 2,600
12/12 100 $14 1,400
TOTALS $7,600 $9,500
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Last-in, First-out (LIFO) Method
Step 1: Assign the cost of the last units purchased to cost of goods sold.
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Last-in, First-out (LIFO) Method ALLOCATE TO
Ending Cost ofUnits Cost Inventory Goods Sold
1/1 500 $10
1/20 300 $11
4/8 400 $12
9/5 200 $13
12/12 100 $14 $1,400
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Step 2: Work backwards until you assign the total number of units sold during the period to cost of goods sold (allocate the remaining costs to ending inventory).
Last-in, First-out (LIFO) Method
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Last-in, First-out (LIFO) Method
ALLOCATE TO Ending Cost of
Units Cost Inventory Goods Sold
1/1 500 $10 $5,000
1/20 100 /200 $11 1,100 $ 2,200
4/8 400 $12 4,800
9/5 200 $13 2,600
12/12 100 $14 1,400
TOTALS $6,100 $11,000
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Comparison of Costing Methods
Cost of GoodsSold
Ending Inventory
11,000
6,840
7,600
10,260
9,500
17,100
17,100
17,100
WeightedAverageFIFO
LIFO
Goods Available for Sale
6,100
Specific Identification $7,300 $ 9,800 $17,100
LO7
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Comparison of Costing Methods
X X X
X X
Weighted Average FIFO LIFO
In periods of rising prices: Highest cost of goods sold? Lowest cost of goods sold?Highest gross profit?Lowest net income?Lowest income taxes?
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LIFO Issues LIFO liquidation
• Liquidation can result in high gross profit (and large tax bill)
LIFO conformity rule• If used for tax, LIFO must also be used for books
LIFO reserve• Difference between inventory value stated at FIFO
and value stated at LIFO
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International Inventory Valuation Methods
Acceptable methods of costing inventory in the United States may not be acceptable in other countries
• LIFO is generally accepted in the United States• IASB (international standards) prohibit the use of LIFO
by companies that follow international standards It is uncertain whether LIFO will survive as an acceptable
inventory valuation method
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Reasons for Inventory Errors
Mathematical mistakesPhysical inventory counting errorsCutoff problems – in-transitGoods on consignment
LO8
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Effect of Inventory Errors on the Income Statement, 2010
Reported Corrected EffectSales $1,000 $1,000Beginning inventory $ 200 $ 200 Add: Purchases 700 700 Goods available for sale $ 900 $ 900 Less: Ending inventory 300 250 $50 OS Cost of goods sold $ 600 $ 650 50 US Gross margin $ 400 $ 350 50 OS Operating expenses 100 100 Net income $ 300 $ 250 50 OS
OS = overstatement
US = understatement
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Effect of Inventory Errors on the Income Statement, 2011
Reported Corrected EffectSales $1,500 $1,500Beginning inventory $ 300 $ 250 $50 OS Add: Purchases 1,100 1,100 Goods available for sale $1,400 $1,350 50 OS Less: Ending inventory 350 350Cost of goods sold $1,050 $1,000 50 OSGross margin $ 450 $ 500 50 USOperating expenses 120 120Net income $ 330 $ 380 50 US
OS = overstatement
US = understatement
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Counterbalancing ErrorsAssume ending inventory is overstated (+) by$50 in 2010:
2010 Beginning inventory xxxAdd: Purchases xxx = Goods available for sale xxx Less: Ending inventory +50 = Cost of goods sold –50
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Counterbalancing Errors2010 ending inventory becomes 2011 beginninginventory:
2010 2011Beginning inventory $xxx +50Add: Purchases xxx= Goods available for sale xxx Less: Ending inventory +50= Cost of goods sold –50
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Counterbalancing Errors
–50 +50
The 2010 error reverses in 2011 (but 2010 inventory both 2010 and 2011 profits are misstated by 50):
2010 2011Beginning inventory $xxx $+50Add: Purchases xxx xxx= Goods available for sale xxx +50Less: Ending inventory +50 xxx= Cost of goods sold
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Lower of Cost or Market Before After Price Price
Change Change
Cost $100 $ 85
Report loss in year
market falls below cost…
LO9
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Before After Price Price
Change ChangeSelling price $100 $ 80Cost 75 60Gross profit $ 25 $ 20
Lower of Cost or Market
Gross profit % 25% 25%
…to maintain
normal gross
profit % when
sold
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Market = replacement cost (not retail value) Cost determined under one of the costing methods Justified on basis of conservatism Can be applied to:
• Entire inventory• Individual items• Groups of items
Lower of Cost or Market
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Both U.S. GAAP and international financial reporting standards (IFRS) require lower-of-cost-or-market
Differences between U.S. GAAP and IFRS• How market value is defined • Recording changes in market value in
future periods
Lower of Cost or Marketunder International Standards
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Cost of Goods SoldAverage Inventory
Inventory Turnover Ratio
LO10
The number of times per period inventory is turned over (ie. sold)
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Number of Days’ Sales in Inventory
The average number of days inventory is on hand before its sold
Number of Days in the PeriodInventory Turnover Ratio
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Statement of Cash FlowsCash Flows from Operating Activities: Net income xxx Increase in inventory – Decrease in inventory + Increase in accounts payable + Decrease in accounts payable –
IndirectMethod
LO11
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AppendixAccounting Tools:
Inventory Costing Methods with the Use of a Perpetual Inventory System
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FIFO Costing with a Perpetual System
FIFO applied at
time of sale
Same FIFO inventory total under periodic and perpetual systems
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LIFO Costing with a Perpetual System
LIFO applied at
time of sale
Different LIFO inventory total under periodic and perpetual systems because of pricing gap
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Moving Average with a Perpetual System
Different inventory total under weighted average (periodic) and moving average (perpetual)
New weighted average
cost is computed for each
purchase
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End of Chapter 5