ACCOUNTING PRINCIPAL Ppt 06
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Transcript of ACCOUNTING PRINCIPAL Ppt 06
Accounting Accounting PrinciplesPrinciplesSecond Canadian EditionSecond Canadian Edition
Prepared by: Carole Bowman, Sheridan College
Weygandt · Kieso · Kimmel · Trenholm
In the balance sheet of merchandising and manufacturing companies, inventory is frequently the most significant current asset.
In the income statement, inventory is vital in determining the results of operations for a particular period.
Gross profit (net sales - cost of goods sold) is closely watched by management, owners, and other interested parties.
INVENTORY BASICSINVENTORY BASICS
Perpetual vs. PeriodicPerpetual vs. PeriodicInventory AccountingInventory Accounting
Perpetual – Updates inventory and cost of goods sold
after every purchase and sales transaction Periodic
– Delays updating of inventory and cost of goods sold until end of the period
– Misstates inventory during the period
This chapter covers the periodic inventory method.
In order to prepare financial statements, it is necessary to determine the number of units of inventory owned by the company at the statement date, and to value them.
The determination of inventory quantities involves 1. taking a physical inventory of goods on hand, and 2. determining the ownership of goods.
Taking a physical inventory involves counting, weighing, or measuring each kind of inventory on hand.
DETERMINING INVENTORY DETERMINING INVENTORY QUANTITIESQUANTITIES
TAKING A PHYSICAL INVENTORYTAKING A PHYSICAL INVENTORY
A company, in order to minimize errors in taking the inventory, should adhere to internal control principles by adopting the following procedures:1. Employees who do not have custodial
responsibility for the inventory should do the counting (segregation of duties).
2. Each counter should establish the authenticity of each inventory item
(establishment of responsibility).
TAKING A PHYSICAL INVENTORYTAKING A PHYSICAL INVENTORY
3. Another employee should make a second count (independent verification).
4. All inventory tags should be pre-numbered and accounted for (documentation procedures).
5. At the end of the count, a designated supervisor should ascertain that all inventory items are tagged and that no items have more than one tag (independent verification).
Seller
Buyer
PublicCarrier
Co.
Ownership passes to buyer here Ownership passes to buyer here
FOB Shipping Point FOB Destination Point
TERMS OF SALETERMS OF SALE
PublicCarrier
Co.
Buyer
Seller
Under a consignment arrangement, the holder of the goods (called the consignee) does not own the goods.
Ownership remains with the shipper of the goods (consignor) until the goods are actually sold to a customer.
Consigned goods should be included in the consignor’s inventory, not the consignee’s inventory.
Consignee Company
DETERMINING OWNERSHIP OF DETERMINING OWNERSHIP OF CONSIGNED GOODSCONSIGNED GOODS
Owned by a consignor; do not count in our (consignee) inventory
SALES TRANSACTIONSSALES TRANSACTIONS
J1Date Account Title and Explanation Ref Debit CreditMay 4 Accounts Receivable 3,800
Sales 3,800 To record credit sale.
General Journal
Only one entry is required to record a sale under a periodic method.
RECORDING SALES RETURNS RECORDING SALES RETURNS AND ALLOWANCESAND ALLOWANCES
The normal balance of Sales Returns and Allowances is a debit. Sales Returns and
Allowances is a contra revenue account to the Sales account.
J1Date Account Title and Explanation Ref Debit CreditMay 8 Sales Returns and Allowances 300
Accounts Receivable 300 To record returned goods.
General Journal
PURCHASES OF PURCHASES OF MERCHANDISEMERCHANDISE
For purchases on account, Purchases is debited and Accounts Payable is credited. For
cash purchases, Purchases is debited and Cash is credited.
J1Date Account Title and Explanation Ref Debit CreditMay 4 Purchases 3,800
Accounts Payable 3,800 To record goods purchased on account, terms n/30.
General Journal
J1Date Account Title and Explanation Ref Debit CreditMay 8 Accounts Payable 300
Purchase Returns and Allowances 300 To record return of goods
General Journal
PURCHASE RETURNS AND PURCHASE RETURNS AND ALLOWANCESALLOWANCES
For purchases returns and allowances that were originally made on account, Accounts Payable is debited and Purchase Returns and Allowances is credited. The Purchase Returns and Allowances
account is a contra account.
J1Date Account Title and Explanation Ref Debit CreditMay 4 Freight In 150
Cash 150 To record payment of freight.
General Journal
When the purchaser directly incurs the freight costs, the account Freight In is
debited and Cash is credited.
ACCOUNTING FOR FREIGHT COSTSACCOUNTING FOR FREIGHT COSTS
Sales revenueSales 480,000$ Less: Sales returns and allowances 20,000
Net sales 460,000$ Cost of goods sold
Inventory, January 1 36,000$ Purchases 325,000$ Less: Purchase returns and allowances 17,200 Net purchases 307,800$ Add: Freight in 12,200 Cost of goods purchased 320,000 Cost of goods available for sale 356,000$ Inventory, December 31 40,000
Cost of goods sold 316,000 Gross profit 144,000$ Operating expenses
Salaries expense 45,000$ Rent expense 19,000 Utilities expense 17,000 Advertising expense 16,000 Amortization expense 8,000 Freight out 7,000 Insurance expense 2,000
Total operating expenses 114,000 Net income 30,000$
For the Year Ended December 31, 2002
HIGHPOINT ELECTRONICSIncome Statement
The multi-step income statement under the periodic system requires more detail in the cost
of goods sold section, as shown above.
ALLOCATION OF ALLOCATION OF INVENTORIABLE COSTSINVENTORIABLE COSTS
Beginning Inventory
Goods Purchased during the
year
Cost of Goods Available for Sale
Ending Inventory (Balance
Sheet)
Cost of Goods Sold (Income
Statement)
USING ACTUAL PHYSICAL USING ACTUAL PHYSICAL FLOW COSTINGFLOW COSTING
The specific identification method tracks the actual physical flow of the goods.
Each item of inventory is marked, tagged, or coded with its specific unit cost.
It is most frequently used when the company sells a limited variety of high unit-cost items.
USING ASSUMED COST USING ASSUMED COST FLOW METHODSFLOW METHODS
Other cost flow methods are allowed since specific identification is often impractical.
These methods assume flows of costs that may be unrelated to the physical flow of goods.
Cost flow assumptions:1. First-in, first-out (FIFO).2. Average cost.3. Last-in, first-out (LIFO).
FIFOFIFO The FIFO method assumes that the earliest
goods purchased are the first to be sold. Often reflects the actual physical flow of
merchandise. Under FIFO, the costs of the earliest goods
purchased are the first to be recognized as cost of goods sold. The costs of the most recent goods purchased are recognized as the ending inventory.
AVERAGE COSTAVERAGE COST
The average cost method assumes that the goods available for sale are homogeneous.
The allocation of the cost of goods available for sale is made on the basis of the weighted average unit cost incurred.
The weighted average unit cost is then applied to the units sold to determine the cost of goods sold and to the units on hand to determine the ending inventory.
Allocation of the cost of goods available for sale in average cost method is made on the
basis of the weighted average unit cost
LIFO The LIFO method assumes that the latest
goods purchased are the first to be sold and that the earliest goods purchased remain in ending inventory.
Seldom coincides with the actual physical flow of inventory.
Under the periodic method, all goods purchased during the year are assumed to be available for the first sale, regardless of date of purchase.
Rarely used in Canada.
INCOME STATEMENT EFFECTSINCOME STATEMENT EFFECTS
In periods of rising prices, FIFO reports the highest net income, LIFO the lowest and average cost falls in the middle.
The reverse is true when prices are falling.
When prices are constant, all cost flow methods will yield the same results.
FIFO produces the best balance sheet
valuation since the inventory costs are closer
to their current, or replacement, costs.
BALANCE SHEET EFFECTSBALANCE SHEET EFFECTS
USING INVENTORY COST FLOW USING INVENTORY COST FLOW METHODS CONSISTENTLYMETHODS CONSISTENTLY
A company needs to use its chosen cost flow method consistently from one accounting period to another.
Such consistent application enhances the comparability of financial statements over successive time periods.
When a company adopts a different cost flow method, the change and its effects on net income should be disclosed in the financial statements.
Both beginning and ending inventories appear on the income statement.
The ending inventory of one period automatically becomes the beginning inventory of the next period.
Inventory errors affect the determination of cost of goods sold and net income.
INVENTORY ERRORS - INVENTORY ERRORS - INCOME STATEMENT EFFECTSINCOME STATEMENT EFFECTS
FORMULA FOR FORMULA FOR COST OF GOODS SOLDCOST OF GOODS SOLD
+ =BeginningInventory
Cost of Goods
Purchased
EndingInventory
Cost of GoodsSold
_
The effects on cost of goods sold can be determined by entering the incorrect data in the above formula and then substituting the correct data.
EFFECTS OF INVENTORY EFFECTS OF INVENTORY ERRORS ON CURRENT YEAR’S ERRORS ON CURRENT YEAR’S
INCOME STATEMENT INCOME STATEMENT
An error in ending inventory of the current periodwill have a reverse effect on net income of the next
accounting period.
Understate beginning inventory Understated OverstatedOverstate beginning inventory Overstated UnderstatedUnderstate ending inventory Overstated UnderstatedOverstate ending inventory Understated Overstated
The effect of ending inventory errors on the balance sheet can be determined by using the basic accounting equation: Assets = Liabilities + Owner’s Equity
ENDING INVENTORY ERROR – ENDING INVENTORY ERROR – BALANCE SHEET EFFECTSBALANCE SHEET EFFECTS
Overstated Overstated None Overstated Understated Understated None Understated
When the value of inventory is lower than the cost, the inventory is written down to its market value.
This is known as the lower of cost and market (LCM) method.
Market is defined as replacement cost or net realizable value.
VALUING INVENTORY AT THE VALUING INVENTORY AT THE LOWER OF COST AND MARKETLOWER OF COST AND MARKET
ILLUSTRATION ILLUSTRATION 6-206-20 ALTERNATIVE LOWER OF COST ALTERNATIVE LOWER OF COST AND MARKET (LCM) RESULTSAND MARKET (LCM) RESULTS
Cost Market LCMTelevision setsConsoles 60,000$ 55,000$ Portables 45,000 52,000 Total 105,000 107,000 Video equipmentRecorders 48,000 45,000 Movies 15,000 14,000 Total 63,000 59,000 Total inventory 168,000$ 166,000$ $ 166,000
The common practice is to use total inventory rather than individual items or major
categories in determining the LCM valuation.
COPYRIGHTCOPYRIGHT
Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.