Chapter 7 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Chapter 7 Reporting and...

© The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

Chapter 7

Reporting and Interpreting Cost of Goods Sold and Inventory


Business Background

Provides accurate information.

Provides accurate information.

Provides up-to-date information.

Provides up-to-date information.

Provides information to help protect assets. Provides information

to help protect assets.

Roles of the Accounting

System

Roles of the Accounting

System


Nature of Inventory and Cost of Goods Sold

BeginningInventory

BeginningInventory

Purchasesfor the PeriodPurchases

for the Period

Ending Inventory(Balance Sheet)

Ending Inventory(Balance Sheet)

Goods availablefor Sale

Goods availablefor Sale

Cost of Goods Sold(Income Statement)

Cost of Goods Sold(Income Statement)

Beginning inventory + Purchases – Ending inventory = Cost of goods soldBeginning inventory + Purchases – Ending inventory = Cost of goods sold


Flow of Inventory Costs

MerchandisePurchases

MerchandisePurchases

Cost ofGoods Sold

Cost ofGoods Sold

MerchandiseInventory

MerchandiseInventory

RawMaterials

RawMaterials

DirectLaborDirectLabor

FactoryOverheadFactory

Overhead

Raw MaterialsInventory

Raw MaterialsInventory

Work in ProcessInventory

Work in ProcessInventory

Finished GoodsInventory

Finished GoodsInventory

Cost ofGoods Sold

Cost ofGoods Sold

Merchandiser

Manufacturer


Inventory Cost

The cost principlecost principlerequires that inventory be

recorded at the price paid or the

consideration given up.


Inventory Cost

Include all costsincurred to bring

the asset to useable or saleable condition, such as:

Invoice priceFreight chargesInspection costsPreparation costs.


Errors in Measuring InventoryErrors in Measuring Inventory

Beginning Inventory Ending InventoryOverstated Understated Overstated Understated

Effect on Income StatementGoods Available for Sale + - N/A N/ACost of Goods Sold + - - +Gross Profit - + + -Net Income - + + -Effect on Balance SheetInventory (12/31) N/A N/A + -Retained Earnings - + + -


Question

If the 2000 ending inventory is understated by $3,000, which of the

following is true for 2000?

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.











QuestionErrors in Measuring Inventory

Ending InventoryOverstated Understated

Effect on Income StatementGoods Available for Sale N/A N/ACost of Goods Sold - +Gross Profit + -Net Income + -Effect on Balance SheetInventory (12/31) + -Retained Earnings + -


Question



a. Beginning Inventory was understated.b. Cost of Goods Sold will be understated.c. Gross Profit will be overstated.d. All of the above.











Question

Errors in Measuring InventoryBeginning Inventory

Overstated UnderstatedEffect on Income StatementGoods Available for Sale + -Cost of Goods Sold + -Gross Profit - +Net Income - +Effect on Balance SheetInventory (12/31) N/A N/ARetained Earnings - +

Remember: The ending inventory for 2000 becomes the beginning inventory for 2001.


Inventory Costing Methods

FIFO LIFO

Weighted Average

Specific Identification


Applying the Four Methods

Total Dollar Amount of Goods Available for Sale

Total Dollar Amount of Goods Available for Sale

Ending InventoryEnding Inventory Cost of Goods SoldCost of Goods Sold


First-In, First-Out

Costs of Goods Sold

Costs of Goods SoldOldest CostsOldest Costs

Ending InventoryEnding

InventoryRecent CostsRecent Costs


First-In, First-Out

The schedule on the next screen shows the mouse pad inventory for Computers, Inc.

The physical inventory count shows 1,200 mouse pads in ending inventory.

Use the FIFO inventory method to determine:

(1) Ending inventory cost.

(2) Cost of goods sold.



Use the FIFO inventory method to determine:




First-In, First-OutC o m p u t e r s , In c .

M o u s e P a d In v e n t o r yD a t e U n it s $ /U n it T o t a l

B e g in n in g In v e n t o r y 1 ,0 0 0 5 .2 5$ 5 ,2 5 0 .0 0$ P u r c h a s e s :J a n . 3 3 0 0 5 .3 0 1 ,5 9 0 .0 0 J u n e 2 0 1 5 0 5 .6 0 8 4 0 .0 0 S e p t . 1 5 2 0 0 5 .8 0 1 ,1 6 0 .0 0 N o v . 2 9 1 5 0 5 .9 0 8 8 5 .0 0 G o o d s A v a ila b le f o r S a le 1 ,8 0 0 9 ,7 2 5 .0 0$

E n d in g In v e n t o r y 1 2 0 0 ?

C o s t o f G o o d s S o ld 6 0 0 ?

Remember:The costs of most recent

purchases are in ending inventory. Start with

11/29 and add units

purchased until you reach the number in

ending inventory.


First-In, First-Out

Date Beg. Inv. Purchases End. Inv.Cost of

Goods Sold

Nov. 29 150@$5.90 150@$5.90Units 150



Goods Sold

Sept. 15 200@$5.80 200@$5.80Nov. 29 150@$5.90 150@$5.90Units 350

First-In, First-Out



Goods Sold

June 20 150@$5.60 150@$5.60Sept. 15 200@$5.80 200@$5.80Nov. 29 150@$5.90 150@$5.90Units 500

First-In, First-Out



Goods Sold

Jan. 3 300@$5.30 300@$5.30June 20 150@$5.60 150@$5.60Sept. 15 200@$5.80 200@$5.80Nov. 29 150@$5.90 150@$5.90Units 800

First-In, First-Out



Goods Sold1,000@$5.25 600@$5.25

400@$5.25Jan. 3 300@$5.30 300@$5.30June 20 150@$5.60 150@$5.60Sept. 15 200@$5.80 200@$5.80Nov. 29 150@$5.90 150@$5.90Units 1,200 600

First-In, First-Out

Now, we have allocated the cost to all 1,200

units in ending inventory.





Goods Sold1,000@$5.25 600@$5.25

400@$5.25Jan. 3 300@$5.30 300@$5.30June 20 150@$5.60 150@$5.60Sept. 15 200@$5.80 200@$5.80Nov. 29 150@$5.90 150@$5.90Units 1,200 600

Costs $6,575 $3,150

Cost of Goods Available for Sale $9,725

First-In, First-Out


ANY QUESTIONS BEFORE WE

DISCUSS LIFO?


Last-In, First-Out

??

??

Oldest CostsOldest Costs

Recent CostsRecent Costs


Last-In, First-Out

Ending InventoryEnding

Inventory

Cost of Goods Sold

Cost of Goods Sold

Oldest CostsOldest Costs

Recent CostsRecent Costs


Last-In, First-Out



Use the LIFO inventory method to determine:





Use the LIFO inventory method to determine:




Last-In, First-OutC o m p u te r s , In c .

M o u s e P a d In v e n to r yD a te U n its $ /U n it T o ta l

B e g in n in g In v e n t o r y 1 ,0 0 0 5 .2 5$ 5 ,2 5 0 .0 0$ P u r c h a s e s :J a n . 3 3 0 0 5 .3 0 1 ,5 9 0 .0 0 J u n e 2 0 1 5 0 5 .6 0 8 4 0 .0 0 S e p t . 1 5 2 0 0 5 .8 0 1 ,1 6 0 .0 0 N o v . 2 9 1 5 0 5 .9 0 8 8 5 .0 0 G o o d s Av a ila b le fo r S a le 1 ,8 0 0 9 ,7 2 5 .0 0$



Remember:The costs of

the oldestpurchases are

in ending inventory. Start with beginning inventory and

add units purchased until you reach the

number in ending

inventory.



Goods Sold1,000@$5.25 1,000@$5.25

Units 1,000

Last-In, First-Out



Goods Sold1,000@$5.25 1,000@$5.25

Jan. 3 300@$5.30 200@$5.30

Units 1,200

Last-In, First-Out







Goods Sold1,000@$5.25 1,000@$5.25

Jan. 3 300@$5.30 200@$5.30100@$5.30

Units 1,200 100

Last-In, First-Out



Goods Sold1,000@$5.25 1,000@$5.25

Jan. 3 300@$5.30 200@$5.30100@$5.30

June 20 150@$5.60 150@$5.60Sept. 15 200@$5.80 200@$5.80Nov. 29 150@$5.90 150@$5.90Units 1,200 600

Costs $6,310 $3,415

Cost of Goods Available for Sale $9,725

Last-In, First-Out


Now let’s move on to the weighted-average inventory costing method.

Weighted-Average


Weighted-Average

Weighted-average cost (WAC) per unitCost of goods available for sale

Number of units available for sale

Ending InventoryUnits in Ending Inventory × WAC per Unit

Cost of Good SoldUnits Sold × WAC per Unit

Weighted-average cost (WAC) per unitCost of goods available for sale

Number of units available for sale

Ending InventoryUnits in Ending Inventory × WAC per Unit

Cost of Good SoldUnits Sold × WAC per Unit


Weighted-Average



Use the weighted-average inventory method to determine:





Use the weighted-average inventory method to determine:




Weighted-AverageC o m p u t e r s , In c .

M o u s e P a d In v e n t o r yD a t e U n it s $ /U n it T o t a l

B e g in n in g In v e n t o r y 1 ,0 0 0 5 .2 5$ 5 ,2 5 0 .0 0$ P u r c h a s e s :J a n . 3 3 0 0 5 .3 0 1 ,5 9 0 .0 0 J u n e 2 0 1 5 0 5 .6 0 8 4 0 .0 0 S e p t . 1 5 2 0 0 5 .8 0 1 ,1 6 0 .0 0 N o v . 2 9 1 5 0 5 .9 0 8 8 5 .0 0 G o o d s A v a i la b le f o r S a le 1 ,8 0 0 9 ,7 2 5 .0 0$




Weighted-Average

Weighted-Average Cost per Unit:$9,7251,800

Ending Inventory:

1,200 Units × $5.40278 = $6,483*

Cost of Goods Sold:

600 Units × $5.40278 = $3,242*

* Rounded

Weighted-Average Cost per Unit:$9,7251,800

Ending Inventory:

1,200 Units × $5.40278 = $6,483*

Cost of Goods Sold:

600 Units × $5.40278 = $3,242*

* Rounded

= $5.40278


Specific Identification

• Specific cost of each inventory item is known.

• Used with small volume, high dollar inventory.

• Specific cost of each inventory item is known.

• Used with small volume, high dollar inventory.


Comparison of MethodsComputers, Inc.

Income StatementFor Year Ended December 31, 2001

Weighted Average FIFO LIFO

Net sales 25,000$ 25,000$ 25,000$ Cost of goods sold:Merchandise inventory, 12/31/98 5,250$ 5,250$ 5,250$ Net purchases 4,475 4,475 4,475 Goods available for sale 9,725$ 9,725$ 9,725$ Merchandise inventory, 12/31/99 6,483 6,575 6,310 Cost of goods sold 3,242$ 3,150$ 3,415$ Gross profit from sales 21,758$ 21,850$ 21,585$ Operating expenses: 750 750 750 Income before taxes 21,008$ 21,100$ 20,835$ Income taxes expense (30%) 6,302 6,330 6,251 Net income 14,706$ 14,770$ 14,585$

* Tax expense amounts were rounded.







In periods of rising prices, FIFO results in the highest ending

inventory, gross profit, tax expense, and net income, and the lowest cost

of goods sold.

In periods of rising prices, FIFO results in the highest ending

inventory, gross profit, tax expense, and net income, and the lowest cost

of goods sold.







In periods of rising prices, LIFO results in the lowest ending inventory, gross profit, tax expense, and net income, and the highest cost of goods sold.

In periods of rising prices, LIFO results in the lowest ending inventory, gross profit, tax expense, and net income, and the highest cost of goods sold.


Choosing Inventory Costing Methods

54% of firms in a study used LIFO for some

portion of inventories.

54% of firms in a study used LIFO for some

portion of inventories.

Only 17% of firms used LIFO for all inventories.Only 17% of firms used LIFO for all inventories.


Choosing Inventory Costing Methods

LIFO for books

LIFO for taxes

If . . . Then . . .LIFO Conformity

Rule


Lower of Cost or Market

Ending inventory is reported at the lower of cost or market (LCM).

Ending inventory is reported at the lower of cost or market (LCM).

Net Realizable ValueThe expected sales price

less selling costs.

Net Realizable ValueThe expected sales price

less selling costs.

Replacement CostThe current purchase

price of identical goods.

Replacement CostThe current purchase

price of identical goods.

Market is either . . .

or


Perpetual and Periodic Inventory Systems

Provides up-to-date inventory records.

Provides up-to-date inventory records.

Provides up-to-date CGS records.

Provides up-to-date CGS records.

Perpetual System

Perpetual System


Comparison of Perpetual and Periodic Systems

Source of InformationModel Periodic System Perpetual System

Beginning Inventory Carried over from prior period

Carried over from prior period

Add: PurchasesAccumulated in the Purchases

account

Accumulated in the Inventory

account

Less: Ending Inventory

Measured at end of period by

physical inventory count

Perpetual record updated at every

sale

Cost of Goods Sold

Computed as a residual amount at end of period

Measured at every sale based

on perpetual record


Now, let’s compare the

various entries that are made

when using the periodic and

perpetual inventory systems.

Now, let’s compare the

various entries that are made

when using the periodic and

perpetual inventory systems.

Comparison of Perpetual and Periodic Systems


Transaction Periodic PerpetualMerchandise purchased from supplier on account. Purchases XX Inventory XX

Accounts Payable XX Accounts Payable XXMerchandise returned to supplier. Accounts Payable XX Accounts Payable XX

Purchases Returns & Allow. XX Inventory XXMerchandise sold to customer on account. Accounts Receivable XX Accounts Receivable XX

Sales XX Sales XX

Cost of Goods Sold XX Inventory XX

Purchases Returns and Allowances is subtracted from Purchases on the income

statement.

Purchases Returns and Allowances is subtracted from Purchases on the income

statement.

Comparison of Periodic and Perpetual Systems


Transaction Periodic PerpetualMerchandise purchased from supplier on account. Purchases XX Inventory XX

Accounts Payable XX Accounts Payable XXMerchandise returned to supplier. Accounts Payable XX Accounts Payable XX

Purchases Returns & Allow. XX Inventory XXMerchandise sold to customer on account. Accounts Receivable XX Accounts Receivable XX

Sales XX Sales XX

Cost of Goods Sold XX Inventory XX


This entry is recorded at retail.

This entry is recorded at cost.


Transaction Periodic PerpetualMerchandise returned by customer. Sales Returns and Allow. XX Sales Returns and Allow. XX

Accounts Receivable XX Accounts Receivable XX

Inventory XX Cost of Goods Sold XXThis is recorded at

retail.

This entry is recorded at cost.



Transaction Periodic PerpetualMerchandise returned by customer. Sales Returns and Allow. XX Sales Returns and Allow. XX

Accounts Receivable XX Accounts Receivable XX

Inventory XX Cost of Goods Sold XX

At end of accounting period. Cost of Goods Sold XX No entry.

Inventory (beginning) XX Purchases XX

Inventory (ending) XX Cost of Goods Sold XX



Methods for Estimating Inventory

I use the periodicinventory method.Can you help me

estimate inventory?

I sure can, if you can give

me some information.



I know sales,beginning inventory,

purchases, and my gross margin

is 30%.

Let’s constructan income

statement using your gross

margin.



Sales 100%Cost of goods sold 70%Gross margin 30%

You told me that your sales are $200,000, beginning inventory is $4,500, and purchases are $150,000, so your income statement looks like this . . .

Sales 200,000$ Beginning inventory 4,500$ Purchases 150,000 Goods available for sale 154,500 Ending inventory ?Cost of goods sold 140,000 Gross margin 60,000$



Estimated ending inventory must be $14,500 ($154,500 - $140,000).

Sales 200,000$ Beginning inventory 4,500$ Purchases 150,000 Goods available for sale 154,500 Ending inventory 14,500 Cost of goods sold 140,000 Gross margin 60,000$


The End of Chapter 7

Chapter 7 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Chapter 7 Reporting and...

Documents

Transcript of Chapter 7 · Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Chapter 7 Reporting and...