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This document discusses inventory costing and cost of goods sold. It provides examples of how to calculate inventory and cost of goods sold using different costing methods like FIFO, LIFO, and weighted average. FIFO assigns the oldest costs to cost of goods sold and most recent costs to ending inventory. LIFO does the opposite by assigning most recent costs to cost of goods sold. Weighted average assigns an average unit cost. The choice of method affects reported income and taxes. Inventory is also reported at the lower of cost or market value. Managers may choose methods to maximize reported income and minimize taxes within GAAP.
chapter_07.ppt
- 1. Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Reporting and Interpreting Cost of Goods Sold and Inventory Chapter 7
- 2. 7-2 Understanding the Business Provide sufficient quantities of high- quality inventory. Minimize the costs of carrying inventory. Primary Goals of Inventory Management
- 3. 7-3 Learning Objectives Apply the cost principle to identify the amounts that should be included in inventory and the matching principle to determine cost of goods sold for typical retailers, wholesalers, and manufacturers.
- 4. 7-4 Items Included in Inventory Inventory Tangible Held for Sale Used to Produce Goods or Services Merchandise Inventory Raw Materials Inventory Work in Process Inventory Finished Goods Inventory
- 5. 7-5 Costs Included in Inventory Purchases The cost principle requires that inventory be recorded at the price paid or the consideration given. Invoice Price Freight Inspection Costs Preparation Costs
- 6. 7-6 Flow of Inventory Costs Merchandise Purchases Cost of Goods Sold Merchandise Inventory Merchandiser Raw Materials Raw Materials Inventory Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Manufacturer Direct Labor Factory Overhead
- 7. 7-7 Nature of Cost of Goods Sold Beginning Inventory Purchases for the Period Ending Inventory (Balance Sheet) Goods available for Sale Cost of Goods Sold (Income Statement) Beginning inventory + Purchases = Goods Available for Sale Goods Available for Sale – Ending inventory = Cost of goods sold
- 8. 7-8 Learning Objectives Report inventory and cost of goods sold using the four inventory costing methods.
- 9. 7-9 Inventory Costing Methods Specific Identification FIFO LIFO Weighted Average
- 10. 7-10 Inventory Costing Methods Total Dollar Amount of Goods Available for Sale Ending Inventory Cost of Goods Sold Inventory Costing Method
- 11. 7-11 Specific Identification When units are sold, the specific cost of the unit sold is added to cost of goods sold.
- 12. 7-12 Cost Flow Assumptions The choice of an inventory costing method is not based on the physical flow of goods on and off the shelves.
- 13. 7-13 First-In, First-Out Method Cost of Goods Sold Oldest Costs Ending Inventory Recent Costs
- 14. 7-14 First-In, First-Out 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. Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25 $ 5,250.00 $ Purchases: Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00 $ Ending Inventory 1,200 ? Cost of Goods Sold 1,050 ?
- 15. 7-15 First-In, First-Out Beg. Inv. 1,000 @ 5.25 $ Jan. 3 500 @ 5.30 June 20 300 @ 5.60 Sept. 15 250 @ 5.80 Nov. 29 200 @ 5.90 200 @ $5.90 200 Units Units Ending Inventory Cost of Goods Sold Given Information
- 16. 7-16 First-In, First-Out Now, we have allocated the cost to all 1,200 units in ending inventory. Beg. Inv. 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 Units 6,695 $ Cost Ending Inventory Cost of Goods Sold Given Information
- 17. 7-17 First-In, First-Out Now, we have allocated the cost to all 1,050 units sold. Beg. Inv. 1,000 @ 5.25 $ 1,000 @ 5.25 $ Jan. 3 500 @ 5.30 450 @ $5.30 50 @ 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 1,050 Units 6,695 $ Cost 5,515 $ Cost Ending Inventory Cost of Goods Sold Given Information
- 18. 7-18 First-In, First-Out Here is the cost of ending inventory and cost of goods sold using FIFO. Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25 $ 5,250.00 $ Purchases: Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00 $ Ending Inventory 1,200 6,695.00 $ Cost of Goods Sold 1,050 5,515.00 $
- 19. 7-19 Last-In, First-Out Method Ending Inventory Cost of Goods Sold Oldest Costs Recent Costs
- 20. 7-20 Last-In, First-Out 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. Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25 $ 5,250.00 $ Purchases: Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00 $ Ending Inventory 1,200 ? Cost of Goods Sold 1,050 ?
- 21. 7-21 Last-In, First-Out Beg. Inv. 1,000 @ 5.25 $ 1,000 @ $5.25 Jan. 3 500 @ 5.30 June 20 300 @ 5.60 Sept. 15 250 @ 5.80 Nov. 29 200 @ 5.90 1,000 Units Units Ending Inventory Cost of Goods Sold Given Information
- 22. 7-22 Last-In, First-Out Now, we have allocated the cost to all 1,200 units in ending inventory. Beg. Inv. 1,000 @ 5.25 $ 1,000 @ $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 Units 6,310 $ Cost Ending Inventory Cost of Goods Sold Given Information
- 23. 7-23 Last-In, First-Out Now, we have allocated the cost to all 1,050 units sold. Beg. Inv. 1,000 @ 5.25 $ 1,000 @ $5.25 Jan. 3 500 @ 5.30 200 @ 5.30 300 @ 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 1,050 Units 6,310 $ Cost 5,900 $ Cost Ending Inventory Cost of Goods Sold Given Information
- 24. 7-24 Last-In, First-Out Here is the cost of ending inventory and cost of goods sold using LIFO. Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25 $ 5,250.00 $ Purchases: Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00 $ Ending Inventory 1,200 6,310.00 $ Cost of Goods Sold 1,050 5,900.00 $
- 25. 7-25 Average Cost Method When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. Cost of Goods Available for Sale Number of Units Available for Sale ÷
- 26. 7-26 Average Cost Method 12,210 $ 2,250 = $5.42667 Weighted Average Cost Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25 $ 5,250.00 $ Purchases: Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00 $ Ending Inventory 1,200 Cost of Goods Sold 1,050
- 27. 7-27 Average Cost Method Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25 $ 5,250.00 $ Purchases: Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00 $ Ending Inventory 1,200 6,512.00 $ Cost of Goods Sold 1,050 5,698.00 $ 12,210 $ 2,250 = $5.42667 Weighted Average Cost 1,200 × 5.42667 $ 1,050 × 5.42667 $
- 28. 7-28 Comparison of Methods FIFO LIFO Weighted Average Net sales 25,000 $ 25,000 $ 25,000 $ Cost of goods sold: Merchandise inventory, beginning 5,250 $ 5,250 $ 5,250 $ Net purchases 6,960 6,960 6,960 Goods available for sale 12,210 $ 12,210 $ 12,210 $ Merchandise inventory, ending 6,695 6,310 6,512 Cost of goods sold 5,515 $ 5,900 $ 5,698 $ Gross profit 19,485 $ 19,100 $ 19,302 $ Operating expenses 750 750 750 Income before taxes 18,735 $ 18,350 $ 18,552 $ Income taxes expense (30%)* 5,621 5,505 5,566 Net income 13,114 $ 12,845 $ 12,986 $ * Tax expense amounts were rounded. Computers, Inc. Income Statement For Year Ended December 31, 2006
- 29. 7-29 Financial Statement Effects of Costing Methods Advantages of Methods Better matches current costs in cost of goods sold with revenues. Ending inventory approximates current replacement cost. First-In, First-Out Last-In, First-Out Smoothes out price changes. Weighted Average
- 30. 7-30 Learning Objectives Decide when the use of different inventory costing methods is beneficial to a company.
- 31. 7-31 Managers Choice of Inventory Methods 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.
- 32. 7-32 Choosing Inventory Costing Methods LIFO for books LIFO for taxes If . . . Then . . . LIFO Conformity Rule
- 33. 7-33 Learning Objectives Report inventory at the lower of cost or market (LCM).
- 34. 7-34 Valuation at Lower of Cost or Market Ending inventory is reported at the lower of cost or market (LCM). Replacement Cost The current purchase price for identical goods. The company will recognize a “holding” loss in the current period rather than the period in which the item is sold. This practice is conservative.
- 35. 7-35 Valuation at Lower of Cost or Market Item Quantity Cost Replacement Cost LCM Total LCM Pentium chips 1,000 250 $ 200 $ 200 $ 200,000 $ Disk drives 400 100 110 100 40,000 Debit Credit Cost of goods sold 50,000 Inventory 50,000 Date Description GENERAL JOURNAL
- 36. 7-36 Learning Objectives Evaluate inventory management using the inventory turnover ratio and the effects of inventory on cash flows.
- 37. 7-37 Inventory Turnover Cost of Goods Sold = Average Inventory Inventory Turnover 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.
- 38. 7-38 Inventory and Cash Flows Add Subtract Cash Payment to Suppliers Cost of Goods Sold Increase in Inventory Decrease in Accounts Payable Decrease in Inventory Increase in Accounts Payable
- 39. 7-39 Learning Objectives Compare companies that use different inventory costing methods.
- 40. 7-40 Inventory Methods and Financial Statement Analysis Beginning LIFO Reserve - Ending LIFO Reserve Difference in COGS Under FIFO Beginning inventory FIFO - Beginning inventory LIFO Beginning LIFO Reserve (Excess of FIFO over LIFO) Ending inventory FIFO - Ending inventory LIFO Ending LIFO Reserve (Excess of FIFO over LIFO) U.S. public companies using LIFO also report beginning and ending inventory on a FIFO basis if the FIFO values are materially different.
- 41. 7-41 LIFO and International Comparisons LIFO Permitted? Yes No China Singapore Canada Great Britain Australia
- 42. 7-42 Learning Objectives Understand methods for controlling and keeping track of inventory and analyze the effects of inventory errors on financial statements.
- 43. 7-43 Internal Control of Inventory Separation of inventory accounting and physical handling of inventory. Storage in a manner that protects from theft and damage. Limiting access to authorized employees. Maintaining perpetual inventory records. Comparing perpetual records to periodic physical counts.
- 44. 7-44 Perpetual and Periodic Inventory Systems Provides up-to-date inventory records. Provides up-to-date cost of sales records. Perpetual System In a periodic inventory system, ending inventory and cost of goods sold are determined at the end of the accounting period based on a physical count.
- 45. 7-45 Perpetual and Periodic Inventory Systems Inventory System Item Periodic System Perpetual System Beginning Inventory Carried over from prior period Carried over from prior period Add: Purchases Accumulated 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
- 46. 7-46 Errors in Measuring Ending Inventory Errors in Measuring Inventory Ending Inventory Beginning Inventory Overstated Understated Overstated Understated Ending Inventory + - N/A N/A Retained Earnings + - - + Goods Available for Sale N/A N/A + - Cost of Goods Sold - + + - Gross Profit + - - + Net Income + - - + Effect on Current Period's Balance Sheet Effect on n Current Period's Income Statement
- 48. 7-48 LIFO Liquidations When a LIFO company sells more inventory than it purchases or manufactures, items from beginning inventory become part of cost of goods sold. This is called a LIFO liquidation. When inventory costs are rising, these lower cost items in beginning inventory produce a higher gross profit, higher taxable income, and higher taxes when they are sold.
- 49. 7-49 LIFO Liquidations Companies must disclose the effects of LIFO liquidations in the notes when they are material. Many companies avoid LIFO liquidations and the accompanying increase in tax expense by purchasing sufficient quantities of inventory at year-end to ensure that ending inventory quantities are greater than or equal to beginning inventory quantities.
- 50. 7-50 Additional Issues in Measuring Purchases Chapter Supplement B
- 51. 7-51 Purchase Returns and Allowances Purchase returns and allowances are a reduction in the cost of purchases associated with unsatisfactory goods. Returned goods require a reduction in the cost of inventory purchases and the recording of a cash refund or a reduction in the liability to the vendor.
- 52. 7-52 Purchase Discounts Terms Time Due Discount Period Full amount less discount Credit Period Full amount due Purchase or Sale A purchase discount is a cash discount received for prompt payment of an account.
- 53. 7-53 2/10,n/30 Purchase Discounts Discount Percent Number of Days Discount Is Available Otherwise, Net (or All) Is Due Credit Period
- 54. 7-54 Purchase Discounts Purchases paid for within the discount period reduce the Inventory account for the amount of the cash discount received.
- 55. 7-55 Chapter Supplement C Comparison of Perpetual and Periodic Inventory Systems
- 56. 7-56 Perpetual Inventory System Jan. 1 Apr. 14 Purchased 1,100 units at a unit cost of $50. Inventory 55,000 Accounts payable 55,000 Nov. 30 Sold 1,300 units at a sales price of $83. Accounts receivable 107,900 Sales revenue 107,900 Cost of goods sold 65,000 Inventory 65,000 Dec. 31 Use cost of goods sold and inventory amounts. Had beginning inventory of 800 units at a unit cost of $50.
- 57. 7-57 Periodic Inventory System Jan. 1 Apr. 14 Purchased 1,100 units at a unit cost of $50. Purchases 55,000 Accounts payable 55,000 Nov. 30 Sold 1,300 units at a sales price of $83. Accounts receivable 107,900 Sales revenue 107,900 Dec. 31 Count the number of units on hand. Compute the dollar valuation of the ending inventory. Compute and record the cost of goods sold. Cost of goods sold 95,000 Inventory (beginning) 40,000 Purchases 55,000 Inventory (ending) 30,000 Cost of goods sold 30,000 Had beginning inventory of 800 units at a unit cost of $50.
- 58. 7-58 End of Chapter 7