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Financial Accounting: Tools for Business Decision Making

ELS. Financial Accounting: Tools for Business Decision Making. Kimmel, Weygandt, Kieso. 1. Chapter 6 Reporting and Analyzing Inventory. After studying Chapter 6, you should be able to: Explain the recording of purchases and sales of inventory under a periodic inventory system.

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Financial Accounting: Tools for Business Decision Making

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  1. ELS Financial Accounting:Tools for Business Decision Making Kimmel, Weygandt, Kieso 1

  2. Chapter 6Reporting and Analyzing Inventory After studying Chapter 6, you should be able to: • Explain the recording of purchases and sales of inventory under a periodic inventory system. • Explain how to determine cost of goods sold under a periodic inventory system. • Describe the steps in determining inventory quantities. • Identify the unique features of the income statement for a merchandising company under a periodic inventory system. 3

  3. Chapter 6Reporting and Analyzing Inventory After studying Chapter 6, you should be able to: • Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. • Explain the financial statement and tax effects of each of the inventory cost flow assumptions. • Explain the lower of cost or market basis of accounting for inventories. • Compute and interpret the inventory turnover ratio. • Describe the LIFO reserve and explain its importance for comparing results of different companies. 4

  4. Merchandise Inventory • owned by the company • in form ready to sale to customers 5

  5. Manufacturing Inventory • Finished goods inventory • Work in process • Raw materials 6

  6. Finished Goods Inventory Manufactured items that are complete and ready for sale. 7

  7. Work in Process Manufactured inventory that has been placed into production but is not yet complete. 8

  8. Raw Materials The basic goods that will be used in production, but have not been placed in production. 9

  9. Key difference between periodic and perpetual inventory… is the point at which the costs of goods sold is computed.

  10. No attempt is made on date of sale to record the cost of merchandise sold... • Cost of merchandise on hand; • Cost of goods sold. A physical count of inventory is taken at end of period to determine:

  11. Page 204 in the book Comparing Periodic and Perpetual Inventory Systems End of Period Inventory Purchased Item Sold Point of Sale Perpetual Perpetual Cost of Goods Sold Computed Inventory Purchased End of Period Item Sold Point of Sale Periodic Cost of Goods Sold Computed

  12. Businesses that use the periodic method generally do not have sophisticated computer systems required to compute cost of goods sold when sale is made.

  13. Merchandise Purchases On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc. Task:Record the purchase by getting information from the Purchase Invoice. The Purchase Invoice is just a copy of the sales invoice. 14

  14. Invoice No. 731 Firm Name: Sauk Stero City Chelsea State Illinois Zip 60915 • 1. Seller • 2.Invoice Date • 3.Purchaser • 4.Salesperson • 5.Credit terms • 6.Freight terms • 7.Goods sold: catalog no.,description,quantity, price per unit • 8.Total invoice price Page 206 in book Attention o f James Hoover, Purchasing Agent Address 125 Main Street Date 8/4/98 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer Catalog No. Description QTY Price Amount 15

  15. Purchase Returns & All. Purchase Discounts Purchases Merchandise Purchases-Periodic On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc. May 4 3800 Accounts Payable Freight-In Cash May 4 3,800

  16. Purchase Returns & All. Purchase Discounts Purchases Purchases Returns and Allowances - Periodic On May 8 the company returned $300 worth of merchandise to PW Audio Supply, Inc. May 4 3800 May 8 300 Accounts Payable Freight-In Cash May 8 300 May 4 3,800

  17. Freight Costs - On Incoming Inventory 18

  18. Freight - In Periodic On May 9 the company paid $ 150 to have the merchandise inventory delivered to them. Purchase Returns & All. Purchase Discounts Purchases May 4 3800 May 8 300 Accounts Payable Freight-In Cash May 9 150 May 9 150 May 8 300 May 4 3,800

  19. Purchase Discounts • Credit terms of a purchase on account may permit the buyer to claim a cash discount for prompt payment. • Credit terms specify the amount of cash discounts and the time period during which it is offered. • 2/10,n/30 • 1/10 EOM 20

  20. Purchase Returns & All. Purchase Discounts Purchases May 4 3800 May 8 300 Accounts Payable Freight-In Cash May 9 150 May 9 150 May 8 300 May 4 3,800 Purchase Discounts On May 14, the company pays the balance due on the account within the discount period

  21. Purchases Discounts Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period. Original Invoice $3,800 -Returns 300 Amount due before discount $3,500 2% discount 70 Net due $3,430

  22. Purchase Returns & All. Purchase Discounts Purchases May 14 70 May 4 3800 May 8 300 Accounts Payable Freight-In Cash May 9 150 May 9 150 May 8 300 May 4 3,800 May 14 3,500 May 14 3,430 Purchase Discounts On May 14, the company pays the balance due on the account within the discount period

  23. Sales Revenues - Under a Periodic System • are recorded when earned-revenue recognition principle • must be supported by a business document-written evidence • ONLY 1 entry is made for each sale • one to record sale 24

  24. Sales Returns and Allowances Flip side of purchase returns and allowance On buyer’s books GENERAL JOURNAL Debit Credit May 8 Accounts Payable 300 Purchase Returns and Allowances 300 To record goods returned that were purchased on account On seller’s books GENERAL JOURNAL Debit Credit May 8 Sales Returns and Allowance 300 Accounts Receivable 300 To record return of goods delivered to Sauk Stero 25

  25. Accounts Receivable Merchandise Inventory Cash Sales Returns & Allowances Cost of Goods Sold Sales Sales - Under a Periodic System Assume a sale of $ 3,800 on Account May 4 3,800 May 4 3,800

  26. What is the Sales Returns and Allowances Account? • Contra Revenue Accountto sales • Used to show how much came in on returns and allowances • Excessive returns and allowances suggest: • inferior merchandise • inefficiencies in filing orders • errors in billing customers • mistakes in delivery or shipment of goods 27

  27. What Is the Sales Discount Account? • Contra Revenue Accountto sales • Used to disclose amount of cash discounts taken by customers 28

  28. Sales Discounts Flip side of purchase discounts On buyer’s books GENERAL JOURNAL Debit Credit May 14 Accounts Payable 3,500 Cash 3,430 Merchandise Inventory 70 To record payment within discount period On seller’s books GENERAL JOURNAL Debit Credit May 14 Cash 3,430 Sales Discounts 70 Accounts Receivable 3500 To record collection within discount period 29

  29. Net Purchases NetPurchases are gross purchases adjusted for returns and discounts. Purchases $ 325,000 Less: Purchase returns and allowances $ 10,400 Purchase discounts 6,80017,200 Net purchases 307,800 30

  30. Cost of Goods Purchased Purchases $ 325,000 Less: Purchase returns and allowances $ 10,400 Purchase discounts 6,80017,200 Net purchases 307,800 Add: Freight-in 12,200 Cost of goods purchased 320,000 Cost of goods purchased is net purchases plus freight-in. 31

  31. Companies that use periodic inventory take a physical count to... • determine ending inventory • compute cost of goods sold Companies that use perpetual inventory must take a physical inventory to check accuracy of “book inventory” to actual inventory. 32

  32. Taking a Physical Inventory • Counting, weighting or measuring each type of inventory • Determining ownership of goods • Quantity of each kind of inventory listed on inventory summary sheets where unit costs are applied 33

  33. Questions Concerning Ownership • Do all the goods included in the count belong to the company? • Does the company own any goods not included in the count? 34

  34. Goods in Transit These are goods on board a truck, train, ship, or plane at the end of the period. 35

  35. Goods in Transit • Who includes these in inventory? • Buyer? • Seller? The Company with Legal Title 36

  36. Ownership passes to owner here Page 245 in book FOB Shipping Point Public Carrier Co Seller Buyer Ownership passes to buyer here FOB Destination Point Public Carrier Co Seller Buyer

  37. Shipping Terms • FOB (free on board) shipping point- ownership of goods passes to buyer when public carrier accepts the goods • FOB (free on board) destination- ownership of goods remains with the seller until the goods reach the buyer 38

  38. Consigned Goods Goods in your store that you don’t pay for until they sell… the company does not take ownership. 39

  39. Income Statement Presentation The income statement for a merchandising company is the same whether a periodic or perpetual inventory system is used, except for the cost of goods soldsection. 40

  40. Page 213 in book PW AUDIO SUPPLY, INC.Income Statement (Perpetual)For the Year Ended December 31, 1998 Sales revenues Sales $ 480,000 Less: Sales returns and allowance $12,000 Sales discounts 8,000 20,000 Net sales460,000 Cost of goods sold 316,000 Gross profit 144,000 Operating expenses Store salaries expense 45,000 Rent expense 19,000 Utilities expense 17,000 Advertising expense 16,000 Depreciation expense 8,000 Freight-out 7,000 Insurance expense 2,000Total operating expenses 114,000 Net Income $ 30,000

  41. Income Statement (Periodic) Page 247 in book Sales revenues Sale $ 480,000 Less: Sales returns and allowance $12,000 Sales discounts 8,000 20,000 Net sales460,000 Cost of goods sold Inventory, January 36,000 Purchases $ 325,000 Less: Purchase returns and allowances $10,400 Purchase discounts 6,800 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 114,000 Net Income $ 30,000

  42. Page 248 in book Specific Identification An actual physical flow costing method in which items still in inventory are specifically costed to arrive at the total cost of ending inventory.

  43. Inventory Costing • Specific Identification method • Assumed Cost Flow methods • FIFO- First-in, First-Out- earliest goods purchased first to be sold • LIFO- Last-in,First-Out- latest goods purchased the first to be sold • Average Cost Method- costs are charged on the basis of weighted average unit cost 44

  44. What Makes Cost Flow Assumptions Necessary? Changing Prices 45

  45. Use of Cost Flow Methods in Major U.S. Companies

  46. The FIFO method assumes the earliest goods purchased are the first to be sold.

  47. The LIFO method assumes the latest goods purchased are the first to be sold.

  48. The average cost method assumes that 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 unitcost incurred.

  49. The average cost method assumes that goods available for sale are homogeneous.

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