1 / 81

Chapter 6

Chapter 6 . Inventories & Cost of Goods Sold. Key Objectives & Concepts. Merchandise Inventories Inventory Valuation & Income Measurement Inventory Costing Assumptions (GAAP): Specific Identification Weighted Average First-In, First-Out (FIFO) Last-In, Last-Out (LIFO)

toki
Download Presentation

Chapter 6

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 6 Inventories & Cost of Goods Sold

  2. Key Objectives & Concepts • Merchandise Inventories • Inventory Valuation & Income Measurement • Inventory Costing Assumptions (GAAP): • Specific Identification • Weighted Average • First-In, First-Out (FIFO) • Last-In, Last-Out (LIFO) • Periodic vs. Perpetual Inventory Recording • Lower of Cost or Market (LCM) rule • Inventory Ratio Analysis

  3. Merchandise Inventory:Wholesale and Retail Companies • Goods are: • Purchased in finished form (“finished goods”) • Resold without further manufacturing • Classified as “Merchandise Inventory” on Balance Sheet

  4. Expense Inventory Inventory (A) Balance Sheet (Deferred Expense) Income Statement Cost of Goods Sold (E) Inventory Costing & Income Measurement When goods aresold, recordSalesand……. Follows the Matching Principle

  5. Relationships-Periodic InventoryInventory / CGS / Profit / Taxes /Cash Sales-COGS = GP - Op. Exp. =Inc.before Tax -Income Tax Exp.=NI • Higher Inventory Value (on B/S) => Lower CGS (on I/S) • Lower CGS (on I/S) => Higher Profits (on I/S) • Higher Profits (on I/S) => Higher Taxes (on I/S) • Higher Taxes (on I/S) => Lower Cash (on B/S) BEG INV. + PURCHASES = COGAS – ENDING INV. = COGS Summary: 2 general cases exist HIGHEREI => HIGHERPROFITS => LOWER CASH and conversely LOWER EI => LOWER PROFITS => HIGHERCASH

  6. Beginning Inventory * (A) $ 30,000 + Cost of Goods Purchased 100,000 Cost of Goods Available for Sale 130,000 -Ending Inventory * (A) 40,000 Cost of Goods Sold (E) $ 90,000 Calculating Cost of Goods Sold forPeriodic Inventory: A Review • An internal calculation needed for I/S * Must be determined by taking a physical inventory

  7. Internal calculation needed for I/S Beginning Inventory + Purchases = Cost of Goods Available for Sale -Ending Inventory Cost of Goods Sold (E) As presented on (multi-step) Income Statement Sales $200,000 Cost of goods sold 90,000 Gross margin 110,000 : : Net Income $ 30,000 Calculating Cost of Goods Sold forPeriodic Inventory:A Review

  8. Inventory Costing MethodsHow we determine key F/Samounts Cost of Goods Sold (E) Ending Inventory (A) Income Statement Balance Sheet COST OF GOODS AVAILABLE FOR SALE can only be accounted for in 1 of 2 accounts Cost of Goods Available for Sale $$$$$$ If goods were sold: If they’re still on hand:

  9. Inventory Costing MethodsObjective & Flows • Objective:We need $ amounts for COGS & EI on the financial statements (I/S and B/S) • ButPhysical Flows = Cost Flows(an assumption) – e.g., think of how goods flow in a grocery store. • How to proceed?We usecost flow assumptions(except for Specific Identification Method) to calculate COGS and EIwithout having to track physical flows. • Why?It is too costly to obtain exact information, which requires tracking exact physical flows.

  10. Inventory Costing MethodsAlternates for determining the I/S amounts Four alternate costing methods are available: Specific Identification Weighted Average First-in, First-out (FIFO) Last-in, First-out (LIFO)

  11. PERIODIC INVENTORY SYSTEMA REVIEW • Is a type of recording system. • AssetaccountInventory is updated only when a physical inventory is taken – i.e., units are actually counted at the end of the period. • Expenseaccount Purchases is used during the period to record all purchases from the company’s vendors. • Cost of Goods Sold and update of Inventory cannot be recorded for individual sales since the information is unknown. (System doesn’t record cost of individual sales) • COGS and EI are both updated at the end of the period (periodic). • Example follows 

  12. May 1 May 12 May 20 Cost = $10.00 ea. Cost = $10.20 ea. Cost = $10.50 ea. Illustrated Example - Ken’s Camera Shop Inventory Data: COGAS 4 @ $10.00 = $40.00 5 @ $10.20 = $51.00 3 @ $10.50 = $31.50 Total COGAS (Entire Period) = $122.50

  13. Specific Identification Cost-Flow Approach Assume Ken can identify and track the cost of each camera sold Sell five cameras in May sold sold sold sold sold May 1 May 12 May 20 Cost = $10.00 ea. Cost = $10.20 ea. Cost = $10.50 ea. Total COGAS = $122.50

  14. Cost of Five Cameras Sold Using Specific Identification Method: May 1 May 12 May 20 Cost of Goods Sold $10.00 sold 10.00 sold sold 10.20 10.20 sold 10.50 $50.90 sold May 1 May 12 May 20 Cost = $10.00 ea. Cost = $10.20 ea. Cost = $10.50 ea. Total COGAS= $122.50

  15. Cost of Goods Sold $50.90 Seven Cameras Unsold Using Specific Identification Method: May 1 May 12 May 20 unsold unsold Ending Inv. $10.00 unsold 10.00 10.20 unsold unsold 10.20 10.20 unsold 10.50 unsold 10.50 $71.60 Cost = $10.00 ea. Cost = $10.20 ea. Cost = $10.50 ea.

  16. Specific Identification Cost-Flow Approach Specific Identification Cost-Flow Approach Cost of Goods Available for Sale = $122.50 Approach allocates COGAS between Cost of Goods Sold (E) Ending Inventory (A) $50.90 $71.60 Income Statement Balance Sheet

  17. = Per Unit Cost Cost of Goods Available for Sale $$ Units Available for Sale for Period Weighted Average Cost Flow Assumptionand Periodic Inventory Method May 1 May 12 May 20 Assigns same unit cost to all units of inventory available for sale during a period

  18. Weighted Average Cost Flow Assumptionand Periodic Inventory Method May 1 May 12 May 20 = Per Unit Cost = Per Unit Cost Cost of Goods Available for Sale $$ Units Available for Sale for Period Cost of Goods Available for Sale $$ Units Available for Sale for Period Assigns same unit cost to all units of inventory available for sale during a period $122.50 $10.21/camera 12

  19. Cost of Five Cameras Sold Using Weighted Average Cost Assumption & Periodic Inventory: COGS = # units sold x unit cost =5 cameras @ $10.21 = $51.05(rounded) sold sold sold sold sold Weighted Average Cost = $10.21/camera

  20. Seven Cameras Unsold Using Weighted Average Cost Method: unsold unsold EI = # units Unsold x unit cost =7 cameras @ $10.21 = $71.45(rounded) unsold unsold unsold unsold unsold Weighted Average Cost = $10.21/camera

  21. Weighted Average Cost Flow Assumptionand Periodic Inventory Method Cost of Goods Available for Sale = $122.50 Assumption allocates CGAS between Cost of Goods Sold (E) Ending Inventory (A) $51.05 $71.45 Income Statement Balance Sheet

  22. Comparison of Costing Assumptions Cost of Goods Sold Ending Inventory Goods Available for Sale Weighted Average $51.05 $71.45 $122.50 FIFO TBD $122.50 TBD LIFO $122.50 TBD TBD

  23. FIFO Cost-Flow Assumption& Periodic Inventory Method May 1 May 12 May 20 First cameras purchased are assumedfirst sold Sold Sold unsold Sold unsold unsold Sold unsold unsold Sold unsold unsold Sell five cameras in May; Which ones? Remaining 7 cameras are Ending Inventory

  24. Cost of Five Cameras Sold Using FIFO Method & Periodic Inventory May 1 May 12 May 20 Cost of Goods Sold Sold Sold $10.00 unsold 10.00 Sold unsold unsold 10.00 10.00 Sold unsold unsold 10.20 $50.20 Sold unsold unsold Cost = $10.00 ea. Cost = $10.20 ea. Cost = $10.50 ea.

  25. Cost of Seven Cameras Unsold Using FIFO Method & Periodic Inventory May 1 May 12 May 20 Ending Inventory $10.20 unsold 10.20 unsold unsold 10.20 10.20 unsold unsold 10.50 10.50 unsold unsold 10.50 $50.20 Cost = $10.00 ea. Cost = $10.20 ea. Cost = $10.50 ea.

  26. FIFO Cost-Flow Assumption& Periodic Inventory Method Cost of Goods Available for Sale = $122.50 Assumption allocates CGAS between Cost of Goods Sold (E) Ending Inventory (A) $50.20 $72.30 Income Statement Balance Sheet

  27. Comparison of Costing Assumptions Cost of Goods Sold Ending Inventory Goods Available for Sale Weighted Average $51.05 $71.45 $122.50 FIFO $72.30 $122.50 $ 50.20 LIFO $122.50 TBD TBD

  28. LIFO Cost-Flow Assumption& Periodic Inventory Method May 1 May 12 May 20 Last cameras purchased are assumedfirst sold unsold unsold unsold Sold unsold unsold Sold unsold Sold unsold Sold Sold Sell five cameras in May; Which ones? Remaining 7 cameras are Ending Inventory

  29. Cost of Five Cameras Sold using LIFO Assumption & Periodic Inventory May 1 May 12 May 20 Cost of Goods Sold unsold unsold unsold 10.50 Sold unsold 10.50 unsold 10.50 unsold Sold 10.20 Sold 10.20 $51.90 unsold Sold Sold Cost = $10.00 ea. Cost = $10.20 ea. Cost = $10.50 ea.

  30. Cost of Seven Cameras Unsold using LIFO Assumption & Periodic Inventory May 1 May 12 May 20 Ending Inventory $10.00 unsold 10.00 unsold unsold 10.00 10.00 unsold unsold 10.20 10.20 unsold unsold 10.20 $70.60 Cost = $10.00 ea. Cost = $10.20 ea. Cost = $10.50 ea.

  31. LIFO Cost-Flow Assumptionand Periodic Inventory Method Cost of Goods Available for Sale = $122.50 Assumption allocates CGAS between Cost of Goods Sold (E) Ending Inventory (A) $51.90 $70.60 Income Statement Balance Sheet

  32. LIFO Issues • LIFO used on Tax Return • Then must be used for financial reporting purposes • LIFO Liquidation – Selling very old (low $ ) inventory out of Beginning Inventory • LIFO liquidation can result in high gross margin (and therefore large tax bill) • LIFO Reserve • DEFN: Difference between inventory value stated at FIFO and value stated at LIFO • Can be found in footnotes to Financial Statements

  33. Comparison of Costing Assumptions Cost of Goods Sold Ending Inventory Goods Available for Sale Weighted Average $71.45 $122.50 $51.05 FIFO $72.30 $122.50 $50.20 LIFO $122.50 $70.60 $51.90

  34. Inventory Choice & Cash Flow Impact(Assumes:Periodic inventory, Cash sales = $100 & Inventory bought on credit) Red = Lowest Black = Highest

  35. LIFO Cost-Flow Assumption and Periodic Inventory – Some Questions • Which do you think is more important? Reporting higher EI and NIusing FIFO, or Saving taxes (and Cash) using LIFO? Why? • Why/when would a company use FIFO? LIFO? • If you are the CEO, whose bonus is based on net income, which method would you select? Why? • If you’re a stockholder, which method would you prefer? Why? How do you motivate the CEO?

  36. PERPETUAL INVENTORY SYSTEM: A REVIEW • Inventory is updated for every purchase and sale. The asset account Inventory is used. • Cost of Goods Soldexpense & update of asset Inventory is recorded for each individual sale at the time of the sale. • Inventory cost assumptionswork the same way as periodic except COGS & EI is updated for every purchase and sale (by date) instead of waiting until the end of the period (periodic). • Examples follow 

  37. PERPETUAL INVENTORY SYSTEM Accounts Payable $3,000 Inventory $3,000 Assume a purchase of $3,000 in inventory on account with payment terms of 2/10, net 30. Reflect effect on B/S Equation. -----------Balance Sheet------------- --Income Statement-- Assets = Liabilities + OE+ Rev.- Expenses Perpetual method uses Inventory(A) account; Periodic usedPurchases(E)

  38. PERPETUAL INVENTORY SYSTEM(Reflects Matching Principle) A/R $1,600 Sales Revenue $1,600 Inventory ($1,000) COGS ($1,000) Sold merchandise for $1,600 with payment terms of 2/10, net 30. Cost of merchandise is $1,000. Record effect on B/S Equation. -----------Balance Sheet------------- --Income Statement-- Assets = Liabilities + OE+ Rev.- Expenses #1 Record the Sale #2 Record the Cost of the Sale

  39. PERPETUAL INVENTORY SYSTEM A: Inventory A/R $1,600 Sales Revenue $1,600 Inventory ($1,000) COGS ($1,000) E: Cost of Goods Sold PURCHSES $1,000 $3,000 $1,000 Inventory updated $2,000 -----------Balance Sheet------------- --Income Statement-- Assets = Liabilities + OE+ Rev.- Expenses Sales $1,600 - COGS 1,000 Gross Profit $600

  40. May 1 May 12 May 20 Cost = $10.00 ea. Cost = $10.20 ea. Cost = $10.50 ea. Ken’s Camera Shop - Perpetual InventoryInventory Purchases and Camera Sales May 10 Sell 3 units May 25 Sell 2 units Total COGAS $ (Entire Period) = $122.50

  41. Example-Perpetual Inventory Weighted-Average: $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 COGS EI Unit Cost Unit Cost DATE Purchase Total $ Total $ 5/1 $10.00 Average Unit Cost = $10.00 On May 1 purchase 4 cameras at $10.00 each

  42. Example-Perpetual Inventory Weighted-Average: COGS EI Unit Cost Unit Cost DATE Purchase Total $ Total $ $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 sold sold 5/1 $10.00 sold $10.00 5/10 $10.00 COGS = $30.00 On May 10 Ken sells 3 cameras at $25.00 each. What is the average unit cost? What is COGS? What is EI?

  43. Example-Perpetual Inventory Weighted-Average: COGS EI Unit Cost Unit Cost DATE Purchase Total $ Total $ ?????? $10.00 $10.20 $10.20 ?????? ?????? $10.20 $10.20 ?????? ?????? $10.20 5/12 ?????? ??? 5/12 On May 12 purchase 5 cameras at $10.20 each What is the average unit cost? Must be updated on a purchase.

  44. Example-Perpetual Inventory Weighted-Average: Weighted Average Cost COGAS $ = Units Available for Sale COGS EI Unit Cost Unit Cost DATE Purchase Total $ Total $ $10.17 ??? 5/12 $10.17 $10.17 $10.17 $10.17 $61.00 = = $10.17 $10.17 $10.17 6 $61.00 On May 12 purchase 5 cameras at $10.20 each What is the average unit cost? Must be updated on a purchase.

  45. Example-Perpetual Inventory Weighted-Average: COGS EI Unit Cost Unit Cost DATE Purchase Total $ Total $ $10.50 $10.50 $10.50 Weighted Average Cost COGAS $ = Units Available for Sale $10.28 ????? $10.17 5/20 5/12 $10.28 $10.28 $10.28 $10.28 $10.28 $10.28 $92.50 $10.28 $10.28 $10.28 $10.28 = = $92.50 9 On May 20 purchase 3 cameras at $10.50 each What is the average unit cost? Must be updated after every purchase.

  46. Example-Perpetual Inventory Weighted-Average: $10.28 $10.28 $10.28 $10.28 $10.28 $10.28 $10.28 $10.28 $10.28 $10.28 $10.28 $10.28 $10.28 X 2= $20.56 $10.28 x 7 = $71.94 7 COGS EI Unit Cost Unit Cost DATE Purchase Total $ Total $ sold sold $10.28 5/20 $92.50 5/25 On May 25 Sold 2 cameras at $22.00 each What is the average unit cost ,COGS and EI?

  47. Weighted Average Cost Flow Assumptionand Perpetual Inventory Method Cost of Goods Available for Sale = $122.50 Assumption allocates COGAS between Cost of Goods Sold (E) Ending Inventory (A) $30.00 + 20.56 = $50.56 $71.94 Income Statement Balance Sheet

  48. Comparison of Costing Assumptions using Perpetual Inventory Method Cost of Goods Sold Ending Inventory Goods Available for Sale Weighted Average $50.56 $71.94 $122.50 FIFO TBD $122.50 TBD LIFO $122.50 TBD TBD

  49. Illustrated Example - Perpetual Inventory FIFO: $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 COGS EI DATE Purchase Total $ Total $ 5/1 On May 1 purchase 4 cameras at $10.00 each

  50. Illustrated Example - Perpetual Inventory FIFO: COGS EI DATE Purchase Total $ Total $ $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 $10.00 sold sold 5/1 sold 5/10 COGS = $30.00 On May 10 Sell 3 cameras at $25.00 each. What is COGS $ ? Where did they come from? What is EI $ ? Where did they come from?

More Related