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Inventory & Cost of Goods Sold
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Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
1
Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
22
Inventory & Cost of Goods SoldChapter 6
Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.
3
Show how to account for inventory
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4
Merchandise Inventory
Balance Sheet (partial)
Current assets:
Cash $XXX
Accounts receivable XXX
Inventory (1 chair @ cost of $300)
$300
Income Statement (partial)
Sales (2 chairs @ $500 selling price) $1,000
Cost of goods sold (2 chairs @ $300 cost)
600
Gross profit $400
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The cost of inventory on
hand = Inventory
The cost of inventory on
hand = Inventory
The cost of inventory
that’s been sold =
Cost of Goods Sold
The cost of inventory
that’s been sold =
Cost of Goods Sold
Asset on the Balance SheetAsset on the
Balance Sheet
Expense on the Income
Statement
Expense on the Income
Statement
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Sales Price vs. Cost of Inventory•Sales revenue based on sales price of
inventory sold•Cost of goods sold based on cost of
inventory sold•Inventory based on cost of inventory on
hand•Gross profit, also called gross margin
▫Sales revenue minus cost of goods sold
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Number of Units of Inventory
•Determined from accounting records•Evidenced by physical count at year-end•Consigned goods:
▫Does not include those held for another company
▫Does include those out on consignment•In transit goods
▫Depends on shipping terms
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FOB Shipping Point FOB Destination
• Legal title passes to purchaser when items leave seller’s place of business
• Purchaser owns good while in transit▫ Included in purchaser’s
inventory count
• Purchaser pays transportation costs
• Legal title passes to purchaser when items arrive at purchaser’s receiving dock
• Seller owns goods while in transit▫ Included in seller’s
inventory count
• Seller pays transportation costs
Shipping terms
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Inventory Accounting Systems
Perpetual Inventory System
Periodic Inventory System
Used for all types of goods
Used for inexpensive goods
Keeps a running total of all goods bought, sold, and on hand
Does not keep a running total of all goods bought, sold, and on hand
Inventory counted at least once a year
Inventory counted at least once a year
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Perpetual Inventory
•Bar codes on products provide information to record▫Sale of item▫Update of inventory record
•Two entries needed for each sale▫Record revenue and asset received (cash or
receivables)▫Record cost of sale and reduction of
inventory
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11
Recording Inventory (Amounts Assumed)
JOURNAL
Date
Accounts and explanation Debit Credit
Inventory 560,000
Accounts payable 560,000
Purchased inventory on account
Accounts receivable 900,000
Sales 900,000
Sold inventory on account
Cost of goods sold 540,000
Inventory 540,000
Recorded cost of goods sold
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Recording Inventory (Amounts Assumed)
Inventory
Cost of Goods Sold
100,000Beginning balance
Purchases 560,000 Cost of goods sold 540,000
Cost of goods sold 540,000
Ending balance 120,000
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Reporting in the Financial Statements
Balance Sheet (partial)
Current assets:
Cash $ XXX
Accounts receivable XXX
Inventory 120,000
Prepaid expenses XXX
Income Statement (partial)
Sales $900,000
Cost of goods sold 540,000
Gross profit $360,000
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Cost of Net Purchases
Purchase price of the inventory
$600,000
+ Freight-in 4,000
− Purchase returns (25,000)
− Purchase allowances (5,000)
− Purchase discounts (14,000)
= Net purchases of inventory $ 560,000
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15
Net Sales
Sales revenue− Sales returns and
allowances− Sales discounts= Net sales
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Apply and compare various inventory cost methods
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Inventory Costing Methods
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Specific Unit Cost
•Used for businesses with unique inventory items▫Automobiles, antique furniture, jewels, and
real estate•Businesses cost their inventories at the
specific cost of the particular unit•Too expensive for inventories with
common characteristics
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Average Cost
Average cost per
unit
Cost of goods available *
Number of units available*
*Goods available = Beginning inventory + Purchases
Cost of goods sold
Number of units sold
Average cost per
unit
Average cost per
unit
Ending inventory
Number of units on
hand
Average cost per
unit
Average cost per
unit
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20
First-in, First-out (FIFO)
•Oldest items assumed to be sold first•Ending inventory consists of most recent
purchase costs
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Last-in, First-out (LIFO)
•Most recent items purchased are assumed to be sold first
•Oldest costs in ending inventory
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Problem 6-60A
Date Units Cost per unit
Total cost
Beg. inventory
75 tents $16 $1,200
March 3 95 tents 18 1,710
March 17 165 tents 20 3,300
March 23 36 tents 21 756
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Problem 6-60A Average Cost
Average cost per
unit
Cost of goods available *
Number of units available*
*Goods available = Beginning inventory + Purchases
$1,200 + $1,710 +$3,300 + $756
$1,200 + $1,710 +$3,300 + $756
75 +95 +165 + 3675 +95 +165 + 36
$6,966$6,966
371 units371 units
$18.78(rounded)$18.78
(rounded)
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Cost of goods sold
Number of units sold
Average cost per
unit
Average cost per
unit
Ending inventory
Number of units on
hand
Average cost per
unit
Average cost per
unit
318 tents318 tents $18.78(rounded)$18.78
(rounded)$5,972$5,972
53 tents53 tents$18.78
(rounded)$18.78
(rounded)$995$995
Problem 6-60A Average Cost
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Problem 6-60A FIFO
Cost of goods sold
75 tents $16 $1,200
95 tents 18 1,710
148 tents
20 2,960
318 tents
$5,870
Ending inventory
36 tents $21 $756
17 tents 20 340
53 tents $1,096
Oldest items sold first
Oldest items sold first
Newest items on hand
Newest items on hand
Date Units Cost per unit
Total cost
Beg. inventory 75 tents
$16 $1,200
March 3 95 tents
18 1,710
March 17 165 tents
20 3,300
March 23 36 tents
21 756
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Cost of goods sold
36 $21 $756
165 20 3,300
95 18 1,710
22 16 352
318 tents
$6,118
Ending inventory
53 tents $16 $848
Problem 6-60A LIFO
Newest items sold first
Newest items sold first
Oldest items on hand
Oldest items on hand
Date Units Cost per unit
Total cost
Beg. inventory 75 tents
$16 $1,200
March 3 95 tents
18 1,710
March 17 165 tents
20 3,300
March 23 36 tents
21 756
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Impact of Inventory Methods on Financial Statements
Increasing inventory prices
Cost of goods sold
Ending inventory
FIFO Lowest because based on older costs, which are less expensive
Highest because based on more recent and expensive costs
LIFO Highest because based on more recent costs, which are more expensive
Lowest because based on older costs, which are less expensive
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Impact of Inventory Methods on Financial Statements
Decreasing inventory prices
Cost of goods sold
Ending inventory
FIFO Highest because based on older costs, which are more expensive
Lowest because based on more recent, less expensive costs
LIFO Lowest because based on more recent costs which are less expensive
Highest because based on older, more expensive costs
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Tax Advantage of LIFOIn periods of increasing
prices
In periods of increasing
prices
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Cost of Goods Sold Ending Inventory
•LIFO provides a better matching of expense to revenue▫More recent costs
included in Cost of Goods Sold
•FIFO provides a more up-to-date inventory cost ▫More recent costs
on the Balance Sheet
Comparison of Inventory Methods
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LIFO Issues
•Allows manipulation of net income▫When inventory prices are rising, large
quantities purchased at end of year to lower taxes
•Liquidation can occur▫Quantities decrease from last year,
companies must “dip into” older inventory layers
•Not allowed under International Financial Reporting Standards (IFRS)
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32
Explain and apply underlying GAAP for inventory
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Principles Related to Inventories
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Disclosure Principle
•Financial statement should disclose enough information for users to make informed decisions▫Information should be relevant and
representationally faithful•Examples:
▫Accounting methods used▫Substance of material transactions
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35
Lower-of-Cost-or-Market Rule
•Inventory is reported at the lower of:▫Cost or▫Market
Usually replacement cost•If market is lower, inventory is written
down JOURNAL
Date
Accounts and explanation Debit Credit
Cost of Goods Sold
Inventory
Wrote inventory down to market value
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36
Compute and evaluate gross profit (margin) and inventory turnover
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Gross Profit Percentage
Gross profitGross profit
Net sales revenueNet sales revenue
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Inventory Turnover
Cost of Goods Sold
Cost of Goods Sold
Average InventoryAverage
Inventory
(Beginning Inventory + Ending Inventory)/2
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39
Use the COGS model to make management decisions
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Use the COGS Model to Make Management Decisions
Cost of Goods Sold:Beginning Inventory
+ Purchases
=
Cost of goods available for sale
− Ending Inventory
= Cost of goods sold
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41
Computing Budgeted Purchases
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Rearranging the Cost of Goods Sold Model
Cost of goods sold (based on plan for next period)
+ Ending inventory (based on plan for next period)
= Goods available as planned
− Beginning inventory (actual amount)
= Purchases (amount manager should buy)
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Estimating Inventory by the Gross Profit Method
Beginning inventory $XXX
Purchases XXX
Goods available for sale XXX
Estimated cost of goods sold:
Net sales revenue $XXX
Less estimated gross profit (XXX)
Estimated cost of goods sold XXX
Estimated cost of ending inventory lost
$XXX
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Exercise 6-26A
Beginning inventory $45,300
Purchases 33,300
Goods available for sale 78,600
Estimated cost of goods sold:
Net sales revenue $61,600
Less estimated gross profit
Estimated cost of goods sold
Estimated cost of ending inventory cost
45% × $61,600
$27,720 33,88
0$44,720
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45
Analyze effects of inventory errors
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Effects of Inventory Errors
Period 1 Period 2
Inventory Error
Cost of Goods Sold
Gross Profit
and Net Income
Cost of Goods Sold
Gross Profit
and Net Income
Period 1
Ending inventory overstated
Understated
Overstated Overstated Understated
Period 1
Ending inventory understated
Overstated Understated
Understated
Overstated
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