Lecture Principles of financial accouting - Chapter 6: Inventories and cost of sales

After completing this chapter you should be able to: Identify the items making up merchandise inventory, identify the costs of merchandise inventory, analyze the effects of inventory methods for both financial and tax reporting, analyze the effects of inventory errors on current and future financial statements,...

PowerPoint Authors:

Susan Coomer Galbreath, Ph.D., CPA Charles W Caldwell, D.B.A., CMA Jon A Booker, Ph.D., CPA, CIA Cynthia J Rooney, Ph.D., CPA Winston Kwok, Ph.D., CPA

INVENTORIES AND COST OF SALES

McGraw­Hill/Irwin         Copyright © 2011 by The McGraw­Hill Companies, Inc. All rights reserved.

DETERMINING INVENTORY ITEMS

Merchandise inventory includes all goods that a company owns and holds for sale, regardless of where the goods are located when inventory is

Goods on Consignment

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FOB Destination Point

Public Carrier

GOODS IN TRANSIT

Public Carrier

GOODS ON CONSIGNMENT

Merchandise is included in the inventory of the

consignor, the owner of the inventory.

GOODS DAMAGED OR OBSOLETE

Damaged or obsolete goods are not counted in

inventory if they cannot be sold.

Cost should be reduced to net realizable

value if they can be sold.

Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs

necessary to make the sale.

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DETERMINING INVENTORY COSTS

Invoice Cost

Invoice Cost

Include all expenditures necessary to bring an item to

a salable condition and location.

Minus Discounts

and Allowances

Minus

Discounts

and Allowances

Plus Storage

Plus Storage

Plus Insurance

Plus Insurance

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 Most companies take a

Good internal controls over count include:

1.Pre-numbered inventory tickets.

2.Counters have no inventory responsibility.

3.Counts confirm existence, amount, and

quality of inventory item.

4.Second count is taken.

5.Manager confirms all items counted.

Good internal controls over count include:

1.Pre-numbered inventory tickets.

2.Counters have no inventory responsibility.

3.Counts confirm existence, amount, and

quality of inventory item.

4.Second count is taken.

5.Manager confirms all items counted.

INVENTORY COSTING UNDER

A PERPETUAL SYSTEM

Inventory affects

The matching principle requires matching costs

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INVENTORY COST FLOW

ASSUMPTIONS

C2

Management decisions in accounting for inventory

involve the following:

1.Items included in inventory and their costs.

2.Costing method (specific identification, FIFO, LIFO,

or weighted average).

3.Inventory system (perpetual or periodic).

4.Use of market values or other estimates.

INVENTORY COST FLOW

Assumes costs flow at an average of the costs available

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INVENTORY COSTING ILLUSTRATION

Here is information about the mountain bike inventory of

Trekking for the month of August.

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SPECIFIC IDENTIFICATION

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SPECIFIC IDENTIFICATION

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Balance Sheet Inventory

Income Statement

Cost of Goods SoldIncome Statement

Cost of Goods Sold

SPECIFIC IDENTIFICATION

Here are the entries to record the purchases and sales The

numbers in red are determined by the cost flow assumption used.

All purchases and sales are made on credit.

The selling price of inventory was as follows:

8/14 $130 8/31 150

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FIRST-IN, FIRST-OUT (FIFO)

Cost of Goods Sold

Cost of Goods Sold

Ending Inventory

Ending Inventory

Oldest Costs

Oldest Costs

Recent Costs

Recent Costs

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FIRST-IN, FIRST-OUT (FIFO)

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FIRST-IN, FIRST-OUT (FIFO)

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FIRST-IN, FIRST-OUT (FIFO)

Here are the entries to record the purchases and sales entries The numbers in red are determined by the cost flow assumption used.

All purchases and sales are made on credit.

The selling price of inventory was as follows:

8/14 $130 8/31 150

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LAST-IN, FIRST-OUT (LIFO)

Cost of Goods Sold

Cost of Goods Sold

Recent Costs

Recent Costs

Oldest Costs

Oldest Costs

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LAST-IN, FIRST-OUT (LIFO)

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LAST-IN, FIRST-OUT (LIFO)

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LAST-IN, FIRST-OUT (LIFO)

Here are the entries to record the purchases and sales entries

The numbers in red are determined by the cost flow assumption

used.

All purchases and sales are made on credit.

The selling price of inventory was as follows:

8/14 $130 8/31 150

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WEIGHTED AVERAGE

When a unit is sold, the

average cost of each unit in

inventory is assigned to cost of goods sold Cost of Goods

WEIGHTED AVERAGE

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WEIGHTED AVERAGE

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WEIGHTED AVERAGE

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WEIGHTED AVERAGE

Here are the entries to record the purchases and sales entries for Trekking The numbers in red are determined by the cost flow

assumption used.

All purchases and sales are made on credit.

The selling price of inventory was as follows:

8/14 $130 8/31 150

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FINANCIAL STATEMENT EFFECTS

OF COSTING METHODS

Because prices change, inventory methods nearly

always assign different cost amounts.

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FINANCIAL STATEMENT EFFECTS

of goods sold with

revenues.

Better matches current costs in cost

of goods sold with

revenues.

Ending inventory approximates

current replacement cost.

Ending inventory approximates

current replacement cost.

First-In, First-Out

First-In, First-Out

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CONSISTENCY IN USING COSTING

METHODS

The consistency principle consistency principle requires a requires a

company to use the same accounting methods period after period so that financial statements are comparable across periods.

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LOWER OF COST AND NET REALIZABLE

VALUE

Inventory must be reported at NRV when

Can be applied two ways:

LOWER OF COST AND NRV

A motor sports retailer has the following

items in inventory:

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LOWER OF COST AND NRV

Here is how to compute lower of cost and

NRV for individual inventory items.

P2

FINANCIAL STATEMENT EFFECTS OF

INVENTORY ERRORS

Income Statement Effects

A2

FINANCIAL STATEMENT EFFECTS

OF INVENTORY ERRORS

Balance Sheet Effects

A2

INVENTORY TURNOVER

Inventory

Shows how many times a company turns over its

inventory during a period Indicator of how well

management is controlling the amount of inventory

available.

Shows how many times a company turns over its

inventory during a period Indicator of how well

management is controlling the amount of inventory

available.

Average

A3

DAYS’ SALES IN INVENTORY

Reveals how much inventory is available in

terms of the number of days’ sales.

Reveals how much inventory is available in

terms of the number of days’ sales.

A3

APPENDIX 6A: INVENTORY COSTING

UNDER A PERIODIC SYSTEM

P3

LIFO computation of COGS and ending inventory under

a periodic system

APPENDIX 6B:

INVENTORY ESTIMATION METHODS

P4

Inventory sometimes requires estimation for interim statements or

if some casualty such as fire or flood makes taking a physical

count impossible

Retail Inventory Method Gross Profit Method

END OF CHAPTER 6