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McGraw-Hill/IrwinCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 7 Inventories and Cost of Goods Sold PowerPoint Authors:

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Presentation on theme: "McGraw-Hill/IrwinCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 7 Inventories and Cost of Goods Sold PowerPoint Authors:"— Presentation transcript:

1 McGraw-Hill/IrwinCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 7 Inventories and Cost of Goods Sold PowerPoint Authors: Brandy Mackintosh Lindsay Heiser

2 7-2 Learning Objective 7-1 Describe the issues in managing different types of inventory.

3 7-3 Inventory Management Decisions The primary goals of inventory managers are to: 1. Maintain a sufficient quantity to meet customers needs 2. Ensure quality meets customers expectations and company standards 3. Minimize the costs of acquiring and carrying the inventory

4 7-4 Types of Inventory Merchandisers... Buy finished goods. Sell finished goods. Manufacturers... Buy raw materials. Produce and sell finished goods. Raw Materials Work in Process Finished goods Merchandise inventory Materials waiting to be processed Partially complete products Completed products awaiting sale

5 7-5 Learning Objective 7-2 Explain how to report Inventory and Cost of Goods Sold.

6 7-6 Balance Sheet and Income Statement Reporting

7 7-7 Cost of Goods Sold Equation BI + P – CGS = EI National Outfitters beginning inventory was $4,800. During the period, the company purchased inventory for $10,200. The cost of goods sold for the period is $9,000. Compute the ending inventory. Cost of Goods Sold Calculation +=-=+=-= Beginning Inventory Purchases Cost of Goods Available for Sale Cost of Goods sold Ending Inventory $ 4,800 10,200 15,000 9,000 $ 6,000

8 7-8 Cost of Goods Sold Equation beginning Inventory $4,800 + goods available for sale $15,000 purchases $10,000 ending Inventory $6,000 (Balance Sheet) Cost of Goods Sold $9,000 (Income Statement)

9 7-9 Learning Objective 7-3 Compute costs using four inventory costing methods.

10 7-10 Inventory Costing Methods First-in, first-out (FIFO) Last-in, first-out (LIFO) Weighted average Specific identification

11 7-11 Inventory Costing Methods Consider the following information This method individually identifies and records the cost of each item sold as part of cost of goods sold. If the items sold were identified as the ones that cost $70 and $95, the total cost of those items ($70 + 95 = $165) would be reported as Cost of Goods Sold. The cost of the remaining item ($75) would be reported as Inventory on the balance sheet at the end of the period. Specific Identification May 5 $75 cost May 3 $70 cost May 6 $95 cost May 3 May 5 May 6 May 8 Purchased 1 unit for $70 Purchased 1 more unit for $75 Purchased 1 more unit for $95 Sold 2 units for $125 each

12 7-12 Inventory Costing Methods FIFOLIFOWeighted average May 6 $95 cost May 5 $75 cost May 3 $70 cost May 6 $95 cost May 5 $75 cost May 3 $70 cost Sold Still there Income Statement Net Sales Cost of Goods Sold Gross Profit $250 145 $105 Balance Sheet Inventory $95 May 6 $95 cost May 5 $75 cost May 3 $70 cost Sold Still there Income Statement Net Sales Cost of Goods Sold Gross Profit $250 170 $ 80 Balance Sheet Inventory $70 $80 per unit Sold Still there $240 3 = Income Statement Net Sales Cost of Goods Sold Gross Profit $250 160 $ 90 Balance Sheet Inventory $80

13 7-13 Inventory Costing Methods Summary Cost of Goods sold (Income Statement) Inventory (Balance sheet) FIFO Oldest cost Newest cost LIFO Newest cost Oldest cost Weighted Average Average cost Lets consider a more complex example. Date Oct 1 Oct 3 Oct 5 Oct 6 Description Beginning Inventory Purchase Sales Ending Inventory # of Units 10 30 10 (35) 15 Cost per Unit $ 7 $ 8 $10 To calculate Total Cost $ 70 240 100 To calculate

14 7-14 Inventory Cost Flow Computations FIFO +-=+-= beginning Inventory purchases cost of goods available for sale ending Inventory Cost of Goods Sold 10 units x $ 7 = $ 70 30 units x $ 8 = 240 10 units x $ 10 = 100 $ 410 140 $ 270 (10 units @ $10) + (5 units @ $8) (10 units @ $7) + (25 units @ $8)

15 7-15 Inventory Cost Flow Computations LIFO +-=+-= beginning Inventory purchases cost of goods available for sale ending Inventory Cost of Goods Sold 10 units x $ 7 = $ 70 30 units x $ 8 = 240 10 units x $ 10 = 100 $ 410 110 $ 300 (10 units @ $7) + (5 units @ $8) (10 units @ $10) + (25 units @ $8)

16 7-16 Inventory Cost Flow Computations Weighted Average Weighted Average Cost = Cost of goods Available for Sale Number of Units Available for Sale Weighted Average Cost = $410 50 units = $8.20 per unit Description beginning Inventory purchase cost of goods available for sale # of Units 10 30 10 50 Cost per Unit $ 7 $ 8 $10 Total Cost $ 70 240 100 $ 410

17 7-17 Inventory Cost Flow Computations Weighted Average +-=+-= Beginning Inventory Purchases Cost of Goods Available for Sale Ending Inventory Cost of Goods Sold 10 units x $ 7 = $ 70 30 units x $ 8 = 240 10 units x $ 10 = 100 $ 410 123 $ 287 15 units @ $8.20 35 units @ $8.20

18 7-18 Financial Statement Effects Effects on the Income Statement Sales Cost of Goods Sold Gross Profit Operating Expenses Income from Operations Other Revenue (Expenses) Income before Income Tax Expense Income Tax Expense (30%) Net Income Effects on the Balance Sheet Inventory Weighted Average $ 525 287 238 125 113 20 133 40 $ 93 $ 123 LIFO $ 525 300 225 125 100 20 120 36 $ 84 $ 110 FIFO $ 525 270 255 125 130 20 150 45 $ 105 $ 140

19 7-19 Financial Statement Effects

20 7-20 Financial Statement Effects Advantages of Methods First-In, First-Out Weighted Average Last-In, First-Out

21 7-21 Tax Implications and Cash Flow Effects Effects on the Income Statement Sales Cost of Goods Sold Gross Profit Operating Expenses Income from Operations Other Revenue (Expenses) Income before Income Tax Expense Income Tax Expense (30%) Net Income Effects on the Balance Sheet Inventory Weighted Average $ 525 287 238 125 113 20 133 40 $ 93 $ 123 LIFO $ 525 300 225 125 100 20 120 36 $ 84 $ 110 FIFO $ 525 270 255 125 130 20 150 45 $ 105 $ 140

22 7-22 Learning Objective 7-4 Reporting inventory at the lower of cost or market.

23 7-23 The value of inventory can fall below its recorded cost for two reasons: 1. its easily replaced by identical goods at a lower cost, or 2. its become outdated or damaged. The value of inventory can fall below its recorded cost for two reasons: 1. its easily replaced by identical goods at a lower cost, or 2. its become outdated or damaged. Lower of Cost or Market When the value of inventory falls below its recorded cost, the amount recorded for inventory is written down to its lower market value. This is known as the lower of cost or market (LCM) rule.

24 7-24 Lower of Cost or Market Item Leather coats Vintage jeans Cost per Item $165 20 Market Value per Item $150 25 LCM per Item $150 20 Quantity 1,000 400 Total Lower of cost or Market $150,000 8,000 Total cost $165,000 8,000 Write- down $15,000 0 1,000 items @ $165 2 Record dr Cost of Goods Sold (+E, -SE) cr Inventory (-A) 15,000 1,000 items @ $150 400 items @ $20 1 Analyze Liabilities Assets = Stockholders Equity + Inventory -$15,000Cost of Goods Sold (+E) -$15,000

25 7-25 Lower of Cost or Market

26 7-26 Learning Objective 7-5 Analyze and record inventory purchases, transportation, returns and allowances, and discounts.

27 7-27 Recording Inventory Transactions We will now look at the accounting for purchases, transportation costs, purchase returns and allowances, and purchase discounts. We will record all inventory-related transactions in the Inventory account.

28 7-28 Inventory Purchases American Eagle Outfitters purchases $10,500 of vintage jeans on credit. 1 Analyze Liabilities Assets = Stockholders Equity + Inventory (+A) +$10,500Accounts Payable (+L) $10,500 2 Record dr Inventory (+A) cr Accounts Payable (+L) 10,500

29 7-29 Transportation Cost American Eagle pays $400 cash to a trucker who delivers the $10,500 of vintage jeans to one of its stores. 1 Analyze Liabilities Assets = Stockholders Equity + Cash (-A) -$400 Inventory (+A) +$400 2 Record dr Inventory (+A) cr Cash (-A) 400

30 7-30 Purchase Returns and Allowances American Eagle returned some of the vintage jeans to the supplier and received a $500 reduction in the balance owed. 1 Analyze Liabilities Assets = Stockholders Equity + Inventory (-A) -$500Accounts Payable (-L) -$500 2 Record dr Accounts Payable (-L) cr Inventory (-A) 500

31 7-31 Purchase Discounts American Eagles vintage jeans purchase for $10,500 had terms of 2/10, n/30. Recall that American Eagle returned inventory costing $500 and received a $500 reduction in its Accounts Payable. American Eagle paid within the discount period. 1 Analyze Liabilities Assets = Stockholders Equity + Cash (-A) -$9,800 Inventory (-A) -$200 Accounts Payable (-L) -10,000 2 Record dr Accounts Payable (-L) cr Cash (-A) cr Inventory (-A) 9,800 200 10,000

32 7-32 Summary of Inventory Transactions

33 7-33 Learning Objective 7-6 Evaluate inventory management by computing and interpreting the inventory turnover ratio.

34 7-34 Inventory Turnover Analysis

35 7-35 Comparison to Benchmarks

36 McGraw-Hill/IrwinCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Supplement 7A FIFO, LIFO, and Weighted Average in a Perpetual Inventory System

37 7-37 Perpetual Inventory System This is the same information that we used earlier in the chapter to illustrate a periodic inventory system. The only difference is that we have assumed the sales occurred on October 4, prior to the final inventory purchase.

38 7-38 FIFO (First-in, First-Out)

39 7-39 LIFO (Last-in, First-Out)

40 7-40 Weighted Average Cost $310 ÷ 40 units = $7.75 per unit

41 7-41 Financial Statement Effects Summary of Perpetual Inventory System Cost Flow Assumptions on Financial Statements

42 McGraw-Hill/IrwinCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Supplement 7B The Effects of Errors in Ending Inventory

43 7-43 The Effects of Errors in Ending Inventory Cost of Goods Sold Equation BI + P – CGS = EI Errors in Ending Inventory will affect the Balance Sheet and the Income Statement. Assume that Ending Inventory was overstated in 2012 by $10,000 due to an error that was not discovered until 2013. 2012 +-=+-= Beginning Inventory Purchases Ending Inventory Cost of Goods Sold Accurate Overstated $10,000 Understated $10,000

44 7-44 The Effects of Errors in Ending Inventory Now lets examine the effects of the 2012 Ending Inventory Error on 2013. Assume that Ending Inventory was overstated in 2012 by $10,000 due to an error that was not discovered until 2013. 2013 +-=+-= Beginning Inventory Purchases Ending Inventory Cost of Goods Sold Overstated $10,000 Accurate Overstated $10,000

45 McGraw-Hill/IrwinCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Supplement 7C Recording Inventory Transactions in a Periodic System

46 7-46 Recording Inventory Transactions in a Periodic System A local cell phone dealer stocks and sells one item. The following events occurred in the past year: We will record these events assuming the company uses a periodic inventory system and then compare the periodic inventory system to a perpetual inventory system.

47 7-47 Recording Inventory Transactions in a Periodic System Periodic Inventory SystemPerpetual Inventory System

48 7-48 Recording Inventory Transactions in a Periodic System Periodic Inventory System BI + P – CGS = EI End-of-year adjustment entries are not required using a perpetual inventory system.

49 7-49 Recording Inventory Transactions in a Periodic System Periodic Inventory SystemPerpetual Inventory System Summary of the Effects on the Accounting Equation

50 McGraw-Hill/IrwinCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 7 Solved Exercises M7-6, M7-7, E7-2, E7-5, E7-10, E7-17

51 7-51 M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost Given the following information, calculate cost of goods available for sale and ending inventory, then sales, cost of goods sold, and gross profit, under (a) FIFO, (b) LIFO, and (c) weighted average. Assume a periodic inventory system is used.

52 7-52 M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost a.FIFO Beginning Inventory50 units x $10 = $ 500 + Purchase250 units x $13 = $3,250 Cost of Goods Available for Sale $3,750 - Ending Inventory (200 x $13)= $2,600 = Cost of Goods Sold (50 x $10) + (50 x $13) $1,150

53 7-53 M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost b. LIFO Beginning Inventory50 units x $10 = $ 500 + Purchase250 units x $13 = $3,250 Cost of Goods Available for Sale $3,750 - Ending Inventory (150 x $13) + (50 x $10)= $2,450 = Cost of Goods Sold (100 x $13) $1,300

54 7-54 Weighted Average Cost = $3,750 300 units = $12.50 per unit M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost c. Weighted Average Beginning Inventory50 units x $10 = $ 500 + Purchase250 units x $13 = $3,250 Cost of Goods Available for Sale $3,750 - Ending Inventory (200 x $12.50)= $2,500 = Cost of Goods Sold (100 x $12.50) $1,250

55 7-55 M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost FIFOLIFOWeighted Avg Sales (100 units at $15)$1,500$1,500$1,500 Cost of Goods Sold 1,150 1,300 1,250 Gross Profit$ 350 $ 200 $ 250

56 7-56 M7-7 Calculating Cost of Goods Available for Sale, Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Weighted Average Cost (Periodic Inventory) Aircard Corporation tracks the number of units purchased and sold throughout each accounting period, but applies its inventory costing method at the end of each period as if it uses a periodic inventory system. Given the following information, calculate the cost of goods available for sale, ending inventory, and cost of goods sold, if Aircard uses (a) FIFO, (b) LIFO, or (c) weighted average cost.

57 7-57 M7-7 Calculating Cost of Goods Available for Sale, Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Weighted Average Cost (Periodic Inventory) Goods Available for Sale – same for all methods UnitsUnitTotalCost Beginning Inventory2,000$40$ 80,000 + Purchase (July 13)6,000$44 264,000 + Purchase (July 25)8,000$50 400,000 Goods Available for Sale16,000 $744,000

58 7-58 M7-7 Calculating Cost of Goods Available for Sale, Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Weighted Average Cost (Periodic Inventory) a. FIFO Ending Inventory (7,000 units x $50)= $350,000 Cost of Goods Sold (2,000 units x $40) (6,000 units x $44) (1,000 units x $50)= $394,000 b. LIFO Ending Inventory (2,000 units x $40) (5,000 units x $44)= $300,000 Cost of Goods Sold (8,000 units x $50) (1,000 units x $44)= $444,000

59 7-59 M7-7 Calculating Cost of Goods Available for Sale, Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Weighted Average Cost (Periodic Inventory) c. Weighted Average Average Unit Cost$744,000 / 16,000 = $46.50 Ending Inventory (7,000 units x $46.50)= $325,500 Cost of Goods Sold (9,000 units x $46.50)= $418,500

60 7-60 End of Chapter 7


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