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Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter 6.

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Presentation on theme: "Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter 6."— Presentation transcript:

1 Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter 6

2 Income Statements Service revenue$XXX Expenses Salary expense X Depreciation expense X Income tax expense X Net income$ X Service Company Century 21 Real Estate Income Statement Year Ended December 31, 20xx Sales revenue$185 Cost of goods sold 146 Gross profit 39 Operating expenses: Salary expense X Depreciation expense X Income tax expense$ X Net income$ 4 Merchandising Company General Motors Corporation Income Statement Year Ended December 31, 20xx

3 Balance Sheets Current assets: Cash$X Short-term investments X Accounts receivable, net X Prepaid expenses X Service Company Century 21 Real Estate Balance Sheet Year Ended December 31, 20xx Current assets: Cash$ X Short-term investments X Accounts receivable, net X Inventory 11 Prepaid expenses X Merchandising Company General Motors Corporation Balance Sheet Year Ended December 31, 20xx

4 Accounting for Inventory Current assets: Cash$ XXX Short-term investments XXX Accounts receivable XXX Inventory (1 truck @$15,000)$15,000 Prepaid expenses XXX General Motors Corporation Balance Sheet (partial) Sales revenue (2 trucks @ $20,000)$40,000 Cost of goods sold (2 trucks @ $15,000) 30,000 Gross profit$10,000 General Motors Corporation Income Statement (partial)

5 Sales revenues – Cost of goods sold = Gross profit (before operating expenses) Sales revenues – Cost of goods sold = Gross profit (before operating expenses) Gross profit – Operating expenses = Net income Gross profit – Operating expenses = Net income Gross Profit (Gross Margin)

6 Use the cost-of-goods- sold model.

7 Cost of Goods Sold Model Beginning inventory $20 Purchases $100 Cost of goods available for sale $120 Ending inventory $30 Cost of goods sold $90

8 How Much Inventory Should Be Purchased? Budgeted cost of goods sold$6,000 + Budgeted ending inventory 1,500 – Actual beginning inventory 1,200 = Budgeted purchases$6,300 = Budgeted cost of goods available for sale$7,500

9 How Much Inventory Should Be Purchased? EI1500 -BI1200 +COGS6000 =P6300

10 What is EI or what is COGS? BI +P -COGS =EI BI +P -EI =COGS OR…

11 Account for inventory transactions.

12 Perpetual systems maintain a running record to show the inventory on hand at all times. Perpetual systems maintain a running record to show the inventory on hand at all times. Periodic systems do not keep a continuous record of inventory on hand. Periodic systems do not keep a continuous record of inventory on hand. Inventory Accounting Systems

13 Debit Cash or Accounts Receivable Credit Sales Revenue Debit Cash or Accounts Receivable Credit Sales Revenue Debit Cost of Goods Sold Credit Inventory Debit Cost of Goods Sold Credit Inventory Recording Transactions in the Perpetual System Debit Inventory Credit Cash or Accounts Payable Debit Inventory Credit Cash or Accounts Payable

14 Recording Transactions in the Perpetual System 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 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

15 Recording Transactions and the T-Accounts Accounts Payable 560,000Beg.100,000 560,000 Inventory Inventory560,000 Accounts Payable560,000 Purchased inventory on account Inventory560,000 Accounts Payable560,000 Purchased inventory on account

16 Recording Transactions and the T-Accounts Sale on account $900,000 (cost $540,000): Accounts Receivable900,000 Sales Revenue900,000 Cost of Goods Sold540,000 Inventory540,000 Accounts Receivable900,000 Sales Revenue900,000 Cost of Goods Sold540,000 Inventory540,000

17 Recording Transactions and the T-Accounts Cost of Goods Sold 540,000 Inventory Beg.100,000 560,000 120,000 540,000

18 Reporting in the Financial Statements Income Statement (partial) Sales revenue$900,000 Cost of goods sold 540,000 Gross profit$360,000 Ending Balance Sheet (partial) Current assets: Cash$ XXX Short-term investments XXX Accounts receivable, net XXX Inventory 120,000 Prepaid expenses XXX

19 Net sales= Sales revenue – Sales returns & allowances – Sales discounts Net sales= Sales revenue – Sales returns & allowances – Sales discounts Reporting in the Financial Statements Net purchases= Purchases + Freight-in – Purchase returns & allowances – Purchases discount Net purchases= Purchases + Freight-in – Purchase returns & allowances – Purchases discount

20 Analyze the various inventory methods.

21 The cost of any asset, such as inventory, is the sum of all the costs incurred to bring the asset to its intended use. What Goes Into Inventory Cost? Generally accepted inventory costing methods: Specific unit costWeighted-average costFirst-in, first-out (FIFO)Last-in, first-out (LIFO)

22 Beginning inventory (10 units @ $10)$100 No. 1 (25 units @ $14 per unit)$350 No. 2 (25 units @ $18 per unit 450 Total purchases 800 Cost of goods available for sale$900 Ending inventory:20 units Cost of goods sold:40 units Illustrative Data

23 Cost of Goods Sold $ 50 350 180 $580 Specific Unit Cost 5 Units @ $10 25 Units @ $14 10 Units @ $18

24 Weighted-Average $900 total cost ÷ 60 units = $15/unit Cost of goods sold = 40 × $15 = $600

25 Cost of Goods Sold $100 350 90 $540 First-In, First-Out 10 Units @ $10 25 Units @ $14 5 Units @ $18

26 Cost of Goods Sold $450 210 $660 Last-In, First-Out 25 Units @ $18 15 Units @ $14

27 Cost of Goods Sold Specific unit cost$580.00 Weighted-average$600.00 FIFO$540.00 LIFO$660.00 Income Effects of Inventory Methods

28 Ending Inventory Specific unit cost$320.00 Weighted-average$300.00 FIFO$360.00 LIFO$240.00 Income Effects of Inventory Methods

29 Specific unit cost $1,000 –580 =$420 Weighted-average $1,000 – 600 =$400 FIFO $1,000 – 540 =$460 LIFO $1,000 – 660 =$340 Assumed Sales Revenue Cost of Goods Sold Gross Profit

30 Income Effects – Inventory Costs Are Increasing Gross profit, and net income LIFO Weighted- average FIFO

31 Income Effects – Inventory Costs Are Decreasing Gross profit, and net income LIFO Weighted- average FIFO

32 Identify the income and the tax effects of the inventory methods.

33 The Tax Advantage of LIFO Gross profit$460$340 Operating expenses 260 260 Income before taxes$200$ 80 Income tax expense (40%)$ 80$ 32 FIFOLIFO The most attractive feature of LIFO is low income tax payments.

34 Comparison of Inventory Methods LIFO liquidation occurs when inventory quantities fall below the pervious level resulting in higher net income and increased taxes. FIFO produces inventory profits during periods of inflation.

35 Businesses should use the same accounting methods and procedures from one period to the next. Businesses should use the same accounting methods and procedures from one period to the next. A company may change inventory methods, but it must disclose the effects of the change on net income. A company may change inventory methods, but it must disclose the effects of the change on net income. Accounting Principles and Inventories

36 The financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company. The financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company. Accounting Principles and Inventories

37 An item is material if it has the potential to alter a statement users decision to invest in the stock of the company. An item is material if it has the potential to alter a statement users decision to invest in the stock of the company. Materiality is different For different firms. Materiality is different For different firms.

38 Err on the side of caution when reporting any item in the financial statements. Err on the side of caution when reporting any item in the financial statements. Accounting Principles and Inventories

39 Lower-of-Cost-or-Market Rule Inventory is reported at the lower of its historical cost or market (replacement) value. If the replacement cost falls below its historical cost, the business must write down the value of its inventory.

40 Show how inventory errors affect cost of goods sold and income.

41 Effects of Inventory Errors The current years ending inventory is next years beginning inventory. An error in the ending inventory creates errors for cost of goods sold and gross profit.

42 Effects of Inventory Errors Sales revenue Cost of goods sold: Beg. inventory Purchases Cost of goods available for sale Ending inventory Cost of goods sold Gross profit $100,000 $10,000 50,000 $60,000 (15,000) 45,000 $ 55,000 $100,000 $15,000 50,000 $65,000 (10,000) 55,000 $ 45,000 $100,000 $10,000 50,000 $60,000 (10,000) 50,000 $ 50,000 Period 1 Ending Inventory Overstated by $5,000 Period 1 Beginning Inventory Overstated by $5,000 Period 1 Correct

43 Ethical Considerations Managers of companies whose profits do not meet stockholder expectations are sometimes tempted to cook the books to increase reported income. 1. Overstating ending inventory 2. Creating fictitious sales revenue

44 Use the gross profit percentage and inventory turnover to evaluate business.

45 Inventory turnover = Cost of goods sold ÷ Average inventory Inventory turnover = Cost of goods sold ÷ Average inventory Gross profit percentage = Gross profit ÷ Net sales revenue Gross profit percentage = Gross profit ÷ Net sales revenue Using the Financial Statements for Decision Making

46 Gross Profit on $1 of Sales for Two Merchandisers Gross profit $0.21 Gross profit $0.61 Cost of goods sold $0.79 Cost of goods sold $0.39 $1.00 $0.75 $0.50 $0.25 $0.00 General Motors Pepsi Co.

47 End of Chapter 6


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