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©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 1 Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter.

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Presentation on theme: "©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 1 Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter."— Presentation transcript:

1 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 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 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

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, netX Inventory 11 Prepaid expensesX Merchandising Company General Motors Corporation Balance Sheet Year Ended December 31, 20xx ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

4 4 Gross Profit (Gross Margin) Sales Revenue - Gross Profit - Operating Expenses Net Income

5 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 5 Learning Objective 1 Account for inventory transactions.

6 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 6 Periodic systems do not keep a continuous record of inventory on hand. Perpetual systems maintain a running record to show the inventory on hand at all times. Inventory Accounting Systems

7 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 7 Recording Transactions in the Perpetual System Purchase price of the inventory$600,000 + Freight-in4,000 – Purchase returns– 25,000 – Purchase allowances– 5,000 – Purchase discounts – 14,000 = Net purchases of inventory$560,000

8 Recording Transactions and the T-Accounts Accounts Payable 560,000Beg.100, ,000 Inventory Inventory560,000 Accounts Payable560,000 Purchased inventory on account ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

9 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 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

10 10 Recording Transactions and the T-Accounts Cost of Goods Sold 540,000 Inventory Beg.100, , , ,000

11 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 11 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

12 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 12 Net sales Sales revenue – Sales returns & allowances – Sales discounts Reporting in the Financial Statements Net purchases Purchases + Freight-in – Purchase returns & allowances – Purchases discount

13 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 13 Learning Objective 2 Analyze the various inventory methods.

14 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 14 What Goes Into Inventory Cost? Sum of all costs incurred to bring asset to its intended use Inventory costing methods: Specific unit cost Weighted-average cost First-in, first-out (FIFO) Last-in, first-out (LIFO)

15 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 15 Beginning inventory (10 $10)$ 100 No. 1 (25 $14 per unit)$350 No. 2 (25 $18 per unit) 450 Total purchases 800 Cost of goods available for sale$ 900 Ending inventory: 20 units Cost of goods sold: 40 units Illustrative Data

16 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 16 Cost of Goods Sold $ $580 Specific Unit Cost $900 – $580 = $ $14 10 $18 5 $10

17 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 17 Weighted-Average $900 total cost ÷ 60 units = $15/unit Cost of goods sold = 40 × $15 = $600 Ending inventory = 20 × $15 = $300

18 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren units Less units sold40 Ending inventory20 units First-In, First-Out Ending Inventory Cost: 20 units × $18 per unit = $360

19 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 19 Cost of Goods Sold $ $540 First-In, First-Out 10 $10 25 $14 5 $18

20 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren units Less units sold40 Ending inventory20 units Last-In, First-Out Ending Inventory Cost: 10 units × 10 =$ units × 14 = 140 Total$240

21 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 21 Cost of Goods Sold $ $660 Last-In, First-Out 25 $18 15 $14

22 Income Effects of Inventory Methods 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 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

23 23 Learning Objective 3 Identify the income and the tax effects of the inventory methods.

24 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 24 The Tax Advantage of LIFO Gross profit$460$340 Operating expenses Income before taxes$200$ 80 Income tax expense (40%)$ 80$ 32 FIFOLIFO The most attractive feature of LIFO is low income tax payments when prices are increasing.

25 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 25 Use of the Various Inventory Methods

26 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 26 Comparison of Inventory Methods FIFO produces inventory profits during periods of inflation LIFO allows managers to manipulate net income LIFO liquidation

27 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 27 Consistency Principle Use the same accounting methods and procedures from one period to the next May change inventory methods, but must disclose the effects of the change on net income

28 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 28 Disclosure Principle Financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company.

29 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 29 Conservatism The least favorable figures are presented in the financial statements.

30 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 30 Lower-of-Cost-or-Market Rule Report inventory at the lower of its historical cost or market (replacement) value If the replacement cost falls below its historical cost, write down the value of the inventory

31 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 31 Learning Objective 4 Use the gross profit percentage and inventory turnover to evaluate business.

32 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 32 Inventory turnover = Cost of goods sold ÷ Average inventory Gross profit percentage = Gross profit ÷ Net sales revenue Using the Financial Statements for Decision Making

33 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 33 Learning Objective 5 Estimate inventory by the gross profit method.

34 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 34 Estimating Inventory Gross profit method - based on computation of cost-of-goods- sold Beginning inventory +Purchases =Cost of goods available for sale –Ending inventory =Cost of goods sold -Cost of goods sold = Ending inventory

35 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 35 Objective 6 Show how inventory errors affect cost of goods sold and income.

36 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 36 Effects of Inventory Errors An error in the ending inventory creates errors for cost of goods sold and gross profit. The current years ending inventory is next years beginning inventory.

37 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 37 Reporting Inventory Transactions on the Statement of Cash Flows Inventory transactions are operating activities The purchase of inventory requires a cash payment, and the sale a cash receipt

38 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 38 End of Chapter 6


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