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Merchandise Inventory, Cost of Goods Sold, and Gross Profit

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

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

2 Merchandising Company General Motors Corporation
Income Statements Service Company Century 21 Real Estate Income Statement Year Ended December 31, 20xx Merchandising Company General Motors Corporation Income Statement Year Ended December 31, 20xx Service revenue $XXX Expenses Salary expense X Depreciation expense X Income tax expense X Net income $ X Sales revenue $185 Cost of goods sold Gross profit Operating expenses: Salary expense X Depreciation expense X Income tax expense $ X Net income $ 4 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

3 Merchandising Company General Motors Corporation
Balance Sheets Service Company Century 21 Real Estate Balance Sheet Year Ended December 31, 20xx Merchandising Company General Motors Corporation Balance Sheet Year Ended December 31, 20xx Current assets: Cash $X Short-term investments X Accounts receivable, net X Prepaid expenses X Current assets: Cash $ X Short-term investments X Accounts receivable, net X Inventory Prepaid expenses X ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

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

5 Learning Objective 1 Account for inventory transactions.

6 Inventory Accounting Systems
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.

7 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

8 Recording Transactions and the T-Accounts
Inventory 560,000 Accounts Payable 560,000 Purchased inventory on account Beg. 100,000 560,000 Inventory Accounts Payable 560,000 ©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 Receivable 900,000 Sales Revenue 900,000 Cost of Goods Sold 540,000 Inventory 540,000 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

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

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

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

13 Learning Objective 2 Analyze the various inventory methods.

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

16 Specific Unit Cost 5 Units @ $10 Cost of Goods Sold $ 50 350 180 $580
$ 50 350 180 $580 25 $14 10 $18 $900 – $580 = $320

17 Weighted-Average $900 total cost ÷ 60 units = $15/unit
Ending inventory = 20 × $15 = $300 Cost of goods sold = 40 × $15 = $600

18 First-In, First-Out Ending Inventory Cost: 60 units Less units sold 40
Ending inventory 20 units 20 units × $18 per unit = $360

19 First-In, First-Out 10 Units @ $10 Cost of Goods Sold $100 350 90 $540

20 Last-In, First-Out Ending Inventory Cost: 60 units Less units sold 40
Ending inventory 20 units 10 units × 10 = $100 10 units × 14 = 140 Total $240

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

22 Income Effects of Inventory Methods
Assumed Sales Revenue Cost of Goods Sold Gross Profit Specific unit cost $1,000 – 580 = $420 Weighted-average $1,000 – 600 = $400 FIFO $1,000 – 540 = $460 LIFO $1,000 – 660 = $340 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

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

24 The Tax Advantage of LIFO
Gross profit $460 $340 Operating expenses Income before taxes $200 $ 80 Income tax expense (40%) $ $ 32 FIFO LIFO The most attractive feature of LIFO is low income tax payments when prices are increasing.

25 Use of the Various Inventory Methods

26 Comparison of Inventory Methods
FIFO produces inventory profits during periods of inflation LIFO allows managers to manipulate net income LIFO liquidation

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 Disclosure Principle Financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company.

29 Conservatism The least favorable figures are presented in the financial statements.

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 Learning Objective 4 Use the gross profit percentage and inventory turnover to evaluate business.

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

33 Learning Objective 5 Estimate inventory by the gross profit method.

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 Objective 6 Show how inventory errors affect cost of goods sold and income.

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

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 End of Chapter 6


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