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CHAPTER 6 Accounting for Merchandising Inventory, Cost of Goods Sold, and the Gross Margin.

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Presentation on theme: "CHAPTER 6 Accounting for Merchandising Inventory, Cost of Goods Sold, and the Gross Margin."— Presentation transcript:

1 CHAPTER 6 Accounting for Merchandising Inventory, Cost of Goods Sold, and the Gross Margin

2 Opening Vignette - Huntington Galleries
Change in way Huntington accounts for inventory helped increase company’s net income Significant because Huntington is a merchandising company Earns substantial portion of revenues selling products to customers What is the relationship between inventory accounting and financial statements?

3 Opening Vignette - Huntington Galleries
Inventory accounting decisions have “trickle-down” effect Income statement - Cost of goods sold Balance sheet - Inventory (asset) Statement of cash flows Cash flows from operating activities

4 Chapter Learning Objectives
1. Account for inventory by the perpetual and periodic systems 2. Apply the inventory costing methods: specific unit cost, weighted-average cost, FIFO, and LIFO 3. Identify the income effects and the tax effects of the inventory costing methods 4. Apply the lower-of-cost-or-market rule to inventory

5 Chapter Learning Objectives
5. Compute the effects of inventory errors on cost of goods sold and net income 6. Estimate inventory by the gross margin method 7. Use the gross margin percentage and the inventory turnover ratio to evaluate a business

6 Account for inventory by the perpetual and periodic systems
Chapter Objective 1 Account for inventory by the perpetual and periodic systems

7 The Basic Concept of Inventory Accounting
Record amount and quantity of inventory on hand at end of accounting period

8 The Basic Concept of Inventory Accounting
Record amount and quantity of inventory on hand at end of accounting period Recognize cost of sales (an “expense”) to be matched against period sales revenues

9 The Basic Concept of Inventory Accounting
Inventory is primary current asset for merchandising organization Cost of goods sold (cost of sales) is organization’s primary expense Refer to Lands’ End’s financial statements (textbook Chapter 1)

10 The Basic Concept of Inventory Accounting
COST OF GOODS SOLD $588,017,000 57 cents of every sales dollar earned goes to pay for cost of merchandise sold to customers by Lands’ End

11 The Basic Concept of Inventory Accounting
COST OF GOODS SOLD $588,017,000 57 cents of every sales dollar earned goes to pay for cost of merchandise sold to customers by Lands’ End INVENTORY $164,816,000 Comprises 74.2% of Lands’ End total current assets Comprises nearly 51% of total company assets

12 Inventory Accounting - Perpetual System
Keeps perpetual (continuous) accounting records for every inventory item purchased and sold by company Generally used for expensive merchandise items: trucks, jewelry, furniture Point-of-sale technology eases implementation

13 Perpetual System Advantages
Allows quick determination of cost of goods sold and merchandise inventory from ledger account balances Facilitates inventory resource management activities Links to electronic document interchange (EDI) systems decrease inventory ordering time Product managers perform multidimensional analyses of inventory/sales data Managers make realtime changes to sales plans, purchasing budgets, etc.

14 Perpetual System Advantages
Improves internal control over merchandise inventory Physical counts should agree with amounts reported in records Otherwise, adjust records for spoilage, theft, etc.

15 Perpetual System Advantages
Improves internal control over merchandise inventory Physical counts should agree with amounts reported in records Otherwise, adjust records for spoilage, theft, etc. Enhances customer service Report up-to-date information to customers: quantity, expected delivery dates, etc.

16 Entries Under the Perpetual System
Goods purchased debited to Inventory (or Merchandise Inventory) ledger account Cash or A/P credited SITUATION: On November 14, Asian Art, Inc. purchases $43,000 of sculptures and watercolors on account for resale to customers.

17 Entries Under the Perpetual System
How would you record this transaction? 11/14/xx Inventory $43,000 A/P $43,000 To record inventory purchased on account

18 Entries Under the Perpetual System
How would you record this transaction? 11/14/xx Inventory $43,000 A/P $43,000 To record inventory purchased on account Inventory 11/14 $43,000

19 Entries Under the Perpetual System
How would you record this transaction? 11/14/xx Inventory $43,000 A/P $43,000 To record inventory purchased on account Inventory Accounts Payable 11/14 $43, $43, /14

20 Entries Under the Perpetual System
Sales to customers captured through two journal entries (1) record sales revenue (2) reduce inventory and increase cost of goods sold

21 Entries Under the Perpetual System
Sales to customers captured through two journal entries (1) record sales revenue (2) reduce inventory and increase cost of goods sold How would Asian Art journalize a $7,000 sale on account on Nov. 29, assuming cost of goods sold is $2,900?

22 Entries Under the Perpetual System
11/29/xx A/R $7,000 Sales Revenue $7,000 To record sale on account

23 Entries Under the Perpetual System
11/29/xx A/R $7,000 Sales Revenue $7,000 To record sale on account Accounts Receivable 11/29 $7,000

24 Entries Under the Perpetual System
11/29/xx A/R $7,000 Sales Revenue $7,000 To record sale on account Accounts Receivable Sales Revenue 11/29 $7, $7, /29

25 Entries Under the Perpetual System
11/29/xx Cost of Goods Sold $2,900 Inventory $2,900 To record cost of sales

26 Entries Under the Perpetual System
11/29/xx Cost of Goods Sold $2,900 Inventory $2,900 To record cost of sales Cost of Goods Sold 11/29 $2,900

27 Entries Under the Perpetual System
11/29/xx Cost of Goods Sold $2,900 Inventory $2,900 To record cost of sales Cost of Goods Sold Inventory 11/29 $2, $2, /29

28 Inventory Accounting - Periodic System
Accounting records do not continuously track on-hand inventory At period end, physical count performed to determine proper ending inventory account balance Inventory and cost of goods sold account balances adjusted before preparing financials INVENTORY COUNT SCHEDULE: March 31

29 Periodic System Advantages
Fewer journal entries required during accounting period Easy to use for small companies with rather homogenous goods Although computerized accounting and sales systems make perpetual system just as easy to work with

30 Entries Under the Periodic System
Goods purchased debited to Purchases ledger account Cash or A/P credited SITUATION: On February 20, Ray’s Seafood Shack purchases $850 of shark, red snapper, and black grouper filets for the next week’s dinner specials.

31 Entries Under the Periodic System
How would you record this transaction? 2/20/xx Purchases $850 A/P $850 To record inventory purchased on account

32 Entries Under the Periodic System
How would you record this transaction? 2/20/xx Purchases $850 A/P $850 To record inventory purchased on account Purchases 2/ $850

33 Entries Under the Periodic System
How would you record this transaction? 2/20/xx Purchases $850 A/P $850 To record inventory purchased on account Purchases Accounts Payable 2/ $ $ /20

34 Entries Under the Periodic System
Only entry necessary to capture Seafood Shack’s sales to customers is one to record sales revenues earned REMEMBER: inventory and cost of goods sold adjusted at month-end only

35 Entries Under the Periodic System
Textbook Exhibit 6-2 details adjusting entries used to update account balances

36 Entries Under the Periodic System
Textbook Exhibit 6-2 details adjusting entries used to update account balances INVENTORY Beginning balance COST OF GOODS SOLD

37 Entries Under the Periodic System
Textbook Exhibit 6-2 details adjusting entries used to update account balances INVENTORY Beginning balance COST OF GOODS SOLD Beginning bal.

38 Entries Under the Periodic System
Textbook Exhibit 6-2 details adjusting entries used to update account balances INVENTORY Ending Beginning balance balance COST OF GOODS SOLD Beginning bal.

39 Entries Under the Periodic System
Textbook Exhibit 6-2 details adjusting entries used to update account balances INVENTORY Ending Beginning balance balance COST OF GOODS SOLD Beginning bal Ending bal.

40 Entries Under the Periodic System
Textbook Exhibit 6-2 details adjusting entries used to update account balances INVENTORY PURCHASES Ending Beginning Net purchases balance balance during period COST OF GOODS SOLD Beginning bal Ending balance

41 Entries Under the Periodic System
Textbook Exhibit 6-2 details adjusting entries used to update account balances INVENTORY PURCHASES Ending Beginning Net purchases balance balance during period COST OF GOODS SOLD Beginning bal Ending balance Net purchases

42 Entries Under the Periodic System
Textbook Exhibit 6-2 details adjusting entries used to update account balances INVENTORY PURCHASES Ending Beginning Net purchases balance balance during period COST OF GOODS SOLD Beginning bal Ending balance Net purchases Cost of goods sold

43 Cost of Goods Sold (Cost of Sales)
Represents net purchase costs of inventory sold to customers during accounting period Cost of goods sold = beginning inventory + net purchases - ending inventory

44 Managers’ Use of the Cost of Goods Sold Model
How do product managers and corporate buyers at Pier 1 Imports, Sears, or Williams-Sonoma decide how much inventory to buy for the upcoming year? Want to have enough product on hand to meet customer demand But not TOO much inventory - requiring company to discount sales prices to rid itself of excess merchandise!

45 Managers’ Use of the Cost of Goods Sold Model
Rearranging model allows managers to determine appropriate amount of inventory purchases Budgeted Cost of Goods Sold - budgeted ending inventory = cost of goods available for sale - actual beginning inventory = budgeted purchases

46 Gross Margin (Gross Profit)
Difference between sales revenue and cost of sales

47 Gross Margin (Gross Profit)
Difference between sales revenue and cost of sales Revenues = $700,000

48 Gross Margin (Gross Profit)
Difference between sales revenue and cost of sales Revenues = $700,000 Cost of sales = $450,000

49 Gross Margin (Gross Profit)
Difference between sales revenue and cost of sales Revenues = $700,000 Cost of sales = $450,000 Gross margin = $250,000

50 Gross Margin (Gross Profit)
Difference between sales revenue and cost of sales Revenues = $700,000 Cost of sales = ,000 Gross margin = ,000 What is the significance of the gross margin?

51 Gross Margin (Gross Profit)
Low gross margin % indicates possible difficulties in covering all other company operating expenses And being able to earn a profit ILLUSTRATION: Huntington Galleries’ gross margin is $75,100,000 ($165,900, ,800,000). Can the company cover its operating costs and still earn profits acceptable to its shareholders?

52 Gross Margin (Gross Profit)
Information taken from textbook Chapter 6 opening pages Net sales $165,900,000 Cost of sales ,800,000 Gross margin ,100,000 All other expenses ,000,000 Net income $35,100,000

53 Gross Margin (Gross Profit)
Information taken from textbook Chapter 6 opening pages Net sales $165,900,000 Cost of sales ,800,000 Gross margin ,100,000 All other expenses ,000,000 Net income $35,100,000 Huntington’s gross margin seems sufficient

54 Gross Margin (Gross Profit)
Information taken from textbook Chapter 6 opening pages Net sales $165,900,000 Cost of sales ,800,000 Gross margin ,100,000 All other expenses ,000,000 Net income ,100,000 Huntington’s gross margin seems sufficient Company generated a 21% return on sales

55 Computing the Cost of Inventory
Inventory cost calculation Inventory quantities in units x Unit cost

56 Determining Inventory Quantities
Physical count of merchandise owned taken on last day of fiscal year - regardless of method Sometimes taken monthly or quarterly for interim financial reports Complicating factors Who owns merchandise in transit between vendor and company? Who owns goods on consignment?

57 Goods in Transit Inventory has left supplier’s place of business
Topeka, Kansas

58 Goods in Transit Inventory has left supplier’s place of business
Topeka, Kansas

59 Goods in Transit At accounting period end, goods still “in transit”
Haven’t yet reached their destination Las Cruces, New Mexico

60 Goods in Transit At accounting period end, goods still “in transit”
Haven’t yet reached their destination Las Cruces, New Mexico

61 Goods in Transit At accounting period end, goods still “in transit”
Haven’t yet reached their destination Las Cruces, New Mexico Who owns/records inventory at period end? Supplier? Buyer?

62 Goods in Transit Entity possessing legal title to inventory
Generally based on shipping terms FOB shipping point Title passes at seller’s place of business Cost/units reflected in buyer’s inventory FOB destination Title passes at buyer’s business location Seller retains cost/units in its accounting records

63 Consigned Goods Inventory stored/sold on company premises but not owned by entity Antiques store or used clothing store accepts inventory owned by others Tries to sell it for owners Earns commission on each piece of furniture or clothing sold

64 Consigned Goods Consigned goods included in inventory of owner
Excluded from inventory of antiques store or used clothing store Not assets of the store

65 Unit Cost of Inventory Amount paid to

66 Unit Cost of Inventory Amount paid to purchase

67 Unit Cost of Inventory Amount paid to purchase transport

68 Unit Cost of Inventory Amount paid to purchase transport store

69 inventory held for sale to customers
Unit Cost of Inventory Amount paid to purchase transport store insure inventory held for sale to customers

70 inventory held for sale to customers
Unit Cost of Inventory Amount paid to purchase transport store insure inventory held for sale to customers Several cost methods exist ...

71 Chapter Objective 2 Apply the inventory costing methods: specific unit cost, weighted-average cost, FIFO, and LIFO

72 Inventory Costing Methods
Specific Unit Cost

73 Inventory Costing Methods
Specific Unit Cost Weighted-Average Cost

74 Inventory Costing Methods
Specific Unit Cost Weighted-Average Cost First-In-First-Out (FIFO)

75 Inventory Costing Methods
Specific Unit Cost Weighted-Average Cost First-In-First-Out (FIFO) Last-In-First-Out (LIFO)

76 Inventory Costing Methods
Business free to use any inventory method

77 Inventory Costing Methods
Business free to use any inventory method Inventory cost flow doesn’t necessarily match PHYSICAL flow of goods

78 Inventory Costing Methods
Business free to use any inventory method Inventory cost flow doesn’t necessarily match PHYSICAL flow of goods Assigns value to Cost of goods sold Ending inventory

79 Inventory Costing Methods
Assume following data for Asian Art, Inc. Purchases of silk and paper lanterns during 19x1 1/5/x $20 5/19/x $30 10/23/x $31 Total purchases in units Units sold during 19x Ending inventory in units

80 Inventory Costing Methods - Sales Information
Sales in units 1/8/x = 17 5/21/x = 18 10/28/x = 35 Total sales = units

81 Specific Identification
COST OF GOODS SOLD JAN 8 $340 17 $20

82 Specific Identification
COST OF GOODS SOLD JAN 8 $340 ENDING INVENTORY $60 17 $20 3 $20

83 Specific Identification
COST OF GOODS SOLD MAY 21 $540 JAN 8 $340 ENDING INVENTORY $60 18 $30 17 $20 3 $20

84 Specific Identification
COST OF GOODS SOLD MAY 21 $540 JAN 8 $340 ENDING INVENTORY $210 $60 18 $30 7 $30 17 $20 3 $20

85 Specific Identification
COST OF GOODS SOLD OCT 28 $1085 MAY 21 $540 JAN 8 $340 $1965 ENDING INVENTORY $210 $60 35 $31 18 $30 7 $30 17 $20 3 $20

86 Specific Identification
COST OF GOODS SOLD OCT 28 $1085 MAY 21 $540 JAN 8 $340 $1965 ENDING INVENTORY $155 $210 $60 $425 35 $31 5 $31 18 $30 7 $30 17 $20 3 $20

87 First-In-First-Out (FIFO)
COST OF GOODS SOLD $400 15 $31 25 $31 25 $30 20 $20

88 First-In-First-Out (FIFO)
COST OF GOODS SOLD $750 $400 15 $31 25 $31 25 $30 20 $20

89 First-In-First-Out (FIFO)
COST OF GOODS SOLD $775 $750 $400 $1925 15 $31 25 $31 25 $30 20 $20

90 First-In-First-Out (FIFO)
COST OF GOODS SOLD $775 $750 $400 $1925 ENDING INVENTORY $465 15 $31 25 $31 25 $30 20 $20

91 Last-In-First-Out (LIFO)
COST OF GOODS SOLD $ 1240 40 $31 25 $30 5 $20 15 $20

92 Last-In-First-Out (LIFO)
COST OF GOODS SOLD $ 1240 $ 750 40 $31 25 $30 5 $20 15 $20

93 Last-In-First-Out (LIFO)
COST OF GOODS SOLD $ 1240 $ 750 $ 100 $2090 40 $31 25 $30 5 $20 15 $20

94 Last-In-First-Out (LIFO)
ENDING INVENTORY $300 COST OF GOODS SOLD $ 1240 $ 750 $ 100 $2090 40 $31 25 $30 5 $20 15 $20

95 Weighted-Average Cost
$2390 total cost goods available for sale 40 $ 31 25 $ 30 20 $ 20

96 Weighted-Average Cost
$2390 total cost goods available for sale 85 units available for sale 40 $ 31 25 $ 30 20 $ 20

97 Weighted-Average Cost
$2390 total cost goods available for sale 85 units available for sale $28.12 cost per unit 40 $ 31 25 $ 30 20 $ 20

98 Weighted-Average Cost
$2390 total cost goods available for sale 85 units available for sale $28.12 cost per unit $28.12 x 70 units sold in 19x1 = $1968 cost of goods sold 40 $ 31 25 $ 30 20 $ 20

99 Weighted-Average Cost
$2390 total cost goods available for sale 85 units available for sale $28.12 cost per unit $28.12 x 70 units sold in 19x1 = $1968 cost of goods sold $28.12 x 15 units on hand = $422 ending inventory 40 $ 31 25 $ 30 20 $ 20

100 Chapter Objective 3 Identify the income effects and the tax effects of the inventory costing methods

101 Income Effects of Each Method
SPECIF WEIGHTED IDENTIFIC AVERAGE FIFO LIFO

102 Income Effects of Each Method
SPECIF WEIGHTED IDENTIFIC AVERAGE FIFO LIFO SALES $3, $3, $3, $3,000

103 Income Effects of Each Method
SPECIF WEIGHTED IDENTIFIC AVERAGE FIFO LIFO SALES $3, $3, $3, $3,000 COST OF GOODS SOLD BEGINNING INVENTORY

104 Income Effects of Each Method
SPECIF WEIGHTED IDENTIFIC AVERAGE FIFO LIFO SALES $3, $3, $3, $3,000 COST OF GOODS SOLD BEGINNING INVENTORY PURCHASES , , , ,390

105 Income Effects of Each Method
SPECIF WEIGHTED IDENTIFIC AVERAGE FIFO LIFO SALES $3, $3, $3, $3,000 COST OF GOODS SOLD BEGINNING INVENTORY PURCHASES , , , ,390 COST OF GOODS AVAILABLE FOR SALE , , , ,390

106 Income Effects of Each Method
SPECIF WEIGHTED IDENTIFIC AVERAGE FIFO LIFO SALES $3, $3, $3, $3,000 COST OF GOODS SOLD BEGINNING INVENTORY PURCHASES , , , ,390 COST OF GOODS AVAILABLE FOR SALE , , , ,390 LESS ENDING INVENTORY

107 Income Effects of Each Method
SPECIF WEIGHTED IDENTIFIC AVERAGE FIFO LIFO SALES $3, $3, $3, $3,000 COST OF GOODS SOLD BEGINNING INVENTORY PURCHASES , , , ,390 COST OF GOODS AVAILABLE FOR SALE , , , ,390 LESS ENDING INVENTORY COST OF GOODS SOLD , , , ,090

108 Income Effects of Each Method
SPECIF WEIGHTED IDENTIFIC AVERAGE FIFO LIFO SALES $3, $3, $3, $3,000 COST OF GOODS SOLD BEGINNING INVENTORY PURCHASES , , , ,390 COST OF GOODS AVAILABLE FOR SALE , , , ,390 LESS ENDING INVENTORY COST OF GOODS SOLD , , , ,090 GROSS MARGIN $1, $1, $1, $910

109 Income Effects of Each Method
SPECIF WEIGHTED IDENTIFIC AVERAGE FIFO LIFO GROSS MARGIN $1, $1, $1, $910 In times of rising prices, LIFO yields lowest gross margin (net income)

110 Income Effects of Each Method
SPECIF WEIGHTED IDENTIFIC AVERAGE FIFO LIFO GROSS MARGIN $1, $1, $1, $910 FIFO yields highest gross margin

111 Income Tax Advantage of LIFO
TAXES When income is lower, taxes are lower Most attractive aspect of LIFO Recall the textbook opening vignette ... Huntington Galleries saved nearly $1.3-million in taxes by using LIFO!

112 Income Tax Advantages of LIFO
Why would a company use FIFO?

113 Incentives for Using FIFO
Higher net income results in larger bonuses Industries experiencing falling costs end up with lower net income - still save on taxes Higher net income looks better to creditors/investors

114 Accounting Principles and Their Relevance to Inventory
CONSISTENCY Entity employs same methods of accounting from period to period Enhances users’ ability to compare financial statements for company over time Trend analysis Forecasts

115 Accounting Principles and Their Relevance to Inventory
CONSISTENCY Entity employs same methods of accounting from period to period Enhances users’ ability to compare financial statements for company over time Trend analysis Forecasts FULL DISCLOSURE Entity reports sufficient quantity and quality of information for users

116 Accounting Principles and Their Relevance to Inventory
CONSISTENCY Entity employs same methods of accounting from period to period Enhances users’ ability to compare financial statements for company over time Trend analysis Forecasts FULL DISCLOSURE Entity reports sufficient quantity and quality of information for users Failure to disclose important data can result in financial reports which mislead readers Impacts their decision-making activities

117 Consistency and Disclosure
Company can change inventory methods, but must disclose impact of change on net income Financials should provide investors/creditors with adequate information on which to base their actions Relevant Reliable Comparable

118 Accounting Principles and Their Relevance to Inventory
MATERIALITY Information is material if its omission from financial statements would cause users to alter their decisions Measured in relation to other information provided on financial statements CONSERVATISM Statement preparers use accounting methods and principles which Least overstate net assets Least overstate net income

119 Apply the lower-of-cost-or-market rule to inventory
Chapter Objective 4 Apply the lower-of-cost-or-market rule to inventory

120 Lower-of-Cost-or-Market Rule
Inventory reported on balance sheet at lower of original cost or current replacement (market) value Communicates to statement users the decline in value of inventory

121 Lower-of-Cost-or-Market Rule
Suppose a retailer sells laptop computers ... Laptop original cost/unit = $1,200 Laptop replacement cost/unit = $900 Retailer would reduce ending inventory value by $300 per unit Rapid changes in technology quickly diminishes utility of this inventory item

122 Lower-of-Cost-or-Market Rule
Doesn’t this violate historical cost principle? Yes, but ... Other principles provide more compelling reasons to depart from historical cost Conservatism Full disclosure Materiality

123 Chapter Objective 5 Compute the effects of inventory errors on cost of goods sold and net income

124 Effects of Inventory Errors
Textbook Exhibits 6-9 and 6-10 demonstrate the carry-forward effects of errors related to ending inventory How many periods’ financial statements will be affected by an error in ending inventory?

125 Effects of Inventory Errors
Textbook Exhibits 6-9 and 6-10 demonstrate the carry-forward effects of errors related to ending inventory How many periods’ financial statements are affected by an error in ending inventory? 1?

126 Effects of Inventory Errors
Textbook Exhibits 6-9 and 6-10 demonstrate the carry-forward effects of errors related to ending inventory How many periods’ financial statements are affected by an error in ending inventory? 1? 2?

127 Effects of Inventory Errors
Textbook Exhibits 6-9 and 6-10 demonstrate the carry-forward effects of errors related to ending inventory How many periods’ financial statements are affected by an error in ending inventory? 1? 2? More?

128 Effects of Inventory Errors
Ending inventory errors impact TWO periods’ financial statements

129 Effects of Inventory Errors
Ending inventory errors impact TWO periods’ financial statements Current period Ending inventory 1998

130 Effects of Inventory Errors
Ending inventory errors impact TWO periods’ financial statements Current period Ending inventory Next period Beginning inventory 1998 1999

131 Effects of Inventory Errors
Ending inventory errors impact TWO periods’ financial statements Current period Ending inventory Next period Beginning inventory Error counterbalanced by end of second period 1998 1999

132 Effect of Inventory Errors on Cost of Sales and Net Income
How do errors in ending inventory impact ... Cost of sales? Gross margin? Net income?

133 Effect of Inventory Errors on Cost of Sales and Net Income
UNDER OVER CORRECT STATED STATED COST OF GOODS SOLD BEGINNING INVENTORY

134 Effect of Inventory Errors on Cost of Sales and Net Income
UNDER OVER CORRECT STATED STATED COST OF GOODS SOLD BEGINNING INVENTORY NET PURCHASES

135 Effect of Inventory Errors on Cost of Sales and Net Income
UNDER OVER CORRECT STATED STATED COST OF GOODS SOLD BEGINNING INVENTORY NET PURCHASES GOODS AVAILABLE FOR SALE

136 Effect of Inventory Errors on Cost of Sales and Net Income
UNDER OVER CORRECT STATED STATED COST OF GOODS SOLD BEGINNING INVENTORY NET PURCHASES GOODS AVAILABLE FOR SALE ENDING INVENTORY Errors during physical count!

137 Effect of Inventory Errors on Cost of Sales and Net Income
UNDER OVER CORRECT STATED STATED COST OF GOODS SOLD BEGINNING INVENTORY NET PURCHASES GOODS AVAILABLE FOR SALE ENDING INVENTORY COST OF GOODS SOLD OVER- STATED UNDER-

138 Effect of Inventory Errors on Cost of Sales and Net Income
UNDER OVER CORRECT STATED STATED COST OF GOODS SOLD BEGINNING INVENTORY NET PURCHASES GOODS AVAILABLE FOR SALE ENDING INVENTORY COST OF GOODS SOLD INCOME STATEMENT NET SALES

139 Effect of Inventory Errors on Cost of Sales and Net Income
UNDER OVER CORRECT STATED STATED COST OF GOODS SOLD BEGINNING INVENTORY NET PURCHASES GOODS AVAILABLE FOR SALE ENDING INVENTORY COST OF GOODS SOLD INCOME STATEMENT NET SALES COST OF GOODS SOLD

140 Effect of Inventory Errors on Cost of Sales and Net Income
UNDER OVER CORRECT STATED STATED COST OF GOODS SOLD BEGINNING INVENTORY NET PURCHASES GOODS AVAILABLE FOR SALE ENDING INVENTORY COST OF GOODS SOLD INCOME STATEMENT NET SALES COST OF GOODS SOLD GROSS MARGIN

141 Effect of Inventory Errors on Cost of Sales and Net Income
UNDER OVER CORRECT STATED STATED COST OF GOODS SOLD BEGINNING INVENTORY NET PURCHASES GOODS AVAILABLE FOR SALE ENDING INVENTORY COST OF GOODS SOLD INCOME STATEMENT NET SALES COST OF GOODS SOLD GROSS MARGIN OPERATING EXPENSES

142 Effect of Inventory Errors on Cost of Sales and Net Income
UNDER OVER CORRECT STATED STATED COST OF GOODS SOLD BEGINNING INVENTORY NET PURCHASES GOODS AVAILABLE FOR SALE ENDING INVENTORY COST OF GOODS SOLD INCOME STATEMENT NET SALES COST OF GOODS SOLD GROSS MARGIN OPERATING EXPENSES NET INCOME OVER- STATED UNDER- STATED

143 Ethical Issues in Inventory Accounting
Pressure to report positive earnings picture Bonuses linked to gross margin or net income Stockholders’ expectations Creditor or analyst forecasts

144 Estimate inventory by the gross margin method
Chapter Objective 6 Estimate inventory by the gross margin method

145 Estimating Inventory Sometimes necessary to estimate ending inventory
Why?

146 Estimating Inventory Sometimes necessary to estimate ending inventory
Why? Not practical to perform physical count every month

147 Estimating Inventory Sometimes necessary to estimate ending inventory
Why? Not practical to perform physical count every month Losses related to fire, natural disaster, theft, or other causes

148 Gross Margin (Gross Profit) Method
Relying on income statement information, can use gross margin % to estimate cost of sales Rearrange cost of goods sold model to solve for the unknown variable, ending inventory Beginning inventory + net purchases - cost of sales = ending inventory

149 Gross Margin (Gross Profit) Method
Ray’s Seafood Shack lost all of its inventory due to coastal flooding: What’s the amount of the loss to be filed with the insurance company? Period net sales = $150,000 Gross margin = 31.5% Beginning inventory = $18,500 Period purchases = $110,500

150 Gross Margin (Gross Profit) Method
Ray’s Seafood Shack lost all of its inventory due to coastal flooding: What’s the amount of the loss to be filed with the insurance company? Period net sales = $150,000 Gross margin = 31.5% Beginning inventory = $18,500 Period purchases = $110,500 Net sales x Gross margin % $150,000 x .315 = $47,250 Gross margin

151 Gross Margin (Gross Profit) Method
Ray’s Seafood Shack lost all of its inventory due to coastal flooding: What’s the amount of the loss to be filed with the insurance company? Period net sales = $150,000 Gross margin = 31.5% Beginning inventory = $18,500 Period purchases = $110,500 Net sales x Gross margin % $150,000 x .315 = $47,250 Gross margin Net sales - gross margin $150, $47,250 = $102,750 Cost of sales

152 Gross Margin (Gross Profit) Method
Ray’s Seafood Shack lost all of its inventory due to coastal flooding: What’s the amount of the loss to be filed with the insurance company? Period net sales = $150,000 Gross margin = 31.5% Beginning inventory = $18,500 Period purchases = $110,500 Beg. inventory $ 18,500

153 Gross Margin (Gross Profit) Method
Ray’s Seafood Shack lost all of its inventory due to coastal flooding: What’s the amount of the loss to be filed with the insurance company? Period net sales = $150,000 Gross margin = 31.5% Beginning inventory = $18,500 Period purchases = $110,500 Beg. inventory $ 18,500 Purchases ,500

154 Gross Margin (Gross Profit) Method
Ray’s Seafood Shack lost all of its inventory due to coastal flooding: What’s the amount of the loss to be filed with the insurance company? Period net sales = $150,000 Gross margin = 31.5% Beginning inventory = $18,500 Period purchases = $110,500 Beg. inventory $ 18,500 Purchases ,500 Available for sale $ 129,000

155 Gross Margin (Gross Profit) Method
Ray’s Seafood Shack lost all of its inventory due to coastal flooding: What’s the amount of the loss to be filed with the insurance company? Period net sales = $150,000 Gross margin = 31.5% Beginning inventory = $18,500 Period purchases = $110,500 Beg. inventory $ 18,500 Purchases ,500 Available for sale $ 129,000 Cost of sales (102,750)

156 Gross Margin (Gross Profit) Method
Ray’s Seafood Shack lost all of its inventory due to coastal flooding: What’s the amount of the loss to be filed with the insurance company? Period net sales = $150,000 Gross margin = 31.5% Beginning inventory = $18,500 Period purchases = $110,500 Beg. inventory $ 18,500 Purchases ,500 Available for sale $ 129,000 Cost of sales (102,750) Estimated ending inventory lost in flood $ 26,250

157 Chapter Objective 7 Use the gross margin percentage and the inventory turnover ratio to evaluate a business

158 Analyzing Financial Statements
Two important ratios used to measure merchandiser’s success

159 Analyzing Financial Statements
1 Gross margin percentage

160 Analyzing Financial Statements
2 Inventory turnover

161 Analyzing Financial Statements
Gross margin percentage measures average percentage of gross profit generated by one dollar of sales Changes in gross margin alert users to possible shifts in profitability Examine Lands’ End’s gross margin %

162 Analyzing Financial Statements
Gross margin percentage measures average percentage of gross profit generated by one dollar of sales Changes in gross margin alert users to possible shifts in profitability Examine Lands’ End’s gross margin % Gross Margin Net Sales

163 Analyzing Financial Statements
Gross margin percentage measures average percentage of gross profit generated by one dollar of sales Changes in gross margin alert users to possible shifts in profitability Examine Lands’ End’s gross margin % Gross Margin Net Sales $443,531,000 $1,031,548,000

164 Analyzing Financial Statements
Gross margin percentage measures average percentage of gross profit generated by one dollar of sales Changes in gross margin alert users to possible shifts in profitability Examine Lands’ End’s gross margin % Gross Margin Net Sales $443,531,000 $1,031,548,000 = 43% Every sales dollar generates 43 cents profit before all other expenses

165 Analyzing Financial Statements
Inventory turnover indicates number of times per year, on average, inventory is sold Quicker turnover generally indicates more profitable entity Allows business to invest current assets in more productive resources

166 Analyzing Financial Statements
Cost of Goods Sold Average Inventory Inventory turnover indicates number of times per year, on average, inventory is sold Quicker turnover generally indicates more profitable entity Allows business to invest current assets in more productive resources

167 Analyzing Financial Statements
Cost of Goods Sold Average Inventory Lands’ End’s turnover ratio: $588,017,000 $166,734,000 Inventory turnover indicates number of times per year, on average, inventory is sold Quicker turnover generally indicates more profitable entity Allows business to invest current assets in more productive resources

168 Analyzing Financial Statements
Cost of Goods Sold Average Inventory Lands’ End’s turnover ratio: $588,017,000 $166,734,000 3.53 times Inventory turnover indicates number of times per year, on average, inventory is sold Quicker turnover generally indicates more profitable entity Allows business to invest current assets in more productive resources

169 Internal Control Over Inventory
Periodic physical count Effective purchasing, receiving, and shipping procedures Limited/restricted access to inventory storage locations Computerization/perpetual recordkeeping for high cost inventory Adequate stock of on-hand inventory to prevent shortages/stockouts Automatic reorder points/EOQ models to minimize investment

170 Reporting Inventory Transactions on the Statement of Cash Flows
Inventory purchases and sales of inventory to customers reflected in cash flows from operating activities section of statement Refer to textbook Exhibit 6-15 to view the statement of cash flows for Huntington Galleries

171 World Wide Web Sites Black and Decker http://www.blackanddecker.com/
Wendy’s

172 THE END


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