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©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 6 - 1 Merchandise Inventory, Cost of Goods Sold, and Gross Profit.

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Presentation on theme: "©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 6 - 1 Merchandise Inventory, Cost of Goods Sold, and Gross Profit."— Presentation transcript:

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2 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter 6

3 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

4 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

5 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Accounting for Inventory Current assets: Cash$ XXX Short-term investments XXX Accounts receivable XXX Inventory (1 Prepaid expenses XXX General Motors Corporation Balance Sheet (partial) Sales revenue (2 $20,000)$40,000 Cost of goods sold (2 $15,000) 30,000 Gross profit$10,000 General Motors Corporation Income Statement (partial)

6 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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)

7 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Computing Cost Cost of inventory on hand = Number of units on hand × unit cost Cost of inventory on hand = Number of units on hand × unit cost Cost of goods sold = Number of units sold × unit cost Cost of goods sold = Number of units sold × unit cost

8 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 1 Use the cost-of-goods- sold model.

9 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

10 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

11 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 2 Account for inventory transactions.

12 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Recording Transactions and the T-Accounts Accounts Payable 560,000Beg.100, ,000 Inventory Inventory560,000 Accounts Payable560,000 Purchased inventory on account Inventory560,000 Accounts Payable560,000 Purchased inventory on account

16 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Recording Transactions and the T-Accounts Cost of Goods Sold 540,000 Inventory Beg.100, , , ,000

18 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 3 Analyze the various inventory methods.

21 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

23 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Cost of Goods Sold $ $580 Specific Unit Cost 5 $10 25 $14 10 $18 $900 – $580 = $320

24 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Weighted-Average $900 total cost ÷ 60 units = $15/unit Cost of goods sold = 40 × $15 = $600 Ending inventory = 20 × $15 = $300

25 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren units Less units sold40 Ending inventory20 units First-In, First-Out 20 units × $18 per unit = $360

26 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Cost of Goods Sold $ $540 First-In, First-Out 10 $10 25 $14 5 $18

27 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren units Less units sold40 Ending inventory20 units Last-In, First-Out 10 units × 10 =$ units × 14 = 140 Total$240

28 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Cost of Goods Sold $ $660 Last-In, First-Out 25 $18 15 $14

29 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Ending Inventory Specific unit cost$ Weighted-average$ FIFO$ LIFO$ Income Effects of Inventory Methods

30 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Cost of Goods Sold Specific unit cost$ Weighted-average$ FIFO$ LIFO$ Income Effects of Inventory Methods

31 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

32 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Income Effects – Inventory Costs Are Increasing Ending inventory, gross profit, and net income LIFO Weighted- average FIFO

33 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Income Effects – Inventory Costs Are Decreasing Ending inventory, gross profit, and net income LIFO Weighted- average FIFO

34 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 4 Identify the income and the tax effects of the inventory methods.

35 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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.

36 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Use of the Various Inventory Methods

37 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Comparison of Inventory Methods LIFO liquidation occurs when inventory quantities fall below the level of the previous period resulting in higher net income and increased taxes. FIFO produces inventory profits during periods of inflation. LIFO allows managers to manipulate net income.

38 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren International Perspective LIFO is not allowed in some countries, e.g., Australia and the U. K. Companies that use LIFO must use another accounting method for their inventories in these foreign countries.

39 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

40 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

41 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Accounting Principles and Inventories An item is material if it has the potential to alter a statement users decision. An item is material if it has the potential to alter a statement users decision. Materiality is specific to the entity being evaluated. Materiality is specific to the entity being evaluated.

42 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

43 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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.

44 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Show how inventory errors affect cost of goods sold and income. Objective 5

45 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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.

46 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

47 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

48 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Learning Objective 6 Use the gross profit percentage and inventory turnover to evaluate business.

49 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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

50 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 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.

51 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Estimating Inventory The gross profit method of estimating ending inventory is based on the cost-of-goods-sold model. Beginning inventory +Purchases =Cost of goods available for sale –Ending inventory =Cost of goods sold

52 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Estimating Inventory Rearranging ending inventory and cost of goods sold makes the model useful for estimating ending inventory. Beginning inventory +Purchases =Cost of goods available for sale –Cost of goods sold =Ending inventory

53 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Estimating Inventory Beginning inventory Net purchases + Goods available for sale Goods available for sale = Ending inventory = Cost of goods sold –

54 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Estimating Inventory Beginning inventory$14,000 Purchases 66,000 Cost of goods available for sale 80,000 Cost of goods sold: Net sales revenue$100,000 Less estimated gross profit of 42% – 42,000 Estimated cost of goods sold 58,000 Estimated cost of ending inventory$22,000

55 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren Reporting Inventory Transactions on the Statement of Cash Flows Inventory transactions are operating activities because the purchase and sale of merchandise drives a companys operations. The purchase of inventory requires a cash payment, and the sale a cash receipt.

56 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren End of Chapter 6


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