5 Gross Profit (Gross Margin) Sales revenues – Cost of goods sold= Gross profit (before operating expenses)Gross profit – Operating expenses= Net income
6 Computing Cost Balance Sheet Cost of inventory on hand = Number of units on hand × unit costBalance SheetCost of goods sold= Number of units sold × unit costIncome Statement
7 Use the cost-of-goods- Learning Objective 1Use the cost-of-goods-sold model.
8 Cost of Goods Sold Model Beginninginventory$20Endinginventory$30Cost ofgoods sold$90Cost of goodsavailablefor sale$120Purchases$100
9 How Much Inventory Should Be Purchased? Budgeted cost of goods sold $6,000+ Budgeted ending inventory 1,500= Budgeted cost of goodsavailable for sale $7,500– Actual beginning inventory 1,200= Budgeted purchases $6,300
10 Learning Objective 2Account for inventorytransactions.
11 Inventory Accounting Systems Periodic systems do not keep acontinuous record of inventory on hand.Perpetual systems maintain a running recordto show the inventory on hand at all times.
12 Recording Transactions in the Perpetual System Debit InventoryCredit Cash or Accounts PayableDebit Cash or Accounts ReceivableCredit Sales RevenueDebit Cost of Goods SoldCredit Inventory
13 Recording Transactions in the Perpetual System Purchase price of the inventory $600,000+ Freight-in ,000– Purchase returns – 25,000– Purchase allowances – 5,000– Purchase discounts – 14,000= Net purchases of inventory $560,000
14 Recording Transactions and the T-Accounts Inventory ,000Accounts Payable ,000Purchased inventory on accountBeg. 100,000560,000InventoryAccounts Payable560,000
15 Recording Transactions and the T-Accounts Sale on account $900,000 (cost $540,000):Accounts Receivable 900,000Sales Revenue ,000Cost of Goods Sold 540,000Inventory ,000
16 Recording Transactions and the T-Accounts InventoryCost of Goods Sold540,000Beg. 100,000560,000120,000540,000
17 Reporting in the Financial Statements Income Statement (partial)Sales revenue $900,000Cost of goods sold ,000Gross profit $360,000Ending Balance Sheet (partial)Current assets:Cash $ XXXShort-term investments XXXAccounts receivable, net XXXInventory ,000Prepaid expenses XXX
18 Reporting in the Financial Statements Net purchases = Purchases+ Freight-in– Purchase returns & allowances– Purchases discountNet sales = Sales revenue– Sales returns & allowances– Sales discounts
19 Learning Objective 3Analyze the variousinventory methods.
20 What Goes Into Inventory Cost? The cost of any asset, such as inventory,is the sum of all the costs incurred tobring the asset to its intended use.Generally accepted inventory costing methods:Specific unit costWeighted-average costFirst-in, first-out (FIFO)Last-in, first-out (LIFO)
21 Illustrative Data Beginning inventory (10 units @ $10) $100 No. 1 (25 $14 per unit) $350No. 2 (25 $18 per unitTotal purchasesCost of goods available for sale $900Ending inventory: 20 unitsCost of goods sold: 40 units
22 Specific Unit Cost 5 Units @ $10 Cost of Goods Sold $ 50 350 180 $580 $ 50350180$58025 $1410 $18$900 – $580 = $320
23 Weighted-Average $900 total cost ÷ 60 units = $15/unit Ending inventory = 20 × $15 = $300Cost of goods sold = 40 × $15 = $600
24 First-In, First-Out Ending inventory cost 60 units Less units sold 40 Ending inventory 20 units20 units × $18 per unit = $360
25 First-In, First-Out 10 Units @ $10 Cost of Goods Sold $100 350 90 $540
26 Last-In, First-Out Ending inventory cost 60 units Less units sold 40 Ending inventory 20 units10 units × 10 = $10010 units × 14 = 140Total $240
27 Last-In, First-Out 25 Units @ $18 Cost of Goods Sold $450 210 $660
28 Income Effects of Inventory Methods Ending InventorySpecific unit cost $320.00Weighted-average $300.00FIFO $360.00LIFO $240.00
29 Income Effects of Inventory Methods Cost of Goods SoldSpecific unit cost $580.00Weighted-average $600.00FIFO $540.00LIFO $660.00
30 Income Effects of Inventory Methods AssumedSalesRevenueCost ofGoodsSoldGrossProfitSpecific unit cost $1,000 – = $420Weighted-average $1,000 – = $400FIFO $1,000 – = $460LIFO $1,000 – = $340
31 Income Effects – Inventory Costs Are Increasing Ending inventory, gross profit, and net incomeFIFOWeighted-averageLIFO
32 Income Effects – Inventory Costs Are Decreasing Ending inventory, gross profit, and net incomeLIFOWeighted-averageFIFO
33 Identify the income and Learning Objective 4Identify the income andthe tax effects of theinventory methods.
34 The Tax Advantage of LIFO Gross profit $460 $340Operating expensesIncome before taxes $200 $ 80Income tax expense (40%) $ $ 32FIFO LIFOThe most attractive feature of LIFOis low income tax payments.
36 Comparison of Inventory Methods FIFO produces inventory profitsduring periods of inflation.LIFO allows managers tomanipulate net income.LIFO liquidation occurs when inventoryquantities fall below the level of theprevious period resulting in highernet income and increased taxes.
37 International Perspective LIFO is not allowed in some countries,e.g., Australia and the U. K.Companies that use LIFO must useanother accounting method for theirinventories in these foreign countries.
38 Accounting Principles and Inventories Consistency PrincipleBusinesses should use the sameaccounting methods and proceduresfrom one period to the next.A company may change inventorymethods, but it must disclose theeffects of the change on net income.
39 Accounting Principles and Inventories Disclosure PrincipleThe financial statements shouldreport enough information toenable an outsider to makeknowledgeable decisionsabout the company.
40 Accounting Principles and Inventories Materiality ConceptAn item is material if it has the potentialto alter a statement user’s decision.Materiality is specific tothe entity being evaluated.
41 Accounting Principles and Inventories ConservatismErr on the sideof caution whenreporting any item inthe financial statements.
42 Lower-of-Cost-or-Market Rule Inventory is reported at thelower of its historical costor market (replacement) value.If the replacement cost falls below itshistorical cost, the business must writedown the value of its inventory.
43 Show how inventory errors affect cost of goods sold Objective 5Show how inventory errorsaffect cost of goods soldand income.
44 Effects of Inventory Errors An error in the ending inventorycreates errors for cost of goodssold and gross profit.The current year’s ending inventoryis next year’s beginning inventory.
45 Effects of Inventory Errors Period 1EndingInventoryOverstatedby $5,000Period 1BeginningInventoryOverstatedby $5,000Period 1CorrectSales revenueCost of goods sold:Beg. inventoryPurchasesCost of goodsavailable for saleEnding inventoryCost of goods soldGross profit$100,000$10,00050,000$60,000(15,000)45,000$ 55,000$100,000$15,00050,000$65,000(10,000)55,000$ 45,000$100,000$10,00050,000$60,000(10,000)$ 50,000
46 Ethical Considerations Managers of companies whose profitsdo not meet stockholder expectationsare sometimes tempted to “cook thebooks” to increase reported income.What are some possibilities?1. Overstating ending inventory2. Creating fictitious sales revenue
47 percentage and inventory Learning Objective 6Use the gross profitpercentage and inventoryturnover to evaluatebusiness.
48 Using the Financial Statements for Decision Making Gross profit percentage= Gross profit÷ Net sales revenueInventory turnover= Cost of goods sold÷ Average inventory
49 Gross Profit on $1 of Sales for Two Merchandisers $1.00 —$0.75 —$0.50 —$0.25 —$0.00Grossprofit $0.21Grossprofit$0.61Cost ofgoods sold$0.79Cost ofgoods sold$0.39GeneralMotorsPepsi Co.
50 Estimating Inventory The gross profit method of estimating ending inventory is based on thecost-of-goods-sold model.Beginning inventory+ Purchases= Cost of goods available for sale– Ending inventory= Cost of goods sold
51 Estimating Inventory Rearranging ending inventory and cost of goods sold makes the modeluseful for estimating ending inventory.Beginning inventory+ Purchases= Cost of goods available for sale– Cost of goods sold= Ending inventory
52 Estimating Inventory Step 1 Step 2 + = – = Beginning inventory Net purchases+Goodsavailablefor sale=Cost ofgoodssold–Endinginventory=Step 2Goodsavailablefor sale
53 Estimating Inventory Beginning inventory $14,000 Purchases 66,000 Cost of goods available for sale ,000Cost of goods sold:Net sales revenue $100,000Less estimated gross profit of 42% – 42,000Estimated cost of goods sold ,000Estimated cost of ending inventory $22,000
54 Reporting Inventory Transactions on the Statement of Cash Flows Inventory transactions are operating activitiesbecause the purchase and sale of merchandisedrives a company’s operations.The purchase of inventory requires a cashpayment, and the sale a cash receipt.