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Merchandise Inventory and Cost of Sales C H A P T E R 7 Electronic Presentations in Microsoft® PowerPoint®

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Presentation on theme: "Merchandise Inventory and Cost of Sales C H A P T E R 7 Electronic Presentations in Microsoft® PowerPoint®"— Presentation transcript:

1 Merchandise Inventory and Cost of Sales C H A P T E R 7 Electronic Presentations in Microsoft® PowerPoint®

2 1. Identify the components and costs included in merchandise inventory. 2. Calculate the cost of goods sold and merchandise inventory using specific identification, moving weighted average, FIFO, and LIFO-perpetual. 3. Analyze the effects of the costing methods on financial reporting. Learning Objectives

3 4. Calculate the lower of cost or market value of inventory. 5. Analyze the effects of inventory errors on current and future financial statements- perpetual. 6. Apply both the gross profit and retail methods to estimate inventory. Learning Objectives

4 7. Calculate cost of goods sold and merchandise inventory using specific identification, weighted average, FIFO, and LIFO-periodic. (Appendix 7A). 8. Analyze the effects of inventory errors on current and future financial statements-periodic. (Appendix 7A). 9. Assess inventory management using both merchandise turnover and days’ sales in inventory. (Appendix 7B) Learning Objectives

5 Accounting for inventory requires several decisions which include:  Items to include in cost.  Inventory System.  Perpetual or Periodic  Costing Method.  FIFO, LIFO, Moving Weighted Average, Specific ID  Use of estimates.  Gross profit method, Retail inventory method Assigning Costs to Inventory

6 Inventory includes all goods owned by a company and held for sale. Items requiring special attention:  Goods in Transit  Goods on consignment  Obsolete or damaged goods Items in Merchandise Inventory

7 All expenditures necessary to bring an item to a saleable condition and location.  This includes:  Invoice price less discounts  Import duties  Transportation-in  Storage  Insurance Costs of Merchandise Inventory

8  Management must decide on method of determining unit cost.  This will affect both the income statement and the balance sheet. Methods: 1. Specific Identification 2. FIFO 3. LIFO 4. Average Cost Assigning Costs to Inventory

9 Merchandise Available for Sale Net Cost of Purchases Cost of Goods Sold Beginning Inventory Ending Inventory Balance Sheet Income Statement Merchandising Cost Flows

10 Use of Inventory Methods in Practice

11 This method is used when items:  Are unique.  Can be directly identified with a specific purchase and its invoice. Examples: Automobiles, art custom furniture. Specific Identification

12 Specific Identification — Example The opening inventory consists of 10 $91/unit.

13 Specific Identification — Example This results in two layers of inventory. Additional units are $106/unit.

14 Specific Identification — Example On August 14, 20 units are sold. Eight of these units came from the opening inventory and the remaining 12 units came from the August 3 purchase.

15 Specific Identification — Example This leaves 2 units remaining from the original inventory and 3 units remaining from the August 3 purchase.

16 Under this method, the cost of all units are averaged together. Cost of goods available for sale Number of units available for sale Average cost per unit = Moving Weighted Average Method

17 Moving Weighted Average - Example The opening inventory consists of 10 $91/unit.

18 Moving Weighted Average- Example Additional units are $106/unit. This results in an average cost of $100/unit. (10 x $91) + (15 x $106) 25 units

19 Moving Weighted Average- Example These 20 units are sold at the average cost of $100/unit.

20 Moving Weighted Average- Example This leaves 5 units remaining at an average cost of $100/unit.

21 Mini-Quiz A company that uses a perpetual inventory system made the following cash purchases and sales: Jan. 1-Purchased 100 units at $10 per unit. Feb. 5-Purchased 60 units at $12 per unit. Mar.16-Sold for cash 40 units for $16 per unit. Prepare journal entries to record the sale assuming a Moving Weighted Average system is used. Cash 640 Sales (40x16) 640 Cost of goods sold430 Inventory 430 (100x x12)/160 x 40

22 Based on the assumption that the items are sold in the order acquired. When a sale occurs:   The earliest units purchased are charged to Cost of Goods Sold.   The cost of the most recent purchases remain in inventory. First-In, First-Out (FIFO)

23 FIFO — Example The opening inventory consists of 10 $91/unit.

24 FIFO — Example Additional units re $106/unit. This results in two layers of inventory. Additional units are $106/unit.

25 FIFO — Example Under FIFO, units are assumed to be sold in the order acquired. Therefore, of the 20 units sold on August 14, the first 10 units come from beginning inventory. Therefore, those 10 units are removed from the inventory record based on the cost of those units of $91.

26 FIFO — Example The remaining 10 units sold on August 14 th come from the next purchase, made on August 3 rd. Therefore, these units are removed from the inventory record based on their cost of $106.

27 FIFO — Example The ending inventory consists of the 5 remaining units from the August 3 purchase.

28 Mini-Quiz A company that uses a perpetual inventory system made the following cash purchases and sales: Jan. 1-Purchased 100 units at $10 per unit. Feb. 5-Purchased 60 units at $12 per unit. Mar.16-Sold for cash 40 units for $16 per unit. Prepare journal entries to record the sale assuming a FIFO system is used. Cash 640 Sales (40x16) 640 Cost of goods sold400 Inventory (40x10) 400

29 Based on the assumption that the most recently purchased items are sold first. When a sale occurs:   The latest units purchased are charged to Cost of Goods Sold.   The cost of the earliest purchases remain in inventory. Last-In, First-Out (LIFO)

30 LIFO — Example The opening inventory consists of 10 $91/unit.

31 LIFO — Example Additional units are $106/unit. This results in two layers of inventory.

32 LIFO — Example Of the 20 units sold, these units are assumed to be sold first.

33 LIFO — Example Once the latest units purchased are sold, units are sold from the previous purchase.

34 LIFO — Example This leaves 5 units remaining from the first purchase.

35 Mini-Quiz A company that uses a perpetual inventory system made the following cash purchases and sales: Jan. 1-Purchased 100 units at $10 per unit. Feb. 5-Purchased 60 units at $12 per unit. Mar.16-Sold for cash 40 units for $16 per unit. Prepare journal entries to record the sale assuming a LIFO system is used. Cash 640 Sales (40x16) 640 Cost of goods sold480 Inventory (40x12) 480

36 Because prices change, the choice of an inventory method is important. Financial Reporting

37 Advantages of Each Method First-In, First-Out Ending inventory approximates current replacement cost. Weighted Average Smoothes out purchase price changes. Last-In, First-Out Better matches current costs in cost of goods sold with revenues. Financial Reporting First-In, First-Out Ending inventory approximates current replacement cost.

38  A company is required to use the same accounting methods from period to period (consistency principle).  A change is only acceptable when it improves financial reporting.  The costing method used must be disclosed in the notes to the financial statements (full- disclosure principle). Financial Reporting

39  Inventory must be reported at market value when market is lower than cost (conservatism principle).  Market may be defined as:  Net realizable value  Current replacement cost Lower of Cost or Market

40 May be applied in one of three ways: 1. Separately to each item. 2. To major categories of items. 3. To the inventory as a whole. Lower of Cost or Market

41 Errors in the computation of or physical count of inventory will cause a misstatement of:  Cost of goods sold  Gross profit  Net income  Current assets  Owner’s equity Inventory Errors

42 Inventory Errors- Effects on the Income Statement

43 Inventory Errors- Effects on the Balance Sheet

44 Ending inventory is estimated by applying gross profit ratio to net sales. It is used:  when inventory has been destroyed, lost, or stolen.  for testing the reasonableness of the physical inventory count. Gross Profit Method

45 Occasionally used for interim period reporting. Information required: 1. Beginning inventory at cost and retail. 2. Net purchases at cost and retail. 3. Net sales. Retail Inventory Method

46 Q Describe how management’s decisions can affect the determination of the cost of inventory. A Choice of method –FIFO,LIFO, Moving weighted average, Specific item. Choice of application of LCM -separate item, categories, whole inventory. Definition of market. Choice of periodic or perpetual system. Items to include in cost. Other. Review

47  The periodic system also uses FIFO, LIFO, specific identification, and weighted average methods to assign costs to inventory and cost of goods sold.  The results may be the same or different under both systems. Periodic System-Appendix 7A

48  Applied in same manner as periodic system.  Yields same results as perpetual system since units are specifically identified. Specific Identification- Appendix 7A

49 Steps: 1. Calculate weighted average unit cost. (# units beg. Inv. X unit cost) + (#units purchased x unit cost) # units available for sale = weighted average unit cost 2. Use weighted average unit cost to assign costs to cost of goods sold and ending inventory. Weighted Average-Appendix 7A

50 Yields same results as perpetual system since most recent purchases are in ending inventory under both systems. FIFO-Appendix 7A

51 Yields different results than perpetual system since:  LIFO periodic assigns costs at the end of period.  LIFO perpetual assigns most recent costs to cost of goods sold. LIFO-Appendix 7A

52  An error in the ending inventory affects the assets, net income, and owner’s equity of that period.  The ending inventory of one period becomes the opening inventory of the next period.The cost of goods sold and net income of the next period are affected as well. Inventory Errors in a Periodic System-Appendix 7A

53 Inventory ratios may be used to assess: 1. Short-term liquidity. 2. Inventory management. Ratios-Appendix 7B

54 Merchandise Turnover Ratio  Measures how many times a company turns its inventory over each period.  The ratio will vary from industry to industry. Merchandise turnover cost of goods sold average inventory Ratios-Appendix 7B

55 Days’ Sales in Inventory  Used to estimate how many days it will take to convert inventory to cash or receivables.  Used to assess if inventory levels can meet sales demand. Days’ sales in inventory = Ending inventory x 365 Cost of goods sold Ratios-Appendix 7B

56 End of Chapter


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