Presentation is loading. Please wait.

Presentation is loading. Please wait.

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

Similar presentations


Presentation on theme: "1 Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter 6."— Presentation transcript:

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

2 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 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

3 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, netX Inventory 11 Prepaid expensesX Merchandising Company General Motors Corporation Balance Sheet Year Ended December 31, 20xx ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

4 4 Gross Profit (Gross Margin) Sales Revenue -Cost of Goods Sold -Cost of Goods Sold =Gross Profit - Operating Expenses - Operating Expenses Net Income

5 5 Learning Objective 1 Account for inventory transactions.

6 6 Periodic (a.k.a. physical inventory) systems do not keep a continuous record of inventory on hand: Periodic (a.k.a. physical inventory) systems do not keep a continuous record of inventory on hand: Inventory quantities can only be determined based upon a 100% physical count, usually annually Inventory quantities can only be determined based upon a 100% physical count, usually annually Quantities x relevant prices = inventory valuation Quantities x relevant prices = inventory valuation 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. Inventory Accounting Systems

7 7 Recording Transactions in the Perpetual System Purchase price of the inventory$600,000 + Freight-in4,000 – 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 Accounts Payable 560,000Beg.100, ,000 Inventory Inventory560,000 Accounts Payable560,000 Purchased inventory on account ©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 Receivable900,000 Sales Revenue900,000 Cost of Goods Sold540,000 Inventory540,000 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

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

11 11 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

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

13 13 Learning Objective 2 Analyze the various inventory costing methods.

14 14 What Goes Into Inventory Cost? Sum of all costs incurred to bring asset to its intended use Sum of all costs incurred to bring asset to its intended use Acceptable nventory costing methods: Acceptable nventory costing methods: Specific unit cost Specific unit cost Weighted-average cost Weighted-average cost First-in, first-out (FIFO) First-in, first-out (FIFO) Last-in, first-out (LIFO) Last-in, first-out (LIFO)

15 15 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 (60 avail left) 40 units Illustrative Data (Text Exhibit 6-6)

16 16 Cost of Goods Sold $ $580 Specific Unit Cost $900 – $580 = $ $14 10 $18 5 $10

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

18 18 Available units60 units Less units sold40 Ending inventory20 units First-In, First-Out Ending Inventory Cost: 20 units × $18 per unit = $360

19 19 Cost of Goods Sold $ $540 First-In, First-Out 10 $10 25 $14 5 $18

20 20 Available units60 units Less units sold40 Ending inventory20 units Last-In, First-Out Ending Inventory Cost: 10 units × 10 =$ units × 14 = 140 Total$240

21 21 Cost of Goods Sold $ $660 Last-In, First-Out 25 $18 (All of Last batch) 15 $14

22 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 ©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren

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

24 24 The Tax Advantages 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 when prices are increasing.

25 25 Use of the Various Inventory Methods

26 26 Comparison of Inventory Methods FIFO produces “inventory profits” during periods of inflation, but you are eating your seed corn FIFO produces “inventory profits” during periods of inflation, but you are eating your seed corn LIFO can allow managers to manipulate net income by purchasing more costly inventories, which will be associated with revenue LIFO can allow managers to manipulate net income by purchasing more costly inventories, which will be associated with revenue LIFO liquidation: LIFO liquidation: when old LIFO balance sheet layers are associated with current revenues when old LIFO balance sheet layers are associated with current revenues If the liquidated layers are 10 or 20 years old, those old inventory costs might be a fiction compared to current costs, artificially inflating profits If the liquidated layers are 10 or 20 years old, those old inventory costs might be a fiction compared to current costs, artificially inflating profits

27 27 Why do 50% More Public Companies Use FIFO vs. LIFO? [Re: Slide no. 25] FIFO is easier to account for, and a more natural cost flow assumption FIFO is easier to account for, and a more natural cost flow assumption Public companies will pay the price of higher taxes to report better earnings than LIFO would, in a period of rising prices Public companies will pay the price of higher taxes to report better earnings than LIFO would, in a period of rising prices That’s all we’ve had since the 1930’s! That’s all we’ve had since the 1930’s!

28 28 Consistency Principle Use the same accounting methods and principles from one period to the next Use the same accounting methods and principles from one period to the next Cannot change accounting principles whimsically Cannot change accounting principles whimsically May change inventory methods, but must: May change inventory methods, but must: be able to demonstrate that the new inventory costing method is preferable to the old method be able to demonstrate that the new inventory costing method is preferable to the old method disclose the effects of the change on net income in the financial statement footnotes disclose the effects of the change on net income in the financial statement footnotes

29 29 Disclosure Principle Financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company Financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company All material facts must be fully and fairly disclosed All material facts must be fully and fairly disclosed

30 30 Conservatism The least favorable figures are presented in the financial statements The least favorable figures are presented in the financial statements

31 31 Lower-of-Cost-or-Market Rule is an Example of Conservatism Report inventory at the lower of its historical cost or market (replacement) value 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 If the replacement cost falls below its historical cost, write down the value of the inventory However, never write up inventories to market if it higher than cost However, never write up inventories to market if it higher than cost

32 32 Learning Objective 4 Use the gross profit percentage and inventory turnover to evaluate business.

33 33 Inventory turnover = Cost of goods sold ÷ Average inventory Gross profit percentage = Gross profit ÷ Net sales revenue Using the Financial Statements for Decision Making

34 34 Learning Objective 5 Estimate inventory by the gross profit method Gross profit method can be used: To estimate inventories for quarterly balance sheets so physical count not needed, or To estimate value of inventories lost in a fire or other catastrophe for insurance indemnification, or To estimate value of inventories lost in a fire or other catastrophe for insurance indemnification, or To test reasonableness of a physical count of inventories To test reasonableness of a physical count of inventories

35 35 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 - Est’d Cost of goods sold = Est’d Ending inventory

36 36 An Example Using Gross Profit Method to Estimate Inventories Mav Co. has a fire, losing all inventories Mav Co. has a fire, losing all inventories Assume usual gross profit is 25% [$.25 of every sales dollar is gross profit] Assume usual gross profit is 25% [$.25 of every sales dollar is gross profit] Therefore, usual CGS percent would be 75% [$.75 of every sales dollar is inventory cost] Therefore, usual CGS percent would be 75% [$.75 of every sales dollar is inventory cost] Assume Beg inventory = $10,000 Assume Beg inventory = $10,000 Purchases to date of fire = $60,000 Purchases to date of fire = $60,000 Therefore goods available = $70,000 Therefore goods available = $70,000 Sales to date of fire = $55,000 Sales to date of fire = $55,000

37 37 An Example Using Gross Profit Method (con.) Goods available (last slide) $70,000 Goods available (last slide) $70,000 Est’d CGS ($55,000 x 75%) 41,250 Est’d CGS ($55,000 x 75%) 41,250 Est’d inventory lost to fire 28,750 Est’d inventory lost to fire 28,750

38 38 Objective 6 Show how inventory errors affect cost of goods sold and income.

39 39 Effects of Inventory Errors An error in the ending inventory creates errors for cost of goods sold and gross profit: An error in the ending inventory creates errors for cost of goods sold and gross profit: Income will be overstated by exact amount of an inventory overstatement, because Income will be overstated by exact amount of an inventory overstatement, because CGS will be understated by exact amount of the inventory overstatement (CGS=Beg+Purchs-Ending) CGS will be understated by exact amount of the inventory overstatement (CGS=Beg+Purchs-Ending) The current year’s ending inventory becomes next year’s beginning inventory: The current year’s ending inventory becomes next year’s beginning inventory: Income will be understated by that same amount Income will be understated by that same amount CGS will be overstated by that same amount CGS will be overstated by that same amount That is, the error washes out over two periods That is, the error washes out over two periods


Download ppt "1 Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter 6."

Similar presentations


Ads by Google