Merchandise Inventory Chapter 6 Merchandise Inventory 02/12/2018 6-Okt-03

Inventory Inventory : All the goods that the company owns and expects to sell in the normal course of operations. Merchandise Companies Merchanise inventory Manufacturing Companies Raw materials Work-in process Finished goods Companies usually operate in three broad business categories: * Service *Retail or wholesale * Manufacturing Service companies provide service such as advertising, bookkeeping, and consultihng, and therefore they do not have any goods on hand for resale. Retail or wholesale companies on the other hand, buy ready-made goods and sell those redy-made goods to costumers who colud also be the end users. In general, wholesale companies sell merchandise to retail companies and the retail companies sell these goods to consumers. Manufacturing companies on the other hand also have inventories of raw materials that neeed to be turned into finished goods, complete products for sale Merchandise companies have one general class of merchandise inventory or simply inventory. However, this account usually consists of several different types of goods for resale purposes. MC have at least three inventory categories because they produce their own products. They buy raw materials and work on the raw materials Toturn them into a product for sale. 02/12/2018 MK 6-Okt-03

Inventory and financial statement Income Statement Balance Sheet: Current Assets Cash Account receivable INVENTORIES (*) Prepaid expenses Non-Current Assets Net Sales xxx COST OF GOODS SOLD (xx) GROSS PROFIT xx Ending inventory : Number of Units on Hand x Unit Cost Cost of goods sold: Number of Units Sold x Unit Cost 02/12/2018 MK 6-Okt-03

Inventory Costing Methods Debit Inventory Account Credit 10 units x $10 = $100 Suppose the company sells 8 units of inventories Cost of goods sold : 8 x 10 = 80 Ending inventory : 2 x 10 = 20 02/12/2018 MK 6-Okt-03

Inventory Costing Methods Debit Inventory Account Credit 10 units x $10 = $100 15 units x $10 = $150 Suppose the company sells 18 units of inventories Cost of goods sold : 18 x 10 = 180 Ending inventory : 7 x 10 = 70 Journal enteries: 02/12/2018 MK 6-Okt-03

Inventory Costing Methods Debit Inventory Account Credit 10 units x $10 = $100 15 units x $12 = $180 Suppose the company sells 18 units of inventories Cost of goods sold : ? Ending inventory : ? 02/12/2018 MK 6-Okt-03

Inventory Costing Methods Specific unit cost (specific idendification method). FIFO LIFO Average-Cost Method 02/12/2018 MK 6-Okt-03

Inventory Accounting Systems Perpetual system Perpetual systems maintain a running record to show the inventory on hand at all times. 2. Periodic system Periodic systems do not keep a continuous record of inventory on hand. 02/12/2018 MK 6-Okt-03

Inventory Costing in a Perpetual System Now let’s see how to compute inventory amounts under the FIFO, LIFO and average costing methods. Assume that inventory transactions are as below during december Dec.1 Begining inventory (balance) 5 units x $60 5 Purchase 20 units x 65 16 Sale 15 units 26 Purchase 20 units 70 30 Sale 16 units 02/12/2018 MK 6-Okt-03

Inventory Costing in a Perpetual System FIFO Date Purchases Cost of Good Sold Inventory on Hand Quantity Unit Cost ($) Total Cost($) Unit Cost($) Dec. 1 5 60 300 Dec. 5 20 65 1.300 Dec.16 10 650 Dec.26 70 1.400 Dec.30 6 420 14 980 Dec. 31 40 2.700 31 2.020 02/12/2018 MK 6-Okt-03

Inventory Costing in a Perpetual System Journal entries / The sale price of unit is $80 FIFO Date Description Debit Credit Dec. 5 Inventory Cash/Accounts Payable 1.300 Dec. 16 Cash/Accounts Receivable (15x$80) Sales Cost of Goods Sold 1.200 950 Dec. 26 1.400 Dec. 30 Cash/Accounts Receivable (16x$80) 1.280 1.070 02/12/2018 MK 6-Okt-03

Inventory Costing in a Perpetual System Journal entries / The sale price of unit is $80 - FIFO Debit Inventory C redit Dec. 1 Balance 300 Des. 5 1.300 Dec.26 1.400 Dec. 16 950 Dec. 30 1.070 Total 3.000 Total 2.020 Debit Cost of Goods Sold Credit Dec. 16 950 Dec. 30 1.070 Total 2.020 Debit Sales Revenue Credit Dec. 16 1.200 Dec. 30 1.280 Total 2.480 Income Statement Sales COST OF GOODS SOLD Gross Profit 2.480 (2.020) 460 02/12/2018 MK 6-Okt-03

Inventory Costing in a Perpetual System LIFO Date Purchases Cost of Good Sold Inventory on Hand Quantity Unit Cost ($) Total Cost($) Unit Cost($) Dec. 1 5 60 300 Dec. 5 20 65 1.300 Dec.16 15 975 325 Dec.26 70 1.400 1400 Dec.30 16 1.120 4 280 Dec. 31 40 2.700 31 2.095 14 905 02/12/2018 MK 6-Okt-03

Inventory Costing in a Perpetual System Journal entries / The sale price of unit is $80 LIFO Date Description Debit Credit Dec. 5 Inventory Cash/Accounts Payable 1.300 Dec. 16 Cash/Accounts Receivable (15x$80) Sales Cost of Goods Sold 1.200 975 Dec. 26 1.400 Dec. 30 Cash/Accounts Receivable (16x$80) 1.280 1.120 02/12/2018 MK 6-Okt-03

Inventory Costing in a Perpetual System Journal entries / The sale price of unit is $80 - LIFO Debit Inventory C redit Dec. 1 Balance 300 Des. 5 1.300 Dec.26 1.400 Dec. 16 975 Dec. 30 1.120 Total 3.000 Total 2.095 Debit Cost of Goods Sold Credit Dec. 16 975 Dec. 30 1.120 Total 2.095 Debit Sales Revenue Credit Dec. 16 1.200 Dec. 30 1.280 Total 2.480 Income Statement Sales COST OF GOODS SOLD Gross Profit 2.480 (2.095) 385 02/12/2018 MK 6-Okt-03

Inventory Costing in a Perpetual System Average Cost Method Date Purchases Cost of Good Sold Inventory on Hand Quantity Unit Cost ($) Total Cost($) Unit Cost($) Dec. 1 5 60 300 Dec. 5 20 65 1.300 25 64 1.600 Dec.16 15 960 10 640 Dec.26 70 1.400 30 68 2.040 Dec.30 16 1.088 14 952 Dec. 31 40 2.700 31 2.048 02/12/2018 MK 6-Okt-03

Inventory Costing in a Perpetual System Journal entries / The sale price of unit is $80 Average Date Description Debit Credit Dec. 5 Inventory Cash/Accounts Payable 1.300 Dec. 16 Cash/Accounts Receivable (15x$80) Sales Cost of Goods Sold 1.200 960 Dec. 26 1.400 Dec. 30 Cash/Accounts Receivable (16x$80) 1.280 1.088 02/12/2018 MK 6-Okt-03

Inventory Costing in a Perpetual System Journal entries / The sale price of unit is $80 - Average Debit Inventory C redit Dec. 1 Balance 300 Des. 5 1.300 Dec.26 1.400 Dec. 16 960 Dec. 30 1.088 Total 3.000 Total 2.048 Debit Cost of Goods Sold Credit Dec. 16 960 Dec. 30 1.088 Total 2.048 Debit Sales Revenue Credit Dec. 16 1.200 Dec. 30 1.280 Total 2.480 Income Statement Sales COST OF GOODS SOLD Gross Profit 2.480 (2.048) 432 02/12/2018 MK 6-Okt-03

Inventory Costing in a Perpetual System Compare Results for FIFO, LIFO and Average Cost FIFO Average LIFO Sales Cost of Goods Sold Gross Profit $ 2.480 2.020 460 2.048 432 2.095 385 Ending ınventory $980 $952 $905 02/12/2018 MK 6-Okt-03

Inventory Costing in a Periodic System COST OF GOODS SOLD IN A PERIODIC INVENTORY SYSTEM BEGINING INVENTORY (The inventory on hand at the end of the preceding period) NET PURCHASES Xxx XXXX Cost of goods available for sale Less: ENDING INVENTORY (The inventory on hand at the end of the current period) Xxxxx (xxxx) COST OF GOODS SOLD XXX COST OF GOODS SOLD : Begining Inventory + Net Purchases – Ending Inventory Net purchases is determined as follows (all amount assumed) Purchases 20.000 Less: Puchase discounts (1.000) Puchase returns and allowances (2.000) Add: Transpotation – In 4.000 NET PURCHASES 21.000 02/12/2018 MK 6-Okt-03

Inventory Costing in a Periodic System Now let’s see how to compute inventory amounts under the FIFO, LIFO and average costing methods. Assume that inventory transactions are as below during december Dec.1 Begining inventory (balance) 5 units x $60 5 Purchase 20 units x 65 16 Sale 15 units 26 Purchase 20 units 70 30 Sale 16 units 02/12/2018 MK 6-Okt-03

Inventory Costing in a Periodic System COST OF GOODS SOLD IN A PERIODIC INVENTORY SYSTEM FIFO BEGINING INVENTORY NET PURCHASES $300 2.700 Cost of goods available for sale (45 units) Less: ENDING INVENTORY (14 X $70) 3.000 (980) COST OF GOODS SOLD 2.020 Cost of goods avaliable is always the sum of begining inventory plus net purchases Under FIFO, the ending inventory comes from the latest – the most recent- purchases (in our case, unit cost of the latest purchase is $ 70) Ending inventory is therefore $980, cost of goods sold is $2.020 These amounts are exactly the same as we saw for FIFO in the perpetual system. There is no cost of goods sold entry in the periodic system during the period. 02/12/2018 MK 6-Okt-03

Inventory Costing in a Periodic System Journal entries / The sale price of unit is $80 Date Description Debit Credit Dec. 5 Purchases Cash/Accounts Payable 1.300 Dec. 16 Cash/Accounts Receivable (15x$80) Sales 1.200 Dec. 26 1.400 Dec. 30 Cash/Accounts Receivable (16x$80) 1.280 02/12/2018 MK 6-Okt-03

Inventory Costing in a Periodic System At the end of period before updating inventory and recording COGS, “T” accounts as follows: Debi Inventory (Begining) Credit Dec. 1 Balance 300 Total 300 Debit Purchases Credit Dec. 5 1.300 Dec.26 1.400 Total 2.700 End of the period entries to update inventory and record cost of goods sold Date Description Debit Credit Dec. 31 Cost of Goods Sold Inventory (Begining balance) 300 Dec. 31 Purchases 2.700 Inventory (Ending balance) 980 02/12/2018 MK 6-Okt-03

Inventory Costing in a Periodic System After updating inventory and recording COGS, “T” accounts as follows: Debi Inventory (Begining) Credit Dec. 1 Balance 300 Dec. 31 300 Total 300 Total 300 Debit Purchases Credit Dec. 5 1.300 Dec.26 1.400 Dec.31 2.700 Total 2.700 Total 2.700 Debit Cost of Goods Sold Credit Dec. 31 300 Dec.31 2.700 Dec.31 980 Total 3.000 Total 980 Balance of COGS: $3.000- 980 : $2.220 Debit Inventory (Ending balance) Credit Dec. 31 980 Total 980 02/12/2018 MK 6-Okt-03

Inventory Costing in a Periodic System COST OF GOODS SOLD IN A PERIODIC INVENTORY SYSTEM LIFO BEGINING INVENTORY NET PURCHASES $300 2.700 Cost of goods available for sale(45 units) Less: ENDING INVENTORY (5 units X $60 + 9 units x $65) 3.000 (885) COST OF GOODS SOLD (31 units) 2.115 Under LIFO, the ending inventory comes from the earliest units obtained – the 5 units that cost $60 plus 9 of the units purchased for $65. Ending inventory is therefore $885, cost of goods sold is $2.115 These amounts are not the same as we saw for LIFO in the perpetual system. In some cases, the LIFO amounts can be same both perpetual and the periodic systems. 02/12/2018 MK 6-Okt-03

Inventory Costing in a Periodic System COST OF GOODS SOLD IN A PERIODIC INVENTORY SYSTEM Average BEGINING INVENTORY NET PURCHASES $300 2.700 Cost of goods available for sale(45 units) Less: ENDING INVENTORY (14x$66,67) 3.000 (933) COST OF GOODS SOLD (31 units x 66,67) 2.067 Average Cost Per Unit Cost of Goods Number of Units For the entire period = Available For Sale / Avaliable For Sale = $3.000 / 45 units = $66,67 Ending inventory and cost of goods sold under the periodic system differ from the amounts in a perpetual system. Why? Because under teh perpetual system a new average cost is computed after each purchase. But the periodic system uses a single average cost that is determined at the end of the period. 02/12/2018 MK 6-Okt-03

Consistency prenciple Disclosure prenciple Materiality Concept Accounting Principles and Inventories Several accounting prenciples have special relevance to inventories. Consistency prenciple Disclosure prenciple Materiality Concept Accounting Conservatism 02/12/2018 MK 6-Okt-03

Other Inventory Issues LOWER-OF-COST-OR-MARKET RULE The lower-of-cost-or-market rule (abbreviated as LCM) shows accounting conservatism in action. LCM requires that inventory be reported in the financial statements at whichever is lower-the invenory’s historical cost or its market value. For inventories, market value generally means current replacement cost (that is, the cost to replace on hand). If the replacement cost of the inventory falls below its historical cost, the business must write down its goods. The business reports ending inventory at its LCM value on the balance sheet. 02/12/2018 MK 6-Okt-03

Other Inventory Issues LOWER-OF-COST-OR-MARKET RULE Assume that inventory transactions are as below during May May.1 Begining inventory (balance) 20 units x $20 25 Purchase 10 units x 22 30 Sale 25 units Compute ending inventory and cost of goods sold under FIFO in periodic system Ending inventory : (5 units x $22) = $110 Market value per unit : $18 (5 units x $18 =$90) Market value is below FIFO cost, and the entry to write down the inventory to LCM follows. Date Description Debit Credit Dec. 31 Cost of Goods Sold Inventory (Ending balance) 20 Balance Sheet Current assets Inventory, at market $90 (which is lower than FIFO cost) NOTE: STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES Inventories: Inventories are carried at the lower of cost or market. Cost is determined using the first in, first out. 02/12/2018 MK 6-Okt-03

Other Inventory Issues EFFECT OF INVENTORY ERRORs Business count their invenories at the end od the period. An error in the ending inventory creates errors in cost of goods sold and gross profit. Recall that one period’s ending inventory becomes the next period’s begining inventory. Thus, the error in ending inventory carries over the next period. The results of errors made current period on inventory effect financial statements of both current and the following period. Because ending inventory is subtracted to compute COGS in one period and the same amount is added as beginin inventory the next period cancels out after two periods. The overstatement of COGS in period 2 countebalances the understatement for period 1. Thus, total gross profit for the two periods combined is correct. 02/12/2018 MK 6-Okt-03

Exercises E6-1 p. 268 Date Item Quantity Unit cost May1 May 6 May 8 Picker paradise carries a large inventory of guitars and other musical instruments. Picker uses the FIFO method and a perpetual inventory system. Company records indicate the following for a particular line of Honeydew guitar. Date Item Quantity Unit cost May1 May 6 May 8 May 17 May 30 Balance Sale Puchase 5 3 10 4 $70 80 Required: Prepare a perpetual inventory record for the guitars. Then determine the amounts Picker should report for ending inventory and cost of goods sold by the FIFO 02/12/2018 MK 6-Okt-03

HONEYDEW GUITARS May 1 5 $70 $350 6 3 $210 2 70 140 8 10 $80 $800 80 (10-15 min.) E 6-1 Perpetual Inventory Record – FIFO HONEYDEW GUITARS Purchases Cost of Goods Sold Inventory on Hand Date Quantity Unit Cost Total May 1 5 $70 $350 6 3 $210 2 70 140 8 10 $80 $800 80 800 17 160 640 30 400 240 31 12 $910 $240 Ending inventory = $240. Cost of goods sold = $910. 02/12/2018 MK 6-Okt-03

Exercises E6-2 After preparing the FIFO perpetual inventory records in E-6-1, journalize Picker Paradise’s May 8 purchase of inventory on account and cash sale on May 17 (sale price of each guitar was $140). E6-3 Refer to the Picker Paradise inventory data in E6-1. Assume that the Picker uses LIFO method. … E6-4 Refer to the Picker Paradise inventory data in E6-1. Assume that the Picker uses Average cost method. … 02/12/2018 MK 6-Okt-03

(15-20 min.) E 6-4 Perpetual Inventory Record – AVerage Cost HONEYDEW GUITARS Purchases Cost of Goods Sold Inventory on Hand Date Quantity Unit Cost Total May 1 5 $70.00 $350 6 3 $210 2 70.00 140 8 10 $80.00 $800 12 78.33 940 17 4 313 627 30 392 235 31 $915 $235 02/12/2018 MK 6-Okt-03

Exercises E6-5 Inventory, December 31, 2004 Accounting records for Durraşş Luggage yield the following data for the year ended December 31, 2005 (amounts in thousands) Inventory, December 31, 2004 Purchases of inventory (on account) Sales of inventory-80% on account; %20 for cash (cost $2821) Inventory, December 31, 2005 $ 370 3,105 4,395 ? Required: Journalize Durall’s inventory transactions in the perpetual system. Report ending inventory on the balance sheet, cost of goods sold and gross profit on the income statement. Acc. Rec. 3516 Cash 879 02/12/2018 MK 6-Okt-03

Exercises E6-9 Oct. 1 Begining inventory 8 Purchase 15 Purchase The periodic inventory records of Flexon indicate the following at October 31: Oct. 1 Begining inventory 8 Purchase 15 Purchase 26 Purchase 9 units x $160 4 units x $160 12 units x $170 3 units x $176 The physical inventory at October 31 counts 8 units on hand. Required: Compute ending inventory and cost of goods sold, using each of the following methods. Specific unit cost, assuming four $170 units and four $160 units are on hand. Average cost ( round average unit cost to three decimall places) FİFO LIFO 02/12/2018 MK 6-Okt-03

Exercises (15-20 min.) E 6-9 Cost of goods available for sale Oct. 1 Beginning inventory………. 9 @ $160 = $1,440 8 Purchase……………………. 4 160 640 15 12 170 2,040 26 3 176 528 Goods available for sale…. 28 $4,648 02/12/2018 MK 6-Okt-03

Exercises (15-20 min.) E 6-9 02/12/2018 MK Ending inventory Cost of goods sold       (1) Specific unit cost (4 @ $170) + (4 @ $160) = $1,320 $4,648 – $1,320 $3,328 (2) Average cost $4,648  28 units = average unit cost of $166  8 $1,328 $4,648 – $1,328 $3,320 (3) FIFO (3 @ $176) + (5 @ $170) $1,378 $4,648 – $1,378 $3,270 (4) LIFO 8 @ $160 $1,280 $4,648 – $1,280 $3,368 02/12/2018 MK 6-Okt-03