Reporting and Interpreting Cost of Goods Sold and Inventory Chapter 7 Reporting and Interpreting Cost of Goods Sold and Inventory

Business Background Roles of the Accounting System Provides accurate information. Roles of the Accounting System Provides up-to-date information. Provides information to help protect assets. 5 5 5 5

Nature of Inventory and Cost of Goods Sold Beginning Inventory Purchases for the Period Goods available for Sale Ending Inventory (Balance Sheet) Cost of Goods Sold (Income Statement) Beginning inventory + Purchases – Ending inventory = Cost of goods sold 6 6 6 6

Flow of Inventory Costs Merchandise Purchases Cost of Goods Sold Merchandise Inventory Merchandiser Raw Materials Raw Materials Inventory Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Manufacturer Direct Labor Factory Overhead

Inventory Cost The cost principle requires that inventory be recorded at the price paid or the consideration given up. 7 7 7 7

Inventory Costing Methods FIFO LIFO Weighted Average Specific Identification 24 24 24 24

Applying the Four Methods Total Dollar Amount of Goods Available for Sale Ending Inventory Cost of Goods Sold 25 25 25 25

Specific Identification Specific cost of each inventory item is known. Used with low volume, high dollar cost inventory items. 56 56 55 56

First-In, First-Out (FIFO) Costs of Goods Sold Oldest Costs Ending Inventory Recent Costs 26 26 26 26

First-In, First-Out The schedule on the next screen shows the mouse pad inventory for Computers, Inc. The physical inventory count shows 1,200 mouse pads in ending inventory. Use the FIFO inventory method to determine: (1) Ending inventory cost. (2) Cost of goods sold. 27 27 27 27

Remember: The costs of most recent purchases are in ending inventory Remember: The costs of most recent purchases are in ending inventory. Start with 11/29 and add units purchased until you reach the number in ending inventory. First-In, First-Out 28 28 28 28

First-In, First-Out 36 36 30 30

First-In, First-Out 36 36 31 31

First-In, First-Out 36 36 32 32

First-In, First-Out 36 36 33 33

First-In, First-Out Now, we have allocated the cost to all 1,200 units in ending inventory. 36 36 35 35

First-In, First-Out 36 36 36 36

ANY QUESTIONS BEFORE WE DISCUSS LIFO? 37 37 37 37

Last-In, First-Out Oldest Costs ? Recent Costs ? 38 38 38 38

Last-In, First-Out Ending Inventory Oldest Costs Cost of Goods Sold Recent Costs 38 38 38 38

Last-In, First-Out The schedule on the next screen shows the mouse pad inventory for Computers, Inc. The physical inventory count shows 1,200 mouse pads in ending inventory. Use the LIFO inventory method to determine: (1) Ending inventory cost. (2) Cost of goods sold. 39 39 39 39

Remember: The costs of the oldest purchases are in ending inventory Remember: The costs of the oldest purchases are in ending inventory. Start with beginning inventory and add units purchased until you reach the number in ending inventory. Last-In, First-Out 40 40 40 40

Last-In, First-Out 47 47 47 42

Last-In, First-Out Now, we have allocated the cost to all 1,200 units in ending inventory. 47 47 43 47

Last-In, First-Out 47 47 47 44

Last-In, First-Out 47 47 47 46

Now let’s move on to the average cost inventory method. Average Cost Method Now let’s move on to the average cost inventory method. 48 48 47 48

Average Cost Method Average cost per unit Ending Inventory Cost of goods available for sale Number of units available for sale Ending Inventory Units in Ending Inventory ´ Average cost per Unit Cost of Good Sold Units Sold ´ Average cost per Unit 49 49 48 49

Average Cost Method The schedule on the next screen shows the mouse pad inventory for Computers, Inc. The physical inventory count shows 1,200 mouse pads in ending inventory. Use the average cost inventory method to determine: (1) Ending inventory cost. (2) Cost of goods sold. 50 50 49 50

Average Cost Method 51 51 51 50

Weighted-Average = $5.40278 Weighted-Average Cost per Unit: $9,725 1,800 Ending Inventory: 1,200 Units × $5.40278 = $6,483* Cost of Goods Sold: 600 Units × $5.40278 = $3,242* * Rounded = $5.40278 55 55 54 55

Comparison of Methods 62 62 62 62

In periods of rising prices, FIFO results in the highest ending inventory, gross profit, tax expense, and net income, and the lowest cost of goods sold. Comparison of Methods 62 62 62 62

Comparison of Methods In periods of rising prices, LIFO results in the lowest ending inventory, gross profit, tax expense, and net income, and the highest cost of goods sold. 62 62 62 62

Choosing Inventory Costing Methods Net Income Effects. Managers prefer to report higher earning for their companies. Income Tax Effects. Managers prefer to pay the least amount of taxes allowed by law as late as possible. 69 69 69 69

Choosing Inventory Costing Methods If . . . Then . . . LIFO Conformity Rule LIFO for taxes LIFO for books 68 68 68 68

Inventory Costing Methods and Financial Statement Analysis 69 69 69 69

LIFO and International Comparisons LIFO Permitted? No Yes Singapore China Canada Australia Great Britain

Lower of Cost or Market Ending inventory is reported at the lower of cost or market (LCM). Market is either . . . Net Realizable Value The expected sales price less selling costs. Replacement Cost The current purchase price of identical goods. or 74 74 74 74

Lower of Cost or Market The mouse pads will be shown on the balance sheet at $6,640 (LCM). The company will recognize a “holding” loss in the current period rather than the period in which the item is sold. This practice is conservative.

Measuring Efficiency in Inventory Management Inventory Turnover Cost of Goods Sold = Average Inventory Inventory Turnover Average Inventory is . . . (Beginning Inventory + Ending Inventory) ÷ 2 This ratio is often used to measure the liquidity (nearness to cash) of the inventory. 71 71 71 71

Measuring Efficiency in Inventory Management Inventory Turnover Cost of Goods Sold = Average Inventory Inventory Turnover The 2000 inventory turnover ratio for Harley-Davidson: $1,915,547 ($191,931 + $168,616) ÷ 2 = 10.6

Focus on Cash Flows Increase in Inventory Decrease in Accounts Payable Add Increase in Inventory Decrease in Accounts Payable Cost of Goods Sold Cash Payment to Suppliers Decrease in Inventory Increase in Accounts Payable Subtract 76 76 76

Errors in Measuring Inventory 18 18 18 18

Question If the 2002 ending inventory is understated by $3,000, which of the following is true for 2002? a. Beginning Inventory was understated. b. Cost of Goods Sold will be understated. c. Gross Profit will be overstated. d. Net Income will be understated. 19 19 19 19

Question If the 2002 ending inventory is understated by $3,000, which of the following is true for 2002? a. Beginning Inventory was understated. b. Cost of Goods Sold will be understated. c. Gross Profit will be overstated. d. Net Income will be understated. 20 20 20 20

Question If the 2002 ending inventory is understated by $3,000, which of the following is true for 2003? a. Beginning Inventory was understated. b. Cost of Goods Sold will be understated. c. Gross Profit will be overstated. d. All of the above. 21 21 21 21

Question If the 2002 ending inventory is understated by $3,000, which of the following is true for 2003? a. Beginning Inventory was understated. b. Cost of Goods Sold will be understated. c. Gross Profit will be overstated. d. All of the above. Remember: The ending inventory for 2002 becomes the beginning inventory for 2003. 23 23 23 23

Perpetual and Periodic Inventory Systems Provides up-to-date inventory records. Perpetual System Provides up-to-date cost of sales records. 77 77 77 77

Comparison of Perpetual and Periodic Systems 81 81 81 81

The End of Chapter 7 97 97 97 97