1. Financial Accounting: Tools for Business Decision Making
Kimmel, Weygandt, Kieso, Trenholm
KIMMEL
Prepared by:
Barbara Trenholm
University of New Brunswick

2. Chapter 6 Reporting and Analysing Inventory
After studying Chapter 6, you should be able to:
Explain the recording of purchases and sales of inventory under a periodic inventory system.
Explain how to determine cost of goods sold under a periodic inventory system.
Describe the steps in determining inventory quantities.
Identify the unique features of the statement of earnings for a merchandising company under a periodic inventory system.

3. Chapter 6 Reporting and Analysing Inventory
After studying Chapter 6, you should be able to:
Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.
Explain the financial statement effects of each of the inventory cost flow assumptions.
Explain the lower of cost and market basis of accounting for inventories.
Calculate and interpret the inventory turnover ratio.

4. Merchandise Inventory
Owned by the company
In form ready for sale to customers

5. Manufacturing Inventory
Finished goods inventory
Work in process
Raw materials

6. Comparing Periodic and Perpetual Inventory Systems
Inventory Purchased
Item Sold
End of Period
Perpetual
Perpetual
No Entry
Record Purchase of Inventory
Record Revenue and Cost of Goods Sold
End of Period
Inventory Purchased
Item Sold
Periodic
Record Purchase of Inventory
Record Revenue Only
Compute Cost of Goods Sold

7. (Periodic Inventory System)
Sales Revenues
(Periodic Inventory System)
Record when earned-revenue recognition principle
ONLY one entry is made for each sale in a periodic inventory system
One to record sale
NONE to record cost of goods sold as in a perpetual inventory system

8. Merchandise Inventory Sales Returns & Allowances
Sales - assume a sale of $3,800 on account
Cash
Accounts Receivable
Merchandise Inventory X
May 4 3,800
Cost of Goods Sold
Sales Returns & Allowances
Sales X
May 4 3,800

9. Sales Returns and Allowances
Flip side of purchase returns and allowance
On buyer’s books
GENERAL JOURNAL Debit Credit
May 8 Accounts Payable Purchase Returns and Allowances
To record goods returned that were purchased on account
On seller’s books
GENERAL JOURNAL Debit Credit
May 8 Sales Returns and Allowance Accounts Receivable
To record return of goods delivered to Sauk Stereo
ONLY ONE ENTRY NEEDED IN PERIODIC INVENTORY SYSTEM

10. Flip side of purchase discounts
Sales Discounts
Flip side of purchase discounts
On buyer’s books
GENERAL JOURNAL Debit Credit
May 14 Accounts Payable , Cash ,430 Purchase Discounts
To record payment within discount period
On seller’s books
GENERAL JOURNAL Debit Credit
May 14 Cash , Sales Discounts Accounts Receivable ,500
To record collection within discount period

11. Purchases of Merchandise
Perpetual inventory system
Merchandise Inventory-one account-used to accumulate the cost of goods purchased
Periodic inventory system
Separate accounts used to accumulate the cost of goods purchased

12. Normal Balances Cost of Goods Purchased Accounts
Account Normal Balance
Purchases Debit
Purchase Returns and Allowances Credit
Purchase Discounts Credit
Freight In Debit

13. Merchandise Purchases
On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc.
Purchases
Purchase Returns & All.
Purchase Discounts
May 4 3,800
Accounts Payable
Freight-In
Cash
May 4 3,800

14. Purchase Returns and Allowances
On May 8 the company returned $300 worth of merchandise to PW Audio Supply, Inc.
Purchases
Purchase Returns & All.
Purchase Discounts
May 4 3,800
May
Accounts Payable
Freight-In
Cash
May 4 3,800

15. Freight - In
On May 9 the company paid $ 150 to have the merchandise inventory delivered to them.
Purchase Returns & All.
Purchase Discounts
Purchases
May 4 3,800
May
Accounts Payable
Freight-In
Cash
May
May
May 4 3,800

16. Purchase Discounts Original invoice $3,800 -Returns 300
Review - Company purchased $3,800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period.
Original invoice $3,800
-Returns
Amount due before discount ,500
2% discount
Net due $3,430

17. Purchase Discounts Purchase Returns & All. Purchase Discounts
On May 14, the company pays the balance due on the account within the discount period
Purchase Returns & All.
Purchase Discounts
Purchases
May
May 4 3,800
May
Accounts Payable
Freight-In
Cash
May
May
May 4 3,800
May
May 14 3,500
May 14 3,430

18. Net Purchases
Purchases $325,000
Less: Purchase returns and allowances $ 10,400
Purchase discounts 6, ,200
Net purchases 307,800
Net purchases are gross purchases adjusted for returns and discounts

19. Cost of Goods Purchased
Purchases $325,000
Less: Purchase returns and allowances $ 10,400
Purchase discounts 6, ,200
Net purchases 307,800
Add: Freight-in 12,200
Cost of goods purchased 320,000
Cost of goods purchased is net purchases plus freight-in

20. Comparison of Seller’s and Buyer’s Entries
Sale of goods
Cash (or receivables) xxx
Sales xxx
Return of goods
Sales returns xxx
Cash (or receivables) xxx
Freight (destination)
Delivery expense xxx
Cash (or payables) xxx
BUYER
Purchase of goods
Purchases xxx
Cash (or payables) xxx
Return of goods
Cash (or receivables) xxx
Purchases returns xxx
Freight (shipping point)
Freight In xxx
Cash (or payables) xxx

21. Determining Ending Inventory
A physical inventory count
Determines ending inventory
Enables cost of goods sold to be computed
Companies that use perpetual inventory must also take a physical inventory to check accuracy of “book inventory” to actual inventory-added internal control feature

22. Taking a Physical Inventory
Determining inventory quantities by counting, weighting or measuring each type of inventory
Determining ownership of goods, including goods in transit, consigned goods

23. Goods in Transit
Goods on board a truck, train, ship, or plane at the end of the period

24. Goods in Transit
Who includes goods in transit (on board a truck, train, ship, or plane at the end of the period) in inventory
Buyer?
Seller?
Company with legal title

25. Ownership passes to owner here
Illustration 6-4
FOB Shipping Point
Public
Carrier Co
Seller
Buyer
Ownership
passes to
buyer here
FOB Destination Point
Public
Carrier Co
Seller
Buyer

26. Consigned Goods
Goods in your store that you don’t pay for until they sell
Company does not take ownership

27. Cost of Goods Sold
After taking a physical inventory count, cost of goods sold is determined
By calculation in statement of earnings (no journal entry recorded yet)
Journal entries (closing or adjusting) are made later in the closing process to record ending inventory

28. Computation of Cost of Goods Sold
Beginning inventory $ 36,000
Add: Cost of goods purchased ,000
Cost of goods available for sale ,000
Less: Ending inventory ,000
Cost of goods sold ,000
Remember: Purchases - purchase returns and allowances – purchase discounts = Net purchases + freight-in = Cost of goods purchased

29. Statement of Earnings Presentation
Statement of earnings for a merchandising company is the same whether a periodic or perpetual inventory system is used, except for the level of detail in the cost of goods sold section

30. INVENTORY SYSTEMS COMPARED PERPETUAL & PERIODIC INVENTORY SYSTEMS

31. Perpetual vs. Periodic Journal Entries
Purchase of goods
Inventory xxx
Cash (or payables) xxx
Freight (shipping point)
Inventory xxx
Cash (or payables) xxx
Return of goods
Cash (or receivables)xxx Inventory xxx
PERIODIC
Purchase of goods
Purchases xxx
Cash (or payables) xxx
Freight (shipping point)
Freight In xxx
Cash (or payables) xxx
Return of goods
Cash (or Accts Rec) xxx
Purchase Returns xxx

32. Perpetual vs. Periodic Journal Entries
Sale of goods
Cash (or Accts Rec) xxx
Sales xxx
Cost of goods sold xxx
Inventory xxx
End of period
No entry necessary
PERIODIC
Sale of goods
Cash (or Accts Rec) xxx
Sales xxx
End of period
Closing entry or adjusting entry necessary

33. Inventory Costing Changing Prices Specific identification
Cost flow assumptions
FIFO (First-in, First-Out)
LIFO (Last-in, First-Out)
Average cost
What makes cost flow assumptions necessary?
Changing Prices

34. Cost of goods sold = $700 + $800 = $1,500
Illustration 6-7
Specific Identification
Cost of goods sold = $700 + $800 = $1,500
An actual physical flow costing method in which items on hand are specifically costed to arrive at the total cost of ending inventory

35. FIFO method assumes earliest goods purchased are the first to be sold
Illustration 6-9
FIFO method assumes earliest goods purchased are the first to be sold

36. Illustration 6-11
Allocation of the cost of goods available for sale in average cost method is made on the basis of the weighted average unit cost incurred

37. Illustration 6-12
Average cost method assumes that goods available for sale are homogeneous

38. LIFO method assumes latest goods purchased are the first to be sold
Illustration 6-13
LIFO method assumes latest goods purchased are the first to be sold

39. Use of Cost Flow Methods by Canadian Companies
Each of the four methods are acceptable in Canada
Very few companies use LIFO

40. Factors Used in Selecting Inventory Cost Method
Statement of earnings effects
LIFO gives best match of current revenues to current costs
Balance sheet effects
FIFO gives best measurement of ending inventory (approximates replacement cost)
NO cash impact!

41. Financial Statement Effects
EI CGS NE
FIFO
Average
LIFO
? What are effects on the balance sheet and statement of earnings if prices are assumed to be rising?

42. Financial Statement Effects
EI CGS NE
FIFO H L H
Average
LIFO L H L
? What are effects on the balance sheet and statement of earnings if prices are assumed to be rising?

43. Financial Statement Effects
EI CGS NE
FIFO
Average
LIFO
? What are effects on the balance sheet and statement of earnings if prices are assumed to be falling?

44. Financial Statement Effects
EI CGS NE
FIFO L H L
Average
LIFO H L H
? What are effects on the balance sheet and statement of earnings if prices are assumed to be falling?

45. Financial Statement Effects
EI CGS NE
FIFO
Average
LIFO
? What are effects on the balance sheet and statement of earnings if prices are assumed to be stable?

46. Financial Statement Effects
EI CGS NE
FIFO
Average
LIFO
All three methods will give same results.
? What are effects on the balance sheet and statement of earnings if prices are assumed to be stable?

47. Lower of Cost and Market (LCM)
When the value of the inventory declines below cost, it is written down to its market value
Market is defined as current replacement cost or net realizable value, not selling price

48. Lower of Cost and Market (LCM)
Departure from cost principle
Follows conservatism concept
Used only after one of the cost flow methods (Specific identification, FIFO, LIFO, or average cost)

49. How Much Inventory Should a Company Have?
Only enough for sales needs
Excess inventory costs
Storage costs
Interest costs
Obsolescence

50. Inventory Turnover Inventory turnover = Cost of goods sold
Average inventory

51. Days in Inventory
Days in inventory =
365 days
Inventory turnover

52. Decision Checkpoints Which inventory costing method should be used?
How long is an item in inventory?
Inventory turnover ratio
Days in inventory

53. COPYRIGHT
Copyright © 2001 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.