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

2. 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

3. 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

4. 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

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

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

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

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

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

10. 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

11. 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

12. First-In, First-Out 36 36 30 30

13. First-In, First-Out 36 36 31 31

14. First-In, First-Out 36 36 32 32

15. First-In, First-Out 36 36 33 33

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

17. First-In, First-Out 36 36 36 36

18. ANY QUESTIONS BEFORE WE DISCUSS LIFO?37 37 37 37

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

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

21. 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

22. 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

23. Last-In, First-Out 47 47 47 42

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

25. Last-In, First-Out 47 47 47 44

26. Last-In, First-Out 47 47 47 46

27. 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

28. 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

29. 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

30. Average Cost Method 51 51 51 50

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

32. Comparison of Methods 62 62 62 62

33. 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

34. 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

35. 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

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

37. Inventory Costing Methods and Financial Statement Analysis69 69 69 69

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

39. 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

40. 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.

41. 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

42. 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

43. 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

44. Errors in Measuring Inventory18 18 18 18

45. 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

46. 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

47. 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

48. 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

49. 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

50. Comparison of Perpetual and Periodic Systems81 81 81 81

51. The End of Chapter 7 97 97 97 97