Inventories and COGS

Merchandise Inventory Chapter 9
2002 Prentice Hall, Inc.
Business Publishing
Accounting, 5/E
Horngren/Harrison/Bamber
9-1
Objective 1
Account for inventory by the perpetual and periodic systems.
Business Publishing
Accounting, 5/E
9-2
Inventory Accounting Systems
Perpetual systems maintain a running record to show the inventory on hand at all times. Periodic systems do not keep a continuous record of inventory on hand.
Business Publishing
Accounting, 5/E
9-3
Perpetual System
Debit Inventory Credit Cash or Accounts Payable Debit Cash or Accounts Receivable Credit Sales Revenue Debit Cost of Goods Sold Credit Inventory
2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 9-4
Perpetual System
Item: Teva Sandals Quantity Date Received Nov. 1 5 7 25 12 26 25 30 Totals 50
2002 Prentice Hall, Inc. Business Publishing
Quantity Sold
6
13 21 40
Accounting, 5/E
Quantity on Hand 10 4 29 16 41 20 20
9-5
Cost of Goods Sold

Beginning Inventory $100,000 Cost of Goods Available for Sale $660,000
Net Purchases $560,000
Ending Inventory $120,000

Accounting, 5/E
Cost of Goods = Sold $540,000

Horngren/Harrison/Bamber 9-6
Business Publishing
Gross Profit
Sales revenues Cost of goods sold = Gross margin (before operating expenses) Gross margin Operating expenses = Net income
Business Publishing
Accounting, 5/E
9-7
Cost-of-Goods-Sold Model
Budgeted Cost of Goods Sold
+ = =
Budgeted Ending Inventory Budgeted Cost of Goods Available for Sale Actual Beginning Inventory Purchases
Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 9-8
Computing the Cost of Inventory
Cost of inventory on hand = Quantity unit cost
Physical count is made at least once a year, even with a perpetual system. Consigned goods are excluded.
Business Publishing
Accounting, 5/E
9-9
Periodic System
At the end of the period make a physical count and apply unit cost to determine ending inventory. Inventory purchases are debited to the purchases account. The inventory account carries the beginning inventory balance until adjusted at period end.
2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 9 - 10
Periodic System
Inventory
100,000 100,000 Beginning Beginning Balance Balance 120,000 Ending Balance
Purchases
560,000 560,000 Purchases Purchases
Cost of Goods Sold

100,000 560,000 540,000 120,000 Ending Balance
Accounts Payable
560,000 Purchases
2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E
9 - 11
Objective 2
Apply the inventory costing methods: specific unit cost, weighted-average cost, FIFO, and LIFO.
Business Publishing
Accounting, 5/E
9 - 12
Units Purchased in 200X
January 8 May 19 October 23 Total units Units sold Units left
20 units @ $20 = $ 400 55 units @ $30 = $1,650 25 units @ $31 = $ 775 100 70 30
Business Publishing
Accounting, 5/E
9 - 13
Units Sold and in Ending Inventory

Units sold by date: Jan 5 17 May 19 33 Oct 23 20 Total sales 70 30 units left in inventory
Specific Identification
20 Units @ $31
Cost of Goods Sold Oct 23 $ 620 May 19 990 Jan 5 340 Total $1,950 5 Units @ $31
33 Units @ $30
22 Units @ $30
17 Units @ $20
3 Units @ $20
Accounting, 5/E Horngren/Harrison/Bamber 9 - 15
Business Publishing
Specific Identification
20 Units @ $31
Ending Inventory Oct 23 $155 May 660 Jan 60 Total $875 5 Units @ $31
33 Units @ $30
22 Units @ $30
17 Units @ $20
3 Units @ $20
Accounting, 5/E Horngren/Harrison/Bamber 9 - 16
Business Publishing
Weighted Average
25 Units @ $31 (Oct) 55 Units @ $30 (May)
= $ 775
= 1,650
= 400
20 Units @ $20 (Jan)
100 Total Units = $2,825 Total Cost

Weighted Average
$2,825 total cost/100 units = $28.25/unit
Cost of goods sold = 70 $28.25 = $1977.50
Ending inventory = 30 $28.25 = $847.50
Business Publishing
Accounting, 5/E
9 - 18
First-In, First-Out
25 Units @ $31 (Oct) Cost of Goods Sold Jan $ 400 May 1,500 Total $1,900
5 Units @ $30 (May)

50 Units @ $30 20 Units @ $20 (Jan)
Business Publishing
Accounting, 5/E
9 - 19
First-In, First-Out
25 Units @ $31 (Oct) Ending Inventory Oct $775 May 150 Total $925
5 Units @ $30 (May)

50 Units @ $30 20 Units @ $20 (Jan)
Business Publishing
Accounting, 5/E
9 - 20
Last-In, First-Out
25 Units @ $31 (Oct) Cost of Goods Sold Oct $ 775 May 1,350 Total $2,125
45 Units @ $30 (May)

10 Units @ $30 20 Units @ $20 (Jan)
Business Publishing
Accounting, 5/E
9 - 21
Last-In, First-Out
25 Units @ $31 (Oct) Ending Inventory Oct $300 May 400 Total $700
45 Units @ $30 (May)

10 Units @ $30 20 Units @ $20 (Jan)
Business Publishing
Accounting, 5/E
9 - 22
Comparison of Methods
Ending Inventory Specific identification $875.00 FIFO $925.00 LIFO $700.00 Weighted-average $847.50
Business Publishing
Accounting, 5/E
9 - 23
Cost of Goods Sold Specific identification $1,965.00 FIFO $1,900.00 LIFO $2,125.00 Weighted-average $1,977.50
Business Publishing
Accounting, 5/E
9 - 24
Gross Margin from Sales: Specific identification $1,035.00 FIFO $1,100.00 LIFO $ 875.00 Weighted-average $1,022.50
When prices are rising LIFO produces the lowest income and lowest income tax.
Objective 3
Identify the income effects and the tax effects of the inventory costing methods.
Business Publishing
Accounting, 5/E
9 - 26
The Income Tax Advantage of LIFO

During periods of inflation, LIFOs income is the lowest. The most attractive feature of LIFO is reduced income tax payments.
Business Publishing
Accounting, 5/E
9 - 27
Use of the Various Inventory Costing Methods

Average 19% Other 4% LIFO 34%
FIFO 43%
LIFO Liquidation
When prices are rising... the company draws down inventory quantities below the level of the previous period which releases older costs to the income statement.
Business Publishing
Accounting, 5/E
9 - 29
Perpetual System FIFO Example

Many companies keep their perpetual inventory records in quantities only. Other companies keep perpetual records in both quantities and dollar cost.
Business Publishing
Accounting, 5/E
9 - 30

Deckers Outdoor
Item: Teva Sandals Received Unit Date Qty. Cost Total Nov. 1 5 7 25 $31 $775 12
Sold Unit Qty. Cost Total 6 $30 $180
Balance on Hand Unit Qty. Cost Total 10 $30 $300 4 30 120 4 30 120 25 31 775 16 31 496
9 - 31
4 9
Business Publishing
30 31
120 279
Accounting, 5/E

Deckers Outdoor
Item: Teva Sandals Received Unit Date Qty. Cost Total Nov. 26 25 $32 $ 800 30 Totals 50 $1,575 Sold Unit Qty. Cost Total Balance on Hand Unit Qty. Cost Total 16 $31 $496 25 32 800 25 32 800 20 32 640 20 $32 $640
9 - 32
16 5 40
$31 32
496 160 $1,235
Business Publishing
Accounting, 5/E
Accounting Principles: Consistency

The business should use the same accounting methods and procedures from one period to the next.
A company may change inventory methods, but it must disclose the effects of the change on net income.
Business Publishing
Accounting, 5/E
9 - 33
Accounting Principles: Disclosure
The financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company.
Accounting Principles: Materiality

An item is material if it has the potential to alter a statement users decision.
Materiality is specific to the entity being evaluated.
Business Publishing
Accounting, 5/E
9 - 35
Accounting Principles: Conservatism
Err on the side of caution when reporting any item in the financial statements.
Business Publishing
Accounting, 5/E
9 - 36
Objective 4
Apply the lower-of-costor-market rule to inventory.
Business Publishing
Accounting, 5/E
9 - 37
Lower-of-Cost-or-Market
An asset is reported at the lower of its historical cost or market (replacement) value. If the replacement cost falls below its historical cost, the business must write down the value of its inventory.
Business Publishing
Accounting, 5/E
9 - 38
Lower-of-Cost-or-Market Example
Cost of inventory: $3,000 Market value at balance sheet date: $2,200 What is the journal entry?
December 31 Cost of Goods Sold 800 Inventory 800 Write down inventory to LCM
Objective 5
Determine the effects of inventory errors on cost of goods sold and net income.
Business Publishing
Accounting, 5/E
9 - 40
Inventory Errors
If inventory is computed incorrectly, how many years of financial statements will it affect? Two years The current years ending inventory is next years beginning inventory.
Business Publishing
Accounting, 5/E
9 - 41
Objective 6
Estimate ending inventory by the gross profit method.
Business Publishing
Accounting, 5/E
9 - 42
Gross Profit Method Example

Net Sales Gross Profit Margin Beginning Inventory Net Purchases
Net Sales Gross Profit of 31.5% = Cost of Goods Sold
2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E
$150,000 31.5% $ 18,500 $110,500

$150,000 47,250 $102,750
Horngren/Harrison/Bamber 9 - 43
Gross Profit Method Example

Beginning Inventory $18,500 Cost of Goods Available for Sale $129,000
Net Purchases $110,500
Cost of Goods = Sold $102,750

Accounting, 5/E
Ending Inventory $26,250

9 - 44
Business Publishing
End of Chapter 9
Business Publishing
Accounting, 5/E
9 - 45

Inventories and COGS

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Inventories and COGS

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Merchandise Inventory Chapter 9

2002 Prentice Hall, Inc.

2002 Prentice Hall, Inc.

Inventory Accounting Systems

2002 Prentice Hall, Inc.

Cost of Goods Sold

Net Purchases $560,000

Ending Inventory $120,000

Cost of Goods = Sold $540,000

2002 Prentice Hall, Inc.

Computing the Cost of Inventory

Cost of inventory on hand = Quantity unit cost

2002 Prentice Hall, Inc.

2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber 9 - 10

Cost of Goods Sold

2002 Prentice Hall, Inc.

Units Purchased in 200X

January 8 May 19 October 23 Total units Units sold Units left

2002 Prentice Hall, Inc.

Units Sold and in Ending Inventory

2002 Prentice Hall, Inc.

2002 Prentice Hall, Inc.

25 Units @ $31 (Oct) 55 Units @ $30 (May)

20 Units @ $20 (Jan)

100 Total Units = $2,825 Total Cost

Ending inventory = 30 $28.25 = $847.50

2002 Prentice Hall, Inc.

5 Units @ $30 (May)

2002 Prentice Hall, Inc.

5 Units @ $30 (May)

2002 Prentice Hall, Inc.

45 Units @ $30 (May)

2002 Prentice Hall, Inc.

45 Units @ $30 (May)

2002 Prentice Hall, Inc.

2002 Prentice Hall, Inc.

2002 Prentice Hall, Inc.

2002 Prentice Hall, Inc.

The Income Tax Advantage of LIFO

2002 Prentice Hall, Inc.

Use of the Various Inventory Costing Methods

2002 Prentice Hall, Inc.

Perpetual System FIFO Example

2002 Prentice Hall, Inc.

Perpetual System FIFO Example

Sold Unit Qty. Cost Total 6 $30 $180

Perpetual System FIFO Example

496 160 $1,235

2002 Prentice Hall, Inc.

Accounting Principles: Consistency

2002 Prentice Hall, Inc.

Accounting Principles: Disclosure

Accounting Principles: Materiality

2002 Prentice Hall, Inc.

Accounting Principles: Conservatism

2002 Prentice Hall, Inc.

Apply the lower-of-costor-market rule to inventory.

2002 Prentice Hall, Inc.

2002 Prentice Hall, Inc.

2002 Prentice Hall, Inc.

2002 Prentice Hall, Inc.

Estimate ending inventory by the gross profit method.

2002 Prentice Hall, Inc.

Gross Profit Method Example