(BQ) Part 2 book Financial accounting has contents Inventory cost of goods sold, plant assets intangibles, liabilities, the income statement the statement of stockholders’ equity, the statement of cash flows, financial statement analysis,...and other contents.
www.downloadslide.com Inventory & Cost of Goods Sold SPOTLIGHT ISBN: 0-536-55962-7 PIER IMPORTS You’ve just graduated from college, taken a job, and you’re moving into an apartment The place is unfurnished, so you’ll need a sofa, a table, and a few chairs Where will you find these things? Pier Imports may get some of your business Pier is known for featuring stylish home furnishings at popular prices–just about right for a new graduate The company operates 1,100 stores in the U.S., plus 43 Pier Kids stores that sell children’s furniture and accessories Pier 1’s balance sheet is summarized here You can see that the merchandise inventory (labeled simply as Inventories) is Pier 1’s largest asset That’s not surprising since Pier 1, like other retailers, attracts customers with goods that they can purchase and take home immediately Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc www.downloadslide.com 310 ■ Chapter Inventory & Cost of Goods Sold Pier Imports, Inc Balance Sheets (Adapted) (In millions) 2006 2005 Cash and cash equivalents Receivables, net of allowance for doubtful $ 246 $ 186 account of $1 and $1, respectively Inventories 64 369 47 366 Prepaid expenses and other current assets Total current assets 96 775 80 679 Properties, net Other noncurrent assets 299 96 320 77 $1,170 $1,076 $ 289 184 107 590 $1,170 $ 292 19 101 664 $1,076 Assets Current assets: Liabilities and Shareholders’ Equity Current liabilities Long-term debt Other noncurrent liabilities Shareholders’ equity We also present Pier 1’s income statement Fiscal 2006 was a tough year— Pier had a net loss of $40 million Sales dropped from the preceding year, and expenses increased Pier Imports, Inc Statements of Operations (Adapted) (In millions) Year Ended 2006 2005 $1,777 $1,825 1,175 645 (43) (42) (14) (28) (12) $ (40) 1,122 605 98 99 37 $ 62 (2) 60 Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc ISBN: 0-536-55962-7 Net sales Operating costs and expenses: Cost of sales (Cost of goods sold) Operating expenses Operating income (loss) Nonoperating income Income (loss) before income taxes Income tax expense (income tax saving in 2006) Income (loss) from continuing operations (Loss) from discontinued operations Net income (loss) www.downloadslide.com Accounting for Inventory You can see that the cost of sales (another name for cost of goods sold) is by far Pier 1’s largest expense The account titled Cost of Goods Sold perfectly describes that expense In short, ■ ■ Pier buys inventory, an asset carried on the books at cost The goods that Pier sells are no longer Pier 1’s asset The cost of inventory that’s sold gets shifted into the expense account, Cost of Goods Sold Merchandise inventory is the heart of a merchandising business, and cost of goods sold is the most important expense for a company that sells goods rather than services This chapter covers the accounting for inventory and cost of goods sold It also shows you how to analyze financial statements Here we focus on inventory, cost of goods sold, and gross profit We begin by showing how the financial statements of a merchandiser such as Pier Imports or Ford Motor Company differ from those of service entities such as FedEx and Wells Fargo Bank The financial statements in Exhibit 6-1 (p 312) highlight how service entities differ from merchandisers (dollar amounts are assumed) LEARNING OBJECTIVES Account for inventory Understand the various inventory methods Use gross profit percentage and inventory turnover to evaluate operations Estimate inventory by the gross profit method Show how inventory errors affect the financial statements ACCOUNTING FOR INVENTORY The basic concept of accounting for merchandise inventory can be illustrated with an example Suppose Pier Imports has in stock chairs that cost $300 each Pier marks the chairs up by $200 and sells of the chairs for $500 each Pier 1’s balance sheet reports the chair that the company still holds in inventory ■ The income statement reports the cost of the chairs sold, as shown in Exhibit 6-2 Here is the basic concept of how we identify inventory, the asset, from cost of goods sold, the expense ISBN: 0-536-55962-7 ■ The cost of inventory on hand = Inventory The cost of inventory that’s been sold = Cost of Goods Sold Asset on the Balance Sheet Expense on the Income Statement Inventory’s cost shifts from asset to expense when the seller delivers the goods to the buyer Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc ■ 311 www.downloadslide.com 312 ■ Chapter Inventory & Cost of Goods Sold EXHIBIT 6-1 Contrasting a Service Company with a Merchandiser Service Company Merchandising Company Century 21 Real Estate Income Statement Year Ended December 31, 20XX Ford Motor Company Income Statement Year Ended December 31, 20XX Service revenue Expenses: $XXX Salary expense Depreciation expense X X Income tax expense Net income X X $ Sales revenue $5,000 Cost of goods sold Gross profit 3,000 2,000 Operating expenses: Salary expense X Depreciation, expense Income tax expense X X Net income (net loss) $ 800 Century 21 Real Estate Balance Sheet December 31, 20XX Ford Motor Company Balance Sheet December 31, 20XX Assets Assets Current assets Cash Short-term investments Accounts receivable, net Prepaid expenses $ Current assets Cash Short-term investments Accounts receivable, net Inventory Prepaid expenses X X X X $ X X X 700 X Merchandisers have accounts that service entities don’t need: • cost of goods sold on the income statement • inventory on the balance sheet Sale Price vs Cost of Inventory Note the difference between the sale price of inventory and the cost of inventory In our example, ■ ■ Sales revenue is based on the sale price of the inventory sold ($500 per chair) Cost of goods sold is based on the cost of the inventory sold ($300 per chair) Inventory on the balance sheet is based on the cost of the inventory still on hand ($300 per chair) Exhibit 6-2 shows these items Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc ISBN: 0-536-55962-7 ■ www.downloadslide.com Accounting for Inventory EXHIBIT 6-2 Inventory and Cost of Goods Sold When Inventory Cost Is Constant Balance Sheet (partial) Income Statement (partial) Current assets Cash Short-term investments Accounts receivable Inventory (1 chair @ cost of $300) Prepaid expenses Sales revenue $XXX XXX (2 chairs @ sale price of $500) Cost of goods sold $1,000 XXX 300 (2 chairs @ cost of $300) Gross profit 600 $ 400 XXX Gross profit, also called gross margin, is the excess of sales revenue over cost of goods sold It is called gross profit because operating expenses have not yet been subtracted Exhibit 6-3 shows actual inventory and cost of goods sold data adapted from the financial statements of Pier Imports EXHIBIT 6-3 Pier Imports Inventory and Cost of Goods Sold (Cost of Sales) Pier Imports, Inc Balance Sheet (Adapted) February 28, 2006 Assets (In millions) Current assets Cash and cash equivalents $246 Receivables, net Inventories 64 369 Pier Imports, Inc Statements of Income (Adapted) Year Ended February 28, 2006 (In millions) Net sales ISBN: 0-536-55962-7 Cost of sales (same as Cost of goods sold) Gross profit $1,777 1,175 $ 602 Pier 1’s inventory of $369 million represents Inventory Number of units of Cost per unit = ϫ (balance sheet) inventory on hand of inventory Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc ■ 313 www.downloadslide.com 314 ■ Chapter Inventory & Cost of Goods Sold Pier 1’s cost of goods sold ($1,175 million) represents Cost of goods sold Number of units of Cost per unit = ϫ (income statement) inventory sold of inventory Let’s see what “units of inventory” and “cost per unit” mean Number of Units of Inventory The number of inventory units on hand is determined from the accounting records, backed up by a physical count of the goods at year end Companies not include in their inventory any goods they hold on consignment because those goods belong to another company But they include their own inventory that is out on consignment and held by another company Cost Per Unit of Inventory The cost per unit of inventory poses a challenge because companies purchase goods at different prices throughout the year Which unit costs go into ending inventory? Which unit costs go to cost of goods sold? The next section shows how different accounting methods determine amounts on the balance sheet and the income statement First, however, you need to understand how inventory accounting systems work OBJECTIVE Account for inventory Accounting for Inventory in the Perpetual System There are main types of inventory accounting systems: the periodic system and the perpetual system The periodic inventory system is used for inexpensive goods A fabric store or a lumber yard won’t keep a running record of every bolt of fabric or every two-by-four Instead, these stores count their inventory periodically—at least once a year—to determine the quantities on hand Businesses such as restaurants and hometown nurseries also use the periodic system because the accounting cost of a periodic system is low A perpetual inventory system uses computer software to keep a running record of inventory on hand This system achieves control over goods such as Pier Imports furniture, Ford automobiles, jewelry, and most other types of inventory Most businesses use the perpetual inventory system Even with a perpetual system, the business still counts the inventory on hand annually The physical count establishes the correct amount of ending inventory for the financial statements and also serves as a check on the perpetual records Here is a quick summary of the main inventory accounting systems Perpetual Inventory System • Used for all types of goods • Keeps a running record of all goods bought, sold, and on hand • Inventory counted at least once a year Periodic Inventory System • Used for inexpensive goods • Does not keep a running record of all goods bought, sold, and on hand • Inventory counted at least once a year Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc ISBN: 0-536-55962-7 How the Perpetual System Works Let’s use an everyday situation to show how a perpetual inventory system works When you check out of a Foot Locker, a Best Buy, or a Pier store, the clerk scans the bar codes on the labels of the items you buy www.downloadslide.com Accounting for Inventory Exhibit 6-4 illustrates a typical bar code Suppose you are buying a desk lamp from Pier Imports The bar code on the product label holds lots of information The optical scanner reads the bar code, and the computer records the sale and updates the inventory records EXHIBIT 6-4 Bar Code for Electronic Scanner Recording Transactions in the Perpetual System All accounting systems record each purchase of inventory When Pier makes a sale, entries are needed in the perpetual system: ■ ■ The company records the sale—debits Cash or Accounts Receivable and credits Sales Revenue for the sale price of the goods Pier also debits Cost of Goods Sold and credits Inventory for the cost of the inventory sold Exhibit 6-5, page 317, shows the accounting for inventory in a perpetual system Panel A gives the journal entries and the T-accounts, and Panel B shows the income statement and the balance sheet All amounts are assumed (The chapter’s Appendix 6A illustrates the accounting for these same transactions in a periodic inventory system.) In Exhibit 6-5, the first entry to Inventory summarizes a lot of detail The cost of the inventory, $560,000, is the net amount of the purchases, determined as follows (using assumed amounts): ISBN: 0-536-55962-7 + − − − = Purchase price of the inventory Freight-in (the cost to transport the goods from the seller to the buyer) Purchase returns for unsuitable goods returned to the seller Purchase allowances granted by the seller Purchase discounts for early payment by the buyer Net purchases of inventory—Cost to the buyer $600,000 4,000 (25,000) (5,000) (14,000) $560,000 Freight-in is the transportation cost, paid by the buyer, to move goods from the seller to the buyer Freight-in is accounted for as part of the cost of inventory A purchase return is a decrease in the cost of inventory because the buyer returned the goods to the seller A purchase allowance also decreases the cost of inventory because the buyer got an allowance (a deduction) from the amount owed Throughout this book, we often refer to net purchases simply as Purchases Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc ■ 315 www.downloadslide.com 316 ■ Chapter Inventory & Cost of Goods Sold EXHIBIT 6-5 Recording and Reporting Inventory—Perpetual System (Amounts Assumed) PANEL A—Recording Transactions and the T-accounts (All amounts are assumed) Journal Entry Inventory 560,000 Inventory Accounts Payable 560,000 Purchased inventory on account Accounts Receivable 900,000 Sales Revenue Sold inventory on account 900,000 Beginning balance Purchases Ending balance 100,000* 560,000 Cost of goods sold 120,000 540,000 *Beginning inventory was $100,000 540,000 Cost of Goods Sold Inventory Cost of Goods Sold 540,000 Recorded cost of goods sold Cost of goods sold 540,000 PANEL B—Reporting in the Financial Statements Income Statement (partial) Sales revenue Cost of goods sold Gross profit Ending Balance Sheet (partial) $900,000 540,000 $360,000 Current assets: Cash Short-term investments Accounts receivable Inventory Prepaid expenses $ XXX XXX XXX 120,000 XXX A purchase discount is a decrease in the buyer’s cost of inventory earned by paying quickly Many companies offer payment terms of “2/10 n/30.” This means the buyer can take a 2% discount for payment within 10 days, with the final amount due within 30 days Another common credit term is “net 30,” which tells the customer to pay the full amount within 30 days In summary, Net purchases = Purchases − Purchase returns and allowances − Purchase discounts + Freight-in Net sales are computed exactly the same as net purchases, but with no freight-in, as follows: Net sales = Sales revenue − Sales returns and allowances − Sales discounts Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc ISBN: 0-536-55962-7 Freight-out paid by the seller is not part of the cost of inventory Instead, freight-out is delivery expense It’s the seller’s expense of delivering merchandise to customers (Appendix 6A shows the accounting for these same transactions in a periodic accounting system.) Now study Exhibit 6-5 This exhibit illustrates all the inventory transactions in the perpetual system www.downloadslide.com Inventory Costing ■ 317 INVENTORY COSTING Inventory is the first asset for which a manager can decide which accounting method to use The accounting method selected affects the profits to be reported, the amount of income tax to be paid, and the values of the ratios derived from the balance sheet What Goes into Inventory Cost? The cost of inventory on Pier 1’s balance sheet represents all the costs that Pier incurred to bring its inventory to the point of sale The following cost principle applies to all assets: The cost of any asset, such as inventory, is the sum of all the costs incurred to bring the asset to its intended use, less any discounts As we have seen, inventory’s cost includes its basic purchase price, plus freight-in, insurance while in transit, and any fees or taxes paid to get the inventory ready to sell, less returns, allowances, and discounts After a Pier chair is sitting in the showroom, other costs, such as advertising and sales commissions, are not included as the cost of inventory Advertising, sales commissions, and delivery costs are expenses The Various Inventory Costing Methods Determining the cost of inventory is easy when the unit cost remains constant, as in Exhibit 6-2 But the unit cost usually changes For example, prices often rise The desk lamp that cost Pier $10 in January may cost $14 in June and $18 in October Suppose Pier sells 1,000 lamps in November How many of those lamps cost $10, how many cost $14, and how many cost $18? To compute cost of goods sold and the cost of ending inventory still on hand, we must assign unit cost to the items Accounting uses generally accepted inventory methods: Specific unit cost Average cost First-in, first-out (FIFO) cost Last-in, first-out (LIFO) cost ISBN: 0-536-55962-7 A company can use any of these methods The methods can have very different effects on reported profits, income taxes, and cash flow Therefore, companies select their inventory method with great care Specific Unit Cost Some businesses deal in unique inventory items, such as automobiles, antique furniture, jewels, and real estate These businesses cost their inventories at the specific cost of the particular unit For instance, a Toyota dealer may have vehicles in the showroom—a “stripped-down” model that cost the dealer $19,000 and a “loaded” model that cost the dealer $24,000 If the dealer sells the loaded model, the cost of goods sold is $24,000 The stripped-down auto will be the only unit left in inventory, and so ending inventory is $19,000 The specific-unit-cost method is also called the specific identification method This method is too expensive to use for inventory items that have common characteristics, such as bushels of wheat, gallons of paint, or auto tires The other inventory accounting methods—average, FIFO, and LIFO—are fundamentally different These other methods not use the specific cost of a particular unit Instead, they assume different flows of inventory costs To illustrate average, FIFO, and LIFO costing, we use a common set of data, given in Exhibit 6-6 Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc OBJECTIVE Understand the various inventory methods www.downloadslide.com 318 ■ Chapter Inventory & Cost of Goods Sold EXHIBIT 6-6 Inventory Data Used to Illustrate the Various Inventory Costing Methods Inventory Begin bal Purchases: No No Ending balance (10 units @ $10) 100 (25 units @ $14) (25 units @ $18) (20 units @ ?) 350 450 ? Cost of goods sold (40 units @ ?) ? In Exhibit 6-6, Pier began the period with 10 lamps that cost $10 each; the beginning inventory was therefore $100 During the period Pier bought 50 more lamps, sold 40 lamps, and ended the period with 20 lamps, summarized in the T-account as follows: Goods Available Number of Units Total Cost Goods available = 10 + 25 + 25 = 60 units $100 + $350 + $450 = $900 Cost of goods sold = 40 units ? Ending inventory = 20 units ? The big accounting questions are What is the cost of goods sold for the income statement? What is the cost of the ending inventory for the balance sheet? It all depends on which inventory method Pier uses Pier actually uses the average-cost method, so let’s look at average costing first Average Cost The average-cost method, sometimes called the weighted-average method, is based on the average cost of inventory during the period Average cost per unit is determined as follows (data from Exhibit 6-6): Average costing Purchases Cost of goods sold $900 Cost of goods available* = $15 = 60 Number of units available* *Goods available = Beginning inventory + Purchases Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc ISBN: 0-536-55962-7 Average cost per unit = www.downloadslide.com ISBN: 0-536-55962-7 Appendix A Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc ■ 761 www.downloadslide.com 762 ■ Appendix A ISBN: 0-536-55962-7 Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc www.downloadslide.com ISBN: 0-536-55962-7 Appendix B Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc www.downloadslide.com 764 ■ Appendix B ISBN: 0-536-55962-7 Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc www.downloadslide.com ISBN: 0-536-55962-7 Appendix B Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc ■ 765 www.downloadslide.com 766 ■ Appendix B ISBN: 0-536-55962-7 Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc www.downloadslide.com ISBN: 0-536-55962-7 Appendix B Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc ■ 767 www.downloadslide.com 768 ■ Appendix B ISBN: 0-536-55962-7 Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc www.downloadslide.com ISBN: 0-536-55962-7 Appendix B Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc ■ 769 www.downloadslide.com 770 ■ Appendix B ISBN: 0-536-55962-7 Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc www.downloadslide.com ISBN: 0-536-55962-7 Appendix B Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc ■ 771 www.downloadslide.com 772 ■ Appendix B ISBN: 0-536-55962-7 Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc www.downloadslide.com ISBN: 0-536-55962-7 Appendix B Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc ■ 773 www.downloadslide.com 774 ■ Appendix B ISBN: 0-536-55962-7 Financial Accounting, Seventh Edition, by Walter T Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, 2009 Copyright © 2008 by Pearson Education, Inc www.downloadslide.com ISBN: 0-536-55962-7 Appendix B Financial Accounting , Seventh Edition, by Walter Harrison, Jr and Charles T Horngren Published by Prentice Hall Specially prepared for D03170808 on 21 Oct, T.2009 Copyright © 2008 by Pearson Education, Inc ■ 775 ... summarizes the situations that call for (a) a particular inventory system and (b) the motivation for using each costing method ISBN: 0-5 3 6-5 59 6 2- 7 Financial Accounting, Seventh Edition, by Walter T Harrison, ... money to the wrong business ISBN: 0-5 3 6-5 59 6 2- 7 Accounting Conservatism Conservatism in accounting means reporting financial statement amounts that paint the gloomiest immediate picture of the... accepted inventory methods: Specific unit cost Average cost First-in, first-out (FIFO) cost Last-in, first-out (LIFO) cost ISBN: 0-5 3 6-5 59 6 2- 7 A company can use any of these methods The methods