After completing this chapter you should be able to: Identify the items making up merchandise inventory, identify the costs of merchandise inventory, analyze the effects of inventory methods for both financial and tax reporting, analyze the effects of inventory errors on current and future financial statements,...
Chapter INVENTORIES AND COST OF SALES PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W Caldwell, D.B.A., CMA Jon A Booker, Ph.D., CPA, CIA Cynthia J Rooney, Ph.D., CPA Winston Kwok, Ph.D., CPA McGrawHill/Irwin Copyright © 2011 by The McGrawHill Companies, Inc. All rights reserved 6 2 C1 DETERMINING INVENTORY ITEMS Merchandise inventory includes all goods that a company owns and holds for sale, regardless of where the goods are located when inventory is counted Items Items requiring requiring special special attention attention include: include: Goods in Transit Goods on Consignment Goods Damaged or Obsolete 6 3 C1 GOODS IN TRANSIT FOB Shipping Point Public Carrier Seller Buyer Ownership passes to the buyer here Public Carrier Seller FOB Destination Point Buyer 6 4 C1 GOODS ON CONSIGNMENT Merchandise is included in the inventory of the consignor, the owner of the inventory Consignee Thanks for selling my inventory in your store Consignor 6 5 C1 GOODS DAMAGED OR OBSOLETE Damaged or obsolete goods are not counted in inventory if they cannot be sold Cost should be reduced to net realizable value if they can be sold Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale 6 6 C2 DETERMINING INVENTORY COSTS Include all expenditures necessary to bring an item to a salable condition and location Minus Minus Discounts Discounts and and Allowances Allowances Plus Plus Import Import Duties Duties Invoice Cost Plus Plus Freight Freight Plus Plus Insurance Insurance Plus Plus Storage Storage 6 7 C2 INTERNAL CONTROLS AND TAKING A PHYSICAL COUNT Most companies take a physical count of inventory at least once each year When the physical count does not match the Merchandise Inventory account, an adjustment must be made Good internal controls over count include: 1.Pre-numbered inventory tickets 2.Counters have no inventory responsibility 3.Counts confirm existence, amount, and quality of inventory item 4.Second count is taken 5.Manager confirms all items counted 6 8 C2 INVENTORY COSTING UNDER A PERPETUAL SYSTEM Inventory affects Balance Sheet Income Statement The matching principle requires matching costs with sales 6 9 C2 INVENTORY COST FLOW ASSUMPTIONS Management decisions in accounting for inventory involve the following: 1.Items included in inventory and their costs 2.Costing method (specific identification, FIFO, LIFO, or weighted average) 3.Inventory system (perpetual or periodic) 4.Use of market values or other estimates 6 10 P1 INVENTORY COST FLOW ASSUMPTIONS First-In, First-Out (FIFO) Assumes costs flow in the order incurred Last-In, First-Out (LIFO) Assumes costs flow in the reverse order incurred Weighted Average Assumes costs flow at an average of the costs available 6 26 P1 WEIGHTED AVERAGE 6 27 P1 WEIGHTED AVERAGE Here are the entries to record the purchases and sales entries for Trekking The numbers in red are determined by the cost flow assumption used All purchases and sales are made on credit The selling price of inventory was as follows: 8/14 $130 8/31 150 6 28 A1 FINANCIAL STATEMENT EFFECTS OF COSTING METHODS Because prices change, inventory methods nearly always assign different cost amounts 6 29 A1 FINANCIAL STATEMENT EFFECTS OF COSTING METHODS Advantages Advantages of of Methods Methods Weighted Average First-In, First-Out Last-In, First-Out Smoothes out price changes Ending inventory approximates current replacement cost Better matches current costs in cost of goods sold with revenues 6 30 A1 CONSISTENCY IN USING COSTING METHODS The consistency principle requires a company to use the same accounting methods period after period so that financial statements are comparable across periods 6 31 P2 LOWER OF COST AND NET REALIZABLE VALUE Inventory must be reported at NRV when NRV is lower than cost Can be applied two ways: (1) (2) separately to each individual item to major categories of assets 6 32 P2 LOWER OF COST AND NRV A motor sports retailer has the following items in inventory: 6 33 P2 LOWER OF COST AND NRV Here is how to compute lower of cost and NRV for individual inventory items 6 34 A2 FINANCIAL STATEMENT EFFECTS OF INVENTORY ERRORS Income Statement Effects 6 35 A2 FINANCIAL STATEMENT EFFECTS OF INVENTORY ERRORS Balance Sheet Effects 6 36 A3 INVENTORY TURNOVER Shows how many times a company turns over its inventory during a period Indicator of how well management is controlling the amount of inventory available Inventory Turnover Average Inventory = = Cost of goods sold Avg inventory (Beg Inv + End Inv.) ÷ 6 37 A3 DAYS’ SALES IN INVENTORY Reveals Reveals how how much much inventory inventory is is available available in in terms terms of of the the number number of of days days’’ sales sales 6 38 P3 APPENDIX 6A: INVENTORY COSTING UNDER A PERIODIC SYSTEM LIFO computation of COGS and ending inventory under a periodic system 6 39 P4 APPENDIX 6B: INVENTORY ESTIMATION METHODS Inventory sometimes requires estimation for interim statements or if some casualty such as fire or flood makes taking a physical count impossible Retail Inventory Method Gross Profit Method 6 40 END OF CHAPTER ... Oldest Costs Cost of Goods Sold 6 20 P1 LAST-IN, FIRST-OUT (LIFO) 6 21 P1 LAST-IN, FIRST-OUT (LIFO) 6 22 P1 LAST-IN, FIRST-OUT (LIFO) Here are the entries to record the purchases and sales. .. Recent Costs Ending Inventory 6 16 P1 FIRST-IN, FIRST-OUT (FIFO) 6 17 P1 FIRST-IN, FIRST-OUT (FIFO) 6 18 P1 FIRST-IN, FIRST-OUT (FIFO) Here are the entries to record the purchases and sales. .. cost flow assumption used All purchases and sales are made on credit The selling price of inventory was as follows: 8/14 $130 8/31 150 6 15 P1 FIRST-IN, FIRST-OUT (FIFO) Oldest Costs Cost of