Reporting and Interpreting Cost of Goods Sold and Inventory

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Chapter 7

• Reporting and InterpretingCost of Goods Soldand
  Inventory

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Business Background
Provides accurate information.
Roles of the Accounting System
Provides up-to-date information.
Provides information to help protect assets.
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Nature of Inventory and Cost of Goods Sold
BeginningInventory
Purchasesfor the Period
Goods availablefor Sale
Ending Inventory(Balance Sheet)
Cost of Goods Sold(Income Statement)
Beginning inventory Purchases Ending
inventory Cost of goods sold
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Flow of Inventory Costs
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Inventory Cost

• The cost principle requires that inventory be
  recorded at the price paid or the consideration
• given up.

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Inventory Costing Methods
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Applying the Four Methods
Total Dollar Amount of Goods Available for Sale
Ending Inventory
Cost of Goods Sold
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Specific Identification

• Specific cost of each inventory item is known.
• Used with low volume, high dollar cost inventory
  items.

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First-In, First-Out (FIFO)
Costs of Goods Sold
Oldest Costs
Ending Inventory
Recent Costs
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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.
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First-In, First-Out
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.
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First-In, First-Out
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First-In, First-Out
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First-In, First-Out
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First-In, First-Out
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First-In, First-Out
Now, we have allocated the cost to all 1,200
units in ending inventory.
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First-In, First-Out
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(No Transcript)
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Last-In, First-Out
?
Oldest Costs
?
Recent Costs
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Last-In, First-Out
Ending Inventory
Oldest Costs
Cost of Goods Sold
Recent Costs
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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.
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Last-In, First-Out
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.
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Last-In, First-Out
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Last-In, First-Out
Now, we have allocated the cost to all 1,200
units in ending inventory.
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Last-In, First-Out
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Last-In, First-Out
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Average Cost Method
Now lets move on to the average cost inventory
method.
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Average Cost Method

• Average cost per unit
• 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

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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.
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Average Cost Method
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Weighted-Average
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Comparison of Methods
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Comparison of Methods
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.
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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.
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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.
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Choosing Inventory Costing Methods
If . . .
Then . . .
LIFO Conformity Rule
LIFO for taxes
LIFO for books
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Inventory Costing Methods and Financial Statement
Analysis
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LIFO and International Comparisons
LIFO Permitted?
Singapore
China
Canada
Australia
Great Britain
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Lower of Cost or Market
Ending inventory is reported at the lower of cost
or market (LCM).
Market is either . . .
Net Realizable ValueThe expected sales
priceless selling costs.
Replacement CostThe current purchase price of
identical goods.
or
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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.
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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.
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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
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Focus on Cash Flows
Increase in Inventory Decrease in Accounts Payable
Add
Cash Payment to Suppliers
Cost of Goods Sold
Decrease in Inventory Increase in Accounts
Payable
Subtract
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Errors in Measuring Inventory
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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.

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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.
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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.

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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.
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Perpetual and Periodic Inventory Systems
Provides up-to-date inventory records.
Perpetual System
Provides up-to-date cost of sales records.
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Comparison of Perpetual and Periodic Systems
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The End of Chapter 7