6 - 1 ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Hor Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter 6
Mar 31, 2015
6 - 1©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Merchandise Inventory,
Cost of Goods Sold, and
Gross Profit
Chapter 6
6 - 2©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Income Statements
Service revenue $XXXExpenses Salary expense X Depreciation expense X Income tax expense XNet income $ X
Service CompanyCentury 21 Real Estate
Income StatementYear Ended December 31, 20xx
Sales revenue $185Cost of goods sold 146Gross profit 39Operating expenses: Salary expense X Depreciation expense X Income tax expense $ XNet income $ 4
Merchandising CompanyGeneral Motors Corporation
Income StatementYear Ended December 31, 20xx
6 - 3©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Balance Sheets
Current assets: Cash $X Short-term investments X Accounts receivable, net X Prepaid expenses X
Service CompanyCentury 21 Real Estate
Balance SheetYear Ended December 31, 20xx
Current assets: Cash $ X Short-term investments X Accounts receivable, net X Inventory 11 Prepaid expenses X
Merchandising CompanyGeneral Motors Corporation
Balance SheetYear Ended December 31, 20xx
6 - 4©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Accounting for Inventory
Current assets: Cash $ XXX Short-term investments XXX Accounts receivable XXX Inventory (1 truck @$15,000) $15,000 Prepaid expenses XXX
General Motors CorporationBalance Sheet (partial)
Sales revenue (2 trucks @ $20,000) $40,000Cost of goods sold (2 trucks @ $15,000) 30,000Gross profit $10,000
General Motors CorporationIncome Statement (partial)
6 - 5©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Sales revenues – Cost of goods sold= Gross profit (before operating expenses)
Sales revenues – Cost of goods sold= Gross profit (before operating expenses)
Gross profit – Operating expenses= Net income
Gross profit – Operating expenses= Net income
Gross Profit (Gross Margin)
6 - 6©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Computing Cost
Cost of inventory on hand= Number of units on hand × unit cost
Cost of inventory on hand= Number of units on hand × unit cost
Cost of goods sold= Number of units sold × unit cost
Cost of goods sold= Number of units sold × unit cost
6 - 7©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Learning Objective 1
Use the cost-of-goods-
sold model.
6 - 8©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Cost of Goods Sold Model
Beginninginventory
$20
Purchases$100
Cost of goodsavailablefor sale$120
Endinginventory
$30
Cost ofgoods sold
$90
6 - 9©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
How Much InventoryShould Be Purchased?
Budgeted cost of goods sold $6,000
+ Budgeted ending inventory 1,500
– Actual beginning inventory 1,200
= Budgeted purchases $6,300
= Budgeted cost of goods available for sale $7,500
6 - 10©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Learning Objective 2
Account for inventory
transactions.
6 - 11©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Perpetual systems maintain a running recordto show the inventory on hand at all times.
Perpetual systems maintain a running recordto show the inventory on hand at all times.
Periodic systems do not keep acontinuous record of inventory on hand.
Periodic systems do not keep acontinuous record of inventory on hand.
Inventory Accounting Systems
6 - 12©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Debit Cash or Accounts ReceivableCredit Sales Revenue
Debit Cash or Accounts ReceivableCredit Sales Revenue
Debit Cost of Goods SoldCredit Inventory
Debit Cost of Goods SoldCredit Inventory
Recording Transactionsin the Perpetual System
Debit InventoryCredit Cash or Accounts Payable
Debit InventoryCredit Cash or Accounts Payable
6 - 13©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Recording Transactionsin the Perpetual System
Purchase price of the inventory $600,000+ Freight-in 4,000– Purchase returns – 25,000– Purchase allowances – 5,000– Purchase discounts – 14,000= Net purchases of inventory $560,000
Purchase price of the inventory $600,000+ Freight-in 4,000– Purchase returns – 25,000– Purchase allowances – 5,000– Purchase discounts – 14,000= Net purchases of inventory $560,000
6 - 14©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Recording Transactionsand the T-Accounts
Accounts Payable560,000Beg. 100,000
560,000
Inventory
Inventory 560,000Accounts Payable 560,000
Purchased inventory on account
Inventory 560,000Accounts Payable 560,000
Purchased inventory on account
6 - 15©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Recording Transactionsand the T-Accounts
Sale on account $900,000 (cost $540,000):Sale on account $900,000 (cost $540,000):
Accounts Receivable 900,000Sales Revenue 900,000
Cost of Goods Sold 540,000Inventory 540,000
Accounts Receivable 900,000Sales Revenue 900,000
Cost of Goods Sold 540,000Inventory 540,000
6 - 16©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Recording Transactionsand the T-Accounts
Cost of Goods Sold540,000
InventoryBeg. 100,000
560,000120,000
540,000
6 - 17©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Reporting in theFinancial Statements
Income Statement (partial)Sales revenue $900,000Cost of goods sold 540,000Gross profit $360,000 Ending Balance Sheet (partial)Current assets: Cash $ XXX Short-term investments XXX Accounts receivable, net XXX Inventory 120,000 Prepaid expenses XXX
6 - 18©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Net sales = Sales revenue– Sales returns & allowances– Sales discounts
Net sales = Sales revenue– Sales returns & allowances– Sales discounts
Reporting in theFinancial Statements
Net purchases = Purchases+ Freight-in– Purchase returns & allowances– Purchases discount
Net purchases = Purchases+ Freight-in– Purchase returns & allowances– Purchases discount
6 - 19©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Learning Objective 3
Analyze the various
inventory methods.
6 - 20©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
The cost of any asset, such as inventory,is the sum of all the costs incurred to
bring the asset to its intended use.
What Goes Into Inventory Cost?
Generally accepted inventory costing methods:
Specific unit cost Weighted-average cost
First-in, first-out (FIFO) Last-in, first-out (LIFO)
6 - 21©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Beginning inventory (10 units @ $10) $100No. 1 (25 units @ $14 per unit) $350No. 2 (25 units @ $18 per unit 450Total purchases 800Cost of goods available for sale $900Ending inventory: 20 unitsCost of goods sold:40 units
Illustrative Data
6 - 22©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Cost of Goods Sold$ 50 350 180$580
Specific Unit Cost
5 Units @ $10
25 Units @ $14
10 Units @ $18$900 – $580 = $320
6 - 23©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Weighted-Average
$900 total cost ÷ 60 units = $15/unit
Cost of goods sold = 40 × $15 = $600
Ending inventory = 20 × $15 = $300
6 - 24©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
60 units Less units sold 40 Ending inventory 20 units
First-In, First-Out
20 units × $18 per unit = $360
6 - 25©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Cost of Goods Sold$100 350 90$540
First-In, First-Out
10 Units @ $10
25 Units @ $14
5 Units @ $18
6 - 26©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
60 units Less units sold 40 Ending inventory 20 units
Last-In, First-Out
10 units × 10 = $10010 units × 14 = 140Total $240
6 - 27©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Cost of Goods Sold$450 210$660
Last-In, First-Out
25 Units @ $18
15 Units @ $14
6 - 28©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Ending InventorySpecific unit cost $320.00Weighted-average $300.00FIFO $360.00LIFO $240.00
Income Effects ofInventory Methods
6 - 29©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Cost of Goods SoldSpecific unit cost $580.00Weighted-average $600.00FIFO $540.00LIFO $660.00
Income Effects ofInventory Methods
6 - 30©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Income Effects ofInventory Methods
Specific unit cost $1,000 – 580 = $420Weighted-average $1,000 – 600 = $400FIFO $1,000 – 540 = $460LIFO $1,000 – 660 = $340
AssumedSales
Revenue
Cost ofGoodsSold
GrossProfit
6 - 31©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Income Effects – InventoryCosts Are Increasing
Ending inventory, gross profit, and net income
LIFO
Weighted-average
FIFO
6 - 32©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Income Effects – InventoryCosts Are Decreasing
Ending inventory, gross profit, and net income
LIFOWeighted-
averageFIFO
6 - 33©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Learning Objective 4
Identify the income and
the tax effects of the
inventory methods.
6 - 34©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
The Tax Advantage of LIFO
Gross profit $460 $340Operating expenses 260 260Income before taxes $200 $ 80Income tax expense (40%) $ 80 $ 32
FIFO LIFO
The most attractive feature of LIFOis low income tax payments.
6 - 35©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Use of the VariousInventory Methods
Other4%
Average20%
LIFO32%
FIFO44%
6 - 36©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Comparison of Inventory Methods
LIFO liquidation occurs when inventoryquantities fall below the level of theprevious period resulting in higher
net income and increased taxes.
FIFO produces inventory profitsduring periods of inflation.
LIFO allows managers tomanipulate net income.
6 - 37©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
International Perspective
LIFO is not allowed in some countries,e.g., Australia and the U. K.
Companies that use LIFO must useanother accounting method for their
inventories in these foreign countries.
6 - 38©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Businesses should use the sameaccounting methods and procedures
from one period to the next.
Businesses should use the sameaccounting methods and procedures
from one period to the next.
A company may change inventorymethods, but it must disclose the
effects of the change on net income.
A company may change inventorymethods, but it must disclose the
effects of the change on net income.
Accounting Principlesand Inventories
6 - 39©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
The financial statements shouldreport enough information toenable an outsider to makeknowledgeable decisions
about the company.
The financial statements shouldreport enough information toenable an outsider to makeknowledgeable decisions
about the company.
Accounting Principlesand Inventories
6 - 40©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Accounting Principlesand Inventories
An item is material if it has the potentialto alter a statement user’s decision.
An item is material if it has the potentialto alter a statement user’s decision.
Materiality is specific tothe entity being evaluated.
Materiality is specific tothe entity being evaluated.
6 - 41©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Err on the sideof caution when
reporting any item inthe financial statements.
Err on the sideof caution when
reporting any item inthe financial statements.
Accounting Principlesand Inventories
6 - 42©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Lower-of-Cost-or-Market Rule
Inventory is reported at thelower of its historical cost
or market (replacement) value.
If the replacement cost falls below itshistorical cost, the business must write
down the value of its inventory.
6 - 43©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Show how inventory errors
affect cost of goods soldand income.
Objective 5
6 - 44©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Effects of Inventory Errors
The current year’s ending inventoryis next year’s beginning inventory.
An error in the ending inventorycreates errors for cost of goods
sold and gross profit.
6 - 45©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Effects of Inventory Errors
Sales revenueCost of goods sold: Beg. inventory Purchases Cost of goods available for sale Ending inventory Cost of goods soldGross profit
$100,000
$10,000 50,000
$60,000(15,000)
45,000$ 55,000
$100,000
$15,000 50,000
$65,000(10,000)
55,000$ 45,000
$100,000
$10,000 50,000
$60,000(10,000)
50,000$ 50,000
Period 1Ending
InventoryOverstatedby $5,000
Period 1BeginningInventoryOverstatedby $5,000
Period 1
Correct
6 - 46©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Ethical Considerations
Managers of companies whose profitsdo not meet stockholder expectationsare sometimes tempted to “cook thebooks” to increase reported income.
1. Overstating ending inventory
2. Creating fictitious sales revenue
6 - 47©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Learning Objective 6
Use the gross profit
percentage and inventory
turnover to evaluate
business.
6 - 48©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Inventory turnover= Cost of goods sold÷ Average inventory
Inventory turnover= Cost of goods sold÷ Average inventory
Gross profit percentage= Gross profit
÷ Net sales revenue
Gross profit percentage= Gross profit
÷ Net sales revenue
Using the Financial Statementsfor Decision Making
6 - 49©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Gross Profit on $1 of Salesfor Two Merchandisers
Grossprofit $0.21
Grossprofit$0.61
Cost ofgoods sold
$0.79 Cost ofgoods sold
$0.39
$1.00 —
$0.75 —
$0.50 —
$0.25 —
$0.00 GeneralMotors
Pepsi Co.
6 - 50©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Estimating Inventory
The gross profit method of estimatingending inventory is based on the
cost-of-goods-sold model.
Beginning inventory+ Purchases= Cost of goods available for sale– Ending inventory= Cost of goods sold
6 - 51©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Estimating Inventory
Rearranging ending inventory andcost of goods sold makes the model
useful for estimating ending inventory.
Beginning inventory+ Purchases= Cost of goods available for sale– Cost of goods sold= Ending inventory
6 - 52©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Estimating Inventory
Beginninginventory
Netpurchases+
Goodsavailablefor sale
Goodsavailablefor sale
=
Endinginventory=
Cost ofgoodssold
–
6 - 53©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Estimating Inventory
Beginning inventory $14,000Purchases 66,000Cost of goods available for sale 80,000Cost of goods sold: Net sales revenue $100,000 Less estimated gross profit of 42% – 42,000 Estimated cost of goods sold 58,000Estimated cost of ending inventory $22,000
6 - 54©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
Reporting Inventory Transactions on the Statement of Cash Flows
Inventory transactions are operating activitiesbecause the purchase and sale of merchandise
drives a company’s operations.
The purchase of inventory requires a cashpayment, and the sale a cash receipt.
6 - 55©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren
End of Chapter 6