Chapter 6: Chapter 6: Cost Cost of Sales & Inventories of Sales & Inventories Presentor Presentor: Group 1 : Group 1 - BM 220 BM 220 Jenice Jenice Joy Joy Sumaway Sumaway Mike Mike Agencia Agencia Reference: Accounting Text & Cases 11 Reference: Accounting Text & Cases 11 th th Ed Ed by: Robert Anthony ET AL by: Robert Anthony ET AL
Cost of Sales and Inventories Chapter 7 from the book of Accouting (Text and Cases) 11th edition by: Robert Anthony Et Al
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1. Periodic Inventoryo A physical count is made of merchandise in the
ending inventory & the cost of inventory is determined
o When goods are purchased, a separate set of accounts is used to accumulate information on the net cost of the purchases.
o No entries are made to the inventory account as the merchandise is bought & sold. Only at the end of period, when the inventory is counted, will entries be made to the inventory account to establish proper balance.
- This method is quite straightforward; it takesthe weighted average of all units available forsale during the accounting period and then usesthat average cost to determine the valueof COGS and ending inventory
- This method assumes that the first unit making its way into inventory is the first sold.
- Cost of goods sold - approximate the physical flow of the goods
- Ending Inventory – approximates the current cost of the goods
Cost of Sales & Inventories
Example (FIFO):Example (FIFO):
Units Unit Cost Total Cost
Cost of Goods Sold:
From Beginning Inventory 100 $8 $800
From purchases of Jan. 1 50 9 450
COGS 150 $1, 250
Ending Inventory:
From Purchases of June 1 10 $9 $90
From purchase of October 1 80 10 800
Ending Inventory: 90 $890
Cost of Sales & Inventories
4. LIFO (Last-in, first-out) Method
- Opposite of FIFO
- This method assumes that the last unit makingits way into inventory is sold first. The olderinventory, therefore, is left over at the end ofthe accounting period
- COGS – based on cost of recent purchases
- Ending Inventory – costed at cost of the oldestunits available
Cost of Sales & Inventories
Example(LIFO):Example(LIFO):Units Unit Cost Total Cost
Cost of Goods Sold:From purchases of October 1 80 $10 $800From purchases of June 1 60 9 540From Inventory Jan. 1 10 8 80
LIFO Dollar Value Method- method of valuation used on inventory of physically unlike items.
Inventory Pool – a pool wherein unlike items are grouped. (example: all hardware products)
LIFO reserve – mathematical difference between two inventory amounts; one based on LIFO & the other one based on other valuation method.
Cost of Sales & Inventories
Summary of illustrative case:Summary of illustrative case:
COGS Inventory TOTAL
FIFO $1,250 $890 $2,130
Average Cost 1,338 802 2,130
LIFO 1,420 720 2,130
FIFO – lowest COGS, highest inventory
Average Cost – Somewhere in between
LIFO – highest COGS, lowest inventory
Cost of Sales & Inventories
Arguments for FIFO
1. Cost of goods that are physically sold arematched with the revenues generated of thatsold goods.(physical flow of inventory iscorrupted if LIFO is used)
2. It should reflect the true value of inventory w/c is the current cost
Cost of Sales & Inventories
Arguments for LIFO
1. Gross margin should reflect the differencebetween sales revenue w/c are currentamounts & the current COGS.
- (Current COGS/ replacement cost inventoryaccounting/ NIFO)cost of acquiring identicalitems to those sold to replenish the inventory
2. Argument of FIFO regarding current cost ofinventory can be mitigated through disclosureof LIFO reserves in the notes to FS.
Cost of Sales & Inventories
Income Tax ConsiderationIncome Tax Consideration
- FIFO yields the highest income – tax is higher
- LIFO yields the lowest income – tax is lower
Why not more LIFO if tax is lower?
- in industries where deflation is the trend, LIFOwould yield the highest income resulting to ahigher tax (e.g. technology).
- Cashflow income reported to stockholders willbe low resulting to a smaller earnings/ share.
Cost of Sales & Inventories
Lower of Cost or MarketLower of Cost or Market
- general inventory valuation principle deriving from conservatism concept where inventory is reported at balance sheet at lower of cost or market.
Rules in using this valuation:
1. Should not be higher with the NRV.
2. Should not be lower than NRV less normal profit margin
Cost of Sales & Inventories
Inventory AnalysisInventory Analysis
Inventory Turnover = COGS/ *Inventory
*valued at ending invty. or average (beg. + end/ 2)
- A ratio showing how many times acompany's inventory is sold and replaced over aperiod
Days Inventory = (Inventory/COGS)(365 days)
= 365/ Inventory turnover
- Period how long inventory is disposed in terms of days