Chap006

PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 6

INVENTORIES AND COST OF SALES

6 - 2

DETERMINING INVENTORY ITEMS

Merchandise inventory includes all goods that a Merchandise inventory includes all goods that a company owns and holds for sale, regardless of where company owns and holds for sale, regardless of where

the goods are located when inventory is counted. the goods are located when inventory is counted.

Items requiring special attention include:Items requiring special attention include:Items requiring special attention include:Items requiring special attention include:

Goods in Transit

Goods Damaged or

ObsoleteGoods on Consignment

C1

6 - 3

FOB Destination Point

Public Carrier

Seller Buyer

GOODS IN TRANSIT

Public Carrier

Seller Buyer

FOB Shipping Point

Ownership passes to the buyer here.

C1

6 - 4

GOODS ON CONSIGNMENT

Merchandise is included in the inventory of the consignor, the owner of the inventory.

Consignor

Consignee

Thanks for selling my inventory in your

store.

C1

6 - 5

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.

C1

6 - 6

DETERMINING INVENTORY COSTS

Invoice Cost

Invoice Cost

Include all expenditures necessary to bring an item to Include all expenditures necessary to bring an item to a salable condition and location.a salable condition and location.

Minus Discounts

and Allowances

Minus Discounts

and Allowances

Plus Import Duties

Plus Import Duties Plus

FreightPlus

Freight

Plus StoragePlus

Storage

Plus Insurance

Plus Insurance

C2

6 - 7

Most companies take a physical count of inventory at least once each year.

INTERNAL CONTROLS AND TAKING A PHYSICAL COUNT

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, andquality of inventory item.4.Second count is taken.5.Manager confirms all items counted.

Good internal controls over count include:1.Pre-numbered inventory tickets.2.Counters have no inventory responsibility.3.Counts confirm existence, amount, andquality of inventory item.4.Second count is taken.5.Manager confirms all items counted.

C2

6 - 8

INVENTORY COST FLOW ASSUMPTIONS

First-In, First-OutFirst-In, First-Out(FIFO)(FIFO)

Assumes costs flow in the order Assumes costs flow in the order incurred.incurred.

Last-In, First-OutLast-In, First-Out(LIFO)(LIFO)

Assumes costs flow in the Assumes costs flow in the reverse order incurred.reverse order incurred.

Weighted Weighted AverageAverage

Assumes costs flow at an Assumes costs flow at an average of the costs available. average of the costs available.

P1

6 - 9

FIRST-IN, FIRST-OUT (FIFO)

Cost of Goods Sold

Cost of Goods Sold

Ending InventoryEnding

Inventory

Oldest CostsOldest Costs

Recent Costs

Recent Costs

P1

6 - 10

LAST-IN, FIRST-OUT (LIFO)

Cost of Goods Sold

Cost of Goods Sold

Recent Costs

Recent Costs

Oldest CostsOldest Costs

P1

6 - 11

WEIGHTED AVERAGE

When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold.

Cost of Goods Available for

Sale

Units on hand on the date of

sale÷

P1

6 - 12

FINANCIAL STATEMENT EFFECTSOF COSTING METHODS

Because prices change, inventory methods nearly always assign different cost amounts.

A1

6 - 13

FINANCIAL STATEMENT EFFECTSOF COSTING METHODS

Advantages of MethodsAdvantages of MethodsAdvantages of MethodsAdvantages of Methods

Smoothes out price changes.Smoothes out price changes.

Better matches current costs in cost of goods sold with

revenues.

Better matches current costs in cost of goods sold with

revenues.

Ending inventory approximates

current replacement cost.

Ending inventory approximates

current replacement cost.

First-In, First-OutFirst-In, First-Out

Weighted Average

Weighted Average

Last-In, First-OutLast-In,

First-Out

A1

6 - 14

TAX EFFECTS OF COSTING METHODS

The Internal Revenue Service (IRS) identifies several The Internal Revenue Service (IRS) identifies several acceptable inventory costing methods for reporting acceptable inventory costing methods for reporting

taxable income.taxable income.

If LIFO is used for tax If LIFO is used for tax purposes, the IRS requires purposes, the IRS requires

it be used in financial it be used in financial statements.statements.

If LIFO is used for tax If LIFO is used for tax purposes, the IRS requires purposes, the IRS requires

it be used in financial it be used in financial statements.statements.

A1

6 - 15

LOWER OF COST OR MARKET

Inventory must be reported at market value Inventory must be reported at market value when when marketmarket is is lowerlower than cost.than cost.

Can be applied three ways:(1) separately to each

individual item.(2) to major categories of

assets.(3) to the whole inventory.

Can be applied three ways:(1) separately to each

individual item.(2) to major categories of

assets.(3) to the whole inventory.

P2

6 - 16

FINANCIAL STATEMENT EFFECTS OF INVENTORY ERRORS

Income Statement EffectsIncome Statement Effects

A2

6 - 17

FINANCIAL STATEMENT EFFECTS OF INVENTORY ERRORS

Balance Sheet EffectsBalance Sheet Effects

A2

6 - 18

END OF CHAPTER 6