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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
• 2 of 3: To record purchase returns.• • Accounts payable 600• Purchase returns 600
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Exercise 8-2 (page 428)
• 3 of 3: To record cash sales.• • Cash 5,200• Sales revenue 5,200• • NOTE:
NO ENTRY IS MADE FOR THE COST OF GOODS SOLD AT THE POINT OF SALE
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If the Periodic Inventory System Is Used ….
Beginning Inventory+ Net Purchases
Cost of Goods Available for Sale
- Ending Inventory= Cost of Goods Sold
Cost of goods sold must be calculated after the physical inventory count at the end of the period.
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Comparison of Inventory Systems(students to use as study aid)
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What is Included in Inventory?
General RuleAll goods owned by the company on the inventory
date, regardless of their location.
Goods in TransitGoods in Transit Goods on Consignment
Goods on Consignment
Depends on FOB shipping terms.
Depends on FOB shipping terms.
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Expenditures Included in InventoryExpenditures Included in Inventory
Invoice PriceInvoice Price
Freight-in on Purchases
Freight-in on Purchases
+
Purchase Returns and Allowances
Purchase Returns and Allowances
Purchase Discounts
Purchase Discounts
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Purchase Discount Journal Entries(Ilustr # 8-3 and 8-4, pp. 402-403)
• We will use
• Exercise 8-9 (page 428) – gross method
• Exercise 8-10 (page 428) – net method
• Notice: the similarity of these approaches to the sales discount entries in chapter 7
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Gross Method: Exercise 8-9 p.429Purchase price =1,000 units x $50 = 50,000
• Requirement : 1 of 3• July 15, 2011 • Purchases 50,000• Accounts payable 50,000• July 23, 2011 (in time for discount)• Accounts payable 50,000• Cash (98% x $50,000) 49,000• Purch. Disc. (2% x $50,000) 1,000
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Gross Method: Exercise 8-9 (page 429)
• Requirement : 2 of 3 • If payment is on 8/15 (too late to get the
discount)
• August 15, 2011• Accounts payable 50,000• Cash 50,000
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Gross Method: Exercise 8-9 (page 429)
• Requirement: 3 of 3• The July 15 entry would include a debit to the
inventory account instead of to purchases• the July 23 entry would include a credit to the
inventory account instead of to purchase discounts.
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Net Method: Exercise 8-10 (p.429)
• Requirement : 1 of 3 • July 15, 2011• Purchases (98% x $50,000) 49,000• Accounts payable 49,000• • July 23, 2011• Accounts payable 49,000• Cash 49,000
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Net Method: Exercise 8-10 (p.429)
• Requirement: 2 of 3• if payment is on 8/15 – it is too late to take the
• Demonstrates what the “problem” is that causes accountants to choose between:– FIFO– LIFO– Weighted-Average– Specific Identification
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First-In, First-Out (FIFO)
• The cost of the oldest inventory items are charged to COGS when goods are sold.
• The cost of the newest inventory items remain in ending inventory.
• The cost of the oldest inventory items are charged to COGS when goods are sold.
• The cost of the newest inventory items remain in ending inventory.
The FIFO method
assumes that items are sold
in the chronological order of their acquisition.
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Last-In, First-Out (LIFO)
• The cost of the newest inventory items are charged to COGS when goods are sold.
• The cost of the oldest inventory items remain in inventory.
• The cost of the newest inventory items are charged to COGS when goods are sold.
• The cost of the oldest inventory items remain in inventory.
The LIFO method
assumes that the newest
items are sold first, leaving the
older units in inventory.
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FIFO, LIFO, Weighted-Average
• Exercise 8-13 – periodic system (page 430)
• Exercise 8-14 – perpetual system (page 430)
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Exercise 8-13:periodic system, using FIFO
• Cost of goods sold:• Beginning inventory (2,000 x $6.10) $12,200• Purchases:• Aug 8: 10,000 x $5.50 $55,000• Aug 18: 6,000 x $5.00 30,000 85,000• goods available (18,000 units) $97,200• Less: End inventory (3,000 units) (15,000)
Cost of goods sold $82,200• E/I = 8/18 layer of 3,000 @ $5.00 = $15,000
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Exercise 8-13periodic system, using LIFO
• Cost of goods sold:• Beginning inventory (2,000 x $6.10) $12,200• P - Aug 8: 10,000 x $5.50 $55,000• P - Aug 18:6,000 x $5.00 30,000
85,000
• goods available (18,000 units) $97,200• Less: Ending inventory (17,700)
Cost of goods sold $79,500• E/I: B/I layer. 2,000 @ $6.10 $12,200• 8/8 layer 1,000 @ 5.50 5,500
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Exercise 8-13periodic system, using weighted-average
• Cost of goods sold:• Beginning inventory (2,000 x $6.10) $12,200• P - Aug 8: 10,000 x $5.50 $55,000• P - Aug 18:6,000 x $5.00 30,000
85,000• goods available (18,000 units) $97,200• Less: End invent. (3,000 units) (16,200)
Cost of goods sold $81,000• E/I = $97,200 / 18,000 units = $5.40
3,000 units x $5.40 = $16,200
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Exercise 8-14 (page 430)Perpetual, using FIFO, LIFO, Average
Exercise 8-14 (page 430)Perpetual, using FIFO, LIFO, Average
• Refer to solution hand-out
Exercise 8-14: Costing Methods
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When Prices Are Rising . . .
LIFO• Matches high (newer)
costs with current (higher) sales.
• Inventory is valued based on low (older) cost basis.
• Results in lower taxable income.
FIFO• Matches low (older)
costs with current (higher) sales.
• Inventory is valued at approximate replacement cost.
• Results in higher taxable income.
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U. S. GAAP vs. IFRS
• LIFO is permitted and used by U.S. Companies.
• If used for income tax reporting, the company must use LIFO for financial reporting.
• Conformity with IAS No. 2 would cause many U.S. companies to lose a valuable tax shelter.
• IAS No. 2, Inventories, does not permit the use of LIFO.
• Because of this restriction, many U.S. companies use LIFO only for domestic inventories.
LIFO is an important issue for U.S. multinational companies. Unless the U.S. Congress repeals the LIFO conformity rule, in inability to use LIFO under IFRS will
impose a serious impediment to convergence.
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Simplifying LIFO
Why simplify?
“unit LIFO” (what we just worked through in Exercises 8-13 and 8-14) can:
– Involve expensive record-keeping, and
– May risk of liquidation of LIFO inventory layers
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LIFO Liquidation
LIFO inventory costs in the balance sheet are “out of date” because they
reflect old purchase transactions.
LIFO inventory costs in the balance sheet are “out of date” because they
reflect old purchase transactions.
When prices rise . . .
If inventory quantities decline, these “out of date” costs may be charged to current
earnings.
If inventory quantities decline, these “out of date” costs may be charged to current
earnings.
This LIFOliquidation results in
“paper profits.”
This LIFOliquidation results in
“paper profits.”
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Example
The replacement inventory differs from the old inventory on
hand. We just create a new layer.
Dollar-Value LIFO (DVL)pages 421-422
DVL inventory pools are viewed as layers of value, rather than layers of similar units.DVL inventory pools are viewed as layers
of value, rather than layers of similar units.
DVL simplifies LIFO record-keeping.
DVL simplifies LIFO record-keeping.
DVL minimizes the probability of layer
liquidation.
DVL minimizes the probability of layer
liquidation.
At the end of the period, we determine if a new inventory layer
was added by comparing ending
inventory to beginning inventory.
At the end of the period, we determine if a new inventory layer
was added by comparing ending
inventory to beginning inventory.
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Examples of DVL
• We will use Exercise 8-23 (page 432)
• You should also review Concept Review Exercise on pages 423-424
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Exercise 8-23: DVL
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Supplemental LIFO Disclosures
Many companies use LIFO for external reporting and income tax purposes but maintain internal records using
FIFO or average cost.
The conversion from FIFO or average cost The conversion from FIFO or average cost to LIFO takes place at the end of the to LIFO takes place at the end of the
period. The conversion may look like this:period. The conversion may look like this:
2011 2010
Total inventories at FIFO 15,429$ 15,387$ Less: LIFO allowance (1,508) (1,525) Inventories, at LIFO cost 13,921$ 13,862$