Chapter 6 Lecture

Chapter 6

Inventory and Merchandising

Operations

2Copyright ©2014 Pearson Education.

Chapter 5 ReviewBank Reconciliation Accounts Receivables

• Bank Side▫ + Deposits in Transit▫ - Outstanding Checks

• Book Side▫ +Bank Collections▫ + Interest Earned▫ + EFT receipts▫ - EFT payments▫ - Service charges

• Must enter journal entries related to the book side

• Balance revenues with cost of not being able to collect▫ Bad Debt▫ Uncollectible Accounts▫ Doubtful Accounts

• Steps related to bad debts• 1) Record BDE &

Allowance• 2) Write off bad debts• 3) Calculate how much

allowance is needed▫ Aging method

Learning Objective 1Understand the nature of inventory and retailing operations



Inventory, Supplies, Equipment

•To clarify, these assets are all different▫Inventories are assets purchased with the

intent of selling them to customers, sometimes with additional processing

▫Supplies are assets purchased to be used Usually included in short-term assets Usually consumed when used

▫Equipment are assets purchased to be used Usually included in long-term assets Usually not consumed when used, but

depreciated

Accounting For InventoryBalance Sheet (partial)

Current assets:

Cash $$$$

Accounts receivable $$$$

Inventory (1 shirts @ cost of $30)

$30


Income Statement (partial)

Sales (2 shirts @ $50 selling price) $100

Cost of goods sold (2 shirts @ $30 cost)

60

Gross profit $40

Copyright ©2014 Pearson Education. 6

The cost of inventory on

hand = Inventory

The cost of inventory

that’s been sold =

Cost of Goods Sold

Asset on the Balance Sheet

Expense on the Income

Statement


SALES REVENUE

COST OF GOODS SOLD

GROSS PROFIT

Number of units

•Determined from accounting records•Evidenced by physical count at year end•Consigned goods:

▫Does not include those held for another company

▫Does include those out on consignment•In transit goods

▫Depends on shipping terms


Shipping terms

FOB Shipping Point FOB Destination

• Legal title passes to purchaser when items leave seller’s place of business

• Purchaser owns good while in transit▫ Included in purchaser’s

inventory count

• Purchaser pays transportation costs

• Legal title passes to purchaser when items arrive at purchaser’s place of business

• Seller owns goods while in transit▫ Included in seller’s

inventory count

• Seller pays transportation costs


FOB means Free-On-Board or Freight-On-Board

Learning Objective 2Recording inventory-related transactions


Inventory SystemsPerpetual Periodic

Used for all types of goods

Used for inexpensive goods

Keeps a running total of all goods bought, sold and on hand

Does not keep a running total of all goods bought, sold and on hand

Inventory counted at least once a year

Inventory counted at least once a year


Must count inventory at least once a year under both systems

Perpetual Inventory•Bar codes on products provide

information to record▫Sale of item▫Update of inventory record

•Two entries needed for each sale▫Record revenue and asset received (cash or

receivables)▫Record cost of sale and reduction of

inventory•In this class, assume Perpetual Inventory

unless otherwise specified!


Recording Inventory (Amounts Assumed)


JOURNAL

Date

Accounts and explanation Debit Credit

Inventory 560,000

Accounts payable 560,000

Purchased inventory on account

Accounts receivable 900,000

Sales Revenue 900,000

Sold inventory on account

Cost of goods sold 540,000

Inventory 540,000

Recorded cost of goods sold

Recording Inventory (Amounts Assumed)


Inventory

Cost of Goods Sold

$100,000Beginning balance

Purchases $560,000

Cost of goods sold$540,000

Cost of goods sold $540,000

Ending balance $120,000

Reporting in the Financial Statements


Balance Sheet (partial)

Current assets:

Cash $$$$

Accounts receivable $$$$

Inventory $70,000

Income Statement (partial)

Sales $900,000

Cost of goods sold 540,000

Gross profit $360,000

Cost of Net Purchases (Buyer Perspective)• Purchases and Inventory

includes not only the cost of inventory, but related direct costs, including:▫ Freight-in is the cost of

delivery paid by the buyer▫ Returns are reduction in

inventory for sending goods back to seller

▫ Allowances are reduction in price granted for certain purchases

▫ Discounts are reduction in price, often for paying on time

16

Purchase price+ Freight-in- Purchase returns- Purchase allowances- Purchase discounts= Net purchases

Perpetual Inventory: All of these amounts affect Inventory on the Balance Sheet!

Note: Think of the related Journal Entries


Purchase Payment Terms• Inventory purchases often specify payment

terms that include: Discount Discount period Net due period

▫Example 1, payment terms of 3/5, n/30 means: 3% discount If paid within 5 days Net amount due within 30 days

▫Example 2, payment terms of 2/10, n/eom 2 % discount If paid within 10 days Net amount due by the end of the month

Net Sales (Seller Perspective)•Sales are adjusted

for returns, allowances, and discounts

•Sales do not include shipping, even if paid by seller▫Separate category

called shipping expense or delivery expense


Sales revenue

- Sales returns and allowance

- Sales discounts

= Net sales

Reduces Sales Revenue!

What is the difference from Buyer Perspective?

Learning Objective ThreeDetermine inventory and cost of sales based on various inventory cash flow assumptions.


Inventory Costing


• Manager decides which accounting method to use, which affects:• Profits (higher expense results in lower

profits)• Income tax (lower income lowers taxes)• Ratios

• Cost of inventories comprises of:• Cost of purchase• Cost of conversion (additional work on

inventory)• Cost of bringing in the inventories

Inventory Methods (Assumptions)


Specific unit

Average cost

First-in,

first-out

Last-in, first-out

Specific Unit (Specific Identification)

•Used for businesses with unique inventory items▫Automobiles, fine jewelry, real estate

•Inventory expensed at specific price of the particular unit

•Too expensive for inventories with common characteristics


First-in, First-out (FIFO)•Oldest items assumed to be sold first•Ending inventory consists of most recent

purchase costs


Inventory (at FIFO Cost)

Cost of goods sold (40 units):

(10 units @ $10)(25 units @ $14)(5 units @ $18)

10035090

350450

$100

No. 1 (25 units @ $14)No. 2 (25 units @ $18)

Beg bal (10 units @ $10)Purchases:

360Ending Balance

(20 units @ $18)

Last-in, First-out (LIFO)

•Most recent items purchased are assumed to be sold first

•Oldest costs in ending inventory



Cost of goods sold (40 units):

(25 units @ $18)(15 units @ $14)

450210

350450

$100

No. 1 (25 units @ $14)No. 2 (25 units @ $18)


240Ending Balance

(10 units @ $10)(10 units @ $14)

Average Cost (Weighted Average)


Average cost per

unit

Cost of goods available *

Number of units available*

*Goods available = Beginning inventory + Purchases

Cost of goods sold

Number of units sold

Average cost per

unit

Ending inventory

Number of units on

hand

Average cost per

unit

Average Cost

26


Cost of goods sold (40 units @ average cost of $15 per unit) 600

350450

$100

No. 1 (25 units @ $14)No. 2 (25 units @ $18)


300Ending Balance

(20 units @ average cost of $15 per unit)

Problem 6-62AInventory Purchases Requirements

Date Units Cost per unit

Total cost

Beg. inventory

72 tents

$17 $1,224

Oct. 4 103 tents

$19 $1,957

Oct. 19 158 tents

$21 $3,318

Oct. 25 43 tents

$22 $946

• Determine the CoGS and ending inventory under the three methods▫ Average cost▫ FIFO▫ LIFO


Problem 6-62A Average Cost


Average cost per

unit

Cost of goods available *

Number of units available*

*Goods available = Beginning inventory + Purchases

$1,224 + $1,957 +$3,318 + $946

72 +103 +158 + 43

$7,445

376 units

$19.80(rounded)

Problem 6-62A Average Cost


Cost of goods sold

Number of units sold

Average cost per

unit

Ending inventory

Number of units on

hand

Average cost per

unit

324 tents $19.80(rounded)

$6,415

52 tents$19.80

(rounded)$1,030

Problem 6-62A FIFO


Cost of goods sold

72 tents $17 $1,224

103 tents

$19 $1,957

149 tents

$21 $3,129

324 tents

$6,310


Total cost

Beg. inventory

72 tents $17 $1,224

Oct. 4 103 tents $19 $1,957

Oct. 19 158 tents $21 $3,318

Oct. 25 43 tents $22 $946

Ending inventory

43 tents $22 $946

9 tents $21 $189

52 tents $1,135

Oldest items sold first

Newest items on hand

Cost of goods sold

43 tents $22 $946

158 tents

$21 $3,318

103 tents

$19 $1,957

20 tents $17 $340

324 tents

$6,561

Ending inventory

52 tents $17 $884

Problem 6-62A LIFO



Total cost

Beg. inventory

72 tents $17 $1,224

Oct. 4 103 tents $19 $1,957

Oct. 19 158 tents $21 $3,318

Oct. 25 43 tents $22 $946

Newest items sold first

Oldest items on hand

Impact of Inventory Methods on Financial Statements


Increasing inventory prices

Cost of goods sold

Ending inventory

FIFO Lowest because based on older costs, which are less expensive

Highest because based on more recent and expensive costs

LIFO Highest because based on more recent costs, which are more expensive

Lowest because based on older costs, which are less expensive

Impact of Inventory Methods on Financial Statements


Decreasing inventory prices

Cost of goods sold

Ending inventory

FIFO Highest because based on older costs, which are more expensive

Lowest because based on more recent, less expensive costs

LIFO Lowest because based on more recent costs which are less expensive

Highest because based on older, more expensive costs


Comparison of Inventory MethodsCOST OF GOODS SOLD

ENDING INVENTORY

•LIFO provides a more realistic net income figure▫More recent costs

included in Cost of Goods Sold

•FIFO provides a more up-to-date inventory cost ▫More recent costs

on the Balance Sheet


Principles Related to Inventories

Comparability Principle

Net Realizable

Value


Comparability Principle

•Business should use the same accounting methods from year-to-year

•Allows investors to compare financial statements from one period to the next

•Companies are permitted to change methods▫Must disclose effect on net income


Net Realizable Value• Inventory is reported at the lower of:

▫Cost, or▫Net realizable value (NRV)

• Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

• If NRV is lower, inventory is written down


Net Realizable Value• If NRV is lower, inventory is written down

• If the NRV of inventory had been above cost, it would have made no adjustment for NRV. ▫ report the inventory at cost, which is the lower of

cost and NRV


JOURNAL

Date

Accounts and explanation Debit Credit

Cost of goods sold

Inventory

Wrote down inventory to market

Learning Objective FourUse gross profit percentage and inventory turnover to evaluate operations.


Gross Profit Percentage


Gross profit

Net sales revenue

Inventory Turnover


Cost of Goods Sold

Average Inventory

(Beginning inventory + Ending inventory)/2

Cost of Goods Sold Model


Cost of Goods Sold:Beginning Inventory

+ Purchases=

Cost of goods available for sale

- Ending Inventory= Cost of goods sold

Using Cost of Goods Sold Model


What merchandise should the company purchase?How much inventory should the company buy?

Rearranging the Cost of Goods Sold Model


Cost of goods sold (based on plan for next period)

+ Ending inventory (based on plan for next period)

= Goods available as planned

- Beginning inventory (actual amount)

= Purchases (amount manager should buy)

Gross Profit MethodBeginning inventory $$$$

Purchases $$$$

Goods available for sale $$$$

Estimated cost of goods sold:

Net sales revenue $$$$

Less estimated gross profit ($$$)

Estimated cost of goods sold $$$$

Estimated cost of ending inventory $$$



Exercise 6-26A

•J R Company began May with inventory of $47,500. The business made net purchases of $30,900 and had net sales of $62,100 before a fire destroyed the company’s inventory. For the past several years, J R’s gross profit percentage has been 35%.

•Estimate the cost of the inventory destroyed by the fire.

Exercise 6-26A


Beginning inventory $47,500

Purchases 30,900

Goods available for sale 78,400

Estimated cost of goods sold:

Net sales revenue $62,100

Less estimated gross profit

Estimated cost of goods sold

Estimated cost of ending inventory

(35% x $62,100) $21,735

40,365$38,035

Learning Objective FiveShow how inventory errors affect the financial statements


Effect of Inventory ErrorsPeriod 1 Period 2

Cost of Goods Sold

Gross Profit and

Net Income

Cost of Goods Sold

Gross Profit and

Net Income

Period 1

Ending Inventory overstated

Understated

Overstated

Overstated Understated

Period 2 1

Ending Inventory understated

Overstated Understated

Understated Overstated


Chapter 6 Lecture

Documents

pearson education

nature of inventory

inventory recordtwo

sellers inventory countseller

year endconsigned goods

receivablesrecord cost

shipping terms8copyright

board9learning objective