Reporting and Interpreting Reporting and Interpreting Cost of Goods Sold and Cost of Goods Sold and Inventory Inventory Chapter 7 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc.
Reporting and Interpreting Cost of Goods Sold and Inventory Chapter 7 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc.
Mar 31, 2015
Welcome message from author
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Reporting and Interpreting Cost of Reporting and Interpreting Cost of Goods Sold and InventoryGoods Sold and Inventory
Chapter 7
McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc.
McGraw-Hill/Irwin Slide 2
Understanding the Business
Provide sufficient Provide sufficient quantities of high-quantities of high-quality inventory.quality inventory.
Provide sufficient Provide sufficient quantities of high-quantities of high-quality inventory.quality inventory.
Minimize the costs of Minimize the costs of carrying inventory.carrying inventory.
Minimize the costs of Minimize the costs of carrying inventory.carrying inventory.
Primary Goals of Inventory
Management
Primary Goals of Inventory
Management
McGraw-Hill/Irwin Slide 3
Items Included in Inventory
Inventory
Tangible Held for SaleUsed to
Produce Goods or Services
Merchandise InventoryRaw Materials Inventory
Work in Process InventoryFinished Goods Inventory
McGraw-Hill/Irwin Slide 4
Costs Included in Inventory Purchases
The cost principlecost principle requires that inventory be recorded at the price paid or the
consideration given.
Invoice Price
Freight
Inspection Costs
Preparation Costs
McGraw-Hill/Irwin Slide 5
Flow of Inventory Costs
MerchandiseMerchandisePurchasesPurchases
MerchandiseMerchandisePurchasesPurchases
Cost ofCost ofGoods SoldGoods Sold
Cost ofCost ofGoods SoldGoods Sold
MerchandiseMerchandiseInventoryInventory
MerchandiseMerchandiseInventoryInventory
Merchandiser
RawRawMaterialsMaterials
RawRawMaterialsMaterials
Raw MaterialsRaw MaterialsInventoryInventory
Raw MaterialsRaw MaterialsInventoryInventory
Work in ProcessWork in ProcessInventoryInventory
Work in ProcessWork in ProcessInventoryInventory
Finished GoodsFinished GoodsInventoryInventory
Finished GoodsFinished GoodsInventoryInventory
Cost ofCost ofGoods SoldGoods Sold
Cost ofCost ofGoods SoldGoods Sold
Manufacturer
DirectDirectLaborLaborDirectDirectLaborLabor
FactoryFactoryOverheadOverheadFactoryFactory
OverheadOverhead
McGraw-Hill/Irwin Slide 6
Nature of Cost of Goods Sold
BeginningBeginningInventoryInventory
BeginningBeginningInventoryInventory
PurchasesPurchasesfor the Periodfor the PeriodPurchasesPurchases
for the Periodfor the Period
Ending InventoryEnding Inventory(Balance Sheet)(Balance Sheet)
Ending InventoryEnding Inventory(Balance Sheet)(Balance Sheet)
Goods AvailableGoods Availablefor Salefor Sale
Goods AvailableGoods Availablefor Salefor Sale
Cost of Goods SoldCost of Goods Sold(Income Statement)(Income Statement)
Cost of Goods SoldCost of Goods Sold(Income Statement)(Income Statement)
Beginning inventory + Purchases = Goods Available for SaleBeginning inventory + Purchases = Goods Available for Sale
Goods Available for Sale – Ending inventory = Cost of goods soldGoods Available for Sale – Ending inventory = Cost of goods sold
Beginning inventory + Purchases = Goods Available for SaleBeginning inventory + Purchases = Goods Available for Sale
Goods Available for Sale – Ending inventory = Cost of goods soldGoods Available for Sale – Ending inventory = Cost of goods sold
McGraw-Hill/Irwin Slide 7
Inventory Costing Methods
Total Dollar Amount of Goods Total Dollar Amount of Goods Available for SaleAvailable for Sale
Total Dollar Amount of Goods Total Dollar Amount of Goods Available for SaleAvailable for Sale
Ending InventoryEnding InventoryEnding InventoryEnding Inventory Cost of Goods SoldCost of Goods SoldCost of Goods SoldCost of Goods Sold
Inventory Costing Method
Inventory Costing Methods1. Specific Identification2. First-in, First-out3. Last-in, First-out4. Weighted Average
McGraw-Hill/Irwin Slide 8
Specific Identification
When units are sold, the
specific cost of the unit sold is
added to cost of goods sold and deducted from
inventory
When units are sold, the
specific cost of the unit sold is
added to cost of goods sold and deducted from
inventory
McGraw-Hill/Irwin Slide 9
Cost Flow Assumptions
The choice of an inventory costing method is not always based on the physical flow of goods on and off the shelves.
LIFO
FIFOWeightedAverage
McGraw-Hill/Irwin Slide 10
First-In, First-Out Method
Cost of Cost of Goods SoldGoods Sold
Cost of Cost of Goods SoldGoods SoldOldest CostsOldest CostsOldest CostsOldest Costs
Ending Ending InventoryInventoryEnding Ending
InventoryInventoryRecent CostsRecent CostsRecent CostsRecent Costs
Under the first-in, first-out (FIFO) method The first costs into inventory are the first costs out to cost of
goods sold Ending inventory is based on the cost of the latest purchases
INVENTORY COSTING METHODS
McGraw-Hill/Irwin Slide 12
Last-In, First-Out Method
Ending Ending InventoryInventoryEnding Ending
InventoryInventory
Cost of Cost of Goods SoldGoods Sold
Cost of Cost of Goods SoldGoods Sold
Oldest CostsOldest CostsOldest CostsOldest Costs
Recent CostsRecent CostsRecent CostsRecent Costs
Under the last-in, first-out (LIFO) method The last costs into inventory are the first costs out to cost of
goods sold Ending inventory consists of the oldest costs--those of
beginning inventory and the earliest purchases of the period
INVENTORY COSTING METHODS
McGraw-Hill/Irwin Slide 14
Average Cost Method
When a unit is sold, the average cost of each unit in inventory is assigned to cost
of goods sold.
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
Number of Units Available
for Sale÷
Inventory Value Effects
FIFO ending inventory is highest because it is priced at the most recent costs, which are the highest
LIFO ending inventory is lowest because it is priced at the oldest costs, which are the lowest
When inventory unit costs are increasing
FIFO ending inventory is lowest because it is priced at the most recent costs, which are the lowest
LIFO is highest because it is priced at the oldest costs, which are the highest
Inventory Value Effects
When inventory unit costs are decreasing
McGraw-Hill/Irwin Slide 17
Financial Statement Effects of Costing Methods
Advantages of MethodsAdvantages of MethodsAdvantages of MethodsAdvantages of Methods
Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with
revenues.revenues.
Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with
revenues.revenues.
Ending inventory Ending inventory approximates approximates
current current replacement cost.replacement cost.
Ending inventory Ending inventory approximates approximates
current current replacement cost.replacement cost.
First-In, First-In, First-OutFirst-OutFirst-In, First-In, First-OutFirst-Out
Last-In, Last-In, First-OutFirst-OutLast-In, Last-In,
First-OutFirst-Out
Smooths out Smooths out price changes.price changes.Smooths out Smooths out
price changes.price changes.
Weighted Weighted AverageAverage
Weighted Weighted AverageAverage
McGraw-Hill/Irwin Slide 18
Managers Choice of Inventory Methods
Net Income EffectsNet Income EffectsManagers prefer to report Managers prefer to report higher earnings for their higher earnings for their
companies.companies.
Net Income EffectsNet Income EffectsManagers prefer to report Managers prefer to report higher earnings for their higher earnings for their
companies.companies.
Income Tax EffectsIncome Tax EffectsManagers prefer to pay the Managers prefer to pay the
least amount of taxes least amount of taxes allowed by law as late as allowed by law as late as
possible.possible.
Income Tax EffectsIncome Tax EffectsManagers prefer to pay the Managers prefer to pay the
least amount of taxes least amount of taxes allowed by law as late as allowed by law as late as
possible.possible.
LIFO Conformity RuleIf last-in, first-out is used on the
income tax return, it must also be used to calculate inventory and cost
of goods sold for financial statements.
McGraw-Hill/Irwin Slide 19
Valuation at Lower of Cost or Market
Ending inventory is reported at the Ending inventory is reported at the lower of cost or market (LCM)lower of cost or market (LCM). .
Ending inventory is reported at the Ending inventory is reported at the lower of cost or market (LCM)lower of cost or market (LCM). .
Replacement CostReplacement CostThe current purchase price The current purchase price
for identical goods.for identical goods.
Replacement CostReplacement CostThe current purchase price The current purchase price
for identical goods.for identical goods.
The company will recognize a “holding” loss in the The company will recognize a “holding” loss in the current period rather than the period in which the current period rather than the period in which the
item is sold.item is sold.ThisThis practice is practice is conservativeconservative..
The company will recognize a “holding” loss in the The company will recognize a “holding” loss in the current period rather than the period in which the current period rather than the period in which the
item is sold.item is sold.ThisThis practice is practice is conservativeconservative..
McGraw-Hill/Irwin Slide 20
Valuation at Lower of Cost or Market
Item Quantity Cost Replacement
Cost LCM Total LCMPentium chips 1,000 250$ 200$ 200$ 200,000$ Disk drives 400 100 110 100 40,000
Item Quantity Cost Replacement
Cost LCM Total LCMPentium chips 1,000 250$ 200$ 200$ 200,000$ Disk drives 400 100 110 100 40,000
McGraw-Hill/Irwin Slide 21
Inventory Turnover Cost of Goods Sold
= Average Inventory
Inventory Turnover
Average Inventory is . . .Average Inventory is . . .(Beginning Inventory + Ending Inventory) ÷ 2(Beginning Inventory + Ending Inventory) ÷ 2
Average Inventory is . . .Average Inventory is . . .(Beginning Inventory + Ending Inventory) ÷ 2(Beginning Inventory + Ending Inventory) ÷ 2
This ratio reflects how many times This ratio reflects how many times average inventory was produced and average inventory was produced and sold during the period. A higher ratio sold during the period. A higher ratio indicates that inventory moves more indicates that inventory moves more
quickly thus reducing interest, storage quickly thus reducing interest, storage and obsolescence costs. and obsolescence costs.
This ratio reflects how many times This ratio reflects how many times average inventory was produced and average inventory was produced and sold during the period. A higher ratio sold during the period. A higher ratio indicates that inventory moves more indicates that inventory moves more
quickly thus reducing interest, storage quickly thus reducing interest, storage and obsolescence costs. and obsolescence costs.
This ratio indicates the average time ittakes a business to sell its inventory.
Inventory Days
365
Inventory TurnoverInventory Days =
McGraw-Hill/Irwin Slide 23
Inventory Methods and Financial Statement Analysis
Beginning inventory FIFO- Beginning inventory LIFO
Beginning LIFO Reserve(Excess of FIFO over LIFO)
Beginning inventory FIFO- Beginning inventory LIFO
Beginning LIFO Reserve(Excess of FIFO over LIFO)
Ending inventory FIFO- Ending inventory LIFO
Ending LIFO Reserve(Excess of FIFO over LIFO)
Ending inventory FIFO- Ending inventory LIFO
Ending LIFO Reserve(Excess of FIFO over LIFO)
U.S. public companies using LIFO also report beginning and ending inventory on a FIFO basis if the FIFO values
are materially different.
McGraw-Hill/Irwin Slide 24
Perpetual and Periodic Inventory Systems
Provides Provides up-to-dateup-to-date inventory records.inventory records.
Provides Provides up-to-dateup-to-date inventory records.inventory records.
Provides Provides up-to-date up-to-date cost of sales records. cost of sales records. Provides Provides up-to-date up-to-date
cost of sales records. cost of sales records.
Perpetual Perpetual SystemSystem
Perpetual Perpetual SystemSystem
In a periodic inventory system, ending inventory and cost of goods sold are determined at the end of the accounting
period based on a physical count.
McGraw-Hill/Irwin Slide 25
Comparison of Perpetual and Periodic Inventory Systems
Periodic Inventory System
McGraw-Hill/Irwin Slide 26
Comparison of Perpetual and Periodic Inventory Systems
Jan. 1
Apr. 14 Purchased 1,100 units at a unit cost of $50.Inventory 55,000
Accounts payable 55,000 Nov. 30 Sold 1,300 units at a sales price of $83.
Accounts receivable 107,900 Sales revenue 107,900
Cost of goods sold 65,000 Inventory 65,000
Dec. 31 Use cost of goods sold and inventory amounts.
Had beginning inventory of 800 units at a unit cost of $50.
Perpetual Inventory System
McGraw-Hill/Irwin Slide 27
Perpetual and Periodic Inventory SystemsInventory System
Item Periodic System Perpetual System
Beginning InventoryCarried over
from prior periodCarried over from
prior period
Add: PurchasesAccumulated in the Purchases
account
Accumulated in the Inventory
account
Less: Ending Inventory
Measured at end of period by
physical inventory count
Perpetual record updated at every
sale
Cost of Goods Sold
Computed as a residual amount at end of period
Measured at every sale based
on perpetual record
McGraw-Hill/Irwin Slide 28
Errors in Measuring Ending Inventory
Errors in Measuring InventoryEnding Inventory Beginning Inventory
Overstated Understated Overstated Understated
Ending Inventory + - N/A N/A
Retained Earnings + - NE NE
Goods Available for Sale N/A N/A + -Cost of Goods Sold - + + -Gross Profit + - - +Net Income + - - +
Effect on Current and Next Period's Balance Sheet
Effect on Current and Next Period's Income Statement
© 2008 The McGraw-Hill Companies, Inc.
End of Chapter 7
Related Documents
