Title: Inventories and Cost of Sales
1Chapter 5
- Inventories and Cost of Sales
- NOTE Ignore Specific Identification Method
2Conceptual Chapter Objectives
- C1 Identify the items making up merchandise
inventory. - C2 Identify the costs of merchandise inventory.
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3Analytical Chapter Objectives
- A1 Analyze the effects of inventory methods for
both financial and tax reporting. - A2 Analyze the effects of inventory errors on
current and future financial statements. - A3 Assess inventory management using both
inventory turnover and days sales in inventory.
SELF-STUDY
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4Procedural Chapter Objectives
- P1 Compute inventory in a perpetual system using
the methods of (specific identification), FIFO,
LIFO, and weighted average.HW QS 1, 2 3 - P2 Compute the lower of cost or market amount of
inventory. - NOT COVERED
- P3 Appendix 5A Compute inventory in a periodic
system using the methods of specific
identification, FIFO, LIFO, and weighted average. - P4 Appendix 5B Apply both the retail inventory
and gross profit methods to estimate inventory.
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5Determining Inventory Items
C 1
Merchandise inventory includes all goods that a
company owns and holds for sale, regardless of
where the goods are located when inventory is
counted.
Items requiring special attention include
Goods in Transit
Goods Damaged or Obsolete
Goods on Consignment
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6Goods in Transit
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7Determining Inventory Costs
C 2
Include all expenditures necessary to bring an
item to a salable condition and location.
Invoice Cost
Minus Discounts and Allowances
Plus Insurance
Plus Import Duties
Plus Storage
Plus Freight
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8Practice Problems
Quick Study 10 Exercise 1 Quick Study
11Exercise 2
9Internal Controls and Taking a Physical Count
The Inventory account under a perpetual system is
updated for each purchase and sale, but events
(such as theft, loss, damage, and errors) can
cause the account balance to be different from
the actual inventory on hand.
10Internal Controls and Taking a Physical Count
C 2
- Most companies take a physical count of inventory
at least once each year. - When the physical count does not match the
Merchandise Inventory account, an adjustment must
be made gt Loss
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11Internal Controls and Taking a Physical Count
Internal controls when taking a physical count of
inventory include a. Pre-numbered inventory
tickets each ticket must be accounted
for. b. Those responsible for inventory do not
count inventory. c. Counters confirm the
validity of inventory, including its
existence, amount and quality. d. A second count
is taken by a different counter. e. A
manager confirms that all inventories are
ticketed once, and only once.
12Inventory Costing Under a Perpetual System
P1
Accounting for inventory requires several
decisions . . .
- Costing Method
- Specific Identification, FIFO, LIFO, or Weighted
Average - Inventory System
- Perpetual or Periodic
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13Frequency in Use of Inventory Methods
P1
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14Inventory Cost Flow Assumptions
Physical flow and cost flow need not be the same.
First-In, First-Out(FIFO)
Assumes costs flow in the order incurred.
Last-In, First-Out(LIFO)
Assumes costs flow in the reverse order incurred.
Weighted Average
Assumes costs flow at an average of the costs
available.
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15Inventory Costing Illustration
1. First-in, first-out (FIFO) As sales occur,
FIFO charges costs of the earliest units acquired
to cost of goods sold, leaving costs of most
recent purchases in inventory. 2. Last-in,
first-out (LIFO) As sales occur, LIFO charges
costs of the most recent purchase to cost of
goods sold, leaving costs of earliest purchases
in inventory. 3. Weighted averageAs sales
occur, weighted average computes the average cost
per unit of inventory at time of sale and charges
this cost per unit sold to cost of goods sold
leaving average cost per unit on hand in
inventory.
16P1 Illustrative Example (Exhibit 5.2 Pg. 199)
Three identical units of merchandise are
purchased separately at the following three dates
and costs May 1 1 Unit _at_ 45 May 3 1 Unit _at_
65 May 6 1 Unit _at_ 70 One (1) unit is then
sold on May 5 for 100. 1. What is the Cost of
Goods Sold and Gross Profit on Income
Statement using FIFO or LIFO or Avg. Cost? 2.
What is the Ending Inventory on Balance Sheet
using FIFO or LIFO or Avg. Cost?
17Inventory Costing Illustration
P1
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18Specific IdentificationNOT COVERED
P1
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19First-In, First-Out (FIFO)
P1
The above purchases were made in August. On
August 14, the company sold 20 bikes.
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20First-In, First-Out (FIFO)
P1
The Cost of Goods Sold for the August 14 sale is
1,970. After this sale, there are five units
in inventory at 530 5 _at_ 106
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21First-In, First-Out (FIFO)
P1
230 1190
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22First-In, First-Out (FIFO)
P1
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23First-In, First-Out (FIFO)
P1
Here are the entries to record the purchases and
sales entries. The numbers in red are determined
by the cost flow assumption used.
All purchases and sales are made on credit.The
selling price of inventory was as follows
8/14 130 8/31 150
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24Last-In, First-Out (LIFO)
P1
The above purchases were made in August. On
August 14, the company sold 20 bikes.
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25Last-In, First-Out (LIFO)
P1
The Cost of Goods Sold for the August 14 sale is
2,045. After this sale, there are five units
in inventory at 455 5 _at_ 91
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26Last-In, First-Out (LIFO)
P1
455 7115
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27Last-In, First-Out (LIFO)
P1
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28Last-In, First-Out (LIFO)
P1
Here are the entries to record the purchases and
sales entries. The numbers in red are determined
by the cost flow assumption used.
All purchases and sales are made on credit.The
selling price of inventory was as follows
8/14 130 8/31 150
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29Weighted Average
P1
- When a unit is sold, the average cost of each
unit in inventory is assigned to cost of goods
sold.
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30Weighted Average
P1
First, we need to compute the weighted average
cost per unit of items in inventory.
The Cost of Goods Sold for the August 14 sale is
2,000. After this sale, there are five units in
inventory at 500
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31Weighted Average
P1
Additional purchases were made on August 17 and
28. Twenty-three bikes were sold on August 31.
What is the weighted average cost per unit of
items in inventory?
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32Weighted Average
P1
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33Weighted Average
Ending inventory is comprised of 12 units _at_ an
average cost of 114 each or 1,368.
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34Weighted Average
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35Weighted Average
Here are the entries to record the purchases and
sales entries for Trekking. The numbers in red
are determined by the cost flow assumption used.
All purchases and sales are made on credit.The
selling price of inventory was as follows
8/14 130 8/31 150
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36Financial Statement Effects of Costing Methods
- Because prices change, inventory methods nearly
always assign different cost amounts.
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37Financial Statement Effects of Costing Methods
Advantages of Methods
First-In, First-Out
Weighted Average
Last-In, First-Out
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38Tax Effects of Costing Methods
A1
- The Internal Revenue Service (IRS) identifies
several acceptable methods for inventory costing
for reporting taxable income.
If LIFO is used for tax purposes, the IRS
requires it be used in financial statements.
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39Consistency in Using Costing Methods
A1
- The consistency concept requires a company to use
the same accounting methods period after period
so that financial statements are comparable
across periods.
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40Merchandising Activities
C 1
Merchandising Companies
Manufacturer
Wholesaler
Retailer
Customer
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41Lower of Cost or Market
P2
- Inventory must be reported at market value when
market is lower than cost.
Can be applied three ways (1) separately to each
individual item. (2) to major categories of
assets. (3) to the whole inventory.
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42Lower of Cost or Market
P2
- A motorsports retailer has the following items in
inventory
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43Lower of Cost or Market
P2
- Here is how to compute lower of cost or market
for individual inventory items.
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44Lower of Cost or Market
P2
Here is how to compute lower of cost or market
for the two groups of inventory items.
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45Lower of Cost or Market
P2
Here is how to compute lower of cost or market
for the entire inventory.
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46Exercise 7
47Financial Statement Effects of Inventory Errors
A2
Income Statement Effects
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48Financial Statement Effects of Inventory Errors
A2
Balance Sheet Effects
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49Inventory Turnover
A3
- Shows how many times a company turns over
its inventory during a period. Indicator of how
well management is controlling the amount of
inventory available.
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50Days Sales in Inventory
A3
Reveals how much inventory is available in terms
of the number of days sales.
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51End of Chapter 5
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