Professional Documents
Culture Documents
Inventories and Cost of Goods Sold
Inventories and Cost of Goods Sold
2
The Nature of Inventory
Different Forms
Retailers and wholesalers have single inventory,
merchandise inventory.
Manufacturers have more than one form of inventory,
depending on stage of development.
Raw materials:
materials purchased items that have not yet entered
the manufacturing process.
Work in process:
process unfinished units of the company’s
product:
direct materials: used to make product
direct labor: paid to workers who make the product
from raw materials
manufacturing overhead: indirect costs
Finished goods:
goods product ready for sale.
3
Merchandising Activities
A merchandise company earns profit by buying
and selling merchandise, which consists of
inventory that the company acquire for the
purpose of reselling it to customers.
Both retailers and wholesalers are merchandisers.
4
Merchandising Activities
Typical Income Statement
Net Sales
- Cost of Goods Sold
= Gross Profit
-Operating Expenses
= Net income
5
Accounting for Sales
Revenues = Sales
Calculation of net sales
Sales represent the total cash
Sales
and credit sales made by the
merchandising company. Less
Cash sales are recorded daily Sales returns and allowances
in the journal and are based and Sales discounts
on the total amount shown
on the cash register tape.
=
A journal entry is prepared NET SALES
each day to record sales on
credit made on that day.
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Income Statement of a Merchandiser
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Sales Returns and Allowances
Returns: to account for returned defective goods.
cash refund.
credit against future purchase.
Allowance: if goods delivered were unsatisfactory (damaged or
spoiled), the customer keeps the merchandise for a price reduction
granted to customer.
Contra revenue account: has an opposite balance to its related
account (sales revenue).
Separate account to monitor the amount of returns and allowances
which involve the possibility of lost future sales.
8
Credit Terms & Sales
Discounts
The credit terms for a sale describe the amounts and timing of
payments that the buyer agrees to make in the future.
When the credit period is long, the seller often grants a sale
discount for early payments.
A sale discount is a reduction from the selling price given for
early payments.
It is granted to a buyer when an invoice is paid within a
discount period.
The discount rate and the discount period are pre-specified in
the credit terms on the invoice, along with a credit period.
9
Credit Terms and Sales Discounts
n/30 Payment due 30 days from invoice date.
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Recording Sales Discounts (Gross
Method)
Cash 980
Sales Discounts 20
Accounts Receivable 1,000
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Sales Contra-Accounts
Sales Sales Discounts
normal normal
credit debit
balance balance
13
Cost of Goods Sold (COGS)
The cost of the goods that were sold during a period (i.e., the
matching expense figure of net sales).
Sales revenue represents the inflow of assets (cash &
A/R), from the sale of products during the period.
COGS represents the outflow of an asset (inventory)
from the sale of those same products.
Inventory not sold (on hand) appears on the balance sheet at
the end of the fiscal year (ending inventory).
Inventory sold apprears on the income statement as COGS.
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Cost of Goods Sold (COGS)
Standard format for the calculation of Cost of Goods Sold.
15
Cost of Goods Sold (COGS)
Cost of Goods
Available for
Sale
$78,000
16
Inventory Systems
17
Perpetual Inventory Systems
Maintained by adding the cost of each newly purchased item to the
inventory account and substracting the cost of each item sold from
the account.
When an item is sold, its cost is recorded in the cost of goods sold
account.
More costly to maintain.
more record keeping in a large volume operation.
Point of sale terminals have improved ability of mass merchandisers
to maintain perpetual systems
Most retailers use a perpetual system for units of inventory, but use
a periodic system for cost of inventory.
18
Periodic Inventory Systems
Throughout the year, the inventory account contains the amount of
merchandise on hand at the beginning of the year.
The company simply records the cost of inventory in a temporary
Purchases account.
Ending inventory is determined by counting the quantities of
merchandise on hand at the end of the period.
Inventory records are updated periodically based on physical
inventory counts.
Reduces record-keeping but also decreases ability to track theft,
breakage, etc. and prepare interim financial statements.
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Accounting for Purchases: Cost of Goods Purchased
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Accounting for Purchases:
Cost of Goods Purchased
Purchase Discounts:
A reduction of the cost to purchase the
merchandise when merchandise is bought on
credit.
It is offered when the buyer pays for the
merchandise within the discount period.
Contra purchases account
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Recording Purchase Discounts (Gross Method)
23
Transportation Costs
When there are transportation costs to bring the
purchased goods in, this transportation cost is
added to the “transportation in” account.
24
Inventory Valuation and the Measurement
of Income
26
Valuing Inventory
Periodic System
The problem is to put a $ value on the items which have
been physically counted at the end of the period.
Inventory is purchased at different times, and at different
prices; these costs must be allocated correctly when items
are sold.
Four methods are commonly used:
Specific identification
Weighted Average
FIFO
LIFO
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Inventory Costing Methods with a Periodic
System: Specific identification Method
Find out exactly which items were sold; their actual cost is
cost of goods sold.
Specific identification matches flow of costs to flow of units.
Impractical for most retail merchandise.
May be difficult to keep track of individual units (what if
they are nails? Ping-pong balls? Cans of peas?).
Can lead to income manipulation: sell selected items
(depending on their purchase price) to increase or decrease
income.
28
Inventory Costing Methods with a Periodic
System: Weighted Average Cost Method
Assign the same unit cost to all units available for sale
during the period.
Weighted Average Cost = Cost of goods available for sale
units available for sale
29
Inventory Costing Methods with a Periodic
System: FIFO, or first in, first out method
Assumes that the costs of the first items received
(in most cases the beginning inventory) are the
first used to cost of goods sold, working forward in
time through the purchased goods.
Ending inventory is reported at the most recently
paid prices, working backward in time.
30
Inventory Costing Methods with a Periodic
System: LIFO, or last in, first out method
The opposite of FIFO.
Assumes that the costs of the last units purchased are
the first to be used to value cost of goods sold, working
backward in time.
Ending inventory is reported at the oldest unit costs
available (beginning inventory), working forward.
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Selecting an Inventory Costing
Method
The primary determinant in selecting an inventory costing
method is accurate income reporting.
reporting
32
Selecting an Inventory Costing Method
When prices are rising, LIFO puts higher costs in cost of
goods sold, resulting in lower income, lower taxes. Ending
inventory may be distorted because it consists of older
(earlier) costs.
This is a deferral, not permanent savings, in taxes
because taxes will be paid later when goods are
finally sold.
33
Selecting an Inventory Costing Method
34
Changing Method of Inventory Valuation
35
Valuing Inventory at Lower of Cost or Market
36
Valuing Inventory at Lower of Cost or Market
37
Analyzing The Management of Inventory
Turnover
38