hhofma3e_ch06_inst 2

Transcript hhofma3e_ch06_inst 2

2 Define accounting principles related to inventory Define inventory costing methods Account for perpetual inventory using the three most common costing methods Compare the effects of the three most common inventory costing methods Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

3 Apply the lower-of-cost-or-market rule to inventory Measure the effects of inventory errors Estimate ending inventory by the gross profit method Account for periodic inventory using the three most common costing methods (Appendix 6A) Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Accounting principles guide how we record transactions Consistency Same accounting methods from period to period Disclosure Report enough information for outsiders to make decisions Materiality Follow accounting rules for significant items Conservatism Exercise caution in financial reporting 5 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Consistency Disclosure Materiality

We debited cost of goods sold directly for a small Management wants to delay freight in charge on a writing-down the value of profitable early in the year date. Should we include a and switch mid year to look stronger.

better in year end numbers?

diamond ring in inventory.

Item LL002 Description Abe Lincoln Mask Location Storeroom 2 Purchased Date 5-Sep 7-Sep 10-Sep Units 100 50 Unit Cost $ 30 $ 30 Total $ 3,000 $ 1,500 Units 10 Sold Primary supplier Maskscaraders Secondary supplier Mask Inc.

Inventory level: Min: 25 Max: 200 Balance Unit Cost Cost of Goods Sold $ 30 $ 300 Units 100 150 140 Unit Cost $ 30 $ 30 30 Total $ 3,000 $ 4,500 4,200

Item LL002 Description Abe Lincoln Mask Location Storeroom 2 Purchased Date 5-Sep 7-Sep 10-Sep Units 100 50 Unit Cost $ 30 $ 40 Total $ 3,000 $ 2,000 Units 10 Sold Primary supplier Mascaraders Secondary supplier Masks Inc.

Inventory level: Min: 25 Max: 200 Balance Unit Cost ??

Cost of Goods Sold ??

Units 100 150 140 Unit Cost $ 30 ??

Total $ $ 3,000 5,000 ??

How much is the Cost of Goods Sold expense?

What is our inventory value?

Inventory

c f d e j l h

Sep 5 Purchase: 100 units @$30 each Sep 7 Purchase:50 units @$40 each Ending Balance 3,000 2,000 ??

Sep 10 Sale: 10 units

To the Balance Sheet!

Accounts Receivable

Sep 10 Sale Cost of Goods Sold Expense ??

Advertising & Selling Expense To the Income Statement!

Determining the cost of ending inventory for the balance sheet & COGS for the income statement Four Methods:

Specific unit-cost First-In, First-Out

bother to track individual units 11

Last-In, First-Out cost

Useful when inventory items are specifically identifiable Think: unique items with unique costs: cars, bikes, planes, expensive art works, homes…… Not practical to track vast inventories of homogenous items by the specific item NOTE: This does not mean just a specific part number, this means a specific unit of that specific part number.

Fifo, Lifo, and average costs are just assumptions

 FIFO: First In First Out  Assumes the First item you bought is the First one you sell  Earlier purchase goes to Cost of Goods Sold  Later purchase stays in ending inventory Other examples?

 LIFO: Last In First Out  Assumes the

Last

item you bought is the

First

one you sell  Later purchase goes to Cost of Goods Sold  Earlier purchase stays

More examples?

 Average Cost: Items valued at a

weighted average

of unit cost  Assumes one average cost for all units  Same unit cost given to sold and unsold units

Other examples?

LIFO 31% FIFO 46% Average 20% Other 3% Note: FIFO, LIFO, and Average cost are all assumptions. It is NOT required that a company’s inventory actually flow in the selected reporting assumption. 16 Assume = pretend Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

 FIFO: First In First Out  Assumes the First item you bought is the First one you sell  Earlier purchase goes to Cost of Goods Sold  Later purchase stays in ending inventory Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Beginning Inventory Purchase 6 more at $45 each Date Jul 1 Qty.

Purchases Unit Cost Total Cost Cost of Goods Sold Qty.

Unit Cost Total Cost Inventory on Hand Qty.

On July 15 sold 4 units Date Qty.

Purchases Unit Cost Total Cost Cost of Goods Sold Qty.

Unit Cost Total Cost Inventory on Hand Qty.

On July 26 purchased 9 at $47 Date Qty.

Purchases Unit Cost Total Cost Cost of Goods Sold Qty.

Unit Cost Total Cost Inventory on Hand Qty.

Unit Cost Total Cost Jul 1 2 $40 $80 5 6 $45 $270 2 40 80 6 45 270 15 2 $40 $80 4 45 180 2 45 90 26 9 $47 $423 4 45 180 9 47 423 21 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Do Snickers Exercise Part 1: FIFO Only

Complete Snickers Perpetual Ledger Account.

Prepare the revenue and expense journal entries.

Complete the FIFO financial statements on the last page.

Item Snickers Description Dinky candy bar Location Warehouse Tube Date 1-Oct 5-Oct 10-Oct 15-Oct Units 3 6 1 Purchased Unit Cost 0.10

Total Cost 0.30

Units 0.25

1.50

0.30

2 Sold Unit Cost Primary supplier Mr. Mikkelsen Secondary supplier Trick-or-Treat Inventory level: Min: 5 Max: 10 Balance Cost of Goods Sold Units 3 Unit Cost 0.10

Total 0.30

0.10

0.20

3 6 0.10

0.25

Total Balance 3 6 0.10

0.25

1 0.30

Total Balance 1 6 0.10

0.25

1 0.30

Total Balance 0.30

1.50

1.80

0.30

1.50

0.30

2.10

0.10

1.50

0.30

1.90

 LIFO: Last In First Out  Assumes the

Last

item you bought is the

First

Beginning Inventory Purchase 6 more at $45 each Date Jul 1 Qty.

Purchases Unit Cost Total Cost Cost of Goods Sold Qty.

Unit Cost Total Cost Inventory on Hand Qty.

On July 15 sold 4 units Date Qty.

Purchases Unit Cost Total Cost Cost of Goods Sold Qty.

Unit Cost Total Cost Inventory on Hand Qty.

On July 26 purchased 9 at $47 Date Qty.

Purchases Unit Cost Total Cost Cost of Goods Sold Qty.

Unit Cost Total Cost Inventory on Hand Qty.

2 Unit Cost $40 Total Cost $80 Jul 1 5 6 $45 $270 2 40 80 6 45 270 15 4 $45 $180 2 40 80 2 45 90 26 9 $47 $423 2 40 80 2 45 90 28 9 47 423 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Do Snickers Exercise Part 2 LIFO Only

Complete Snickers Perpetual Ledger Account Prepare the revenue & expense journal entries.

Complete the LIFO financial statements on the last page.

Compare LIFO & FIFO financial statements.

Item Snickers Description Dinky candy bar Location Warehouse Tube Date 1-Oct 5-Oct 10-Oct 15-Oct Units 3 6 1 Purchased Unit Cost 0.10

0.25

0.30

Total Cost 0.30

1.50

0.30

Units 1

Sold Unit Cost Primary supplier Mr. Mikkelsen Secondary supplier Trick-or-Treat Inventory level: Min: 5 Max: 10 Balance Cost of Goods Sold Units 3 Unit Cost 0.10

Total 0.30

0.30

0.25

Total COGS 0.30

0.25

0.55

3 3 6 0.10

6 0.25

Total Balance 0.10

0.25

1 0.30

Total Balance 3 5 0.10

0.25

Total Balance 0.30

1.50

1.80

0.30

1.50

0.30

2.10

0.30

1.25

1.55

 Average Cost: Items valued at a

weighted average

Beginning Inventory Purchase 6 more at $45 each

Three steps to average cost: 1) Add units. 2) Add total inventory dollars. 3) Divide total dollars by total units.

Date Jul 1 Qty.

Purchases Unit Cost Total Cost Cost of Goods Sold Qty.

Unit Cost Total Cost Inventory on Hand Qty.

On July 15 sold 4 units Date Qty.

Purchases Unit Cost Total Cost Cost of Goods Sold Qty.

Unit Cost Total Cost Inventory on Hand Qty.

On July 26 purchased 9 at $47

Three steps to average cost: 1) Add units. 2) Add total inventory dollars. 3) Divide total dollars by total units.

Date Qty.

Purchases Unit Cost Total Cost Cost of Goods Sold Qty.

Unit Cost Total Cost Inventory on Hand Qty.

Do Snickers Exercise Part 3: Average Cost

Item Snickers Description Dinky candy bar Location Warehouse Tube Purchased Date 1-Oct 5-Oct 10-Oct 15-Oct Units 3 6 1 Unit Cost 0.10

Total Cost 0.30

Units 0.25

0.30

1.50

0.30

2 Sold Unit Cost Primary supplier Mr. Mikkelsen Secondary supplier Trick-or-Treat Inventory level: Min: 5 Max: 10 Balance Cost of Goods Sold Units 3 Unit Cost 0.10

Total 0.30

0.21

0.42

9 10 8 0.20

0.21

1.80

2.10

1.68

Express Lane, Inc., a regional convenience store chain, maintains milk inventory by the gallon. The first month’s milk purchases and sales at its Freeport, FL, location follows: Nov 2 6 13 14 1 gallon @ $2.00 each 2 gallons @ $2.10 each 2 gallons @ $2.20 each The store sold 4 gallons of milk to a customer.

Describe which costs would be sold and which costs would remain in inventory. Then, identify the amount that would be reported in inventory on November 15 using

FIFO.

LIFO.

average cost.

Describe which costs would be sold and which costs would remain in inventory.

Units sold include the: FIFO

Oldest costs

LIFO

Newest costs

Ending inventory includes the:

Newest costs Oldest costs

Average Cost

Inventory Record: FIFO

Express Lane, Inc.

Date Nov Bal Bal.

2 6 13 Quantity 1 2 1 2 2 1 2 2 14Sold (4) Bal.

1 2 1 1 Purchases (Sold) Unit Cost $2.00

$2.10

$2.00

2.10

$2.20

$2.00

2.10

2.20

Total Cost $2.00

$4.20

$2.00

$4.20

$4.40

$2.00

$4.20

$4.40

2.00

2.10

$2.00

4.20

2.20

$2.20

Inventory Record : LIFO

Express Lane, Inc.

Date Nov Bal Bal.

2 6 13 Quantity 1 2 1 2 2 1 2 2 14Sold (4) Bal.

End 2 2 1 1 Purchases (Sold) Unit Cost $2.00

$2.10

$2.00

2.10

$2.20

$2.00

2.10

2.20

2.10

2.20

$2.00

Total Cost $2.00

$4.20

$2.00

$4.20

$4.40

$2.00

$4.20

$4.40

$4.20

$2.20

$2.00

Inventory Record : Average-Cost

Express Lane, Inc.

Date Nov 2 6 Quantity 1 2 Bal Bal.

Bal.

End 3 {2.00+4.20} / 3 13 2 5 {6.20+4.40} / 3 14Sold (4) (4) 1 1 Purchases (Sold) Unit Cost $2.00

$2.10

$2.0667

$2.20

$2.12

2.12

$2.12

Total Cost $2.00

$4.20

$6.20

$4.40

$10.60

($8.48) $2.12

$2.12

Inventory level: Min: 25 Max: 200 Balance Unit Cost ??

Cost of Goods Sold ??

Units 100 150 140 Unit Cost $ 30 ??

Total $ $ 3,000 5,000 ??

How much is the Cost of Goods Sold expense?

What is our inventory value?

FIFO method FIFO method Income Statement Balance Sheet Sales Less Cost of Goods Sold 1.00 .20 Assets: Ending Inventory 1.90 Equals Gross Margin .80 LIFO method LIFO method Income Statement Balance Sheet Sales Less Cost of Goods Sold Equals Gross Margin .45 Average Cost method Income Statement Sales Less Cost of Goods Sold Equals Gross Margin 1.00 .55 1.00 .42 .58 Assets: Ending Inventory 1.55 Average Cost method Balance Sheet Assets: Ending Inventory 1.68

First-In, First-Out Last-In, First-Out Average Cost High income attracts investors Overall a very realistic portrayal especially on the balance sheet

Lower income = Less taxes, yields higher cash flow Grossly misleading balance sheet Not conservative Illegal under IFRS “Middle ground”

Remember: Financial Accounting’s job is to portray the

actual

performance and standing of the reporting firm.

Don’t veer too far from that objective, and you’ll be okay.

US Steel uses LIFO to enjoy the tax savings.

How did LIFO contribute to workers’ successful strike?

Management was confident they could out last striking workers because they had months of inventory on hand.

6 weeks of non-replenished sales was releasing their old cost layers (aka lifo reserve) of “cheap” inventory onto the income statement.

Not replenishing these inventories before reporting would lead to high profits, taxes, failed negotiations, and a PR nightmare.

Example of conservatism Inventory is reported at lower of: Historical cost or Market value (current replacement cost) If market is lower than cost, write down inventory value

GENERAL JOURNAL Post Date Accounts Ref Debit Cost of goods sold Inventory

Credit

P6-30A: ACCOUNTING PRINCIPLES FOR INVENTORY AND APPLYING THE LOWER-OF-COST-OR MARKET RULE

Dec 12 Cost of goods sold Inventory 20,000 20,000 M and T should report inventory on the balance sheet at $80,000.

M and T should report Cost of goods sold on the Income Statement at $430,000. Conservatism. The goal of conservatism is to report realistic figures.

IFRS and US GAAP both require revaluation to lower of cost or market.

IFRS also allows restatement to cost in later periods. Conceivably, an IFRS reporting company could take a bath during a down year, then report artificially inflated profits in following years.

This is already a problem in US GAAP with several adjustment areas.

Daddy doesn’t know any magic tricks. Daddy knows accounting tricks.

BB 2010 Inventory 5,000 Purchases 50,000 50,000 COGS EB 5,000 BB Purchases EB 2011 Inventory 50,000 COGS BB 2012 Inventory 5,000 Purchases 50,000 50,000 COGS EB 5,000 Sales COGS Gross Margin Other expenses Net Income $ 75,000 50,000 25,000 25,000 $ Sales COGS Gross Margin Other expenses Net Income $ 75,000 50,000 25,000 25,000 $ Sales COGS Gross Margin Other expenses Net Income $ 75,000 50,000 25,000 25,000 $ Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Grandma Kate Bakery achieved Sales revenue of $52,000 and Cost of goods sold of $22,000.

Compute Grandma Kate’s correct Gross profit if the company made either of the following independent accounting errors. Show your work.

Ending inventory is overstated by $6,000.

Ending inventory is understated by $6,000 .

Sales Revenue Cost of goods sold Gross Profit

60 As reported, correct $ 52,000 (22,000) $ 30,000 Inventory a. overstated by $6,000 $ 52,000 b. understated by $6,000 $ 52,000 (16,000) $ 36,000 (28,000) $ 24,000 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Method to estimate ending inventory using the gross profit percent Beginning inventory Net purchases Cost of goods available Estimated cost of goods sold: Sales revenue Less: Estimated gross profit of 40% Estimated cost of goods sold $100,000 (40,000) $14,000 66,000 80,000 (60,000) Estimated cost of ending inventory $20,000 Show similar method of calculating COGS 62 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

To compute the estimated cost of ending inventory by the gross profit method: Beginning inventory……………………….

Purchases…………………………………...

Cost of goods available…………………..

Cost of goods sold: Sales revenue…………………………….

$42,450 263,000 305,450 $501,000 Less: Estimated gross profit of 55%… (275,550) Estimated cost of goods sold………….

(225,450) Estimated cost of ending inventory……..

Simpler No running record of inventory Inventory counted at end of a period.

Better for small businesses with smaller inventory amounts Adds four new accounts: Purchases Purchase discounts Purchase returns and allowances Freight in 66 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Purchases—Holds the cost of inventory as it is purchased (Debit balance) Purchase discounts—Discounts for early payment of purchases (Credit balance) Purchase returns and allowances—Items purchased, but returned to the vendor or allowances granted (Credit balance) Freight in—holds the transportation cost paid on inventory purchases (Debit balance) 67 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Beginning inventory + Net purchases Cost of goods available

–

Ending inventory Cost of goods sold Purchases - Purchase Discounts - Purchase returns and allowances + Freight In = Net Purchases 68 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

The four new accounts would be closed out at period end.

E6A-1 COMPUTING PERIODIC INVENTORY AMOUNTS

The periodic inventory records of Synergy Prosthetics indicate the following at July 31: Jul 1 8 15 26 Beginning inventory Purchase Purchase Purchase 6 units @ $60 5 units @ $67 10 units @ $70 5 units @ $85 At July 31, Synergy counts two units of inventory on hand.

1. Compute ending inventory and cost of goods sold, using each of the following methods: a. Average-cost (round average unit cost to nearest cent) b. First-In, First-Out c. Last-In, First-Out 73 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

E6A-1 COMPUTING PERIODIC INVENTORY AMOUNTS

Jul 1 Beginning inventory 8 Purchase 15 Purchase 26 Purchase Goods available 6 units @ $60

5 units @ $67 10 units @ $70 5 units 26 units @ $85 $ 360 335 700 425 $1,820

1. Average 2. FIFO 3. LIFO Ending inventory $1,820÷ 26 units =average unit cost of $70 × 2 = $140 2 @ $85 = $170 2 @ $60 = $120 Cost of goods sold $1,820 − $140 = $1,680 $1,820 − $170 = $1,650 $1,820 − $120 = $1,700

The accounting principles are the foundations that guide how we record transactions.

Inventory costing methods include specific unit-cost, FIFO, LIFO, and average cost. Specific unit identifies the specific cost of each unit of inventory that is in ending inventory and each item that is in cost of goods sold.

Under LIFO, the cost of goods sold is based on the newest purchases. Under the average-cost method, the business computes a new average cost per unit after each purchase. Keep in mind the cost paid to purchase goods is the same under all inventory costing methods. The difference is where we divide up the dollars between the asset, Inventory, and the expense, COGS, on the income statement.

The inventory costing method dictates which purchases are deemed sold (COGS). The sales price to the customer (Sales revenue) is the same regardless of which costing method is used to record COGS. Only the amounts in the COGS journal entries differ among the three costing methods.

If the cost of inventory is declining, an adjustment must be made to lower the Inventory account to the lower value (market). If market is greater than cost, no adjustment is made to the Inventory account.

Because the total spent to acquire goods available for sale is allocated to only the Inventory or the COGS account, if Inventory is incorrectly stated due to an error, COGS is also incorrectly stated. When discovered, errors must be disclosed and corrected in the affected financial statements.

Account for periodic inventory using the three most common costing methods (Appendix 6A) Accounting is simpler in a periodic system because the company keeps no daily running record of inventory on hand. The only way to determine the ending inventory and cost of goods sold in a periodic system is to count the goods—usually at the end of the year.

The periodic system uses four additional accounts: 80 Purchases—this account holds the cost of inventory as it is purchased. Purchases carries a debit balance and is an expense account.

Purchase discounts—this contra account carries a credit balance. Discounts for early payment of purchases are recorded here.

Purchase returns and allowances—this contra account carries a credit balance. Items purchased but returned to the vendor are recorded in this account. Allowances granted by a vendor are also recorded in this account.

Freight in—this account holds the transportation cost paid on inventory purchases. It carries a debit balance and is an expense account.

The end-of-period entries are more extensive in the periodic system because we must close out the beginning inventory balance and set up the cost of the ending inventory. This appendix illustrates the closing process for the periodic system.

Cost of goods sold in a periodic system is computed by the following formula (using assumed amounts for this illustration): Beginning inventory + Net purchases = Cost of goods available Ending inventory = Cost of goods sold Net purchases is determined as follows: Purchases Purchase discounts Purchase returns and allowances + Freight in = Net purchases 82 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Copyright

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