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Chapter 7

Inventories and Cost of Goods Sold PowerPoint Authors: Brandy Mackintosh Lindsay Heiser

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

7-2

Learning Objective 7-1 Describe the issues in managing different types of inventory.

7-3

Inventory Management Decisions The primary goals of inventory managers are to: 1. Maintain a sufficient quantity to meet customers’ needs 2. Ensure quality meets customers’ expectations and company standards 3. Minimize the costs of acquiring and carrying the inventory

7-4

Types of Inventory

Merchandisers . . .

Buy finished goods.

Sell finished goods.

Manufacturers . . .

Buy raw materials.

Produce and sell finished goods.

Merchandise inventory Materials waiting to be processed Partially complete products Raw Materials Work in Process Finished goods Completed products awaiting sale

7-5

Learning Objective 7-2 Explain how to report Inventory and Cost of Goods Sold.

7-6

Balance Sheet and Income Statement Reporting

Cost of Goods Sold Equation

BI + P – CGS = EI

7-7 National Outfitters’ beginning inventory was $4,800. During the period, the company purchased inventory for $10,200. The cost of goods sold for the period is $9,000. Compute the ending inventory. + = =

Cost of Goods Sold Calculation

Beginning Inventory Purchases Cost of Goods Available for Sale Cost of Goods sold Ending Inventory $ 4,800 10,200 15,000 9,000 $ 6,000

Cost of Goods Sold Equation

beginning Inventory $4,800

+

purchases $10,000 goods available for sale $15,000

7-8

ending Inventory $6,000 (Balance Sheet) Cost of Goods Sold $9,000 (Income Statement)

7-9

Learning Objective 7-3 Compute costs using four inventory costing methods.

7-10

Inventory Costing Methods

Specific identification First-in, first-out (FIFO) Last-in, first-out (LIFO) Weighted average

7-11

Inventory Costing Methods

Consider the following information M

ay 3 May 5 May 6 May 8 Purchased 1 unit for $70 Purchased 1 more unit for $75 Purchased 1 more unit for $95 Sold 2 units for $125 each May 6 $95 cost May 5 $75 cost May 3 $70 cost Specific Identification

This method individually identifies and records the cost of each item sold as part of cost of goods sold. If the items sold were identified as the ones that cost $70 and $95, the total cost of those items ($70 + 95 = $165) would be reported as Cost of Goods Sold. The cost of the remaining item ($75) would be reported as Inventory on the balance sheet at the end of the period.

Inventory Costing Methods

FIFO LIFO Weighted average May 6 $95 cost May 5 $75 cost May 3 $70 cost May 6 $95 cost May 5 $75 cost May 3 $70 cost May 6 $95 cost May 5 $75 cost May 3 $70 cost

$240 = 3 $80 per unit 7-12 Income Statement Net Sales Cost of Goods Sold Gross Profit $250 145 $105 Balance Sheet Inventory $95 Income Statement Net Sales Cost of Goods Sold Gross Profit $250 170 $ 80 Balance Sheet Inventory $70 Income Statement Net Sales Cost of Goods Sold Gross Profit $250 160 $ 90 Balance Sheet Inventory $80

Sold Still there

Inventory Costing Methods

Summary

Cost of Goods sold (Income Statement) Inventory (Balance sheet) FIFO Oldest cost Newest cost LIFO Newest cost Oldest cost Weighted Average Average cost Average cost Date Oct 1 Oct 3 Oct 5 Oct 6

Let’s consider a more complex example.

Description Beginning Inventory Purchase Purchase Sales Ending Inventory # of Units 10 30 10 (35) 15 Cost per Unit $ 7 $ 8 $10 To calculate To calculate Total Cost $ 70 240 100 To calculate To calculate 7-13

Inventory Cost Flow Computations

7-14 FIFO + = beginning Inventory purchases cost of goods available for sale ending Inventory 10 units x $ 10 = 100 $ 410 140 Cost of Goods Sold 10 units x $ 7 = $ 70 30 units x $ 8 = 240 $ 270

(10 units @ $10) + (5 units @ $8) (10 units @ $7) + (25 units @ $8)

Inventory Cost Flow Computations

7-15 LIFO + = beginning Inventory purchases cost of goods available for sale ending Inventory 10 units x $ 10 = 100 $ 410 110 Cost of Goods Sold 10 units x $ 7 = $ 70 30 units x $ 8 = 240 $ 300

(10 units @ $7) + (5 units @ $8) (10 units @ $10) + (25 units @ $8)

Inventory Cost Flow Computations

Weighted Average

Description beginning Inventory purchase purchase cost of goods available for sale # of Units 10 30 10 50 Cost per Unit $ 7 $ 8 $10 Total Cost $ 70 240 100 $ 410 7-16

Weighted Average Cost = Weighted Average Cost = Cost of goods Available for Sale Number of Units Available for Sale $410 50 units = $8.20 per unit

7-17

Inventory Cost Flow Computations

Weighted Average + = Beginning Inventory Purchases Cost of Goods Available for Sale Ending Inventory 10 units x $ 10 = 100 $ 410 123 Cost of Goods Sold 10 units x $ 7 = $ 70 30 units x $ 8 = 240 $ 287

15 units @ $8.20

35 units @ $8.20

Financial Statement Effects

Effects on the Income Statement Sales Cost of Goods Sold Gross Profit Operating Expenses Income from Operations Other Revenue (Expenses) Income before Income Tax Expense Income Tax Expense (30%) Net Income 7-18 Effects on the Balance Sheet Inventory FIFO $ 525 270 255 125 130 20 150 45 $ 105 LIFO $ 525 300 225 125 100 20 120 36 $ 84 Weighted Average $ 525 287 238 125 113 20 133 40 $ 93 $ 140 $ 110 $ 123

7-19

Financial Statement Effects

Financial Statement Effects

Weighted Average

Advantages of Methods

First-In, First-Out Last-In, First-Out

7-20

Smoothes out price changes.

Ending inventory approximates current replacement cost.

Better matches current costs in cost of goods sold with revenues.

Tax Implications and Cash Flow Effects

Effects on the Income Statement Sales Cost of Goods Sold Gross Profit Operating Expenses Income from Operations Other Revenue (Expenses) Income before Income Tax Expense Income Tax Expense (30%) Net Income FIFO $ 525 270 255 125 130 20 150 45 $ 105 LIFO $ 525 300 225 125 100 20 120 36 $ 84 Weighted Average $ 525 287 238 125 113 20 133 40 $ 93 7-21 Effects on the Balance Sheet Inventory $ 140 $ 110 $ 123

7-22

Learning Objective 7-4 Reporting inventory at the lower of cost or market.

7-23

Lower of Cost or Market

The value of inventory can fall below its recorded cost for two reasons: 1.

it’s easily replaced by identical goods at a lower cost, or 2.

it’s become outdated or damaged.

When the value of inventory falls below its recorded cost, the amount recorded for inventory is written down to its lower market value. This is known as the lower of cost or market (LCM) rule.

7-24

Lower of Cost or Market

Item Leather coats Vintage jeans

1,000 items @ $165

Cost per Item $165 20 Market Value per Item $150 25 LCM per Item $150 20 Quantity 1,000 400 Total Lower of cost or Market $150,000 8,000 Total cost $165,000 8,000 Write down $15,000 0 1

Analyze Assets 1,000 items @ $150 = Liabilities

Inventory -$15,000

+ 400 items @ $20

Cost of Goods Sold (+E) -$15,000 2

Record

dr Cost of Goods Sold (+E, -SE) cr Inventory (-A) 15,000 15,000

7-25

Lower of Cost or Market

7-26

Learning Objective 7-5 Analyze and record inventory purchases, transportation, returns and allowances, and discounts.

7-27

Recording Inventory Transactions

We will now look at the accounting for purchases, transportation costs, purchase returns and allowances, and purchase discounts. We will record all inventory-related transactions in the Inventory account.

7-28

Inventory Purchases

American Eagle Outfitters purchases $10,500 of vintage jeans on credit.

1

Analyze Assets

Inventory (+A) +$10,500

= Liabilities

Accounts Payable (+L) $10,500

+ Stockholders’ Equity

2

Record

dr Inventory (+A) cr Accounts Payable (+L) 10,500 10,500

7-29

Transportation Cost

American Eagle pays $400 cash to a trucker who delivers the $10,500 of vintage jeans to one of its stores.

1

Analyze Assets

Cash (-A) -$400 Inventory (+A) +$400

= Liabilities + Stockholders’ Equity

2

Record

dr Inventory (+A) cr Cash (-A) 400 400

7-30

Purchase Returns and Allowances

American Eagle returned some of the vintage jeans to the supplier and received a $500 reduction in the balance owed.

1

Analyze Assets

Inventory (-A) -$500

= Liabilities

Accounts Payable (-L) -$500

+ Stockholders’ Equity

2

Record

dr Accounts Payable (-L) cr Inventory (-A) 500 500

7-31

Purchase Discounts

American Eagle’s vintage jeans purchase for $10,500 had terms of 2/10, n/30. Recall that American Eagle returned inventory costing $500 and received a $500 reduction in its Accounts Payable. American Eagle paid within the discount period.

1

Analyze Assets

Cash (-A) -$9,800 Inventory (-A) -$200

= Liabilities

Accounts Payable (-L) -10,000

+ Stockholders’ Equity

2

Record

dr Accounts Payable (-L) cr Cash (-A) cr Inventory (-A) 10,000 9,800 200

7-32

Summary of Inventory Transactions

7-33

Learning Objective 7-6 Evaluate inventory management by computing and interpreting the inventory turnover ratio.

7-34

Inventory Turnover Analysis

7-35

Comparison to Benchmarks

Supplement 7A

FIFO, LIFO, and Weighted Average in a Perpetual Inventory System

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

7-37

Perpetual Inventory System

Date Oct 1 Oct 3 Oct 4 Oct 5

This is the same information that we used earlier in the chapter to illustrate a periodic inventory system. The only difference is that we have assumed the sales occurred on October 4, prior to the final inventory purchase.

Description Beginning Inventory Purchase Sales Purchase Ending Inventory # of Units 10 30 (35) 10 15 Cost per Unit $ 7 $ 8 To calculate $ 10 To calculate Total Cost $ 70 $ 240 To calculate $ 100 To calculate

7-38

FIFO (First-in, First-Out)

7-39

LIFO (Last-in, First-Out)

7-40

Weighted Average Cost

$310 ÷ 40 units = $7.75 per unit

7-41

Financial Statement Effects

Summary of Perpetual Inventory System Cost Flow Assumptions on Financial Statements

Supplement 7B

The Effects of Errors in Ending Inventory

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

7-43

The Effects of Errors in Ending Inventory

Cost of Goods Sold Equation BI + P – CGS = EI

Errors in Ending Inventory will affect the Balance Sheet and the Income Statement.

Assume that Ending Inventory was overstated in 2012 by $10,000 due to an error that was not discovered until 2013. + = 2012 Beginning Inventory Purchases Ending Inventory Cost of Goods Sold Accurate Accurate Overstated $10,000 Understated $10,000

The Effects of Errors in Ending Inventory

Now let’s examine the effects of the 2012 Ending Inventory Error on 2013.

7-44 Assume that Ending Inventory was overstated in 2012 by $10,000 due to an error that was not discovered until 2013. + = 2013 Beginning Inventory Purchases Ending Inventory Cost of Goods Sold Overstated $10,000 Accurate Accurate Overstated $10,000

Supplement 7C

Recording Inventory Transactions in a Periodic System

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Recording Inventory Transactions in a Periodic System

7-46

A local cell phone dealer stocks and sells one item.

The following events occurred in the past year: Jan. 1 Apr. 14 Nov. 30 Dec. 31 Beginning inventory: 80 units at a cost of $60.

Purchased 170 additional units on account at a cost of $60.

Sold 150 units on account at a unit sales price of $80.

Counted 100 units at a unit cost of $60.

We will record these events assuming the company uses a periodic inventory system and then compare the periodic inventory system to a perpetual inventory system.

7-47

Recording Inventory Transactions in a Periodic System

Periodic Inventory System Perpetual Inventory System

Recording Inventory Transactions in a Periodic System

Periodic Inventory System

BI + P – CGS = EI

7-48 End-of-year adjustment entries are not required using a perpetual inventory system.

7-49

Recording Inventory Transactions in a Periodic System

Summary of the Effects on the Accounting Equation Periodic Inventory System Perpetual Inventory System

Chapter 7 Solved Exercises

M7-6, M7-7, E7-2, E7-5, E7-10, E7-17

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

7-51

M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost

Given the following information, calculate cost of goods available for sale and ending inventory, then sales, cost of goods sold, and gross profit, under (a) FIFO, (b) LIFO, and (c) weighted average. Assume a periodic inventory system is used.

M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost

7-52 a. FIFO Beginning Inventory + Purchase Cost of Goods Available for Sale - Ending Inventory (200 x $13) 50 units x $10 = $ 500 250 units x $13 = $3,250 = Cost of Goods Sold (50 x $10) + (50 x $13) $3,750 = $2,600 $1,150

M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost

7-53 b. LIFO Beginning Inventory = Cost of Goods Sold (100 x $13) 50 units x $10 = $ 500 + Purchase Cost of Goods Available for Sale 250 units x $13 = $3,250 - Ending Inventory (150 x $13) + (50 x $10) $3,750 = $2,450 $1,300

M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost

7-54 c. Weighted Average Beginning Inventory + Purchase Cost of Goods Available for Sale - Ending Inventory (200 x $12.50) 50 units x $10 = $ 500 250 units x $13 = $3,250 = Cost of Goods Sold (100 x $12.50) $3,750 = $2,500 $1,250

Weighted Average Cost = $3,750 300 units = $12.50 per unit

7-55

M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost

Sales (100 units at $15) Cost of Goods Sold Gross Profit FIFO $1,500 1,150 $ 350 LIFO $1,500 1,300 $ 200 Weighted Avg $1,500 1,250 $ 250

7-56

M7-7 Calculating Cost of Goods Available for Sale, Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Weighted Average Cost (Periodic Inventory)

Aircard Corporation tracks the number of units purchased and sold throughout each accounting period, but applies its inventory costing method at the end of each period as if it uses a periodic inventory system. Given the following information, calculate the cost of goods available for sale, ending inventory, and cost of goods sold, if Aircard uses (

a

) FIFO, (

b

) LIFO, or (

c

) weighted average cost.

7-57

M7-7 Calculating Cost of Goods Available for Sale, Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Weighted Average Cost (Periodic Inventory)

Goods Available for Sale – same for all methods Units Unit Beginning Inventory + Purchase (July 13) + Purchase (July 25) Goods Available for Sale 2,000 6,000 8,000 16,000 Cost $40 $44 $50 Total Cost $ 80,000 264,000 400,000 $744,000

7-58

M7-7 Calculating Cost of Goods Available for Sale, Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Weighted Average Cost (Periodic Inventory)

a. FIFO Ending Inventory Cost of Goods Sold (7,000 units x $50) (2,000 units x $40) (6,000 units x $44) (1,000 units x $50) = $350,000 = $394,000 b. LIFO Ending Inventory Cost of Goods Sold (2,000 units x $40) (5,000 units x $44) (8,000 units x $50) (1,000 units x $44) = $300,000 = $444,000

7-59

M7-7 Calculating Cost of Goods Available for Sale, Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Weighted Average Cost (Periodic Inventory)

c. Weighted Average Average Unit Cost Ending Inventory Cost of Goods Sold $744,000 / 16,000 = $46.50

(7,000 units x $46.50) = $325,500 (9,000 units x $46.50) = $418,500

E7-2 Inferring Missing Amounts Based on Income Statement Relationships

Supply the missing dollar amounts for the income statement of Lewis Retailers for each of the following independent cases.

7-60 Case Sales Revenue Beginning Inventory Purchases A B C D E $700 900 ?

800 1,000 $100 200 100 ?

50 $800 800 ?

600 900 Cost of Goods Available ?

?

?

?

?

Cost of Goods Sold $300 ?

200 650 ?

Cost of Ending Inventory $?

150 300 250 ?

Gross Profit $?

?

400 ?

500

7-61

E7-2 Inferring Missing Amounts Based on Income Statement Relationships

Supply the missing dollar amounts for the 2010 income statement of Lewis Retailers for each of the following independent cases.

Case Sales Revenue Beginning Inventory Purchases A B C D E $700 900

600

?

800 1,000 $100 200 100

300

?

50 $800 800

400

?

600 900 Cost of Goods Available

900

?

1,000

?

500

?

900

?

950

?

Cost of Goods Sold $300

850

?

200 650

500

?

Cost of Ending Inventory

600

$?

150 300 250

450

?

Gross Profit

400

$?

50

?

400

150

?

500

E7-5 Calculating Cost of Ending Inventory and Cost of Goods Sold under Periodic FIFO, LIFO, and Weighted Average

Oahu Kiki tracks the number of units purchased and sold throughout each accounting period but applies its inventory costing method at the end of each month, as if it uses a periodic inventory system. Assume Oahu Kiki’s records show the following for the month of January. Sales totaled 240 units.

7-62

Required

: 1. Calculate the number and cost of goods available for sale.

Goods Available for Sale – same for all methods Units Unit Cost Beginning Inventory + Purchase (Jan 15) + Purchase (Jan 24) Goods Available for Sale 120 380 200 700 $80 $90 $110 Total Cost $ 9,600 34,200 22,000 $65,800

7-63

E7-5 Calculating Cost of Ending Inventory and Cost of Goods Sold under Periodic FIFO, LIFO, and Weighted Average

Assume Oahu Kiki’s uses a periodic inventory system, which shows the following for the month of January. Sales totaled 240 units.

Required

: 2. Calculate the number of units in ending inventory.

Units in Ending Inventory = Units Available – Units Sold Units in Ending Inventory = 700 – 240 = 460 units

E7-5 Calculating Cost of Ending Inventory and Cost of Goods Sold under Periodic FIFO, LIFO, and Weighted Average

Assume Oahu Kiki’s uses a periodic inventory system, which shows the following for the month of January. Sales totaled 240 units.

7-64

Required

: 3. Calculate the cost of ending Inventory and Cost of Goods Sold using the (

a)

FIFO,

(b)

LIFO, and (

c) w

eighted average cost methods.

a. FIFO ending Inventory Cost of Goods Sold (200 units x $110) (260 units x $ 90) (120 units x $80) (120 units x $90) = $45,400 = $20,400

E7-5 Calculating Cost of Ending Inventory and Cost of Goods Sold under Periodic FIFO, LIFO, and Weighted Average

Assume Oahu Kiki’s uses a periodic inventory system, which shows the following for the month of January. Sales totaled 240 units.

7-65

Required

: 3. Calculate the cost of ending inventory and cost of goods sold using the (

a)

FIFO,

(b)

LIFO, and (

c)

weighted average cost methods.

b. LIFO Ending Inventory Cost of Goods Sold (120 units x $80) (340 units x $90) (200 units x $110) ( 40 units x $ 90) = $40,200 = $25,600

E7-5 Calculating Cost of Ending Inventory and Cost of Goods Sold under Periodic FIFO, LIFO, and Weighted Average

Assume Oahu Kiki’s uses a periodic inventory system, which shows the following for the month of January. Sales totaled 240 units.

7-66

Required

: 3. Calculate the cost of ending inventory and cost of goods sold using the (

a)

FIFO,

(b)

LIFO, and (

c)

weighted average cost methods.

c. Weighted Average Average Unit Cost Ending Inventory Cost of Goods Sold $65,800 / 700 units (460 units x $94) (240 units x $94) = $94 = $43,240 = $22,560

E7-10 Reporting Inventory at Lower of Cost or Market

Peterson Furniture Designs is preparing the annual financial statements dated December 31, 2012. Ending inventory information about the five major items stocked for regular sale follows: Item Alligator Armoires Bear Bureaus Cougar Beds Dingo Cribs Elephant Dressers 7-67

Required:

1. Complete the final two columns of the table and then compute the amount that should be reported for the 2012 ending inventory using the LCM rule applied to each item.

Qty 50 75 10 30 400 Total Total Cost x $30 = $1,500 x $40 = $3,000 x $50 = $ 500 x $30 = $ 900 x $15 = $6,000 $11,900 Total Market x $24 = $1,200 x $40 = $3,000 x $52 = $ 520 x $30 = $ 900 x $12 = $4,800

$1,500

LCM Per Item $24 40 50 30 12 LCM Valuation $1,200 3,000 500 900 4,800 $10,400

7-68

E7-10 Reporting Inventory at Lower of Cost or Market

Peterson Furniture Designs is preparing the annual financial statements dated December 31, 2012. Ending inventory information about the five major items stocked for regular sale follows:

Required:

2. Prepare the journal entry that Peterson Furniture Designs would record on December 31, 2012.

dr

Cost of Goods Sold (E+, -SE) 1,500

cr

Inventory (-A) 1,500

E7-17 Analyzing and Interpreting the Inventory Turnover Ratio

Polaris Industries Inc. is the biggest snowmobile manufacturer in the world. It reported the following amounts in its financial statements (in millions): 7-69

Required:

1. Calculate to one decimal place the inventory turnover ratio and average days to sell inventory for 2010, 2009, and 2008. 2010 2009 2008 Inventory Turnover Ratio = Cost of Goods Sold Average Inventory = 7.0* 5.8** Times per year 6.8*** Days to Sell =

*7.0 = $1,461 ÷ $208

365 Days Inventory Turnover =

**5.8 = $1,173

÷

$201

51.9

62.5

days 53.4

***6.8 = $1,502

÷

$220

E7-17 Analyzing and Interpreting the Inventory Turnover Ratio

Polaris Industries Inc. is the biggest snowmobile manufacturer in the world. It reported the following amounts in its financial statements (in millions): 7-70

Required:

2. Comment on any trends, and compare the effectiveness of inventory managers at Polaris to inventory managers at its main competitor, Arctic Cat, where inventory turns over 3.6 times per year (101.4 days to sell). Both companies use the same inventory costing method (FIFO).

The inventory turnover ratio reflects how many times average inventory was made and sold during the year. The inventory turnover ratio for Polaris Industries has increased in 2010 over 2009, leading to a decrease in the average days to sell. This trend suggests that Polaris is selling its inventory more quickly. This is generally considered to be a positive performance. Polaris is performing better than Arctic Cat, where the inventory turnover is 3.6 times per year or every 101.4 days.

7-71

End of Chapter 7