Description
account for inventory by the periodic and perpetual systems, apply the inventory costing methods: specific unit cost, weighted-average cost, FIFO and LIFO, identify the income effects and the tax effects of the inventory costing methods, apply the lower-of-cost-or-market rule to inventory, determine the effects of inventory errors on cost of goods sold and net income and estimate ending inventory by the gross margin method
– ?
is a Maryland based furniture retailer. In a report filed with the SEC, Huntington disclosed that the company switched from the FIFO method to the LIFO method of accounting for inventories.
? ?
Why would a company do this? To save on income taxes.
1 2
Account for inventory by the periodic and perpetual systems. Apply the inventory costing methods: specific unit cost, weighted-average cost, FIFO and LIFO.
3 4 5
Identify the income effects and the tax effects of the inventory costing methods. Apply the lower-of-cost-or-market rule to inventory. Determine the effects of inventory errors on cost of goods sold and net income.
6 7
Estimate ending inventory by the gross margin method. Report inventory transactions on the statement of cash flows.
?
For a merchandising entity, inventory is the major asset. Cost of goods sold is the major expense.
?
Account for inventory by the periodic and perpetual systems.
– –
Perpetual system Periodic system
–
maintains a continuous record of each inventory item.
? ?
? ?
Inventory on hand is known at all times. The cost of ending inventory and cost of goods sold can be determined directly from the accounts. Helps safeguard inventory. Improved customer service is achieved.
– –
errorless processing of large numbers of transactions and... enhanced management information for decision making.
?
?
Purchases are debited to the inventory account. Cash or accounts payable is credited.
?
Cash or Accounts Payable Credit
Inventory Purchases
? 1 2
A sale necessitates two entries: Debit to Cash or Accounts Receivable & Credit to Sales Revenue Debit to Cost of Goods Sold & Credit to Inventory
Cash/or Accounts Receivable Sales price
Sales Revenue Sales price Cost of Goods Sold Cost of sales
Inventory Cost of sales
?
There is no continuous record of inventory on hand. At the end of the period make a physical count and apply unit cost to determine ending inventory.
?
?
Inventory purchases are debited to the purchases account. The inventory account carries the beginning inventory balance until adjusted at period end.
?
?
The inventory account is updated at the end of the period.
Inventory
Beginning Beginning Balance Balance Ending Balance
Purchases
Purchases
Accounts Payable
Purchases
Income Summary
Beginning Ending Balance Balance
Under the periodic system: Beginning inventory +Purchases (including transportation costs) =Cost of goods available for sale – Ending inventory =Cost of goods sold
?
? 1 2 3
The amount of inventory to purchase depends upon three factors: Budgeted cost of goods sold Budgeted ending inventory Beginning inventory
Cost of goods sold (budgeted) +Ending inventory (budgeted) =Cost of goods available for sale – Beginning inventory (actual amount) =Purchases
?
?
?
Sales revenues - cost of goods sold = gross margin (before operating expenses). Gross margin minus all other expenses = net income.
?
Ending inventory cost
=Quantity x unit cost
? ?
Determining quantity:
Physical count is made at least once a year even with a perpetual system.
Adjustments may be required for goods in transit. Consigned goods are excluded.
?
?
?
Goods have been shipped but have not yet arrived. Should we include these goods in inventory? What criteria should we use to determine this?
? ?
? ? ?
Ownership How is ownership determined? When title passes.
?
?
If FOB shipping point, merchandise is included in buyer’s inventory. If FOB destination, merchandise is included in seller’s inventory.
?
Goods that are on the premises but are not owned by the company.
Apply the inventory costing methods: specific unit cost, weighted-average cost, FIFO and LIFO.
– – – –
Specific unit cost Weighted-average cost First-in, first-out (FIFO) cost Last-in, first-out (LIFO) cost
– – – – – –
January 8 May 19 October 23 Total units Units sold Units left
20 units @ $20 = $ 400 55 units @ $30 = $1,650 25 units @ $31 = $ 775 100 70 30
Inventory Layers
25 Units @ $31 (Oct) 55 Units @ $30 (May) 20 Units @ $20 (Jan)
?
Units sold by date: Jan 5 = May 19 = Oct 23 = Total sales = 30 units left in inventory
17 33 20 70
Cost Of Goods Sold Oct 23 $ 620 May 19 990 Jan 5 340 Total $1,950
20 Units @ $31 5 Units @ $31 33 Units @ $30 22 Units @ $30
17 Units @ $20 3 Units @ $20
Ending Inventory Oct 23 $ 155 May 19 660 Jan 5 60 Total $ 875
20 Units @ $31 5 Units @ $31 33 Units @ $30 22 Units @ $30
17 Units @ $20 3 Units @ $20
First-In, First-Out
25 Units @ $31 (Oct) Cost Of Goods Sold Jan $ 400 May 1,500 Total $1,900 5 Units @ $30 (May) 50 Units @ $30
20 Units @ $20 (Jan)
First-In, First-Out
Ending Inventory Oct $775 May 150 Total $925
25 Units @ $31 (Oct) 5 Units @ $30 (May) 50 Units @ $30
20 Units @ $20 (Jan)
Last-In, First-Out
Cost Of Goods Sold Oct $ 775 May 1,350 Total $2,125
25 Units @ $31 (Oct) 45 Units @ $30 (May) 10 Units @ $30
20 Units @ $20 (Jan)
Last-In, First-Out
25 Units @ $31 (Oct) Ending Inventory Oct $300 May 400 Total $700 45 Units @ $30 (May) 10 Units @ $30
20 Units @ $20 (Jan)
Weighted Average
25 Units @ $31 (Oct) 55 Units @ $30 (May) = $ 775 = 1,650
20 Units @ $20 (Jan)
100 Units Totals
=
400
$2,825
Weighted Average
?
$2,825 Total cost/100 Total units
=$28.25 per unit ? Cost of goods sold = $1,977.50 (70 x $28.25) = $1,977.50 ? Ending Inventory = $847.50 (30 x $28.25) = $847.50
? ?
Sales $3,000 (all methods) Cost of goods available for sale $2,825 (all methods)
? ? ? ? ?
Ending Inventory: Specific identification FIFO LIFO Weighted-average
$875.00 $925.00 $700.00 $847.50
? ? ? ? ?
Cost of Goods Sold: Specific identification FIFO LIFO Weighted-average
$1,950.00 $1,900.00 $2,125.00 $1,977.50
? ? ? ? ?
Gross Margin from Sales: Specific identification $1,050.00 FIFO $1,100.00 LIFO $ 875.00 Weighted-average $1,022.50
When prices are rising LIFO produces the lowest income and lowest income tax.
Identify the income effects and the tax effects of the inventory costing methods.
?
?
During periods of inflation LIFO’s income is the lowest. The most attractive feature of LIFO is reduced income tax payments.
? 1
2
3
What questions are asked to judge the major inventory costing methods? How well does each method match inventory expense? Which method reports the most up-todate inventory amount? What effects do the methods have on income taxes?
?
?
During periods of inflation, LIFO overstates income by the so-called inventory profit. Inventory profit is the difference between gross margin figured on the FIFO basis and the LIFO basis.
? – –
When prices are rising... and inventory quantities fall below the level of the previous period... the company must dip into older LIFO layers which releases older costs to the income statement which increases reported income.
?
?
Many companies keep their perpetual inventory records in quantities only. Other companies keep perpetual records in both quantities and dollar cost.
? – – –
A perpetual inventory record shows three columns: Received column Sold column Balance column
?
?
The balance column represents the cost of the inventory on hand. Actual Galleries Item: Contemporary Chairs Balance Date Qty. Unit Cost Total Nov 1 10 $350 $3,500
?
?
The total in the sold column represents cost of goods sold. Actual Galleries Item: Contemporary Chairs Sold Date Qty. Unit Cost Total Nov 5 5 $350 $1,750
?
?
The total in the received column represents total purchases. Actual Galleries Item: Contemporary Chairs Received Date Qty. Unit Cost Total Nov 7 25 $400 $10,000
?
Actual Galleries Item: Contemporary Chairs Received Sold Date Total Total Nov 1 5 $1,750 7 $10,000
Balance Total $ 3,500 1,750 $11,750
?
This principle requires the business to use the same accounting methods and procedures from one period to the next. A company may change inventory methods, but it must disclose the effects of the change on net income.
?
?
The financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company.
? – – – ?
Information should be disclosed that is: Relevant Reliable Comparable The inventory method used must be disclosed.
?
An item is material if it has the potential to alter a statement user’s decision. Materiality is specific to the entity being evaluated.
?
?
Err on the side of caution when reporting any item in the financial statements.
Apply the lower-of-costor-market rule to inventory.
?
An asset is reported at the lower of its historical cost or market (replacement) value. This is required by the conservatism principle.
?
?
?
Market value generally means current inventory replacement cost. If the replacement cost falls below its historical cost, the business must write down the value of its inventory.
?
? ?
To decrease the value of inventory in a perpetual system: (Dr.) Cost of Goods Sold and (Cr.) Inventory. In a periodic system the cost of goods sold also absorbs the decrease in inventory values.
Determine the effects of inventory errors on cost of goods sold and net income.
?
If inventory is computed incorrectly, how many years of financial statements will it affect?
? – – ? ? –
Which two years? The current year The next year Why?
The current year’s ending inventory…
is next year’s beginning inventory.
Estimate ending inventory by the gross margin method.
?
Beginning inventory
+Net purchases
= Cost of goods available for sale – Ending inventory =Cost of goods sold
?
Rearrange ending inventory and cost of goods sold. Beginning inventory
?
+Net purchases
=Cost of goods available for sale
– Cost of goods sold =Ending inventory
?
Using the gross margin rate on net sales you can estimate cost of goods sold. Subtract cost of goods sold from goods available to estimate ending inventory.
?
?
Compute the inventory loss due to flood damage : Net Sales $ 150,000
Gross Profit Margin
Beginning Inventory
31.5%
18,500
Net Purchases
110,500
Net Sales – Gross Profit 31.5% =Cost of Goods Sold ? Beginning Inventory +Purchases =Goods Available For Sale – Cost of Goods Sold =Ending Inventory
?
150,000 47,250 102,750 18,500 110,500 129,000 102,750 26,250
Report inventory transactions on the statement of cash flows.
?
?
?
Huge amounts of cash are involved in inventory transactions. The income statement shows revenues, expenses and net income for a period of time. The balance sheet reports the company’s assets, liabilities and owner’s equity.
?
?
?
The income statement or balance sheet do not report on the following: How much cash did the business spend on inventory? How much cash did the business collect from customers?
?
?
?
Only the statement of cash flows answers these questions. Inventory-related activities are operating activities. The purchase and sale of merchandise are at the very core of a company’s operations.
doc_376974283.pptx
account for inventory by the periodic and perpetual systems, apply the inventory costing methods: specific unit cost, weighted-average cost, FIFO and LIFO, identify the income effects and the tax effects of the inventory costing methods, apply the lower-of-cost-or-market rule to inventory, determine the effects of inventory errors on cost of goods sold and net income and estimate ending inventory by the gross margin method
– ?
is a Maryland based furniture retailer. In a report filed with the SEC, Huntington disclosed that the company switched from the FIFO method to the LIFO method of accounting for inventories.
? ?
Why would a company do this? To save on income taxes.
1 2
Account for inventory by the periodic and perpetual systems. Apply the inventory costing methods: specific unit cost, weighted-average cost, FIFO and LIFO.
3 4 5
Identify the income effects and the tax effects of the inventory costing methods. Apply the lower-of-cost-or-market rule to inventory. Determine the effects of inventory errors on cost of goods sold and net income.
6 7
Estimate ending inventory by the gross margin method. Report inventory transactions on the statement of cash flows.
?
For a merchandising entity, inventory is the major asset. Cost of goods sold is the major expense.
?
Account for inventory by the periodic and perpetual systems.
– –
Perpetual system Periodic system
–
maintains a continuous record of each inventory item.
? ?
? ?
Inventory on hand is known at all times. The cost of ending inventory and cost of goods sold can be determined directly from the accounts. Helps safeguard inventory. Improved customer service is achieved.
– –
errorless processing of large numbers of transactions and... enhanced management information for decision making.
?
?
Purchases are debited to the inventory account. Cash or accounts payable is credited.
?
Cash or Accounts Payable Credit
Inventory Purchases
? 1 2
A sale necessitates two entries: Debit to Cash or Accounts Receivable & Credit to Sales Revenue Debit to Cost of Goods Sold & Credit to Inventory
Cash/or Accounts Receivable Sales price
Sales Revenue Sales price Cost of Goods Sold Cost of sales
Inventory Cost of sales
?
There is no continuous record of inventory on hand. At the end of the period make a physical count and apply unit cost to determine ending inventory.
?
?
Inventory purchases are debited to the purchases account. The inventory account carries the beginning inventory balance until adjusted at period end.
?
?
The inventory account is updated at the end of the period.
Inventory
Beginning Beginning Balance Balance Ending Balance
Purchases
Purchases
Accounts Payable
Purchases
Income Summary
Beginning Ending Balance Balance
Under the periodic system: Beginning inventory +Purchases (including transportation costs) =Cost of goods available for sale – Ending inventory =Cost of goods sold
?
? 1 2 3
The amount of inventory to purchase depends upon three factors: Budgeted cost of goods sold Budgeted ending inventory Beginning inventory
Cost of goods sold (budgeted) +Ending inventory (budgeted) =Cost of goods available for sale – Beginning inventory (actual amount) =Purchases
?
?
?
Sales revenues - cost of goods sold = gross margin (before operating expenses). Gross margin minus all other expenses = net income.
?
Ending inventory cost
=Quantity x unit cost
? ?
Determining quantity:
Physical count is made at least once a year even with a perpetual system.
Adjustments may be required for goods in transit. Consigned goods are excluded.
?
?
?
Goods have been shipped but have not yet arrived. Should we include these goods in inventory? What criteria should we use to determine this?
? ?
? ? ?
Ownership How is ownership determined? When title passes.
?
?
If FOB shipping point, merchandise is included in buyer’s inventory. If FOB destination, merchandise is included in seller’s inventory.
?
Goods that are on the premises but are not owned by the company.
Apply the inventory costing methods: specific unit cost, weighted-average cost, FIFO and LIFO.
– – – –
Specific unit cost Weighted-average cost First-in, first-out (FIFO) cost Last-in, first-out (LIFO) cost
– – – – – –
January 8 May 19 October 23 Total units Units sold Units left
20 units @ $20 = $ 400 55 units @ $30 = $1,650 25 units @ $31 = $ 775 100 70 30
Inventory Layers
25 Units @ $31 (Oct) 55 Units @ $30 (May) 20 Units @ $20 (Jan)
?
Units sold by date: Jan 5 = May 19 = Oct 23 = Total sales = 30 units left in inventory
17 33 20 70
Cost Of Goods Sold Oct 23 $ 620 May 19 990 Jan 5 340 Total $1,950
20 Units @ $31 5 Units @ $31 33 Units @ $30 22 Units @ $30
17 Units @ $20 3 Units @ $20
Ending Inventory Oct 23 $ 155 May 19 660 Jan 5 60 Total $ 875
20 Units @ $31 5 Units @ $31 33 Units @ $30 22 Units @ $30
17 Units @ $20 3 Units @ $20
First-In, First-Out
25 Units @ $31 (Oct) Cost Of Goods Sold Jan $ 400 May 1,500 Total $1,900 5 Units @ $30 (May) 50 Units @ $30
20 Units @ $20 (Jan)
First-In, First-Out
Ending Inventory Oct $775 May 150 Total $925
25 Units @ $31 (Oct) 5 Units @ $30 (May) 50 Units @ $30
20 Units @ $20 (Jan)
Last-In, First-Out
Cost Of Goods Sold Oct $ 775 May 1,350 Total $2,125
25 Units @ $31 (Oct) 45 Units @ $30 (May) 10 Units @ $30
20 Units @ $20 (Jan)
Last-In, First-Out
25 Units @ $31 (Oct) Ending Inventory Oct $300 May 400 Total $700 45 Units @ $30 (May) 10 Units @ $30
20 Units @ $20 (Jan)
Weighted Average
25 Units @ $31 (Oct) 55 Units @ $30 (May) = $ 775 = 1,650
20 Units @ $20 (Jan)
100 Units Totals
=
400
$2,825
Weighted Average
?
$2,825 Total cost/100 Total units
=$28.25 per unit ? Cost of goods sold = $1,977.50 (70 x $28.25) = $1,977.50 ? Ending Inventory = $847.50 (30 x $28.25) = $847.50
? ?
Sales $3,000 (all methods) Cost of goods available for sale $2,825 (all methods)
? ? ? ? ?
Ending Inventory: Specific identification FIFO LIFO Weighted-average
$875.00 $925.00 $700.00 $847.50
? ? ? ? ?
Cost of Goods Sold: Specific identification FIFO LIFO Weighted-average
$1,950.00 $1,900.00 $2,125.00 $1,977.50
? ? ? ? ?
Gross Margin from Sales: Specific identification $1,050.00 FIFO $1,100.00 LIFO $ 875.00 Weighted-average $1,022.50
When prices are rising LIFO produces the lowest income and lowest income tax.
Identify the income effects and the tax effects of the inventory costing methods.
?
?
During periods of inflation LIFO’s income is the lowest. The most attractive feature of LIFO is reduced income tax payments.
? 1
2
3
What questions are asked to judge the major inventory costing methods? How well does each method match inventory expense? Which method reports the most up-todate inventory amount? What effects do the methods have on income taxes?
?
?
During periods of inflation, LIFO overstates income by the so-called inventory profit. Inventory profit is the difference between gross margin figured on the FIFO basis and the LIFO basis.
? – –
When prices are rising... and inventory quantities fall below the level of the previous period... the company must dip into older LIFO layers which releases older costs to the income statement which increases reported income.
?
?
Many companies keep their perpetual inventory records in quantities only. Other companies keep perpetual records in both quantities and dollar cost.
? – – –
A perpetual inventory record shows three columns: Received column Sold column Balance column
?
?
The balance column represents the cost of the inventory on hand. Actual Galleries Item: Contemporary Chairs Balance Date Qty. Unit Cost Total Nov 1 10 $350 $3,500
?
?
The total in the sold column represents cost of goods sold. Actual Galleries Item: Contemporary Chairs Sold Date Qty. Unit Cost Total Nov 5 5 $350 $1,750
?
?
The total in the received column represents total purchases. Actual Galleries Item: Contemporary Chairs Received Date Qty. Unit Cost Total Nov 7 25 $400 $10,000
?
Actual Galleries Item: Contemporary Chairs Received Sold Date Total Total Nov 1 5 $1,750 7 $10,000
Balance Total $ 3,500 1,750 $11,750
?
This principle requires the business to use the same accounting methods and procedures from one period to the next. A company may change inventory methods, but it must disclose the effects of the change on net income.
?
?
The financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company.
? – – – ?
Information should be disclosed that is: Relevant Reliable Comparable The inventory method used must be disclosed.
?
An item is material if it has the potential to alter a statement user’s decision. Materiality is specific to the entity being evaluated.
?
?
Err on the side of caution when reporting any item in the financial statements.
Apply the lower-of-costor-market rule to inventory.
?
An asset is reported at the lower of its historical cost or market (replacement) value. This is required by the conservatism principle.
?
?
?
Market value generally means current inventory replacement cost. If the replacement cost falls below its historical cost, the business must write down the value of its inventory.
?
? ?
To decrease the value of inventory in a perpetual system: (Dr.) Cost of Goods Sold and (Cr.) Inventory. In a periodic system the cost of goods sold also absorbs the decrease in inventory values.
Determine the effects of inventory errors on cost of goods sold and net income.
?
If inventory is computed incorrectly, how many years of financial statements will it affect?
? – – ? ? –
Which two years? The current year The next year Why?
The current year’s ending inventory…
is next year’s beginning inventory.
Estimate ending inventory by the gross margin method.
?
Beginning inventory
+Net purchases
= Cost of goods available for sale – Ending inventory =Cost of goods sold
?
Rearrange ending inventory and cost of goods sold. Beginning inventory
?
+Net purchases
=Cost of goods available for sale
– Cost of goods sold =Ending inventory
?
Using the gross margin rate on net sales you can estimate cost of goods sold. Subtract cost of goods sold from goods available to estimate ending inventory.
?
?
Compute the inventory loss due to flood damage : Net Sales $ 150,000
Gross Profit Margin
Beginning Inventory
31.5%
18,500
Net Purchases
110,500
Net Sales – Gross Profit 31.5% =Cost of Goods Sold ? Beginning Inventory +Purchases =Goods Available For Sale – Cost of Goods Sold =Ending Inventory
?
150,000 47,250 102,750 18,500 110,500 129,000 102,750 26,250
Report inventory transactions on the statement of cash flows.
?
?
?
Huge amounts of cash are involved in inventory transactions. The income statement shows revenues, expenses and net income for a period of time. The balance sheet reports the company’s assets, liabilities and owner’s equity.
?
?
?
The income statement or balance sheet do not report on the following: How much cash did the business spend on inventory? How much cash did the business collect from customers?
?
?
?
Only the statement of cash flows answers these questions. Inventory-related activities are operating activities. The purchase and sale of merchandise are at the very core of a company’s operations.
doc_376974283.pptx