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Chapter 7 - Inventories and Cost of Goods Sold

Chapter 7 - Inventories and Cost of Goods Sold

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Categories:Business/Law, Finance
Published by: Arman on Aug 11, 2011
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 ©  © 
2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
 
Inventories andCost of GoodsSold
CHAPTER
7
 ©  © 
2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
Learning Objectives (LO)
After studying this chapter, you should be able to
1.Link inventory valuation to gross profit2.Use both perpetual and periodic inventory systems3.Calculate the cost of merchandise acquired4.Compute income and inventory values using thethree principal inventory valuation methods allowedunder both U.S. GAAP and IFRS and the onemethod allowed only by U.S. GAAP5.Use the lower-of-cost-or-market method to valueinventories under U.S. GAAP and IFRS
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2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
Learning Objectives (LO)
After studying this chapter, you should be able to
6.Show the effects of inventory errors on financialstatements7.Evaluate the gross profit percentage and inventoryturnover8.Describe characteristics of LIFO and how theyaffect the measurement of income (App. 7A)
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2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO –1 Link Inventory Valuation to GrossProfit
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The initial step in assessing profitability is examining
gross profit
.Gross Profit = Sales –Cost of Goods Sold.Inventory –products being held by the companyprior to sale; a current asset on the balance sheet.The value of each item in the inventory affects thecost of goods sold and therefore the gross profit.
Cost Valuation
 –is the process of assigning aspecific value from the historical cost records toeach item in ending inventory.
 ©  © 
2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO –2 Perpetual and Periodic Systems
Perpetual Inventory System
 –keeps acontinuous record of inventories and cost ofgoods sold that helps managers controlinventory levels and prepare interim financialstatements.
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A=+SE
a. Purchase+Inventory=+AccountsPayableb. Sale+AccountsReceivable=+SalesRevenuec. Cost ofGoods Sold-Inventory =-COGS
 ©  © 
2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO –2 Perpetual and Periodic Systems
Journal entries for the perpetual system
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Merchandise Inventory 870Accounts Payable870To record the purchase of the inventoryAccounts Receivable (or cash) 870Sales Revenue870To record the sale of the inventoryCost of Goods Sold870Merchandise Inventory870To record the reduction in the inventory
 
 ©  © 
2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO –2 Perpetual and Periodic Systems
PeriodicInventory System
 –cost of goodssold is computed only at the end of anaccounting period, when a physical count of aninventory is taken.
PeriodicInventory System
 –cost of goodssold is computed only at the end of anaccounting period, when a physical count of aninventory is taken.
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Beginning
+
Purchases
 – 
Ending = Cost of GoodsInventoryInventory Sold
 ©  © 
2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO –2 Perpetual and Periodic Systems
Physical count
 –Required under a periodic system –A good control practice in a perpetual systems
Firms often choose fiscal accounting periods so thatthe year ends when inventories are lowExternal auditors usually observe a sample of theclient’s physical count to confirm its accuracyPerpetual system provide continues assessments ofinventory levels, but may be costly to implementImplementation costs have fallen with thecomputerized systems
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2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO 3 -Cost of Merchandise Acquired
Cost of merchandize
 –Invoice price –Inbound transportation costs (freight-in) –Discounts –Handling –Insurance –Other costs related to the purchasing and receivingdepartments (treated as period costs by most of thecompanies)
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2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO 3 -Cost of Merchandise Acquired
Transportation
 –FOB (Free on Board) Destination-Seller pays fordelivery to us, the buyer; title transfers on receipt –FOB (Free on Board) Shipping PointWe pay fordelivery from the seller; title transfers when goodsleave buyer*Adjunct account to COGS
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No entryFreight in *30Freight Payable30
 
 ©  © 
2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO 3 -Cost of Merchandise Acquired
Returns, Allowances
Accounts Payable75Purchase Returns/Allowances* 75
* Contra account to inventory or purchases
Discounts
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Merchandise Inventory (Purchases) 960Accounts Payable960Accounts Payable885Discounts on Purchases5Cash880
 ©  © 
2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO 3 -Cost of Merchandise Acquired
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 ©  © 
2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO 4 –Inventory Valuation Methods
If inventory prices were not changing, allmethods would produce the same COGS andending inventory amounts.Since prices do change, which are assigned toCOGS and ending inventory?Four methods are generally accepted:
 –Specific identification -U.S. and IFRS acceptable –First-in, first-out (FIF0) -U.S. and IFRS acceptable –Weighted-average -U.S. and IFRS acceptable –Last-in, first out (LIFO) -U.S. only acceptable
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2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO 4 Inventory Valuation MethodsSpecific Identification
The cost of each inventory item is knownWhen an inventory item is sold, its cost becomespart of COGS. Bar codes facilitate identifyingunits and costs. Physical flow matches theaccounting flowRelatively easy to use, especially for expensivelow-volume merchandiseCOGS/ending inventory easily manipulated ifinventory prices are changing
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2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO 4 –Inventory Valuation MethodsFIFO First In, First Out
Oldest costs are assigned to the income statement(COGS)Latest costs are assigned to the balance sheet(Inventory), making ratios computed there from morereflective of current market valueCOGS can not be manipulatedIn periods of rising prices, FIFO leads to higher taxespaid and net income (by placing the lower costs inCOGS)
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2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO 4 Inventory Valuation MethodsLIFO –Last In, First Out
Oldest costs are assigned to the balance sheet (Inventory).Latest costs are matched to revenue on the income statement(COGS), making ratios computed there from more reflectiveof current market valueCOGS can be manipulated by buying inventory at year-endIn periods of rising prices, LIFO leads to lower net income andlower taxes paidThe Internal Revenue Code requires LIFO users for taxpurposes to also use LIFO for financial reporting purposesNot permitted for IFRS users
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2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO 4 –Inventory Valuation MethodsWeighted Average
Computes a unit cost by dividing the totalacquisition cost of all items available for sale bythe number of units available for saleThe weighted-average method produces grossprofit somewhere between that obtained underFIFO and LIFO
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2010 Pearson Education Inc. Publishing as Prentice Hall2010 Pearson Education Inc. Publishing as Prentice HallIntroduction to Financial Accounting, 10/eIntroduction to Financial Accounting, 10/e
LO 5 –Lower of Cost or Market
LCM method
requires companies to compare the currentmarket price of inventory with historical cost and report thelower of the two as inventory value.
Write-down
reduces the recorded historical cost of an item inresponse to a decline in market value.
Net Realizable Value
 –the net amount the company expectsto receive for the inventory (used under IFRS)
Current Replacement Cost
 –the cost to buy the inventorytoday (used under US GAAP)No reversal of the inventory write-down under US GAAP,Reversal possible under IFRS.
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Loss on write-down of inventory 2Merchandise Inventory2

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