You are on page 1of 50

Chapter 6

Inventory and
Merchandising
Operations

Chapter 5 Review
Bank Reconciliation

Bank Side
+ Deposits in Transit
- Outstanding Checks
Book Side
+Bank Collections
+ Interest Earned
+ EFT receipts
- EFT payments
- Service charges
Must enter journal entries
related to the book side

Copyright 2014 Pearson Education.

Accounts Receivables

Balance revenues with cost of


not being able to collect
Bad Debt
Uncollectible Accounts
Doubtful Accounts
Steps related to bad debts
1) Record BDE & Allowance
2) Write off bad debts
3) Calculate how much
allowance is needed
Aging method
2

Learning Objective 1
Understand the nature of inventory and
retailing operations

Copyright 2014 Pearson Education.

Inventory, Supplies, Equipment


To clarify, these assets are all different
Inventories are assets purchased with the intent of
selling them to customers, sometimes with
additional processing
Supplies are assets purchased to be used
Usually included in short-term assets
Usually consumed when used

Equipment are assets purchased to be used


Usually included in long-term assets
Usually not consumed when used, but depreciated
Copyright 2014 Pearson Education.

Accounting For Inventory


Balance Sheet (partial)
Current assets:
Cash

$$$$

Accounts receivable

$$$$

Inventory (1 shirts @ cost of $30)

$30

Income Statement (partial)


Sales (2 shirts @ $50 selling price)
Cost of goods sold (2 shirts @ $30 cost)
Gross profit

Copyright 2014 Pearson Education.

$100
60
$40

The cost of
inventory on
hand =
Inventory

Asset on the
Balance Sheet

Copyright 2014 Pearson Education.

The cost of
inventory thats
been sold =
Cost of Goods
Sold

Expense on the
Income Statement

GROSS PROFIT
SALES REVENUE

COST OF GOODS SOLD


Copyright 2014 Pearson Education.

Number of units
Determined from accounting records
Evidenced by physical count at year end
Consigned goods:
Does not include those held for another company
Does include those out on consignment

In transit goods
Depends on shipping terms

Copyright 2014 Pearson Education.

Shipping terms
FOB means Free-On-Board or Freight-On-Board

FOB Shipping Point

Legal title passes to


purchaser when items
leave sellers place of
business
Purchaser owns good
while in transit
Included in purchasers
inventory count

Purchaser pays
transportation costs
Copyright 2014 Pearson Education.

FOB Destination

Legal title passes to


purchaser when items
arrive at purchasers
place of business
Seller owns goods while
in transit
Included in sellers
inventory count

Seller pays transportation


costs
9

Learning Objective 2
Recording inventory-related transactions

Copyright 2014 Pearson Education.

10

Inventory Systems
Perpetual

Periodic

Used for all types of goods

Used for inexpensive goods

Keeps a running total of all


goods bought, sold and on
hand

Does not keep a running


total of all goods bought,
sold and on hand

Inventory counted at least


once a year

Inventory counted at least


once a year

Must count inventory at least once a year under both systems

Copyright 2014 Pearson Education.

11

Perpetual Inventory
Bar codes on products provide information to
record
Sale of item
Update of inventory record

Two entries needed for each sale


Record revenue and asset received (cash or
receivables)
Record cost of sale and reduction of inventory

In this class, assume Perpetual Inventory unless


otherwise specified!
Copyright 2014 Pearson Education.

12

Recording Inventory

(Amounts Assumed)

JOURNAL
Date Accounts and explanation
Inventory

Debit

Credit

560,000

Accounts payable

560,000

Purchased inventory on account

Accounts receivable

900,000

Sales Revenue

900,000

Sold inventory on account

Cost of goods sold


Inventory

540,000
540,000

Recorded cost of goods sold


Copyright 2014 Pearson Education.

13

Recording Inventory

(Amounts Assumed)

Inventory
Beginning balance $100,000
Purchases
$560,000
Ending balance
$120,000

$540,000 Cost of goods sold

Cost of Goods Sold


Cost of goods sold

$540,000

Copyright 2014 Pearson Education.

14

Reporting in the Financial


Statements
Balance Sheet (partial)
Current assets:
Cash

$$$$

Accounts receivable

$$$$

Inventory

$70,000

Income Statement (partial)


Sales

$900,000

Cost of goods sold


Gross profit
Copyright 2014 Pearson Education.

540,000
$360,000
15

Cost of Net Purchases (Buyer


Perspective)
Purchases and Inventory
includes not only the cost of
inventory, but related direct
costs, including:

+
=

Purchase price
Freight-in
Purchase returns
Purchase allowances
Purchase discounts
Net purchases

Freight-in is the cost of


delivery paid by the buyer
Returns are reduction in
inventory for sending goods
back to seller
Allowances are reduction in
price granted for certain
purchases
Discounts are reduction in
price,Inventory:
often for paying
on amounts affect Inventory on the Balance Sheet!
Perpetual
All of these
time
Note: Think of the related Journal Entries

16

Purchase Payment Terms


Inventory purchases often specify payment terms
that include:
Discount
Discount period
Net due period

Example 1, payment terms of 3/5, n/30 means:


3% discount
If paid within 5 days
Net amount due within 30 days

Example 2, payment terms of 2/10, n/eom


2 % discount
If paid within 10 days
Net amount due by the end of the month
Copyright 2014 Pearson Education.

17

Net Sales (Seller Perspective)


Sales are adjusted for
returns, allowances,
and discounts
Sales do not include
shipping, even if paid
by seller
Separate category
called shipping
expense or delivery
expense

Sales revenue
- Sales returns and
allowance
- Sales discounts
= Net sales
Reduces Sales Revenue!

What is the difference from Buyer Perspective?


Copyright 2014 Pearson Education.

18

Learning Objective Three


Determine inventory and cost of sales based on
various inventory cash flow assumptions.

Copyright 2014 Pearson Education.

19

Inventory Costing
Manager decides which accounting method to use,
which affects:
Profits (higher expense results in lower profits)
Income tax (lower income lowers taxes)
Ratios
Cost of inventories comprises of:
Cost of purchase
Cost of conversion (additional work on inventory)
Cost of bringing in the inventories
Copyright 2014 Pearson Education.

20

Inventory Methods (Assumptions)

Specific
unit

Average
cost

First-in,
first-out

Last-in,
first-out

Copyright 2014 Pearson Education.

21

Specific Unit (Specific Identification)


Used for businesses with unique inventory items
Automobiles, fine jewelry, real estate

Inventory expensed at specific price of the


particular unit
Too expensive for inventories with common
characteristics

Copyright 2014 Pearson Education.

22

First-in, First-out (FIFO)


Oldest items assumed to be sold first
Ending inventory consists of most recent
purchase costs
Inventory (at FIFO Cost)

Beg bal (10 units @ $10)


Purchases:
No. 1 (25 units @ $14)
No. 2 (25 units @ $18)
Ending
Balance

(20 units @ $18)

$100
Cost of goods sold (40 units):

350
450

(10 units @ $10)


(25 units @ $14)
(5 units @ $18)

100
350
90

360

Copyright 2014 Pearson Education.

23

Last-in, First-out (LIFO)


Most recent items purchased are assumed to be
sold first
Oldest costs in ending inventory
Inventory (at FIFO Cost)

Beg bal (10 units @ $10)


Purchases:
No. 1 (25 units @ $14)
No. 2 (25 units @ $18)
Ending
Balance

(10 units @ $10)


(10 units @ $14)

$100
Cost of goods sold (40 units):

350
450

(25 units @ $18)


(15 units @ $14)

450
210

240

Copyright 2014 Pearson Education.

24

Average Cost (Weighted Average)


Average cost
per unit

Cost of
goods sold
Ending
inventory

Cost of goods available *


Number of units available*

*Goods available = Beginning inventory


+ Purchases
Number of
Number of
units sold

Average cost
per unit

Number of
units on hand

Average cost
per unit

Copyright 2014 Pearson Education.

25

Average Cost
Inventory (at FIFO Cost)
Beg bal (10 units @ $10)
Purchases:
No. 1 (25 units @ $14)
No. 2 (25 units @ $18)
Ending
Balance

$100
350
450

Cost of goods sold (40 units @


average cost of $15 per unit)

600

(20 units @ average 300


cost of $15 per unit)

26

Problem 6-62A
Inventory Purchases

Date

Units

Requirements

Cost
per
unit

Total
cost

Beg.
72 tents
inventory

$17

$1,224

Oct. 4

103
tents

$19

$1,957

Oct. 19

158
tents

$21

$3,318

Oct. 25

43 tents

$22

$946

Copyright 2014 Pearson Education.

Determine the CoGS and


ending inventory under the
three methods
Average cost
FIFO
LIFO
27

Problem 6-62A Average Cost


Average cost
per unit

Cost of goods available *


Number of units available*

*Goods available = Beginning inventory


+ Purchases

$19.80

(rounded)

$1,224 + $1,957
+$3,318 + $946
$7,445

72 +103
+ 43
376+158
units

Copyright 2014 Pearson Education.

28

Problem 6-62A Average Cost


Cost of
$6,415
goods
sold

Number of
324
tents
units
sold

Average
cost
$19.80
per unit
(rounded)

Ending
$1,030
inventory

Number of
52 tents
units
on hand

Average
cost
$19.80
per unit
(rounded)

Copyright 2014 Pearson Education.

29

Problem 6-62A FIFO


Date

Units

Beg. inventory

Cost per
unit

Total
cost

72 tents

$17

$1,224

Oct. 4

103 tents

$19

$1,957

Oct. 19

158 tents

$21

$3,318

Oct. 25

43 tents

$22

$946

Cost of goods sold


72 tents
$17
Oldest
103
tents items
$19sold
first
149 tents $21
324 tents

$1,224
$1,957
$3,129
$6,310

Copyright 2014 Pearson Education.

Ending inventory
Newest items on
43 tents $22
$946
hand
9 tents $21
$189
52 tents

$1,135

30

Problem 6-62A LIFO


Date

Units

Beg. inventory

Cost per
unit

Total
cost

72 tents

$17

$1,224

Oct. 4

103 tents

$19

$1,957

Oct. 19

158 tents

$21

$3,318

Oct. 25

43 tents

$22

$946

Cost of goods sold


43 tents

$22

$946

158 tents
Newest$21
items sold $3,318
first
103 tents $19
$1,957
20 tents
324 tents

$17

Ending inventory
Oldest items on
52 tents $17
$884
hand

$340
$6,561
Copyright 2014 Pearson Education.

31

Impact of Inventory Methods on


Financial Statements
Increasing inventory prices
Cost of goods
sold

Ending
inventory

FIFO

Lowest because
based on older
costs, which are
less expensive

Highest because
based on more
recent and
expensive costs

LIFO

Highest because
based on more
recent costs,
which are more
expensive

Lowest because
based on older
costs, which are
less expensive

Copyright 2014 Pearson Education.

32

Impact of Inventory Methods on


Financial Statements
Decreasing inventory prices
Cost of goods
sold

Ending
inventory

FIFO

Highest because
based on older
costs, which are
more expensive

Lowest because
based on more
recent, less
expensive costs

LIFO

Lowest because
based on more
recent costs which
are less expensive

Highest because
based on older,
more expensive
costs

Copyright 2014 Pearson Education.

33

Copyright 2014 Pearson Education.

34

Comparison of Inventory Methods


COST OF GOODS SOLD

ENDING INVENTORY

LIFO provides a more


realistic net income
figure
More recent costs
included in Cost of
Goods Sold

Copyright 2014 Pearson Education.

FIFO provides a more


up-to-date inventory
cost
More recent costs on
the Balance Sheet
35

Principles Related to Inventories

Comparability
Principle

Copyright 2014 Pearson Education.

Net Realizable
Value

36

Comparability Principle
Business should use the same accounting
methods from year-to-year
Allows investors to compare financial statements
from one period to the next
Companies are permitted to change methods
Must disclose effect on net income

Copyright 2014 Pearson Education.

37

Net Realizable Value


Inventory is reported at the lower of:
Cost, or
Net realizable value (NRV)
Net realizable value is the estimated selling price in the
ordinary course of business less the estimated costs of
completion and the estimated costs necessary to make
the sale.
If NRV is lower, inventory is written down

Copyright 2014 Pearson Education.

38

Net Realizable Value


If NRV is lower, inventory is written down
JOURNAL
Date Accounts and explanation

Debit

Credit

Cost of goods sold


Inventory
Wrote down inventory to market

If the NRV of inventory had been above cost, it would


have made no adjustment for NRV.
report the inventory at cost, which is the lower of cost and
NRV
Copyright 2014 Pearson Education.

39

Learning Objective Four


Use gross profit percentage and inventory
turnover to evaluate operations.

Copyright 2014 Pearson Education.

40

Gross Profit Percentage


Gross profit
Net sales revenue

Copyright 2014 Pearson Education.

41

Inventory Turnover
Cost of Goods Sold
Average Inventory

(Beginning inventory + Ending inventory)/2


Copyright 2014 Pearson Education.

42

Cost of Goods Sold Model

+
=
=

Cost of Goods Sold:


Beginning Inventory
Purchases
Cost of goods available for sale
Ending Inventory
Cost of goods sold
Copyright 2014 Pearson Education.

43

Using Cost of Goods Sold Model

What merchandise should


the company purchase?
How much inventory
should the company buy?
Copyright 2014 Pearson Education.

44

Rearranging the Cost of Goods Sold


Model
Cost of goods sold (based on plan for next period)
+

Ending inventory (based on plan for next period)

Goods available as planned

Beginning inventory (actual amount)

Purchases (amount manager should buy)

Copyright 2014 Pearson Education.

45

Gross Profit Method


Beginning inventory
Purchases
Goods available for sale
Estimated cost of goods sold:
Net sales revenue
Less estimated gross profit
Estimated cost of goods sold
Estimated cost of ending inventory

Copyright 2014 Pearson Education.

$$$$
$$$$
$$$$
$$$$
($$$)
$$$$
$$$

46

Exercise 6-26A
J R Company began May with inventory of
$47,500. The business made net purchases of
$30,900 and had net sales of $62,100 before a
fire destroyed the companys inventory. For the
past several years, J Rs gross profit percentage
has been 35%.
Estimate the cost of the inventory destroyed by
the fire.
Copyright 2014 Pearson Education.

47

Exercise 6-26A
Beginning inventory

$47,500

Purchases

30,900

Goods available for sale

78,400

Estimated cost of goods sold:


Net sales revenue
Less estimated gross profit

(35% x $62,100)

Estimated cost of goods sold


Estimated cost of ending inventory

Copyright 2014 Pearson Education.

$62,100
$21,735
40,365
$38,035

48

Learning Objective Five


Show how inventory errors affect the financial
statements

Copyright 2014 Pearson Education.

49

Effect of Inventory Errors


Period 1

Period 2

Cost of
Goods Sold

Gross
Profit and
Net Income

Cost of Goods
Sold

Gross
Profit and
Net Income

Understated

Overstated

Overstated

Understated

Overstated

Understated

Understated

Overstated

Period 1
Ending
Inventory
overstated
Period 2 1
Ending
Inventory
understated

Copyright 2014 Pearson Education.

50