Download Inventories and Cost of Sales - McGraw Hill Higher Education

Chapter 6
INVENTORIES AND COST OF SALES
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Winston Kwok, Ph.D., CA
Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved.
6-2
C1
DETERMINING INVENTORY ITEMS
Merchandise inventory includes all goods that a
company owns and holds for sale, regardless of where
the goods are located when inventory is counted.
Items requiring special attention include:
Goods in
Transit
Goods on
Consignment
Goods
Damaged or
Obsolete
6-3
C1
GOODS IN TRANSIT
FOB Shipping Point
Public
Carrier
Seller
Buyer
Ownership passes
to the buyer here.
Public
Carrier
Seller
FOB Destination Point
Buyer
6-4
C1
GOODS ON CONSIGNMENT
Merchandise is included in the inventory of the
consignor, the owner of the inventory.
Consignee
Thanks for selling my
inventory in your
store.
Consignor
6-5
C1
GOODS DAMAGED OR OBSOLETE
Damaged or obsolete goods are not counted in
inventory if they cannot be sold.
Cost should be reduced to net realizable
value if they can be sold.
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.
6-6
C2
DETERMINING INVENTORY COSTS
Include all expenditures necessary to bring an item to
a salable condition and location.
Minus
Discounts
and
Allowances
Plus Import
Duties
Invoice
Cost
Plus
Freight
Plus
Insurance
Plus
Storage
6-7
C2
INTERNAL CONTROLS AND TAKING A
PHYSICAL COUNT
 Most companies take a
physical count of
inventory at least once
each year.
 When the physical count
does not match the
Merchandise Inventory
account, an adjustment
must be made.
Good internal controls over count include:
1. Pre-numbered inventory tickets.
2. Counters have no inventory responsibility.
3. Counts confirm existence, amount, and
quality of inventory item.
4. Second count is taken.
5. Manager confirms all items counted.
6-8
C2
INVENTORY COSTING UNDER
A PERPETUAL SYSTEM
Statement
of
Financial
Position
Inventory
affects . . .
Income
Statement
6-9
C2
INVENTORY COST FLOW ASSUMPTIONS
Management decisions in accounting for inventory
involve the following:
1. Items included in inventory and their costs.
2. Costing method (specific identification, FIFO, or
weighted average cost).
3. Inventory system (perpetual or periodic).
4. Use of market values or other estimates.
LIFO is not allowed under IFRS.
6 - 10
P1
INVENTORY COST FLOW ASSUMPTIONS
Specific
Identification
When each item can be
identified with a specific
purchase
First-In, First-Out
(FIFO)
Assumes costs flow in the order
incurred.
Weighted
Average Cost
Assumes costs flow at an
average of the costs available.
6 - 11
P1
INVENTORY COSTING ILLUSTRATION
Here is information about the mountain bike inventory of Trekking
for the month of August.
6 - 12
P1
SPECIFIC IDENTIFICATION
6 - 13
P1
SPECIFIC IDENTIFICATION
Income Statement
Cost of Goods Sold
Statement of Financial Position
Inventory
6 - 14
P1
SPECIFIC IDENTIFICATION
Here are the entries to record the purchases and sales. The
numbers in red are determined by the cost flow assumption used.
All purchases and sales are made on credit.
The selling price of inventory was as follows:
8/14 $130
8/31 150
6 - 15
P1
FIRST-IN, FIRST-OUT (FIFO)
Oldest
Costs
Cost of
Goods Sold
Recent
Costs
Ending
Inventory
6 - 16
P1
FIRST-IN, FIRST-OUT (FIFO)
6 - 17
P1
FIRST-IN, FIRST-OUT (FIFO)
6 - 18
P1
FIRST-IN, FIRST-OUT (FIFO)
Here are the entries to record the purchases and sales entries. The
numbers in red are determined by the cost flow assumption used.
All purchases and sales are made on credit.
The selling price of inventory was as follows:
8/14 $130
8/31 150
6 - 19
P1
WEIGHTED AVERAGE COST
When a unit is sold, the average
cost of each unit in inventory is
assigned to cost of goods sold.
Cost of Goods
Available for
Sale
÷
Units on hand
on the date of
sale
6 - 20
P1
WEIGHTED AVERAGE COST
6 - 21
P1
WEIGHTED AVERAGE COST
6 - 22
P1
WEIGHTED AVERAGE COST
6 - 23
P1
WEIGHTED AVERAGE COST
Here are the entries to record the purchases and sales entries for Trekking.
The numbers in red are determined by the cost flow assumption used.
All purchases and sales are made on credit.
The selling price of inventory was as follows:
8/14 $130
8/31 150
6 - 24
A1
FINANCIAL STATEMENT EFFECTS
OF COSTING METHODS
Because prices change, inventory methods nearly always
assign different cost amounts.
6 - 25
A1
FINANCIAL STATEMENT EFFECTS
OF COSTING METHODS
Advantages of Methods
Weighted
Average
Cost
First-In,
First-Out
Smoothes out
price changes.
Ending inventory
approximates
current
replacement cost.
6 - 26
CONSISTENCY IN USING
COSTING METHODS
A1
•
•
•
The IASB’s Conceptual Framework states that
comparability is an enhancing qualitative
characteristic of financial information.
Related to comparability is consistency which refers
to the use of the same methods for the same items,
either from period to period within a reporting entity
or in a single period across entities.
When a change from one method to another will
improve its financial reporting, the entity can do so,
but the notes to the financial statements must report
the type of change, its justification, and its effect on
profit.
6 - 27
P2
LOWER OF COST AND NET REALIZABLE VALUE
Inventory must be reported at NRV when
NRV is lower than cost.
NRV 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.
Can be applied two ways:
(1)
(2)
separately to each
individual item.
to major categories of
assets.
6 - 28
P2
LOWER OF COST AND
NRV
A motor sports retailer has the following
items in inventory:
Per Unit
Inventory Items
Cycles:
Roadster
Sprint
Off-Road
Trax-4
Blazer
Totals
Units on
Hand
20 $
10
8
5
Cost
NRV
8,000
5,000
$ 7,000
6,000
5,000
9,000
6,500
7,000
Total Cost
Total NRV
$
160,000
50,000
$ 140,000
60,000
40,000
45,000
295,000
52,000
35,000
$
6 - 29
P2
LOWER OF COST AND NRV
Here is how to compute lower of cost and
NRV for individual inventory items.
Lower of Cost and
NRV Applied to
Inventory Items
Cycles:
Roadster
Sprint
Off-Road
Trax-4
Blazer
Totals
Units on
Hand
20
10
8
5
Total Cost
Total NRV
$ 160,000
50,000
$ 140,000
60,000
$
$
40,000
45,000
$ 295,000
Items
$
52,000
35,000
$
140,000
50,000
40,000
35,000
265,000
6 - 30
P2
RECORDING THE LOWER OF COST AND NRV
Lower of Cost
and NRV Applied
to
Units on
Inventory Items Hand
Total Cost Total NRV
$ 295,000
Totals
$
Items
265,000
6 - 31
A2
FINANCIAL STATEMENT EFFECTS OF
INVENTORY ERRORS
Income Statement Effects
Inventory Error
Understate ending inventory
Understate beginning inventory
Overstate ending inventory
Overstate beginning inventory
Cost of Goods Sold
Overstated
Understated
Understated
Overstated
Net Income
Understated
Overstated
Overstated
Understated
6 - 32
A2
FINANCIAL STATEMENT EFFECTS OF
INVENTORY ERRORS
Statement of Financial Position Effects
Inventory Error
Understate ending inventory
Overstate ending inventory
Assets
Equity
Understated Understated
Overstated
Overstated
6 - 33
A3
INVENTORY TURNOVER
Shows how many times a company turns over its inventory
during a period. Indicator of how well management is
controlling the amount of inventory available.
Inventory
Turnover
Average
Inventory
=
=
Cost of goods sold
Avg. inventory
(Beg. Inv. + End Inv.) ÷
2
6 - 34
A3
DAYS’ SALES IN INVENTORY
Reveals how much inventory is available in
terms of the number of days’ sales.
Days' Sales in
Inventory
=
Ending Inventory
Cost of goods sold
×365
6 - 35
P3
APPENDIX 6A: INVENTORY COSTING
UNDER A PERIODIC SYSTEM
WAC computation of
COGS and ending
inventory under a
periodic system.
6 - 36
P4
APPENDIX 6B:
INVENTORY ESTIMATION METHODS
Inventory sometimes requires estimation for interim statements or
if some casualty such as fire or flood makes taking a physical
count impossible.
Retail Inventory Method
Gross Profit Method
6 - 37
P5
APPENDIX 6B:
LAST-IN, FIRST-OUT (LIFO)
Recent
Costs
Cost of
Goods Sold
Oldest
Costs
Ending
Inventory
6 - 38
P5
LAST-IN, FIRST-OUT (LIFO)
PERPETUAL SYSTEM
6 - 39
P5
LAST-IN, FIRST-OUT (LIFO)
PERPETUAL SYSTEM
6 - 40
P5
LAST-IN, FIRST-OUT (LIFO)
PERPETUAL SYSTEM
Here are the entries to record the purchases and sales entries. The
numbers in red are determined by the cost flow assumption used.
All purchases and sales are made on credit.
The selling price of inventory was as follows:
8/14 $130
8/31 150
6 - 41
P5
LAST-IN, FIRST-OUT (LIFO)
PERIODIC SYSTEM
LIFO computation of COGS
and ending inventory under
a periodic system.
6 - 42
END OF CHAPTER 6