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Interpreting
Cost of Goods
Sold and
Inventory
Chapter 7
7-2
Primary
Primary Goals
Goals of
of
Inventory
Inventory
Management
Management
Provide
Provide sufficient
sufficient
quantities
quantities of
of highhighquality
quality inventory.
inventory.
Minimize
Minimize the
the costs
costs of
of
carrying
carrying inventory.
inventory.
7-3
Learning Objectives
Apply
Apply the
the cost
cost principle
principle to
to identify
identify the
the amounts
amounts
that
that should
should be
be included
included in
in inventory
inventory and
and the
the
matching
matching principle
principle to
to determine
determine cost
cost of
of goods
goods
sold
sold for
for typical
typical retailers,
retailers, wholesalers,
wholesalers, and
and
manufacturers.
manufacturers.
7-4
Inventory
Tangible
Merchandise Inventory
Raw Materials Inventory
Work in Process Inventory
Finished Goods Inventory
Used to
Produce Goods
or Services
7-5
Invoice
Price
Freight
Inspection
Costs
Preparation
Costs
7-6
Manufacturer
Raw
Raw
Materials
Materials
Direct
Direct
Labor
Labor
Factory
Factory
Overhead
Overhead
Merchandise
Merchandise
Inventory
Inventory
Raw
Raw Materials
Materials
Inventory
Inventory
Work
Work in
in Process
Process
Inventory
Inventory
Cost
Cost of
of
Goods
Goods Sold
Sold
Finished
Finished Goods
Goods
Inventory
Inventory
Cost
Cost of
of
Goods
Goods Sold
Sold
7-7
Purchases
Purchases
for
for the
the Period
Period
Goods
Goods available
available
for
for Sale
Sale
Ending
Ending Inventory
Inventory
(Balance
(Balance Sheet)
Sheet)
Cost
Cost of
of Goods
Goods Sold
Sold
(Income
(Income Statement)
Statement)
Beginning
Beginning inventory
inventory ++ Purchases
Purchases == Goods
Goods Available
Available for
for Sale
Sale
Goods
Goods Available
Available for
for Sale
Sale Ending
Ending inventory
inventory == Cost
Cost of
of goods
goods sold
sold
7-8
Learning Objectives
Report
Report inventory
inventory and
and cost
cost of
of goods
goods sold
sold using
using
the
the four
four inventory
inventory costing
costing methods.
methods.
7-9
FIFO
LIFO
Weighted
Average
7-10
Cost
Cost of
of Goods
Goods Sold
Sold
7-11
Specific Identification
When
When units
units are
are
sold,
sold, the
the
specific
specific cost
cost
of
of the
the unit
unit sold
sold
is
is added
added to
to
cost
cost of
of goods
goods
sold.
sold.
7-12
7-13
Oldest
Oldest Costs
Costs
Cost
Cost of
of
Goods
Goods Sold
Sold
Recent
Recent Costs
Costs
Ending
Ending
Inventory
Inventory
7-14
First-In, First-Out
Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
Total
1,000
$ 5.25
$ 5,250.00
500
300
250
200
5.30
5.60
5.80
5.90
2,650.00
1,680.00
1,450.00
1,180.00
2,250
$ 12,210.00
Ending
Inventory
1,200
Cost of
Goods Sold
1,050
Remember:
The costs of
most recent
purchases are
in ending
inventory. Start
with 11/29 and
add units
purchased
until you reach
the number in
ending
inventory.
7-15
First-In, First-Out
Given Information
Ending Inventory
Beg. Inv. 1,000 @ $ 5.25
Jan. 3
500 @ 5.30
June 20
300 @ 5.60
Sept. 15
250 @ 5.80
Nov. 29
200 @ 5.90
200 @ $5.90
200 Units
Cost of Goods
Sold
Units
7-16
First-In, First-Out
Given Information
Ending Inventory
Beg. Inv. 1,000 @ $ 5.25
Jan. 3
500 @ 5.30
450 @ $5.30
June 20
300 @ 5.60
300 @ $5.60
Sept. 15
250 @ 5.80
250 @ $5.80
Nov. 29
200 @ 5.90
200 @ $5.90
1,200 Units
Cost of Goods
Sold
Units
$ 6,695 Cost
Now,
Now, we
we have
have allocated
allocated the
the cost
cost to
to all
all
1,200
1,200 units
units in
in ending
ending inventory.
inventory.
7-17
First-In, First-Out
Given Information
Ending Inventory
Beg. Inv. 1,000 @ $ 5.25
Jan. 3
500 @ 5.30
450 @ $5.30
June 20
300 @ 5.60
300 @ $5.60
Sept. 15
250 @ 5.80
250 @ $5.80
Nov. 29
200 @ 5.90
200 @ $5.90
1,200 Units
$ 6,695 Cost
Cost of Goods
Sold
1,000 @ $ 5.25
50 @ 5.30
1,050 Units
$ 5,515 Cost
Now,
Now, we
we have
have allocated
allocated the
the cost
cost to
to all
all
1,050
1,050 units
units sold.
sold.
7-18
First-In, First-Out
Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
1,000
500
300
250
200
5.25
5.30
5.60
5.80
5.90
Total
$
5,250.00
2,650.00
1,680.00
1,450.00
1,180.00
2,250
$ 12,210.00
Ending
Inventory
1,200
$ 6,695.00
Cost of
Goods Sold
1,050
$ 5,515.00
Here is the
cost of
ending
inventory
and cost
of goods
sold using
FIFO.
7-19
Oldest
Oldest Costs
Costs
Ending
Ending
Inventory
Inventory
Recent
Recent Costs
Costs
Cost
Cost of
of
Goods
Goods Sold
Sold
7-20
Last-In, First-Out
Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
Total
1,000
$ 5.25
$ 5,250.00
500
300
250
200
5.30
5.60
5.80
5.90
2,650.00
1,680.00
1,450.00
1,180.00
2,250
$ 12,210.00
Ending
Inventory
1,200
Cost of
Goods Sold
1,050
Remember:
The costs of the
oldest
purchases are
in ending
inventory. Start
with beginning
inventory and
add units
purchased until
you reach the
number in
ending
inventory.
7-21
Last-In, First-Out
Given Information
Ending Inventory
Beg. Inv. 1,000 @ $ 5.25
1,000 @ $5.25
Jan. 3
500 @ 5.30
June 20
300 @ 5.60
Sept. 15
250 @ 5.80
Nov. 29
200 @ 5.90
1,000 Units
Cost of Goods
Sold
Units
7-22
Last-In, First-Out
Given Information
Ending Inventory
Beg. Inv. 1,000 @ $ 5.25
1,000 @ $5.25
Jan. 3
500 @ 5.30
200 @ 5.30
June 20
300 @ 5.60
Sept. 15
250 @ 5.80
Nov. 29
200 @ 5.90
1,200 Units
Cost of Goods
Sold
Units
$ 6,310 Cost
Now,
Now, we
we have
have allocated
allocated the
the cost
cost to
to all
all
1,200
1,200 units
units in
in ending
ending inventory.
inventory.
7-23
Last-In, First-Out
Given Information
Ending Inventory
Beg. Inv. 1,000 @ $ 5.25
1,000 @ $5.25
Jan. 3
500 @ 5.30
200 @ 5.30
June 20
300 @ 5.60
Sept. 15
250 @ 5.80
Nov. 29
200 @ 5.90
1,200 Units
$ 6,310 Cost
Cost of Goods
Sold
300
300
250
200
1,050
@ $ 5.30
@ 5.60
@ 5.80
@ 5.90
Units
$ 5,900 Cost
Now,
Now, we
we have
have allocated
allocated the
the cost
cost to
to all
all
1,050
1,050 units
units sold.
sold.
7-24
Last-In, First-Out
Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
1,000
500
300
250
200
5.25
Total
$
5.30
5.60
5.80
5.90
5,250.00
2,650.00
1,680.00
1,450.00
1,180.00
2,250
$ 12,210.00
Ending
Inventory
1,200
6,310.00
Cost of
Goods Sold
1,050
5,900.00
Here is the
cost of
ending
inventory
and cost of
goods sold
using LIFO.
7-25
Number of
Units
Available for
Sale
7-26
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
1,000
500
300
250
200
5.25
5.30
5.60
5.80
5.90
Total
$
5,250.00
2,650.00
1,680.00
1,450.00
1,180.00
Weighted Average Cost
2,250
Ending
Inventory
1,200
Cost of
Goods Sold
1,050
$ 12,210.00
$ 12,210
= $5.42667
2,250
7-27
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
1,000
500
300
250
200
5.25
Total
$
5.30
5.60
5.80
5.90
5,250.00
2,650.00
1,680.00
1,450.00
1,180.00
Weighted Average Cost
$ 12,210
= $5.42667
2,250
2,250
$ 12,210.00
Ending
Inventory
1,200
6,512.00
1,200 $ 5.42667
Cost of
Goods Sold
1,050
5,698.00
1,050 $ 5.42667
7-28
Comparison of Methods
Computers, Inc.
Income Statement
For Year Ended December 31, 2006
Net sales
Cost of goods sold:
Merchandise inventory, beginning
Net purchases
Goods available for sale
Merchandise inventory, ending
Cost of goods sold
Gross profit
Operating expenses
Income before taxes
Income taxes expense (30%)*
Net income
FIFO
$ 25,000
LIFO
$ 25,000
Weighted
Average
$ 25,000
$
$
$
$
$
5,250
6,960
12,210
6,695
5,515
19,485
750
18,735
5,621
13,114
$
$
$
$
$
5,250
6,960
12,210
6,310
5,900
19,100
750
18,350
5,505
12,845
$
$
$
$
$
5,250
6,960
12,210
6,512
5,698
19,302
750
18,552
5,566
12,986
7-29
Last-In,
First-Out
Weighted
Average
Ending
Ending inventory
inventory
approximates
approximates
current
current
replacement
replacement cost.
cost.
Better
Better matches
matches
current
current costs
costs in
in cost
cost
of
of goods
goods sold
sold with
with
revenues.
revenues.
Smoothes
Smoothes out
out
price
price changes.
changes.
7-30
Learning Objectives
Decide
Decide when
when the
the use
use of
of different
different inventory
inventory
costing
costing methods
methods is
is beneficial
beneficial to
to aa company.
company.
7-31
Net
Net Income
Income Effects
Effects
Managers
Managers prefer
prefer to
to report
report
higher
higher earnings
earnings for
for their
their
companies.
companies.
Income
Income Tax
Tax Effects
Effects
Managers
Managers prefer
prefer to
to pay
pay
the
the least
least amount
amount of
of taxes
taxes
allowed
allowed by
by law
law as
as late
late as
as
possible.
possible.
7-32
If . . .
LIFO for
taxes
LIFO
Conformity
Rule
Then . . .
LIFO for
books
7-33
Learning Objectives
Report
Report inventory
inventory at
at the
the lower
lower of
of cost
cost or
or market
market
(LCM).
(LCM).
7-34
7-35
Item
Pentium chips
Disk drives
Quantity
1,000
400
Cost
$ 250
100
Replacement
Cost
$
200
110
LCM
$ 200
100
Total LCM
$ 200,000
40,000
7-36
Learning Objectives
Evaluate
Evaluate inventory
inventory management
management using
using the
the
inventory
inventory turnover
turnover ratio
ratio and
and the
the effects
effects of
of
inventory
inventory on
on cash
cash flows.
flows.
7-37
Inventory Turnover
Inventory
=
Turnover
Average
Average Inventory
Inventory is
is .. .. ..
(Beginning
(Beginning Inventory
Inventory ++ Ending
Ending Inventory)
Inventory) 22
This
This ratio
ratio reflects
reflects how
how many
many times
times
average
average inventory
inventory was
was produced
produced and
and
sold
sold during
during the
the period.
period. A
A higher
higher ratio
ratio
indicates
indicates that
that inventory
inventory moves
moves more
more
quickly
quickly thus
thus reducing
reducing storage
storage and
and
obsolescence
obsolescence costs.
costs.
7-38
Decrease in Accounts
Payable
Cost of
Goods
Sold
Cash
Payment to
Suppliers
Decrease in Inventory
Increase in Accounts
Subtract
Payable
7-39
Learning Objectives
Compare
Compare companies
companies that
that use
use different
different
inventory
inventory costing
costing methods.
methods.
7-40
Ending
Ending inventory
inventoryFIFO
FIFO
-- Ending
Ending inventory
inventoryLIFO
LIFO
Ending
Ending LIFO
LIFO Reserve
Reserve
(Excess
(Excess of
of FIFO
FIFO over
over LIFO)
LIFO)
7-41
Yes
Singapore
China
Canada
Australia
Great Britain
7-42
Learning Objectives
Understand
Understand methods
methods for
for controlling
controlling and
and
keeping
keeping track
track of
of inventory
inventory and
and analyze
analyze the
the
effects
effects of
of inventory
inventory errors
errors on
on financial
financial
statements.
statements.
7-43
Limiting access to
authorized employees.
Maintaining perpetual
inventory records.
Comparing perpetual
records to periodic
physical counts.
7-44
Perpetual
Perpetual
System
System
Provides
Provides up-to-date
up-to-date
cost
cost of
of sales
sales records.
records.
In a periodic inventory system, ending inventory and cost of
goods sold are determined at the end of the accounting
period based on a physical count.
7-45
Perpetual System
Carried over from
prior period
Accumulated in
the Inventory
account
Perpetual record
updated at every
sale
Measured at
every sale based
on perpetual
record
7-46
Beginning Inventory
+
+
N/A
N/A
N/A
N/A
+
+
+
-
+
+
-
+
+
7-47
Chapter Supplement A
LIFO
LIFO Liquidations
Liquidations
7-48
LIFO Liquidations
When a LIFO company sells more inventory than it
purchases or manufactures, items from beginning
inventory become part of cost of goods sold. This is
called a LIFO liquidation.
When inventory costs are rising,
these lower cost items in
beginning inventory produce a
higher gross profit, higher
taxable income, and higher
taxes when they are sold.
7-49
LIFO Liquidations
Companies must disclose the effects of LIFO
liquidations in the notes when they are material.
7-50
Chapter Supplement B
Additional
Additional Issues
Issues in
in Measuring
Measuring
Purchases
Purchases
7-51
7-52
Purchase Discounts
A purchase discount is a cash discount received for
prompt payment of an account.
Terms
Time
Due
Discount Period
Credit Period
Full amount
less discount
Purchase or Sale
7-53
Purchase Discounts
2/10,n/30
Discount
Discount
Percent
Percent
Number
Number of
of
Days
Days
Discount
Discount Is
Is
Available
Available
Otherwise,
Otherwise,
Net
Net (or
(or All)
All)
Is
Is Due
Due
Credit
Credit
Period
Period
7-54
Purchase Discounts
7-55
Chapter Supplement C
7-56
Nov. 30
Dec. 31
7-57
7-58
End of Chapter 7