Chapter 5, Slide #2 1.1 Inventory of Wholesalers and Retailers Purchased in finished form Resold without transformation Classified as Merchandise Inventory on balance sheet LO1 Chapter 5, Slide #3 1.2 Condensed Income Statement for a Merchandiser Net sales $100,000 Cost of goods sold 60,000 Gross profit $ 40,000 Selling and administrative expenses 29,300 Net income before tax $ 10,700 Income tax expense 4,280 Net income $ 6,420
Chapter 5, Slide #4 1.3 how companies keep track of their inventory Perpetual inventory system Periodic inventory system Chapter 5, Slide #5 Perpetual Inventory Systems Point-of-sale terminals have improved the ability of mass merchandisers to maintain perpetual systems Company knows the cost of sales and ending inventory figure from their books Inventory records are updated after each purchase or sale Chapter 5, Slide #6 Periodic Inventory Systems Reduces record keeping but also decreases the ability to track theft, breakage, etc., and prepare interim financial statements Inventory records are updated periodically based on physical inventory counts Chapter 5, Slide #7 Inventory Costs Included Any freight costs incurred by buyer Cost of insurance for inventory in transit Cost of storing inventory before selling Excise and sales taxes Chapter 5, Slide #8 Inventory Valuation and Income Measurement
Value assigned to inventory on balance sheet
Value expensed as cost of goods sold on income statement When Sold = LO5 Beginning inventory, Jan. 1: 500 units (unit cost $10) Inventory purchases: Date Units Unit Cost 1/20 300 $ 11 4/8 400 12 9/5 200 13 12/12 100 14 Total purchases 1,000 units Ending inventory, Dec. 31: 600 units Detailed Costing Method Example Whatre the cost of goods sold and ending inventory? Chapter 5, Slide #10 Inventory Costing Methods (in a period of inflation) Four costing methods available: Specific Identification Weighted Average First-in, First-out (FIFO) Last-in, First-out (LIFO) LO6 Chapter 5, Slide #11 Specific Identification Method Step 1: Identify the specific units in inventory at the end of the year and their costs. Chapter 5, Slide #12 Specific Identification Method Units in ending inventory: Date purchased Units Cost Total Cost 1/20 100 $11 $1,100 4/8 300 12 3,600 9/5 200 13 2,600 Ending inventory 600 $7,300 Units Cost = Total cost Chapter 5, Slide #13 Specific Identification Method Step 2: cost of goods sold = cost of goods available for sale ending inventory = 17,100 7,300 = 9,800
* Few companies use this method Chapter 5, Slide #14 Weighted Average Method Step 1: Calculate the cost of goods available for sale. Chapter 5, Slide #15 Weighted Average Method Date purchased Units Cost Total cost Beg. inventory 500 $10 $ 5,000 1/20 300 11 3,300 4/8 400 12 4,800 9/5 200 13 2,600 12/12 100 14 1,400 Cost of goods available for sale 1,500 $17,100 Chapter 5, Slide #16 Weighted Average Method Step 2: Divide the cost of goods available for sale by the total units to determine the weighted average cost per unit. : Chapter 5, Slide #17 Weighted Average Method Cost of Goods Available for Sale Units Available for Sale $17,100 1,500 = $11.40/unit Chapter 5, Slide #18 Weighted Average Method Step 3: Calculate ending inventory and cost of goods sold by multiplying the weighted average cost per unit by the number of units in ending inventory and the number of units sold.
Avg. Cost # of Units Chapter 5, Slide #19 Weighted Average Method ALLOCATE TO Ending Cost of Inventory Goods Sold Units on hand 600 Units sold 900 Weighted average cost $11.40 $ 11.40 Total cost of goods available of $17,100 allocated: $6,840 $10,260 Chapter 5, Slide #20 First-in, First-out (FIFO) Method Step 1: Assign the cost of the beginning inventory to cost of goods sold. 1st in Chapter 5, Slide #21 First-in, First-out (FIFO) Method ALLOCATE TO Ending Cost of Units Cost Inventory Goods Sold 1/1 500 $10 $5,000 1/20 300 $11 4/8 400 $12 9/5 200 $13 12/12 100 $14
Chapter 5, Slide #22 First-in, First-out (FIFO) Method Step 2: Continue to work forward until you assign the total number of units sold during the period to cost of goods sold. Allocate the remaining costs to ending inventory. 2nd 3rd etc. Chapter 5, Slide #23 First-in, First-out (FIFO) Method
ALLOCATE TO Ending Cost of Units Cost Inventory Goods Sold 1/1 500 $10 $5,000 1/20 300 $11 3,300 4/8 300 / 100 $12 $3,600 1,200 9/5 200 $13 2,600 12/12 100 $14 1,400 TOTALS $7,600 $9,500 Chapter 5, Slide #24 Last-in, First-out (LIFO) Method Step 1: Assign the cost of the last units purchased to cost of goods sold. 1st in Chapter 5, Slide #25 Last-in, First-out (LIFO) Method
ALLOCATE TO Ending Cost of Units Cost Inventory Goods Sold 1/1 500 $10 1/20 300 $11 4/8 400 $12 9/5 200 $13 12/12 100 $14 $1,400
Chapter 5, Slide #26 1st in Step 2: Work backwards until you assign the total number of units sold during the period to cost of goods sold (allocate the remaining costs to ending inventory). Last-in, First-out (LIFO) Method Chapter 5, Slide #27 Last-in, First-out (LIFO) Method
ALLOCATE TO Ending Cost of Units Cost Inventory Goods Sold 1/1 500 $10 $5,000 1/20 100 / 200 $11 1,100 $ 2,200 4/8 400 $12 4,800 9/5 200 $13 2,600 12/12 100 $14 1,400 TOTALS $6,100 $11,000 Chapter 5, Slide #28 Comparison of Costing Methods Cost of Goods Sold Ending Inventory 11,000 6,840 7,600 10,260 9,500 17,100 17,000 17,100 Weighted Average FIFO LIFO Goods Available for Sale 6,100 Specific Identification $7,300 $ 9,800 $17,100 Chapter 5, Slide #29 Chapter 5, Slide #30 Comparison of Costing Methods X X X X X Weighted Average FIFO LIFO
In periods of rising prices:
Highest cost of goods sold? Lowest cost of goods sold? Highest gross profit? Lowest net income? Lowest income taxes? LO7 Chapter 5, Slide #31 LIFO Conformity Rule LIFO conformity rule If used for tax, LIFO must also be used for books
In general, companies can use one accounting method for financial reporting purpose and use a different method for tax purpose. Accounting choice should be made based on which method produces most useful information. Chapter 5, Slide #32 Lower of Cost or Market (for your information only) If inventorys market value has fallen below the cost, the inventory must be reported at the lower market value, and a loss must be recorded.