Accounting for Current Assets solution

8/17/2019 Accounting for Current Assets solution

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Accounting for current assets

• Inventories and cost of goods sold

o The nature of inventory

o Inventory valuation methods

o Effect of inventory valuation on cost of goods sold

•

Cash and cash equivalents• Accounts receivables

• Notes receivables

Nature of inventoryInventory / StockUsually Asset held for resale!"erating assets are for self use not for resale

Wholesalers and retailers # cost of inventory is sim"ly the "urchase "rice$ay include such costs as ta%es and trans"ortation costs&

!n the balance sheet they use a single account for inventory titled # merchandise inventory or sim"ly inventory&They buy the inventory in finished form and offer it for resale without transforming the"roduct in any 'ay& (ecause they do not use factory buildings) assembly lines or"roduction equi"mentThey have a relatively small investment in o"erating asset and a large amount ininventory&

ManufacturersScenario is quite differentThree distinct ty"e of costs are incurred by a manufacturer* direct materials) direct labour and manufacturing overhead&

Direct material # ra' material # ingredients usedDirect labour # 'orkers to manufacture the "roductMfg overheads # other costs that are related to the manufacturing "rocess but cannotbe directly matched to s"ecific units of out"ut&

The inventory of a manufacturer takes three distinct forms& The three forms of inventoryare raw materials, work in process, and finished goods&These are also the stages in the develo"ment of "roducts&

+irect materials or ra' materials enter a "roduction "rocess in 'hich they aretransformed into a finished "roduct by the addition of direct labour and manufacturing

overhead& Those 'hich are yet to be finished or 'hich are under "rocessing are kno'nas ,I-&

Inventory can be "resented in se"arate heads& At the end of accounting "eriod the manufacturer 'ill definitely have certain amount ofra' materials) some materials under "rocessing # ,I- and some finished goods&

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Inventory Valuation and measurement of incomeThe amount assigned to ending inventory is deducted from Cost of goods available forsale to determine C.S& If the inventory valuation is incorrect) C.S 'ill be 'rong andthus the net income 'ill be in error as 'ell&

rrors

!hysical count "Inventory in Transit # may be erroneously omitted from the valuation of inventory a yearend& Though) they belong to the buyer&#onsignment # though not "resent "hysically consignor have to count) and theconsignee must also be sure not to include any consigned goods in the "hysical count of its o'n merchandise&$ver%under estimation of valuation !verstatement of ending inventory # understatement of C.S # overstatement of grossmargin # overstatement of net income # overstatement of income ta% # overstatement of beginning inventory of the follo'ing "eriod # overstatement of C.S # understatement ofgross margin # understatement of net income

Inventory #osts & to be included

Cost # the sum of the a""licable e%"enditures and charges directly or indirectly incurredin bringing an article to its e%isting condition and location&Shi""ingInsuranceTa%es

$rdering cost ' (andling cost

Valuation methods

)pecific identification methodS"ecific identification of all inventory itemsTracking the record of each individual item

Weighted average cost methodIt assigns same unit cost to all units available for sale during the "eriod&

saleforavailableunits

saleforavailablegoodsof costcos =t averageWeighted

Ending inventory is found by multi"lying the 'eighted average unit cost by the number of units on hand

*irst in first out methodIt assumes the first units in) or "urchased) are the first units out) or sold&,hile selling) 'e sale the oldest unit first&So the ending inventory consists of the most recent "urchases of the "eriod&-erishable goods0IS1 0ast In Still 1ere

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In "eriods of rising "rices) 2I2! leads to higher net income& !ldest chea"est unit is usedin the calculation of cost of goods sold& 1igher re"orted incomes may favorably affectinvestor attitudes to'ard the com"any& Similarly) higher re"orted income may lead tohigher salaries) higher bonuses) or higher status for the management of the com"any&

+ast in first out method Assumes that the last units in) or "urchased) are the first units out) or sold0atest "urchases are sold first&In a "eriod of rising "rices and constant or gro'ing inventories) 0I2! yields lo'er netincome& It is even "referred for the income ta% "ur"ose&+uring a "eriod of higher inflation firms like to change from 2I2! to 0I2!&

!erpetual and !eriodic Inventory systems-er"etual inventory system kee"s a continuous record that tracks inventories and thecost of goods sold on a daytoday basis&

-eriodic inventory system does not involve daytoday record of inventories or of cost ofgoods sold& Instead the cost of goods sold and an u"dated inventory balance arecom"uted only at the end of an accounting "eriod&

sold goodsof Cost Inv Ending Purchasesinvenotry Begining =−+

)electing an inventory costing method(est method is that 'hich should reflect the accurate net income&

Cash flo' # 0I2! saves the ta% 3cash outflo'4) in "eriod of rising "rices) 'hich can beinvested&0I2! liquidation # heavy ta% bill

Actual "hysical flo' of identical "roducts is less im"ortant to the financial success ofmost businesses than is the flo' of unit5s costsCom"anies may choose any of the valuation methodsUnits are same) but costs are different so tracing the flo' or assignment of those costs ismore im"ortant than is tracing 'here each unit goes&No matter 'hat cost flo' assum"tions 'e use) the cumulative gross "rofit over the life of a com"any remains the same&,hatever be chosen) that should be consistent over time& !ther'ise meaningful "eriodiccom"arisons can5t be made&

Example:

Units Unit cost Total cost

Beginning inventory Jan 1 500 10Purchases

Jan 20 300 11

April 8 400 12

September 5 200 13

ecember 12 100 14

Total purc!ase

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Available for sale

Units sold "00 #

Units in ending inventory $00 #

FIFO

%nding inventor& consists of t!e most recent purc!ases of t!e period' (n man&

businesses) t!is cost*flo+ assumption is a fairl& accurate reflection of t!e p!&sicalflo+ of products' ,or e-ample) to maintain a fres! stoc. of products) t!e p!&sical

flo+ in a grocer& store is first*in first*out'

To calculate ending inventor& +e start with the most recent inventory ac/uiredand +or. bac.+ard

ate Units ost Total

ecember 12 100 14

September 5 200 13

April 8 300 12

Ending inventory !! "!!

ost of goods sold can t!en be found

ost of goods available for sale 1)100

ess ending inventor& )$00

ost of goods sold ")500

Since it assumes t!at t!e first units in are t!e first ones sold cost of goods sold can

be calculated b& starting with the #eginning inventor& and +or.ing for+ard

Jan 1 500 10

Januar& 20 300 11

April 8 100 12Units sold $!!

%ost o& goods

sold

$'(!!

For )IFO

To calculate ending inventor& using (,) we start with the #eginning

inventory and +or. for+ard

eginning inv 500 10

Januar& 20 100 11

Ending inventory !! 1'!!ost of goods sold can t!en be found

ost of goods available for sale 1)100

ess ending inventor& $)100ost of goods sold 11)000

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Since it assumes t!at t!e last units in are t!e first ones sold cost of goods sold can

be calculated b& starting with the most recent inventory and +or.ing for+ard

ecember 12 100 14

September 5 200 13

April 8 400 12Januar& 20 200 11

Units sold $!!

%ost o& goods

sold

11'!!!

Example *

T!e il ompan&) a +ell .no+n distributor of fuel oil closes its accounts at t!e

end of eac! mont!'

T!e follo+ing information is available for t!e mont! of June) 2005Sales 6s' 2)50)000

Administrative e-penses 5)000

(nventor&) June 1 50 tons 7 1)000

urc!ases 9including carriage in+ard:

June 10 150 tons 7 800

June 20 150 tons 7 "00

(nventor& ;une 30 100 tons

ompute t!e follo+ing data b& t!e ,(, met!od

(nventor& valuation on June 30

Amount of cost of goods sold for June rofit or loss for June

Example (

T!e follo+ing is an e-tract of t!e record of receipts and issues of Sulp!ur of a

c!emical factor& during ,ebruar&) 2005

,eb 1 pening balance 500 tons 7 6s 200

3 (ssue 0 tons

4 (ssue 100 tons

8 (ssue 80 tons

13 6eceived from supplier 200 tons 7 1"014 6eturned from department 15 tons

1$ (ssue 180 tons

20 6eceived from supplier 240 tons 7 1"0

24 (ssue 300 tons


2$ (ssue 115 tons

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2 6eturned from department 35 tons


(ssues are to be priced on t!e principal of ,(,' T!e stoc. verifier of t!e factor&

!ad found s!ortage of 10 tons on t!e 22nd and left a note accordingl&'

repare store ledger'

Ex

T!e ,

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Accounting for Current Assets solution