McGraw-Hill/IrwinCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 7 Inventories and Cost of Goods Sold PowerPoint Authors:

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 7

Inventories and Cost of Goods Sold

PowerPoint Authors:Brandy MackintoshLindsay Heiser

7-2

Learning Objective 7-1

Describe the issues in managing different types of

inventory.

7-3

Inventory Management Decisions

The primary goals of inventory managers are to:

1. Maintain a sufficient quantity to meet customers’ needs

2. Ensure quality meets customers’ expectations and company standards

3. Minimize the costs of acquiring and carrying the inventory

7-4

Types of InventoryMerchandisers . . .

Buy finished goods. Sell finished goods.

Manufacturers . . . Buy raw materials. Produce and sell

finished goods.

Raw MaterialsWork in ProcessFinished goods

Merchandise inventory

Materials waiting toMaterials waiting tobe processedbe processed

Partially Partially complete productscomplete products

Completed products Completed products awaiting sale awaiting sale

7-5


Explain how to report Inventory and Cost of Goods

Sold.

7-6

Balance Sheet and Income Statement Reporting

7-7

Cost of Goods Sold Equation

BI + P – CGS = EIBI + P – CGS = EI

National Outfitters’ beginning inventory was $4,800. During the period, the company purchased inventory for $10,200. The

cost of goods sold for the period is $9,000. Compute the ending inventory.

Cost of Goods Sold Calculation

+=-=

Beginning InventoryPurchasesCost of Goods Available for SaleCost of Goods soldEnding Inventory

$ 4,800 10,200

15,000 9,000$ 6,000

7-8

Cost of Goods Sold EquationbeginningInventory

$4,800

beginningInventory

$4,800+

goods availablefor sale$15,000

purchases$10,000

purchases$10,000

endingInventory

$6,000

endingInventory

$6,000(Balance Sheet)

Cost ofGoods Sold

$9,000

Cost ofGoods Sold

$9,000(Income Statement)

7-9


Compute costs using four inventory costing methods.

7-10

Inventory Costing Methods

First-in, first-out(FIFO)

First-in, first-out(FIFO)

Last-in, first-out(LIFO)

Last-in, first-out(LIFO)

Weighted average

Weighted average

SpecificSpecificidentificationidentification

SpecificSpecificidentificationidentification

7-11

Inventory Costing MethodsConsider the following information

This method individually identifies and records the cost of This method individually identifies and records the cost of each item sold as part of cost of goods sold. If the items each item sold as part of cost of goods sold. If the items

sold were identified as the ones that cost $70 and $95, the sold were identified as the ones that cost $70 and $95, the total cost of those items ($70 + 95 = $165) would be total cost of those items ($70 + 95 = $165) would be

reported as Cost of Goods Sold. The cost of the remaining reported as Cost of Goods Sold. The cost of the remaining item ($75) would be reported as Inventory on the balance item ($75) would be reported as Inventory on the balance

sheet at the end of the period. sheet at the end of the period.

Specific Identification

May 5$75 cost

May 3$70 cost

May 6$95 costMay 3

May 5May 6May 8

Purchased 1 unit for $70Purchased 1 more unit for $75Purchased 1 more unit for $95Sold 2 units for $125 each

7-12


FIFO LIFO Weighted average

May 6$95 cost

May 5$75 cost

May 3$70 cost

May 6$95 cost

May 5$75 cost

May 3$70 cost

So

ld

Sti

ll t

her

e

Income StatementNet SalesCost of Goods SoldGross Profit

$250 145$105

Balance SheetInventory $95

May 6$95 cost

May 5$75 cost

May 3$70 cost

So

ld

Sti

ll t

her

e


$250 170$ 80


$80per unit

Sold

Still there

$2403 =


$250 160$ 90


7-13


Summary

Cost of Goods sold (Income Statement)Inventory (Balance sheet)

FIFO

Oldest costNewest cost

LIFO

Newest costOldest cost

WeightedAverage

Average costAverage cost

Let’s consider a more complex example.

DateOct 1Oct 3Oct 5Oct 6

DescriptionBeginning InventoryPurchasePurchaseSalesEnding Inventory

# of Units103010

(35)15

Cost per Unit$ 7$ 8$10

To calculateTo calculate

Total Cost$ 70

240100

To calculateTo calculate

7-14

Inventory Cost Flow Computations

FIFO

+

-=

beginning Inventorypurchases

cost of goods available for saleending InventoryCost of Goods Sold

10 units x $ 7 = $ 7030 units x $ 8 = 240

10 units x $ 10 = 100

$ 410140

$ 270

(10 units @ $10) + (5 units @ $8)

7-15


LIFO

+

-=

beginning Inventorypurchases

cost of goods available for saleending InventoryCost of Goods Sold

10 units x $ 7 = $ 7030 units x $ 8 = 240

10 units x $ 10 = 100

$ 410110

$ 300

(10 units @ $10) + (25 units @ $8)

7-16


Weighted Average

WeightedAverage Cost

=Cost of goods Available for Sale

Number of Units Available for Sale

WeightedAverage Cost

=$410

50 units= $8.20 per unit

Description

beginning Inventorypurchasepurchasecost of goods available for sale

# of Units

1030

1050

Cost per Unit

$ 7$ 8$10

Total Cost

$ 70240

100$ 410

7-17


Weighted Average

+

-=

Beginning InventoryPurchases

Cost of Goods Available for SaleEnding InventoryCost of Goods Sold

10 units x $ 7 = $ 7030 units x $ 8 = 240

10 units x $ 10 = 100

$ 410123

$ 287

15 units @ $8.20

35 units @ $8.20

7-18

Financial Statement Effects

Effects on the Income Statement

SalesCost of Goods Sold

Gross Profit

Operating ExpensesIncome from OperationsOther Revenue (Expenses)

Income before Income Tax ExpenseIncome Tax Expense (30%)

Net Income

Effects on the Balance Sheet

Inventory

WeightedAverage

$ 525287

238

12511320

13340

$ 93

$ 123

LIFO

$ 525300

225

12510020

12036

$ 84

$ 110

FIFO

$ 525270

255

12513020

15045

$ 105

$ 140

7-19


7-20


Advantages of MethodsAdvantages of MethodsAdvantages of MethodsAdvantages of Methods

First-In, First-OutFirst-In, First-Out

Weighted Average

Weighted Average

Last-In, First-OutLast-In,

First-Out

7-21

Tax Implications and Cash Flow Effects

Effects on the Income Statement

SalesCost of Goods Sold

Gross Profit

Operating ExpensesIncome from OperationsOther Revenue (Expenses)

Income before Income Tax ExpenseIncome Tax Expense (30%)

Net Income

Effects on the Balance Sheet

Inventory

WeightedAverage

$ 525287

238

12511320

13340

$ 93

$ 123

LIFO

$ 525300

225

12510020

12036

$ 84

$ 110

FIFO

$ 525270

255

12513020

15045

$ 105

$ 140

7-22


Reporting inventory at thelower of cost or market.

7-23

The value of inventory can fall below its The value of inventory can fall below its recorded cost for two reasons:recorded cost for two reasons:

1.1. it’s easily replaced by identical goods at ait’s easily replaced by identical goods at a lower cost, or lower cost, or

2.2. it’s become outdated or damaged.it’s become outdated or damaged.

The value of inventory can fall below its The value of inventory can fall below its recorded cost for two reasons:recorded cost for two reasons:

1.1. it’s easily replaced by identical goods at ait’s easily replaced by identical goods at a lower cost, or lower cost, or

2.2. it’s become outdated or damaged.it’s become outdated or damaged.

Lower of Cost or Market

When the value of inventory falls below its When the value of inventory falls below its recorded cost, the amount recorded for recorded cost, the amount recorded for

inventory is written down to its lower inventory is written down to its lower market value. This is known as the lower of market value. This is known as the lower of

cost or market (LCM) rule.cost or market (LCM) rule.

When the value of inventory falls below its When the value of inventory falls below its recorded cost, the amount recorded for recorded cost, the amount recorded for

inventory is written down to its lower inventory is written down to its lower market value. This is known as the lower of market value. This is known as the lower of

cost or market (LCM) rule.cost or market (LCM) rule.

7-24


Item

Leather coatsVintage jeans

CostperItem

$16520

MarketValue

per Item

$15025

LCMperItem

$15020

Quantity

1,000400

Total Lowerof cost

or Market

$150,0008,000

Totalcost

$165,0008,000

Write-down

$15,0000

1,000 items @ $165

2 Record

dr Cost of Goods Sold (+E, -SE) cr Inventory (-A) 15,000

15,000

1,000 items @ $150 400 items @ $201 Analyze

LiabilitiesAssets = Stockholders’ Equity+

Inventory -$15,000 Cost of GoodsSold (+E) -$15,000

7-25


7-26


Analyze and record inventory purchases, transportation,

returns and allowances, and discounts.

7-27

Recording Inventory Transactions

We will now look at the accounting for We will now look at the accounting for purchases, transportation costs, purchases, transportation costs,

purchase returns and allowances, and purchase returns and allowances, and purchase discounts. We will record all purchase discounts. We will record all

inventory-related transactions in the inventory-related transactions in the Inventory account. Inventory account.

7-28

Inventory Purchases

American Eagle Outfitters purchasesAmerican Eagle Outfitters purchases$10,500 of vintage jeans on credit.$10,500 of vintage jeans on credit.

1 AnalyzeLiabilitiesAssets = Stockholders’ Equity+

Inventory (+A) +$10,500 AccountsPayable (+L) $10,500

2 Record

dr Inventory (+A) cr Accounts Payable (+L) 10,500

10,500

7-29

Transportation Cost

American Eagle pays $400 cash to a trucker whoAmerican Eagle pays $400 cash to a trucker whodelivers the $10,500 of vintage jeans to one of its stores.delivers the $10,500 of vintage jeans to one of its stores.


Cash (-A) -$400Inventory (+A) +$400

2 Record

dr Inventory (+A) cr Cash (-A) 400

400

7-30

Purchase Returns and Allowances

American Eagle returned some of the vintage jeans to theAmerican Eagle returned some of the vintage jeans to thesupplier and received a $500 reduction in the balance owed.supplier and received a $500 reduction in the balance owed.


Inventory (-A) -$500 AccountsPayable (-L) -$500

2 Record

dr Accounts Payable (-L) cr Inventory (-A) 500

500

7-31

Purchase Discounts

American Eagle’s vintage jeans purchase for $10,500 had American Eagle’s vintage jeans purchase for $10,500 had terms of 2/10, n/30. Recall that American Eagle returned terms of 2/10, n/30. Recall that American Eagle returned

inventory costing $500 and received a $500 reduction in its inventory costing $500 and received a $500 reduction in its Accounts Payable. American Eagle paid within Accounts Payable. American Eagle paid within

the discount period.the discount period.


Cash (-A) -$9,800Inventory (-A) -$200

AccountsPayable (-L) -10,000

2 Record

dr Accounts Payable (-L) cr Cash (-A) cr Inventory (-A)

9,800200

10,000

7-32

Summary of Inventory Transactions

7-33


Evaluate inventory management by computing

and interpreting the inventory turnover ratio.

7-34

Inventory Turnover Analysis

7-35

Comparison to Benchmarks


Supplement 7A

FIFO, LIFO, and Weighted Average in a Perpetual Inventory System

7-37

Perpetual Inventory System

Date Description # of Units Cost per Unit Total CostOct 1 Beginning Inventory 10 7$ 70$ Oct 3 Purchase 30 8$ 240$ Oct 4 Sales (35) To calculate To calculateOct 5 Purchase 10 10$ 100$

Ending Inventory 15 To calculate To calculate

This is the same information that we used earlier in the chapter to illustrate a periodic inventory system. The only difference is that we have assumed the sales occurred on

October 4, prior to the final inventory purchase.

7-38

FIFO (First-in, First-Out)

7-39

LIFO (Last-in, First-Out)

7-40

Weighted Average Cost

$310 ÷ 40 units= $7.75 per unit

7-41


Summary of Perpetual Inventory System Cost Summary of Perpetual Inventory System Cost Flow Assumptions on Financial StatementsFlow Assumptions on Financial Statements


Supplement 7B

The Effects of Errors in Ending Inventory

7-43

The Effects of Errors in Ending InventoryCost of Goods Sold Equation


Errors in EndingInventory will affect

the Balance Sheet andthe Income Statement.

Assume that Ending Inventory was overstated in 2012 by$10,000 due to an error that was not discovered until 2013.

2012

+-

=

Beginning InventoryPurchasesEnding Inventory

Cost of Goods Sold

AccurateAccurateOverstated $10,000

Understated $10,000

7-44

The Effects of Errors in Ending Inventory

Now let’s examine the effects of theNow let’s examine the effects of the2012 Ending Inventory Error on 2013.2012 Ending Inventory Error on 2013.

Assume that Ending Inventory was overstated in 2012 by$10,000 due to an error that was not discovered until 2013.

2013

+-

=

Beginning InventoryPurchasesEnding Inventory

Cost of Goods Sold

Overstated $10,000AccurateAccurate

Overstated $10,000


Supplement 7C

Recording Inventory Transactions in a Periodic System

7-46


Jan. 1 Beginning inventory: 80 units at a cost of $60.Apr. 14 Purchased 170 additional units on account at a cost of $60.Nov. 30 Sold 150 units on account at a unit sales price of $80.Dec. 31 Counted 100 units at a unit cost of $60.

A local cell phone dealer stocks and sells one item.The following events occurred in the past year:

We will record these events assuming the company usesa periodic inventory system and then compare the

periodic inventory system to a perpetual inventory system.

7-47


Periodic Inventory System Perpetual Inventory System

7-48


Periodic Inventory System


End-of-year adjustment entries are not required using a perpetual inventory system.

7-49


Periodic Inventory System Perpetual Inventory System

Summary of the Effects on the Accounting Equation


Chapter 7Solved Exercises

M7-6, M7-7, E7-2, E7-5, E7-10, E7-17

7-51

M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average CostGiven the following information, calculate cost of goods available for sale and ending inventory, then sales, cost of goods sold, and gross profit, under (a) FIFO, (b) LIFO, and (c) weighted average. Assume a periodic inventory system is used.

7-52

M7-6 Calculating Cost of Goods Available for Sale, Ending Inventory, Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO, LIFO, and Weighted Average Cost

a. FIFO Beginning Inventory 50 units x $10 = $ 500+ Purchase 250 units x $13 = $3,250 Cost of Goods Available for Sale $3,750 - Ending Inventory (200 x $13) = $2,600 = Cost of Goods Sold (50 x $10) + (50 x $13) $1,150

7-53


b. LIFO Beginning Inventory 50 units x $10 = $ 500+ Purchase 250 units x $13 = $3,250 Cost of Goods Available for Sale $3,750 - Ending Inventory (150 x $13) + (50 x $10) = $2,450 = Cost of Goods Sold (100 x $13) $1,300

7-54

WeightedAverage Cost =

$3,750300 units = $12.50 per unit


c. Weighted Average Beginning Inventory 50 units x $10 = $ 500+ Purchase 250 units x $13 = $3,250 Cost of Goods Available for Sale $3,750 - Ending Inventory (200 x $12.50) = $2,500 = Cost of Goods Sold (100 x $12.50) $1,250

7-55


FIFO LIFO Weighted AvgSales (100 units at $15) $1,500 $1,500 $1,500Cost of Goods Sold 1,150 1,300 1,250 Gross Profit $ 350 $ 200 $ 250

7-56

M7-7 Calculating Cost of Goods Available for Sale, Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Weighted Average Cost (Periodic Inventory)Aircard Corporation tracks the number of units purchased and sold throughout each accounting period, but applies its inventory costing method at the end of each period as if it uses a periodic inventory system. Given the following information, calculate the cost of goods available for sale, endinginventory, and cost of goods sold, if Aircard uses (a) FIFO, (b) LIFO, or (c) weighted average cost.

7-57

M7-7 Calculating Cost of Goods Available for Sale, Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Weighted Average Cost (Periodic Inventory)

Goods Available for Sale – same for all methodsUnits Unit Total

Cost CostBeginning Inventory 2,000 $40 $ 80,000+ Purchase (July 13) 6,000 $44 264,000+ Purchase (July 25) 8,000 $50 400,000 Goods Available for Sale 16,000 $744,000

7-58


a. FIFO Ending Inventory (7,000 units x $50) = $350,000

Cost of Goods Sold (2,000 units x $40)(6,000 units x $44)(1,000 units x $50) = $394,000

b. LIFO Ending Inventory (2,000 units x $40)

(5,000 units x $44) = $300,000

Cost of Goods Sold (8,000 units x $50)(1,000 units x $44) = $444,000

7-59


c. Weighted Average Average Unit Cost $744,000 / 16,000 = $46.50

Ending Inventory (7,000 units x $46.50) = $325,500

Cost of Goods Sold (9,000 units x $46.50) = $418,500

7-60

End of Chapter 7

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McGraw-Hill/IrwinCopyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 7 Inventories and Cost of Goods Sold PowerPoint Authors: