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AND
COST OF GOODS SOLD
Chapter: 3
INVENTORY HELD BY BUSINESSES
Retailers and Wholesalers
Purchase inventory in finished form and hold it for resale
Finished Product
Manufacturers
Transform raw materials into a finished product prior to sale.
Raw Materials
Work In Progress (Semi-finished product)
Finished product
TYPES OF INVENTORY COST
Wholesaler & Retailer:
Purchase cost
Manufactures:
Raw Materials (Direct Materials): Ingredients used in making
a product.
Direct Labor: Paid to workers to manufacture the products.
Manufacturing Overhead: All other costs that are related to the
manufacturing process but cannot be directly matched to specific units
of output. Eg: Depreciation of Factory, Machinery, Salary of factory
accountant etc
NET SALES OF MERCHANDISE
Sales Revenue
The inflow of either cash or accounts receivable from the sale off a
product.
Net Sales: Sales Revenue less sales returns and allowances and sales
discounts.
SALES RETURNS AND
ALLOWANCES
records inventory returned by customers
who are not completely satisfied
a customer may be given an allowance for
spoiled or damaged merchandise
single account used to record both returns
and allowances
CREDIT TERMS AND SALES
DISCOUNTS
n/30 Payment due 30 days from invoice
=
Cost
of goods
sold
THE COST OF GOODS SOLD MODEL
An increase in ending
“Pool” of goods inventory means more
available to sell was bought than sold
during the period
PERPETUAL INVENTORY SYSTEMS
Perpetual: continuous
PERIODIC INVENTORY SYSTEMS
Inventory records are not updated each time a sale or purchase is made.
Inventory records are updated periodically based on physical inventory
counts
Less:
Purchase returns and
allowances
Purchase discounts
Plus:
Transportation-in
RECORDING PURCHASES
Of
particular
interest Gross
to current and Profit %
potential
investors
Value
Value expensed
assigned to When Sold = as cost of
inventory goods sold
on balance on income
sheet statement
Specific Weighted
Identification Average
Steps
1. Indentify the specific units in inventory at the end of the year and
their cost.
2. Identify the units sold and calculate the cost of goods sold.
3. Calculate the cost of goods available for sale.
Steps
1. Calculate the cost of goods available for sale.
2. Divide the cost of goods available for sale by the total units to
determine the weighted average cost per unit
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.
WEIGHTED AVERAGE METHOD
Step
1. Calculate the cost of goods available for sale.
$17,100
1,500
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
EXERCISE: 5-24 WEIGHTED AVERAGE COST
METHOD AND GROSS PROFIT RATIO
Martin Corp. began the year with 2,000 units of
inventory that had been purchased for $6 per unit.
During the year, 5,000 units were purchased for $8
each and 8,000 units for $10 each. Martin sold 9,000
units during the year for $15 each. The company uses
the weighted average cost method.
Required:
1. Compute cost of goods sold expense.
2. Compute the gross profit ratio.
EXERCISE: 5-25 INVENTORY COSTING
METHOD-PERIODIC SYSTEM
The following information is available concerning the inventory of Carter Inc:
Units Unit Cost
Beginning Inventory 200$10
Purchases:
March 5 30011
June 12 40012
August 23 25013
October 2 15015
During the year, Carter sold 1,000 units. It uses a periodic inventory system.
Required: Calculate ending inventory and cost of goods sold using
Weighted average method.
FIRST-IN, FIRST-OUT (FIFO) METHOD
Assumes that the first units in, or purchased, are the first units out, or
sold.
An Inventory costing method that assigns the most recent costs to ending
inventory.
Steps
1. Assign the cost of the beginning inventory to cost of goods sold.
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
FIRST-IN, FIRST-OUT (FIFO)
METHOD
Last-in, First-out
(LIFO)
FIFO COSTING WITH A
PERPETUAL SYSTEM
Steps:
1. Assign the cost of the last units purchased to cost of goods sold.
2. Work backward 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
Required:
Prepare a chart comparing cost of goods sold and ending inventory using the perpetual system
and the following costing methods.
Cost of goods sold Ending Inventory Total
LIFO
EXERCISE: 5-28 INVENTORY COSTING METHOD-
PERPETUAL SYSTEM
The following information is available concerning stillwater Inc:
This
averaging approach is considered to yield a safe and
conservative approach to reporting financial results.
DETERMINING ENDING INVENTORY USING
MOVING AVERAGE WITH A PERPETUAL
SYSTEM
Specific
Identification $7,300 $ 9,800 $17,100
Weighted
Average 6,840 10,260 17,100
FIFO 7,600 9,500 17,100
OS = overstatement OS = Overstatement
US = understatement US= Understatement
EFFECT OF INVENTORY ERRORS
ON THE INCOME STATEMENT, 2013
Reported Corrected Effect
Sales $1,500,000 $1,500,000
Beginning inventory $ 300,000 $ 250,000 $50 OS
Add: Purchases 1,100,000 1,100,000
Goods available for sale $1,400,000 $1,350,000 50 OS
Less: Ending inventory 350,000 350,000
Cost of goods sold $1,050,000 $1,000,000 50 OS
Gross margin $ 450,000 $ 500,000 50 US
Operating expenses 120,000 120,000
Net income $ 330,000 $ 380,000 50 US
OS = overstatement
US = understatement
COUNTERBALANCING ERRORS
Assume ending inventory is overstated (+) by
$50,000 in 2012:
2012
Beginning inventory xxx,xxx
Add: Purchases xxx,xxx
= Goods available for sale xxx,xxx
Less: Ending inventory +50,000
= Cost of goods sold –50,000
Historical cost principle which says that assets should be carried on the balance sheet
at their original cost.
LOWER OF COST OR MARKET
Market = replacement cost (not retail value)
Cost determined under one of the costing methods
Justified on basis of conservatism
Can be applied to:
Entire inventory
Individual items (Most popular)
Groups of items
Indirect Method
Operating Activities
Deduction: Increase in Inventory
Addition: Decrease in Inventory
Addition:Increase in Account Payable
Deduction: Decrease in Account Payable
STATEMENT OF CASH FLOWS
Cash Flows from Operating Activities:
Net income xxx
Increase in inventory –
Decrease in inventory +
Increase in accounts payable +
Decrease in accounts payable –
- OR - Direct
Indirect
Method Method