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Homework assignment  Using Connect – 7 Questions for 60 Points For Chapter 4. Inventories & Cost of Sales Prepare chapters 5 “ Inventories & Cost of Sales.” Happiness is having all homework up to date Atef Abuelaish3

Chapter 05 Inventories and

Chapter 05 Inventories and Cost of Sales

Determining Inventory Items Determining Inventory Items 6

Determining Inventory Items 7 all goods that a company owns and holds for sale, Merchandise inventory includes all goods that a company owns and holds for sale, regardless of where the goods are located when inventory is counted. 1) Goods in Transit 3) Goods Damaged or Obsolete 2) Goods on Consignment C1 Items requiring special attention include:

Destination FOB Destination Point Public Carrier SellerBuyer 1) Goods in Transit 8 Public Carrier Seller Buyer Shipping FOB Shipping Point Ownership passes to the buyer here. C1

2) Goods on Consignment 9 Merchandise is included in the inventory of the consignor, the owner of the inventory. C1

3) Goods Damaged or Obsolete 10 Damaged or obsolete goods are not counted in inventory if they cannot be sold. Cost should be reduced to net realizable value if they can be sold. C1

Determining Inventory Costs Determining Inventory Costs 11

Determining Inventory Costs 12 Invoice Cost Include all expenditures necessary to bring an item to a salable condition and location. Minus Discounts and Allowances Plus Import Duties Plus Freight Plus Storage Plus Insurance C2

Internal Controls and Taking a Physical Count 13  Most companies take a physical count of inventory at least once each year.  When the physical count does not match the Merchandise Inventory account, an adjustment must be made. Good internal controls over count include: 1.Pre-numbered inventory tickets. 2.Counters have no inventory responsibility. 3.Counts confirm existence, amount, and quality of inventory item. 4.Second count is taken. 5.Manager confirms all items counted. Good internal controls over count include: 1.Pre-numbered inventory tickets. 2.Counters have no inventory responsibility. 3.Counts confirm existence, amount, and quality of inventory item. 4.Second count is taken. 5.Manager confirms all items counted. C2

Inventory Costing under a Perpetual System 14 Inventory affects... The matching principle requires matching costs with sales. Balance Sheet Income Statement C2

Inventory Cost Flow Assumptions 15 C2 Management decisions in accounting for inventory involve the following: 1.Items included in inventory and their costs. 2.Costing method (specific identification, FIFO, LIFO, or weighted average). 3.Inventory system (perpetual or periodic). 4.Use of market values or other estimates.

A master carver of wooden birds operates her business out of a garage. At the end of the current period, the carver has 17 units (carvings) in her garage, three of which were damaged by water and cannot be sold. The distributor also has another five units in her truck, ready to deliver per a customer order, terms FOB destination, and another 11 units out on consignment at several small retail stores. How many units does the carver include in the business’s period-end inventory? Units in ending inventory Units in storage17 Less damaged (unsalable) units(3) Plus units in transit (FOB Destination)5 Plus units on consignment11 Total units in ending inventory30 A distributor of artistic iron-based fixtures acquires a piece for $1,000, terms FOB shipping point. Additional costs in obtaining it and offering it for sale include $150 for transportation-in, $300 for import duties, $100 for insurance during shipment, $200 for advertising, a $50 voluntary gratuity to the delivery person, $75 for enhanced store lighting, and $250 for sales staff salaries. For computing inventory, what cost is assigned to this artistic piece? Cost of inventory Cost$1,000 Transportation-in (FOB shipping point)150 Import duties300 Insurance cost100 Inventory cost$1,550 Key point – How many units does she own at year-end? Key point – What are the necessary costs to get the asset ready for its intended purpose? NEED-TO-KNOW

Inventory Costing Inventory Costing 17

Inventory Cost Flow Assumptions 18 First-In, First-Out (FIFO) Assumes costs flow in the order incurred. Last-In, First-Out (LIFO) Assumes costs flow in the reverse order incurred. Weighted Average Assumes costs flow at an average of the costs available. P1

Inventory Costing Illustration 19 Here is information about the mountain bike inventory of Trekking for the month of August. P1

1) Specific Identification 20 P1

First-In, First-Out (FIFO) 21 Cost of Goods Sold Ending Inventory Oldest Costs Recent Costs P1

2) First-In, First-Out (FIFO) 22 P1

Last-In, First-Out (LIFO) 23 Cost of Goods Sold Ending Inventory Recent Costs Oldest Costs P1

3) Last-In, First-Out (LIFO) 24 P1

4) Weighted Average 25 When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. Cost of Goods Available for Sale Units on hand on the date of sale ÷ P1

Weighted Average 26 P1

NEED-TO-KNOW A company reported the following December purchases and sales data for its only product. DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units The company uses a perpetual inventory system. Determine the cost assigned to ending inventory and to cost of goods sold using (a) specific identification, (b) FIFO, (c) LIFO, and (d) weighted average. (Round per unit costs and inventory amounts to cents.) For specific identification, ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. P1 27

NEED-TO-KNOW A company reported the following December purchases and sales data for its only product. DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units The company uses a perpetual inventory system. Determine the cost assigned to ending inventory and to cost of goods sold using (a) specific identification, (b) FIFO, (c) LIFO, and (d) weighted average. (Round per unit costs and inventory amounts to cents.) For specific identification, ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. Regardless of the method used, the cost of 26 units are included in Cost of Goods Sold, and the cost of 10 units are included in Ending Inventory P1 28

NEED-TO-KNOW A company reported the following December purchases and sales data for its only product. DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units The company uses a perpetual inventory system. Determine the cost assigned to ending inventory and to cost of goods sold using (a) specific identification, (b) FIFO, (c) LIFO, and (d) weighted average. (Round per unit costs and inventory amounts to cents.) For specific identification, ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. Specific Identification Method Not an inventory assumption - Actual Cost of Goods Sold represents the actual cost of the units selected by the customer. Ending Inventory represents the actual cost of the units that remain in ending inventory. P1 29

NEED-TO-KNOW DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units Ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. Specific Identification – Cost of exact units sold are expensed as Cost of Goods Sold. DateActivities Dec. 01Beginning $3.00 = $15.00 Dec. $4.50 = $4.50 = $4.50 = $9.00 Dec. $5.00 = $65.00 Dec. $5.30 = $ units$ units$ units$51.40 Cost of Goods SoldCost of Ending InventoryUnits Acquired at Cost Cost of Goods Sold $ Ending inventory Goods available for sale $ P1 30

NEED-TO-KNOW DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units Perpetual FIFO – Cost of Goods Sold is calculated at the time of the sale. The first items in are the first items out – expensed as Cost of Goods Sold. DateGoods PurchasedCost of Goods SoldInventory Balance Dec. $3.00= $15.00 Dec. $3.00 $4.50 Dec. $3.00 $4.50= $31.50 Dec. $4.50 $5.00 Dec. $4.50 $5.00= $10.00 Dec. $5.00 $5.30 $ } = $96.50 } = $86.50 } = $52.40 } = $60.00 } = $28.50 Cost of Goods Sold $ Ending inventory Goods available for sale $ P1 31

NEED-TO-KNOW DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units Perpetual LIFO – Cost of Goods Sold is calculated at the time of the sale. The last items in are the first items out – expensed as Cost of Goods Sold. DateGoods PurchasedCost of Goods SoldInventory Balance Dec. $3.00= $15.00 Dec. $3.00 $4.50 Dec. $3.00 $4.50 Dec. $3.00 $4.50 $5.00 Dec. $3.00= $6.00 $4.50 $5.00 Dec. $3.00 $5.30 $ = $36.00 } = $89.00 } = $83.00 } = $48.40 $4.50} = $24.00 } = $60.00 Cost of Goods Sold $ Ending inventory Goods available for sale $ P1 32

NEED-TO-KNOW DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units Weighted Average – Cost of Goods Sold is calculated at the time of the sale. Average cost is equal to cost of goods available at the time of the sale divided by number of units available at the time of the sale. DateGoods PurchasedCost of Goods SoldInventory Balance Dec. $3.00= $15.00 Dec. $3.00 $4.50 $60 / 15 units = $4.00 avg. cost Dec. $4.00 = $4.00 = $28.00 Dec. $4.00 $5.00 $93 / 20 units = $4.65 avg. cost Dec. $4.65 = $4.65= $9.30 Dec. $4.65 $5.30 $51.70 / 10 units = $5.17 avg. cost $ } = $51.70 } = $60.00 } = $93.00 Cost of Goods Sold $ Ending inventory Goods available for sale $ P1 33

Financial Statement Effects of Costing Methods Financial Statement Effects of Costing Methods 34

Financial Statement Effects of Costing Methods 35 Because prices change, inventory methods nearly always assign different cost amounts. A1

Financial Statement Effects of Costing Methods Advantages of Methods Smoothes out price changes. Better matches current costs in cost of goods sold with revenues. Ending inventory approximates current replacement cost. First-In, First-Out Weighted Average Last-In, First-Out A1

Tax Effects of Costing Methods 37 The Internal Revenue Service (IRS) identifies several acceptable inventory costing methods for reporting taxable income. If LIFO is used for tax purposes, the IRS requires it be used in financial statements. A1

Consistency in Using Costing Methods 38 The consistency principle requires a company to use the same accounting methods period after period so that financial statements are comparable across periods. A1

Lower of Cost or Market Lower of Cost or Market 39

Lower of Cost or Market 40 Inventory must be reported at market value when market is lower than cost. Can be applied three ways: (1)separately to each individual item. (2)to major categories of assets. (3)to the whole inventory. Can be applied three ways: (1)separately to each individual item. (2)to major categories of assets. (3)to the whole inventory. Defined as current replacement cost (not sales price). Consistent with the conservatism principle. Defined as current replacement cost (not sales price). Consistent with the conservatism principle. P2

Lower of Cost or Market 41 A motor sports retailer has the following items in inventory: P2

NEED-TO-KNOW A company has the following products in its ending inventory. (a) Compute the lower of cost or market for its inventory when applied separately to each product. (b) If the LCM amount is less than the recorded cost of the inventory, then record the December 31 LCM adjustment to the Merchandise Inventory account. LCM UnitsCostMarketCostMarketBy item Road bikes5$1,000$800$5,000$4,000 Mountain bikes ,0002,4002,000 Town bikes ,0004,5004,000 Total$11,000$10,000 DateDebitCredit Dec. 31Cost of Goods Sold1,000 Merchandise Inventory1,000 Per UnitTotal General Journal P2 42

Financial Statement Effects of Inventory Errors Financial Statement Effects of Inventory Errors 43

Financial Statement Effects of Inventory Errors 44 A2

Financial Statement Effects of Inventory Errors 45 A2

Global View 46 Items and Costs Making Up Inventory Both U.S. GAAP and IFRS include in inventory all items that a company owns and holds for sale plus all cost expenditures necessary to bring those items to a salable condition and location. Assigning Costs to Inventory Both U.S. GAAP and IFRS allow companies to use specific identification, FIFO, and Weighted Average. IFRS does not currently allow use of LIFO. Estimating Inventory Costs Both U.S. GAAP and IFRS require companies to write down inventory when its value falls below recorded cost. U.S. GAAP prohibits any later increase in value. IFRS does allow reversals of write downs up to the original acquisition cost. Neither allow inventory to be adjusted upward beyond the original cost.

NEED-TO-KNOW A company had $10,000 of sales in each of three consecutive years 20X1-20X3, and it purchased merchan- dise costing $7,000 in each of those years. It also maintained a $2,000 physical inventory from the beginning to the end of that three-year period. In accounting for inventory, it made an error at the end of year 20X1 that caused its year-end 20X1 inventory to appear on its statements as $1,600 rather than the correct $2,000. (a) Determine the correct amount of the company’s gross profit in each of the years 20X1–20X3. (b) Prepare comparative income statements to show the effect of this error on the company’s cost of goods sold and gross profit for each of the years 20X1–20X3. Correct Amounts Sales$10,000 $30,000 Cost of goods sold Beginning inventory$2,000 Cost of purchases7,000 Goods available for sale9,000 Ending inventory2,000 Cost of goods sold7,000 21,000 Gross profit$3,000 $9,000 Inventory error Sales$10,000 $30,000 Cost of goods sold Beginning inventory$2,000$1,600$2,000 Cost of purchases7,000 Goods available for sale9,0008,6009,000 Ending inventory1,6002,000 Cost of goods sold7,4006,6007,00021,000 Gross profit$2,600$3,400$3,000$9,000 Year 20X1Year 20X2Year 20X3 Total Year 20X1Year 20X2Year 20X3 A2 47

Inventory Turnover and Days' Sales in Inventory Inventory Turnover and Days' Sales in Inventory 48

7) Inventory Turnover 49 Inventory turnover = Cost of goods sold Average inventory Shows how many times a company turns over its inventory during a period. Indicator of how well management is controlling the amount of inventory available. Average Inventory = (Beg. Inv. + End Inv.) ÷ 2 A3

8) Days’ Sales in Inventory 50 Reveals how much inventory is available in terms of the number of days’ sales. A3

Inventory Costing under a Periodic System Inventory Costing under a Periodic System 51

Appendix 5A: Inventory Costing under a Periodic System 52 P3 LIFO computation of COGS and ending inventory under a periodic system.

NEED-TO-KNOW A company reported the following December purchases and sales data for its only product. DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units The company uses a periodic inventory system. Determine the cost assigned to ending inventory and to cost of goods sold using (a) specific identification, (b) FIFO, (c) LIFO, and (d) weighted average. (Round per unit costs and inventory amounts to cents.) For specific identification, ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. P3 53

NEED-TO-KNOW A company reported the following December purchases and sales data for its only product. DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units The company uses a periodic inventory system. Determine the cost assigned to ending inventory and to cost of goods sold using (a) specific identification, (b) FIFO, (c) LIFO, and (d) weighted average. (Round per unit costs and inventory amounts to cents.) For specific identification, ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. Regardless of the method used, the cost of 26 units are included in Cost of Goods Sold, and the cost of 10 units are included in Ending Inventory P3 54

NEED-TO-KNOW A company reported the following December purchases and sales data for its only product. DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units The company uses a periodic inventory system. Determine the cost assigned to ending inventory and to cost of goods sold using (a) specific identification, (b) FIFO, (c) LIFO, and (d) weighted average. (Round per unit costs and inventory amounts to cents.) For specific identification, ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. Specific Identification Method Not an inventory assumption - Actual Cost of Goods Sold represents the actual cost of the units selected by the customer. Ending Inventory represents the actual cost of the units that remain in ending inventory. P3 55

NEED-TO-KNOW DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units Ending inventory consists of 10 units, where eight are from the December 30 purchase and two are from the December 8 purchase. Specific Identification – Cost of exact units sold are expensed as Cost of Goods Sold. DateActivities Dec. 01Beginning $3.00 = $15.00 Dec. $4.50 = $4.50 = $4.50 = $9.00 Dec. $5.00 = $65.00 Dec. $5.30 = $ units$ units$ units$51.40 Cost of Goods SoldCost of Ending InventoryUnits Acquired at Cost P3 56

NEED-TO-KNOW DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units DateActivities Dec. 01Beginning $3.00 = $15.00 Dec. $4.50 = $45.00 Dec. $5.00 = $5.00 = $5.00 = $10.00 Dec. $5.30 = $ units$ units$ units$52.40 Units Acquired at CostCost of Goods SoldCost of Ending Inventory Periodic FIFO – Cost of Goods Sold is calculated at the end of the period. The first items in are the first items out – expensed as Cost of Goods Sold. P3 57

NEED-TO-KNOW DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units Periodic LIFO – Cost of Goods Sold is calculated at the end of the period. The last items in are the first items out – expensed as Cost of Goods Sold. DateActivities Dec. 01Beginning $3.00 = $15.00 Dec. $4.50 = $45.00 $4.50 = $22.50 Dec. $5.00 = $5.00 = $55.00 Dec. $5.30 = $ units$ units$ units$37.50 Units Acquired at CostCost of Goods SoldCost of Ending Inventory $4.50 = $22.50 P3 58

NEED-TO-KNOW DateActivitiesUnits Acquired at CostUnits Sold at Retail Dec. 01Beginning inventory5 $3.00 = $15.00 Dec. 08Purchase10 $4.50 = $45.00 Dec. 09Sales8 $7.00 Dec. 19Purchase13 $5.00 = $65.00 Dec. 24Sales18 $8.00 Dec. 30Purchase8 $5.30 = $ units$ units Weighted Average – Cost of Goods Sold is calculated at the end of the period. Each unit sold, and each unit in ending inventory is assigned the same cost per unit: the average cost of units available for sale. DateActivities Dec. 01Beginning $3.00 = $15.00 Dec. $4.50 = $45.00 Cost of goods available for sale Number of units available for sale Dec. $5.00 = $65.00 $ Dec. $5.30 = $ units$ units $4.65 = $ units Units Acquired at CostCost of Goods SoldCost of Ending Inventory 36 units $4.65 = $46.50 $4.65 per unit P3 59

Inventory Estimation Methods Inventory Estimation Methods 60

Page 62 Appendix 5B: Inventory Estimation Methods 61 P4 Inventory sometimes requires estimation for interim statements or if some casualty such as fire or flood makes taking a physical count impossible. Retail Inventory Method Gross Profit Method

NEED-TO-KNOW CostRetail Beginning inventory$324,000$530,000 Purchases195,000335,000 Sales320,000 CostRetail Beginning inventory$324,000$530,000 Purchases195,000335,000 Total merchandise available for sale$519,000$865,000 Less: Sales(320,000) Ending inventory priced at retail$545,000 Cost ratio0.60 Ending inventory at cost$327,000 $519,000 $865, Cost-to-retail ratio Cost of goods available for sale Retail of goods available for sale Using the retail method and the following data, estimate the cost of ending inventory. P4 62

Homework assignment  Using Connect – 4 Questions for 60 Points For Chapter 5. Cash and Internal Controls Prepare chapters 6 “ Cash and Internal Controls.” Happiness is having all homework up to date Atef Abuelaish63

Thank you and See You Wednesday at the Same Time, Take Care Thank you and See You Wednesday at the Same Time, Take Care Atef Abuelaish64