INVENTORIES AND THE COST OF GOODS SOLD CHAPTER:3 Aman Khan MBA-Finance amanullahkhan11@yahoo.com INVENTORIES AND THE COST OF GOODS SOLD 2

Goods owned and held for sale to customers Inventory Defined Inventory Goods owned and held for sale to customers Current asset

The Flow of Inventory Costs BALANCE SHEET Current assets: Inventory Purchase cost (or manufacturing costs) as goods are sold as incurred INCOME STATEMENT Revenue Cost of goods sold Gross profit Expenses Net income Sale Price Purchase Price

Inventory SYSTEMs There are two systems for inventory recording. Perpetual System: In this system inventory record is updated after each sale. Periodic System. In this system inventory will be updated at the end of accounting period.

The Flow of Inventory Costs In a perpetual inventory system, inventory entries parallel the flow of costs.

Which Unit Did We Sell? When identical units of inventory have different unit costs, a question naturally arises as to which of these costs should be used in recording a sale of inventory. 4

Inventory Subsidiary Ledger A separate subsidiary account is maintained for each item in inventory. Purchases Sold Cost Of Goods sold Date Units Unit Cost Total Unit Jan 1 20 10 200 Jan 3 15 225 Jan 7 400 Jan 12 30 300 ? How can we determine the unit cost for the Jan. 12 sale?

Specific identification Inventory Cost Flows We use one of these inventory valuation methods to determine cost of inventory sold. Specific identification LIFO Average cost FIFO 4

First-In First-Out The First-In, First-Out method often called FIFO is based on the assumption that the first merchandise purchased is the first merchandise sold.

fifo 1st 1st 2nd 2nd 3rd 4th January , sold two items FIFO Sold items Purchase item on 1st January Purchase item on 2nd January Purchase item on 3rd January 4th January , sold two items Sold items 1st 1st FIFO 2nd 2nd 3rd

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

Information for the Following Inventory Examples The Bike Company (TBC)

On August 14, TBC sold 20 bikes for $130 each. FIFO – Example The Cost of Goods Sold for the August 14 sale is $1,970, leaving $530 and 5 units in inventory. On August 14, TBC sold 20 bikes for $130 each. Continue

A similar entry is made after each sale. FIFO – Example Retail Cost A similar entry is made after each sale. Continue

FIFO – Example Cost of Goods Sold for August 31 = $2,600 Additional purchases were made on Aug. 17 and Aug. 28. On August 31, an additional 23 units were sold. Cost of Goods Sold for August 31 = $2,600 Continue

FIFO – Example Income Statement Balance Sheet COGS = $4,570 Inventory = $1,420

FIFO-Q1 DATE DESCRIPTION UNITS JAN. 1 Beginning Inventory 900 10 9,000 COST TOTAL COST JAN. 1 Beginning Inventory 900 10 9,000 Feb.23 Purchases 1,200 11 13,200 Apr. 20 3,000 12 36,000 May.4 4,000 13 52,000 Nov.30 Sales 2,000 15 30,000

Fifo-Q2 DATE DESCRIPTION UNIT S UNIT COST TOTAL COST SEP.1 Beginning balance 15 60 900 SEP.4 Purchases 20 65 1300 SEP.8 SALES 25 100 2500 SEP.9 40 70 2800 SEP.20 10 80 800 SEP.25 50 110 5500

LAST-In First-Out The Last-In, First-Out method often called LIFO is based on the assumption that the Last merchandise Purchased is the first merchandise Sold.

Lifo 1st 2nd 2nd 3rd 3rd 4th January , sold two items LIFO Sold items Purchase item on 1st January Purchase item on 2nd January Purchase item on 3rd January 4th January , sold two items Sold items 1st LIFO 2nd 2nd 3rd 3rd

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

On August 14, TBC sold 20 bikes for $130 each. LIFO – Example The Cost of Goods Sold for the August 14 sale is $2,045, leaving $455 and 5 units in inventory. On August 14, TBC sold 20 bikes for $130 each. Continue

A similar entry is made after each sale. LIFO – Example Retail Cost A similar entry is made after each sale. Continue

LIFO – Example Cost of Goods Sold for August 31 = $2,685 Additional purchases were made on Aug. 17 and Aug. 28. On Aug. 31, an additional 23 units were sold. Continue

LIFO – Example Income Statement Balance Sheet COGS = $4,730 Inventory = $1,260

LIFO-EXAMPLE DATE DESCRIPTION UNITS JAN. 1 Beginning Inventory 900 10 COST TOTAL COST JAN. 1 Beginning Inventory 900 10 9,000 Feb.23 Purchases 1,200 11 13,200 Apr. 20 3,000 12 36,000 May.4 4,000 13 52,000 Nov.30 Sales 2,000 15 30,000

Lifo - exAmple DATE DESCRIPTION UNIT S UNIT COST TOTAL COST SEP.1 Beginning balance 15 60 900 SEP.4 Purchases 20 65 1300 SEP.8 SALES 25 100 2500 SEP.9 40 70 2800 SEP.20 10 80 800 SEP.25 50 110 5500

Average-Cost Method 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 ÷

Average-Cost Method – Example The average cost per unit must be computed prior to each sale. $100 = $2,500  25 On August 14, TBC sold 20 bikes for $130 each. Continue

Average-Cost Method – Example The average cost per unit is $100. $100 = $2,500  25 Let’s look at the entries for the Aug. 14 sale. Continue

Average-Cost Method – Example Retail Cost A similar entry is made after each sale. Continue

Average-Cost Method – Example Additional purchases were made on August 17 and August 28. On August 31, an additional 23 units were sold. Continue

Average-Cost Method – Example $114 = $3,990  35

Average-Cost Method – Example The average cost per unit is $114. $114 = $3,990  35

Average-Cost Method – Example Income Statement COGS = $4,622 Balance Sheet Inventory = $1,368 $114 × 12 = $1,368

Specific Identification When a unit is sold, the specific cost of the unit sold is added to cost of goods sold.

Specific Identification – Example On August 14, TBC sold 20 bikes for $130 each. Nine bikes originally cost $91 and 11 bikes originally cost $106. Continue

Specific Identification – Example The Cost of Goods Sold for the August 14 sale is $1,985, leaving $515 and 5 units in inventory. Let’s look at the entries for the Aug. 14 sale. Continue

Specific Identification – Example Retail Cost A similar entry is made after each sale. Continue

Not really. Specific identification is hard to use when we sell a lot of inventory that has lots of different costs. Since specific identification is so easy, can’t we use it all the time?

Taking a Physical Inventory The primary reason for taking a physical inventory is to adjust the perpetual inventory records for unrecorded shrinkage losses, such as theft, spoilage, or breakage.

Periodic Inventory Systems In a periodic inventory system, inventory entries are as follows. Note that an entry is not made to inventory. 4

Periodic Inventory Systems In a periodic inventory system, inventory entries are as follows. 4

CLASS ACTIVITY DATE DESCRIPTION TOTAL UNITS UNIT RATE TOTAL AMOUNT Jan.1 Beginning balance 10 $ 500 $ 5,000 Feb.5 Purchased 15 $ 550 $ 8,250 March.2 25 $ 570 $ 14,250 April.4 Sold 35 $ 600 $ 21,000 May 10 20 $ 580 $ 11,600 June 3 30 $ 590 $ 17,700 July 7 60 $ 600 $ 36,000 Calculate: Cost of Goods Sold (2 ) Ending Balance (3) Pass journal entries According to: FIFO LIFO AVERAGE Specific Identification: For 1st sale ,10 units each from jan.1 and feb.5 and 15 units from March 2 purchases, For 2nd sale All units from June 3 & May 10 and remaining from March 2 purchases.

End of Chapter 8 4