Reporting & Interpreting Cost of Goods Sold & Inventory Libby, Libby & Short

So far we have learned that Assets are reported on the balance sheet representing economic resources owned by the company at a point in time. What happens when we consume our own assets? (i.e. utilize them ) We have also learned that resources consumed by a company are shown on the Income statement as an Expense for a particular period of time. As we consume them they are transferred from the balance sheet to the income statement.

Can you think of some examples? Supplies Pre-Paid Insurance Inventory Shown as an Asset while waiting to be used Expensed as consumed in operations Supplies Inventory Pre-paid Insurance Inventory (R/M, WIP, F/G) Supplies Expense Insurance Expense Cost of Goods Sold

Inventory Goods held for sale in the normal course of business (merchandiser) or goods which are used to produce goods or services for sale (manufacturer). Merchandise inventory is ready to be sold without further processing Manufacturers Inventory can be identified by its stage of production (1)Raw Materials – product which will be utilized in the production process (2)Work In Process- goods in production but not yet completed Includes Raw Materials, Direct Labor, Manufacturing Overhead (1)Finished Goods – completed goods ready for resale

When make a sale to a customer we have two separate transactions to record First- we must remove the inventory off our books (its been sold…we no longer own it). Inventory like any other asset is kept on the balance sheet at historical cost. Inventory is an asset We must debit it to remove it from our books What is the offsetting part of the entry? The cost of the inventory sold should be recorded as an expense on the income statement cost of goods sold is the title of the expense account used

When make a sale to a customer we have two separate transactions to record Second- We have made a sale to a customer….as such we need to record Revenue on our income statement The amount of revenue recorded is based on the price we have charged the customer (i.e. NOT historical cost). Revenue shows up on the I/S and increases by a credit What is the offsetting part of the entry? It depends…have they paid us? If yes…record the cash If no…record the receivable

Due to the high volume of traffic on your street you decide to set up a lemonade stand. By the time you have purchased the lemonade, sugar & cups you determine that each cup of lemonade cost you 15¢. In your first day of business you sell all of your lemonade for a total of 50 cups. You charge 50¢ per cup of lemonade. How should we record these transactions?

Cash Debit Credit $25 Lemonade Sale Revenue $25 Cost of Lemonade Sales$7.50 Cash $7.50 (To record proceeds from lemonade sales) (To record the cost of the lemonade sold) Entry 1: Entry 2:

What is your profit on the lemonade stand? Revenue $25 Less: Cost of Goods Sold (7.50) Gross Profit $17.50 Other Operating Expense-O- Net Income from Operations $17.50

What does your balance sheet look like? Assets Liabilities Owners Equity Cash$17.50 Retained Earnings (Earned Capital) $17.50

During the year we purchase new product and sell old product 5/15 Purchased 4 Lincoln Town Car Automobiles 1.Blue Leather Interior $45,000 2.Beige Interior $39,000 3.Silver Blue with Sunroof $43,000 4.Beige Leather Interior $47,000 6/24 sold Lincoln Town Car Blue Interior Serial # 4m459P 7/4 sold Lincoln Town Car Beige Interior Serial #J6678P5 8/15 sold Lincoln Town Car w/ sunroof Serial # L7P54730 This situation is pretty straight forward but in real life we cant always specifically identify our inventory….

Inventory Equation Beginning Inventory Purchases Goods Available for Sale (Ending Inventory) Cost of Goods Sold Go Over E7-1 When we cant specifically identify our inventory units (i.e. imagine an inventory of steel beams) we must perform a physical count to determine how much inventory we have left. We know how much we had at the beginning of the year & how much new inventory we purchased…..using this we can calculate how much we sold

#/UnitsUnit Price 1/1/02 Beg. Inventory300$12 2/15/02 Purchase #1150$11 7/20/02 Purchase #2200$12 10/15/02 Purchase #350$13 12/31/02 End. Inventory200 How many units did the company sell during the year? Beg. Inventory Purchases 400- Ending Inv 200= 500

#/UnitsUnit Price 1/1/02 Beg. Inventory300$12 2/15/02 Purchase #1150$11 7/20/02 Purchase #2200$12 10/15/02 Purchase #350$13 12/31/02 End. Inventory200 In most cases, inventory is homogenous and individual units can not be specifically identified…. we must make assumptions about which units are being sold.. We sold 500 units….what should the dollar amount of COGS be for the year?

Two Cost Flow Assumptions FIFO- First-In-First-Out assumes that the oldest units (i.e. first in) are the first units out (i.e. sold…COGS) and the newest units (most recently purchased) are left sitting in inventory LIFO- Last-In-First-Out assumes that the newest units (i.e. most recently purchased) are the first units out (i.e. sold…COGS) and the oldest units (i.e. first in) are left sitting in inventory

#/UnitsUnit Price 1/1/02 Beg. Inventory300$12 2/15/02 Purchase #1150$11 7/20/02 Purchase #2200$12 10/15/02 Purchase #350$13 12/31/02 End. Inventory200 FIFO- First-In-First-Out Cost of goods sold (oldest units) + $11 + $12 = $5,850 Ending Inventory is made up of: + $13 = $2,450

#/UnitsUnit Price 1/1/02 Beg. Inventory300$12 2/15/02 Purchase #1150$11 7/20/02 Purchase #2200$12 10/15/02 Purchase #350$13 12/31/02 End. Inventory200 LIFO- Last-In-First-Out Cost of goods sold (newest units) $13 + $12 + $11 + $12 = $5,900 Ending Inventory is made up of: $12 = $2,400

In periods of rising prices, cost of goods sold will be higher under LIFO than under FIFO, this makes sense….my newest (highest priced) items are considered sold first In periods of declining prices the opposite would be true.