BUS 2101 Decision Making Financial Information Financial Statement Analysis Financial Statements GAAP Income Statement Statement of Cash Flow Balance Sheet Statement of Retained Earnings Preparation Annual Reports Management Discussion Notes Auditor’s Report Ratios Liquidity Profitability Solvency Market Users External Internal Business Activities Operating Investing Financing The Big Picture…

Reporting and Analyzing Inventory Classifying Inventory Periodic Inventory System Ownership of inventory Inventory costing

Classifying Inventory Merchandisers (BUS 2101) –Merchandise Inventory Buy and sell Manufacturers (BUS 2102) –Raw Materials –Work in Process –Finished Goods

Inventory systems Inventory Systems Perpetual Keep track COGS each sale Periodic Count at end COGS at end Beginning Inventory + Net Purchases =COG Available -Ending Inventory = Cost of Goods Sold

Purchase of merchandise Perpetual Periodic Merchandise Inventory Purchases 680 A/P680 Use Merchandise Inventory account for only inventory, not supplies, equipment, etc.

Return of merchandise purchases Perpetual Periodic A/P680 Merchandise Inventory Purchase Returns 680

Freight on merchandise purchased Perpetual Periodic Merchandise Inventory Freight-In (Purchases) 10 A/P10 Freight for merchandise purchased is part of the cost of an asset, inventory.

Freight on merchandise sold Perpetual and Periodic Freight expense10 A/P10 Freight for merchandise sold is an expense.

Purchase discounts Perpetual Periodic A/P100 Cash Merchandise Inventory Purchase Discounts 98 2

Sales of merchandise Both A/R100 Sales (Revenue)100 Perpetual Cost of goods sold60 Merchandise Inventory60

Returns of merchandise sold Both Sales R&A50 A/R50 Perpetual Merchandise Inventory20 COGS20 Negative revenue

Sales discounts Both Cash Sales Discounts 98 2 A/R100 Sales Discounts is a negative revenue account.

Net Purchases Purchases100,000 Plus: freight-in 2,000 Less: purchase returns 4,000 = Net purchases 98,000

Cost of Goods Sold Beginning Inventory14,000 + Purchases98,000 = Cost of goods sold112,000 - Ending Inventory 20,000 = Cost of goods sold 92,000 What would happen to COGS if ending inventory was actually $22,000 instead of $20,000? What would happen to net income???

Ownership of Inventory Goods in transit –FOB destination Seller owns goods during delivery and pays for delivery –FOB shipping point Seller owns goods during delivery and pays for delivery –Consignment Retailer tries to sell goods for fee but doesn’t take ownership of goods –Antique stores

Inventory Costing Specific identification FIFO LIFO Average cost

Specific Identification Used for high cost items –Combines, cars, jewelry –Retailer knows the exact cost of each item it sells

FIFO First in, first out Ending inventory is most recent purchases In times of rising prices –Higher inventory value –Lower COGS and higher net income (EPS) –But also higher income taxes If prices fall, lower net income and inventory

LIFO Last in, first out Ending inventory is most oldest purchases In times of rising prices –Lower inventory value –Higher COGS and lower net income (EPS) –Lower income taxes

LIFO If prices fall, –Higher net income and more income taxes Oldest inventory never sold –Caterpillar LIFO inventory $2,842; FIFO inventory $4,820 Large difference due to use of LIFO for over 50 years

LIFO If use LIFO on tax return, must use LIFO in financial statements –But can disclose LIFO reserve in footnotes to financial statements which tells how much inventory would be using FIFO LIFO inventory $2,842 LIFO reserve $1,978 FIFO inventory $4,820 –Annual increase in LIFO reserve is the amount Net Income decreased that year due to use of LIFO If reduce quantity of inventory –Possible large net income as selling inventory with very “old” costs

Average Cost Weighted average, not average cost Average = Total cost / total units 100 units$2.00$ units$4.00$ units$1,000

Inventory errors Understating ending inventory –Increases COGS –Understates net income Understating beginning inventory –Decreases COGS –Overstates net income Over two years, would offset if second year ending inventory correct

BUS 2101 Decision Making Financial Information Financial Statement Analysis Financial Statements GAAP Income Statement Statement of Cash Flow Balance Sheet Statement of Retained Earnings Preparation Annual Reports Management Discussion Notes Auditor’s Report Ratios Liquidity Profitability Solvency Market Users External Internal Business Activities Operating Investing Financing The Big Picture…