Accounting for Merchandise Inventory Chapter 6

Perpetual systems maintain a running record to show the inventory on hand at all times. Periodic systems do not keep a continuous record of inventory on hand. Inventory Accounting Systems

Compute and record journal entries for perpetual inventory amounts under FIFO, LIFO, and average cost. Objectives 1 and 2

Debit Cash or Accounts Receivable Credit Sales Revenue Debit Cost of Goods Sold Credit Inventory Perpetual System Debit Inventory Credit Cash or Accounts Payable

Cost of inventory on hand = Quantity × unit cost Computing the Cost of Inventory Physical count is made at least once a year, even with a perpetual system. Consigned goods are excluded.

Perpetual System Examples Assume the following: Nov. 1Beg. Inventory $40 15 $45 15Sale4 $50 30Sale8

Perpetual System FIFO Example Many companies keep their perpetual inventory records in quantities only. Other companies keep perpetual records in both quantities and dollar cost.

Perpetual FIFO Consistent with the physical flow of inventory Oldest inventory sold first Most recent purchases make-up ending inventory

Perpetual System FIFO Example Item: Ski Parka Received Sold Balance on Hand Unit Unit Unit DateQty. Cost TotalQty. Cost Total Qty. Cost Total Nov. 1 1 $40 $ $45 $ Columbia Sportswear

Perpetual System FIFO Example Item: Ski Parka Received Sold Balance on Hand Unit Unit Unit Date Qty. Cost Total Qty. Cost Total Qty. Cost Total Nov $50 $ $45 $ $ Totals 13 $ $560 2 $100 Columbia Sportswear

Perpetual System FIFO Example Nov. 5 Inventory………….…270 Accounts Payable……270 15Accounts receivable…320 Sales Revenue……… Cost of Goods Sold…175 Inventory…………….175

Perpetual System FIFO Example Nov. 26 Inventory………….…350 Accounts Payable……350 30Accounts receivable…640 Sales Revenue……… Cost of Goods Sold…385 Inventory…………….385

Perpetual LIFO Is not consistent with the physical flow of inventory Oldest inventory costs make-up ending inventory Cost of goods sold is assumed to be from the most recent purchases

Perpetual System LIFO Example Item: Ski Parka Received Sold Balance on Hand Unit Unit Unit DateQty. Cost TotalQty. Cost Total Qty. Cost Total Nov. 1 1 $40 $ $45 $ Columbia Sportswear

Perpetual System LIFO Example Item: Ski Parka Received Sold Balance on Hand Unit Unit Unit Date Qty. Cost Total Qty. Cost TotalQty. Cost Total Nov $50 $ $40 $ $ Totals 13 $ $ Columbia Sportswear

Perpetual System LIFO Example Nov. 5 Inventory………….…270 Accounts Payable……270 15Accounts receivable…320 Sales Revenue……… Cost of Goods Sold…180 Inventory…………….180

Perpetual System LIFO Example Nov. 26 Inventory………….…350 Accounts Payable……350 30Accounts receivable…640 Sales Revenue……… Cost of Goods Sold…395 Inventory…………….395

Perpetual System Average Cost Ending inventory and cost of goods sold are based on the average cost per unit. A new average cost per unit is computed after each purchase.

Perpetual System Average Cost Example Item: Ski Parka Received Sold Balance on Hand Unit Unit Unit DateQty. Cost TotalQty. Cost Total Qty. Cost Total Nov $45 $ Columbia Sportswear

Perpetual System Average Cost Example Item: Ski Parka Received Sold Balance on Hand Unit Unit Unit Date Qty. Cost Total Qty. Cost Total Qty. Cost Total Nov $50 $ Totals 13 $ $563 2 $ 97 Columbia Sportswear

Perpetual System Average Cost Example Nov. 5 Inventory………….…270 Accounts Payable……270 15Accounts receivable…320 Sales Revenue……… Cost of Goods Sold…177 Inventory…………….177

Perpetual System Average Cost Example Nov.26 Inventory………….…350 Accounts Payable……350 30Accounts receivable…640 Sales Revenue……… Cost of Goods Sold…386 Inventory…………….386

Objective 3 Compare the effects of FIFO, LIFO, and average cost

Ending Inventory FIFO$ LIFO$ Weighted-average$ Comparison of Methods

Cost of Goods Sold FIFO$ LIFO$ Weighted-average$ Comparison of Methods

When prices are rising LIFO produces the lowest income and lowest income tax. Comparison of Methods Gross Margin from Sales: FIFO $ LIFO $ Weighted-average $

Compute periodic inventory amounts under weighted-average cost, FIFO, and LIFO. Objective 4

Cost-of-Goods-Sold Model Budgeted Cost of Goods Sold Budgeted Ending Inventory + = Actual Beginning Inventory = Purchases – Budgeted Cost of Goods Available for Sale

Cost of Goods Sold under a periodic Beginning Inventory $100,000 Net Purchases $560,000 Cost of Goods Available for Sale $660,000 + = Ending Inventory $120,000 = Cost of Goods Sold $540,000 –

Accounts Payable Inventory 120,000 Ending Balance Purchases 560,000 Purchases 100,000 Beginning Balance Cost of Goods Sold 100, , , ,000 Ending Balance 560,000 Purchases 560,000 Purchases 100,000 Beginning Balance Periodic System

At the end of the period make a physical count and apply unit cost to determine ending inventory. Inventory purchases are debited to the purchases account. The inventory account carries the beginning inventory balance until adjusted at period end.

January 8 20 $20 = $ 400 May $30 = $1,650 October $31 = $ 775 Total units100 Units sold 70 Units left 30 Units Purchased in 20xx

Units sold by date: Jan 517 May1933 Oct2320 Total sales70 30 units left in inventory Units Sold and in Ending Inventory

Cost of Goods Sold Oct 23$ 620 May Jan Total$1,950 Specific Identification 20 $31 5 $31 20 $31 5 $31 33 $30 22 $30 33 $30 22 $30 17 $20 3 $20 17 $20 3 $20

Ending Inventory Oct 23$155 May 660 Jan 60 Total$875 Specific Identification 20 $31 5 $31 33 $30 22 $30 17 $20 3 $20

Weighted Average 25 $31 (Oct) 55 $30 (May) 20 $20 (Jan) = $ 775 = 1,650 = 400 = $2,825 Total Cost 100 Total Units

Weighted Average $2,825 total cost/100 units = $28.25/unit Cost of goods sold = 70 × $28.25 = $ Ending inventory = 30 × $28.25 = $847.50

Cost of Goods Sold Jan$ 400 May 1,500 Total$1,900 First-In, First-Out 25 $31 (Oct) 5 $30 (May) 50 $30 20 $20 (Jan)

Ending Inventory Oct$775 May 150 Total$925 First-In, First-Out 25 $31 (Oct) 5 $30 (May) 50 $30 20 $20 (Jan)

Cost of Goods Sold Oct$ 775 May 1,350 Total$2,125 Last-In, First-Out 25 $31 (Oct) 45 $30 (May) 10 $30 20 $20 (Jan)

Ending Inventory Oct$300 May 400 Total$700 Last-In, First-Out 25 $31 (Oct) 45 $30 (May) 10 $30 20 $20 (Jan)

Ending Inventory Specific identification$ FIFO$ LIFO$ Weighted-average$ Comparison of Methods

Cost of Goods Sold Specific identification$1, FIFO$1, LIFO$2, Weighted-average$1, Comparison of Methods

When prices are rising LIFO produces the lowest income and lowest income tax. Comparison of Methods Gross Margin from Sales: Specific identification $1, FIFO $1, LIFO $ Weighted-average $1,022.50

The Income Tax Advantage of LIFO During periods of inflation, LIFO’s income is the lowest. The most attractive feature of LIFO is reduced income tax payments.

Use of the Various Inventory Costing Methods

LIFO Liquidation When prices are rising... the company draws down inventory quantities below the level of the previous period which releases older costs to the income statement.

The business should use the same accounting methods and procedures from one period to the next. A company may change inventory methods, but it must disclose the effects of the change on net income. Accounting Principles: Consistency

The financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company. Accounting Principles: Disclosure

Accounting Principles: Materiality An item is material if it has the potential to alter a statement user’s decision. Materiality is specific to the entity being evaluated.

Err on the side of caution when reporting any item in the financial statements. Accounting Principles: Conservatism

Apply the lower-of-cost- or-market rule to inventory. Objective 5

Lower-of-Cost-or-Market An asset is reported at the lower of its historical cost or market (replacement) value. If the replacement cost falls below its historical cost, the business must write down the value of its inventory.

December 31 Cost of Goods Sold 800 Inventory 800 Write down inventory to LCM Lower-of-Cost-or-Market Example Cost of inventory: $3,000 Market value at balance sheet date: $2,200 What is the journal entry?

Determine the effects of inventory errors. Objective 6

Inventory Errors If inventory is computed incorrectly, how many years of financial statements will it affect? Two years The current year’s ending inventory is next year’s beginning inventory.

Estimate ending inventory by the gross profit method. Objective 7

Sales revenues – Cost of goods sold = Gross margin (before operating expenses) Gross margin – Operating expenses = Net income Gross Profit

Net Sales$150,000 Gross Profit Margin 31.5% Beginning Inventory$ 18,500 Net Purchases$110,500 Gross Profit Method Example Net Sales$150,000 – Gross Profit of 31.5% 47,250 = Cost of Goods Sold$102,750

Gross Profit Method Example Beginning Inventory $18,500 Net Purchases $110,500 Cost of Goods Available for Sale $129,000 + = Ending Inventory $26,250 = Cost of Goods Sold $102,750 –

End of Chapter 6