INVENTORY AND COST OF GOODS SOLD Chapter Six

Types of Inventory  MERCHANDISING  Wholesalers Buy from manufacturers sell to retailer  Retailers Buy from wholesalers Sell to general public Acctg 101  Merchandise Inventory  MANUFACTURING  Buy from several suppliers to make a product  Sell to wholesalers and sometimes retailers  Acctg 102  Raw Materials  Work in Process  Finished Goods

Inventory Normal Balance  Inventory is an asset so its normal balance is a Debit.  To increase inventory – Debit  To decrease inventory – Credit

Purchases Normal Balance  Purchases is like expense  Purchases is always increased with a debit  Purchase returns and allowances – credit balance  Purchase discount – credit balance

Cost of Goods Sold (COGS)  Cost of Goods Sold is an expense so it has a debit balance

Gross Margin  Sales  -Sales Return and Allowances  -Sales Discount  =Net Sales  -Cost of Goods Sold  =Gross Margin

Cost of Goods Sold  Beginning Inventory 3000  +Purchases  -Purchase Discount -600  -Purchases Return and Allow -400  + Net Purchases  + Freight In 1000  =Cost of Merchandise Purchased  =Goods Available for Sale  - Ending Inventory (or Goods not Sold)  = Cost of Goods Sold 9000

 Brief Exercise 6-3 page 281  Exercise 6-1 page 283  MUST KNOW THIS FORMULA  MEMORIZE IT

Estimating Inventory-Why important  Sales 150,000  Beginning Inventory 8,000  +Purchases 110,000  -Purchase Discount (1,000)  -Purchases Ret & Allow (2,000)  + Net Purchases 107,000  Goods Available for Sale 115,000  - Ending Inventory (or Goods not Sold) 15,000  = Cost of Goods Sold 100,000  Gross Margin 50,000

Overstating/Understating Ending Inventory  Over Under  SALES  Beg Inventory  + Net Purchases Can’t Change  =Goods Available  - Ending Inventory  = COGS  =Gross Margin 55 45

WHAT EVER I DO TO ENDING INVENTORY, I ALSO DO TO NET INCOME

Two methods to TRACK inventory  Periodic  At some period of time  Perpetual  All the time--- everytime there is a purchase and everytime there is a sale

 IF YOU KNOW PERIODIC YOU WILL KNOW PERPETUAL  SO LETS DO PERIODIC FIRST

4 METHODS TO DETERMINE COST OF ENDING INVENTORY  Specific Indentification  First in First Out  Last In First Out  Average Cost

Specific Indentification  Not estimated  Actual items  Or specific identification  Page 252 example

First In First Out  GUMBALL MACHINE  Physical Flow matches Cost Flow  First one purchased is first one sold  Page 252  Used if few inventory items  BE 6-4 page 281  Increasing costs --- higher cost in Ending Inventory  Lower cost in COGS so higher net income

Last In First Out  COOKIE JAR  Last one purchased first one sold  Page 253  Used if want to put replacement cost in Cost of Goods sold  Increasing costs --- higher cost in COGS  Lower cost in Ending Inventory so lower net income  BE 6-5 pg 281  IFRS – Not used US – tax savings

LIFO RESERVE  Additional amount of inventory a company would report if it used FIFO instead of LIFO  Cost of Goods Sold  Inventory

MUST BE CONSISTENT  Can’t change inventory methods without IRS approval.  Can use different type of methods for different types of inventory

Average Cost  Weighted Average  $50+$66+$96= 212/19 = $11.16  Used if a lot of little inventory items  BE 6-6 page 281  Costs are evenly distributed in COGS and Ending Inventory

Periodic versus Perpetual  Have been using Periodic  Perpetual uses the periodic method every time there is a sale and every time there is a sale.  Perpetual needs exact dates it was purchased and sold.

Perpetual Tracking pg 272  FIFO  Usually not different under perpetual and periodic  LIFO  Usually different than periodic  Exercise 6-15 pg 286

Recording inventory transactions  Periodic Method  Purchase Purchase A/P  Sale A/R Sales  Return & Allowance A/P Purchase Ret and Allowance  Purchase Discount A/P Cash Purchase Discount

 Perpetual Method  Purchase Inventory A/P  Sale A/R Sales COGS Inventory  Return & Allowance A/P Inventory  Purchase Discount A/P Cash Inventory

 Purchase Purchase A/P  Sale A/R Sales  Return & Allowance A/P Purchase Ret and Allowance  Purchase Discount A/P Cash Purchase Discount  Purchase Inventory A/P  Sale A/R Sales COGS Inventory  Return & Allowance A/P Inventory  Purchase Discount A/P Cash Inventory PeriodicPerpetual

Freight - In Freight In Purchases or COGS account Bringing it into the business Freight In A/P 

Freight out  Selling Expense  Cost of Sending it to the customer  Freight Expense  Cash or A/P

Exercises  6-6 pg 284 Perpetual  6-7 Periodic

Lower Cost or Market pg 266  Normally Inventory is replacement cost --- cost to restock the item after identical items are sold  If Market Value is less than Cost (if what you paid for the item is less than you can sell it for) you must make an adjustment.  COGS  Inventory

Exercises  Page 285  6-11  6-12

Inventory Ratios  Inventory Turnover pg 269  COGS/ Average Inventory  # of Days in Inventory 365/ Inventory T/O (Seasons) 6-13 pg 285 Inventory

Gross Profit Ratio Gross Profit pg 271 Gross Profit/ Net Sales Exercise 6-14 pg 286

Homework  Problem 6-2 COGS, Ending Inventory  Problem 6-3Periodic  Problem 6-4Perpetual  Problem 6-6Lower of Cost or Market  Problem 6-8Ratios