1. Inventory

2. JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT: 0322-3385752 0312-2302870 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN

3. JOIN KHALID AZIZ FRESH CLASSES ICap module b & d FINANCIAL ACCOUNTING & COST ACCOUNTING INDIVIDUAL & GROUPS

4. JOIN KHALID AZIZ FRESH CLASSES ICMap STAGE 1,2,3,4 FROM 15 TH JULY 2010 INSHALLAH INDIVIDUAL & GROUPS

5. Learning Objective 1 Identify what items and costs should be included in inventory and cost of goods sold.

6. Define Inventory and COGS. What are some of their characteristics?

7. Describe the Time Line of Business.

8. What is Inventory? Defined according to type and nature of the company. Merchandising:Manufacturing:

9. Define Each Manufacturing Inventory Raw materials Work in process Finished goods

10. What Costs are Included in Inventory?

11. Who Owns the Inventory? When goods are in transit? Q:Who owns inventory on a truck or railroad car? When goods are on consignment? Q:Who owns inventory stocked in a warehouse?

12. Ending Inventory & COGS At period’s end, allocated between inventory is still remaining (an asset), and inventory sold during the period (an expense, Cost of Goods Sold). Cost of goods available for sale Beginning inventory Net purchases =+ The question is where is the inventory that could have been sold this period? Only two choices:

13. Learning Objective 2 Account for inventory purchases and sales using both a perpetual and a periodic inventory system.

14. What are the Two Methods for Accounting for Inventory?

15. Example: Accounting for Inventory Purchases and Sales Beginning inventory10 hats @ $10 each= $100 March 1 Purchase15 hats @ $15 each= $225 March 1 Freight in$10 March 1 Purchase return 3 hats @ $15 each= $ 45 May 2 Purchase10 hats @ $20 each= $200 May 2 Purchase discount2/10, n/30 June 30 Sales20 hats (10 @ $10, 10 @ $15) July 3 Sales return 1 hat @ $15= $ 15 Ending inventory13 hats Harper’s Hats recorded the following transactions for 2006:

16. Example: 2006 Inventory Purchase Sale Balance ` DateUnits TotalUnits TotalUnits Cost Total Jan. 110$10$100 Mar. 115$225 10$10$100 15$15$225 (3) ($45)12$15$180 May 210$200 10$10$100 12$15$180 10$20$200 June 3010$100 10$150 2$15$ 30 10$20$200 July 3(1)($15)3$15$ 45 10$20$200

17. Perpetual & Periodic Journal Entries Purchases Transportation costs Purchase returns Purchase discounts Sales Sales returns Closing entries for COGS Perpetual All purchases are added directly to the inventory account. Periodic At end of period, Inventory balance is updated using inventory count. Temporary purchases account balance is closed to Inventory to compute COGS.

18. PERPETUAL PERIODIC Harper purchased 10 hats at $10 each on January 1. Record the entries for both perpetual and periodic systems. Example: Journal Entries for Purchases

19. Perpetual & Periodic Journal Entries Purchases Transportation costs Purchase returns Purchase discounts Sales Sales returns Closing entries for COGS Perpetual All costs are added directly to the inventory balance. Periodic At end of period, temporary freight in account balance is closed to Inventory to compute COGS.

20. Example: Journal Entries for Transportation Cost PERPETUAL PERIODIC Harper hired a trucking company to deliver its March 1 purchase of 15 hats. The trucking company charged $10. Record the entries for both the perpetual and the periodic systems.

21. Perpetual & Periodic Journal Entries Purchases Transportation costs Purchase returns Purchase discounts Sales Sales returns Closing entries for COGS Perpetual Inventory is decreased. Accounts Payable is decreased by same amount. Periodic If merchandise has been paid for, the supplier will reimburse (debit Cash). At end of period, temporary purchase returns account balance is closed to Inventory to compute COGS.

22. PERPETUAL PERIODIC Of the 15 hats delivered on March 1, three were defective and Harper returned them the same day. Record the entries for both the perpetual and the periodic inventory systems. Example: Journal Entries for Purchase Returns

23. Perpetual & Periodic Journal Entries Purchases Transportation costs Purchase returns Purchase discounts Sales Sales returns Closing entries for COGS Perpetual Subtract the discount amount from the inventory account. Periodic At end of period, temporary purchase discounts account balance is closed to Inventory to compute COGS.

24. Example: Journal Entries for Purchase Discounts PERPETUAL PERIODIC On May 2, Harper purchased 10 hats at $20 each. The supplier offered terms of 2/10, n/30. Record the entries for both the perpetual and the periodic inventory systems.

25. Perpetual & Periodic Journal Entries Purchases Transportation costs Purchase returns Purchase discounts Perpetual All adjustments are entered directly in the Inventory account. Periodic All adjustments are accumulated in an array of temporary holding accounts: Purchases Freight In Purchase Returns Purchase Discounts The difference in terms of journal entries:

26. Perpetual & Periodic Journal Entries Purchases Transportation costs Purchase returns Purchase discounts Sales Sales returns Closing entries for COGS Perpetual Recognize sales and COGS on a transaction- by-transaction basis. Periodic Only total sales are known.

27. Example: Journal Entries for Sales In June, Harper’s Hats sold 20 hats for $25 each (selling the old ones first). Record the entries for both the perpetual and the periodic systems. PERPETUAL PERIODIC

28. JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT: 0322-3385752 0312-2302870 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN

29. Perpetual & Periodic Journal Entries Purchases Transportation costs Purchase returns Purchase discounts Sales Sales returns Closing entries for COGS Perpetual Sales for returned items are canceled. Cost of returned inventory is removed from COGS and restored to the inventory account. Periodic Sales for returned items are canceled. No entry is made to adjust COGS.

30. PERPETUAL PERIODIC Example: Journal Entries for Sales Returns On July 3, one hat was returned from a late June purchase. Record the entries for both the perpetual and the periodic inventory systems.

31. Perpetual & Periodic Journal Entries Purchases Transportation costs Purchase returns Purchase discounts Sales Sales returns Closing entries for COGS Perpetual All journal entries are posted to the ledger. Results in new balances for Inventory and COGS. Numbers are verified by physical count. Periodic Temporary holding accounts are accumulated and added to Inventory. Inventory account balance is reduced by the amount of COGS.

32. Accounting for Inventory Purchases and Sales Beginning inventory10 hats @ $10 each= $100 March 1 Purchase15 hats @ $15 each= $225 March 1 Freight in$10 March 1 Purchase return 3 hats @ $15 each= $ 45 May 2 Purchase10 hats @ $20 each= $200 May 2 Purchase discount2/10, n/30 June 30 Sales20 hats (10 @ $10, 10 @ $15) July 3 Sales return 1 hat @ $15= $ 15 Ending inventory13 hats Harper’s Hats recorded the following transactions for 2006:

33. 6/30250 7/315 Bal. 235 Perpetual:the inventory account will have an ending balance of $255. Closing Entries for Cost of Goods Sold 1/1100 3/12253/145 3/110 5/2200 6/30250 7/315 Bal. 255 InventoryCOGS

34. Periodic:the inventory account will be debited by $386, which represents the net purchases for the year. Closing Entries for Cost of Goods Sold Jul. 31Inventory...................386 Purchase Returns............45 Purchase Discounts..........4 Freight In.................10 Purchases................425

35. Beginning Inventory, January 1, 2006 +Purchases for the year =Cost of goods available for sale during 2006 – Ending Inventory, December 31, 2006 =Cost of Goods Sold for 2006 Periodic Inventory With a periodic system, a physical count is the only way to get the information necessary to compute COGS:

36. Learning Objective 3 Calculate cost of goods sold using the results of an inventory count and understand the impact of errors in ending inventory on reported cost of goods sold.

37. Physical Count of Inventory Periodic The only way to get information necessary to compute COGS: Perpetual Physical count either confirms records are accurate or highlights shortages and clerical errors. Quantity count. Inventory costing (assigning a unit cost to each type of merchandise). Ending inventory = quantity of each type x its unit cost. Essential to maintaining reliable inventory accounting records.

38. COGS Computation Perpetual The accounting records yield the COGS for the period as well as the amount of inventory that should be found with a physical count. The difference between the records and actual count = inventory lost, stolen, or spoiled. Periodic Company does not know what ending inventory should be. Assumes physical count is the difference between cost of goods available for sale and ending inventory. Cannot tell whether goods were sold, lost, stolen, or spoiled.

39. What is the Income Effect of an Error in Ending Inventory?

40. Complete Table of Effects of Inventory Errors Understate Ending Inventory SalesOK Beginning inventoryOK Net purchasesOK Goods availableOK Ending inventoryLOW Cost of goods soldHIGH Gross marginLOW ExpensesOK Net incomeLOW Understate Purchases Understate Beginning Inventory Understate Sales

41. Learning Objective 4 Apply the four inventory cost flow alternatives: specific identification, FIFO, LIFO, and average cost.

42. Inventory Cost Flow Kernel King buys and sells corn and had the following transactions for 2002: June 10 Purchased 10 tons at $6 per ton. July 28 Purchased 10 tons at $9 per ton. October 10 Sold 10 tons at $11 per ton. How much did Kernel King make in 2002? Case #1Case #2Case #3 SoldSoldSold Old CornNew CornMixed Corn Sales ($11 x 10 tons) COGS (10 tons) Gross margin

43. Specific Identification Cost Flow Specifically identify the cost of each unit sold. The individual cost of each unit is charged against revenue as COGS. To compute COGS and ending inventory, a firm must know each unit sold and its cost.

44. Inventory Cost Flow Methods FIFO The oldest units are sold and the newest units remain in inventory. The cost of the oldest units purchased is transferred to COGS. LIFO The newest units are sold and the oldest units remain in inventory. The cost of the most recent units purchased is transferred to COGS. Average Cost An average cost is computed for all inventory available for sale during the period. COGS is computed by multiplying the number of units sold by the average cost per unit.

45. Compare Inventory Methods LIFO gives a better reflection of COGS in the income statement. Therefore, LIFO is a better measure of income. FIFO gives a better measure of inventory on the balance sheet. Therefore, FIFO is a better measure of inventory value.

46. Learning Objective 5 Use financial ratios to evaluate a company’s inventory level.

47. Why Use JIT Inventory Management?

48. Evaluating Inventory Levels Inventory Turnover Measures how many times a company turns over (or replenishes) its inventory. Average inventory = average of the beginning and ending inventory balances. Number of Days’ Sales in Inventory Cost of goods sold Average inventory 365 days Inventory turnover

49. Evaluating Inventory Management Buster Boots had cost of goods sold of $60,000 during 2002. The inventory account decreased by $1,000 to $4,000 during the same time. Calculate the inventory turnover ratio and number of days’ sales in inventory. Inventory turnover ratio Number of days’ sales in inventory

50. Expanded Material Learning Objective 6 Analyze the impact of inventory errors on reported cost of goods sold. ? ?

51. What Is the Effect of These Inventory Errors? If a sale is recorded but the merchandise remains in inventory and is counted in ending inventory, If a sale is not recorded, but inventory is shipped and not counted in ending inventory,

52. Expanded Material Learning Objective 7 Describe the complications that arise when LIFO or average cost is used with a perpetual inventory system.

53. Using Average Cost or LIFO with a Perpetual System Using average cost or LIFO with perpetual leads to complications. The average cost of units available for sale changes every time a purchase is made. The identification of the “last in” units also changes with every purchase. With periodic, One overall average cost is used for all goods available for sale during the period. The “last in” units are identified at the end of the period.

54. Describe the Similarities of Using FIFO for Perpetual and Periodic Systems.

55. Expanded Material Learning Objective 8 Apply the lower-of- cost-or-market method of accounting for inventory.

56. When Do You Report Inventory Below Cost?

57. When Do You Report Inventory at Net Realizable Value (NRV)?

58. Floor: the minimum market amount at which inventory can be carried on the books; equal to net realizable value less a normal profit. Lower of Cost or Market (LCM) LCM: A basis for valuing inventory at the lower of original cost or current market value. Ceiling: the maximum market amount at which inventory can be carried on the books; equal to net realizable value (selling price less estimated selling costs).

59. Example: LCM Market Inventory ReplacementNRV Item Cost Floor Cost Ceiling A 34 20 32 30 B 42 32 36 46 C 52 44 42 62 D 38 50 32 68 Define market value as: replacement cost, if it falls between the ceiling and the floor.,the floor, if the replacement cost is less than the floor.,the ceiling, if the replacement cost is higher than the ceiling. When replacement cost, ceiling, and floor are compared, market is always the middle value. Compare the defined market value with the original cost and choose the lower amount.

60. Expanded Material Learning Objective 9 Explain the gross margin method of estimating inventories.

61. There are times when a physical count of inventory is either impossible or impractical. If perpetual is used, the inventory account balance is assumed to be correct. If periodic is used, an estimate of the inventory balance must be made. Gross margin method. COGS and ending inventory are estimated using available information: beginning inventory purchases historical gross margin percentage Gross Margin Method

62. Gross Margin Method Example Payson Brick has net sales for 1/1 to 3/31 of $100,000 and net purchases of $65,000. Inventory on 1/1 was $15,000 and a historic gross profit percentage of 40%. Dollars % of sales Net sales revenue$100,000100% Cost of goods sold: Beginning inventory$15,000 Purchases 65,000 Total available for sale$80,000 Ending Inventory (3) 20,000 Cost of goods sold (2) 60,000 60% Gross margin (1)$ 40,000 40% (1)$100,000 X.40(2) $100,000 - $40,000 (3) $80,000 - $40,000

64. JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT: 0322-3385752 0312-2302870 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN