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Financial Accounting: Tools for Business Decision Making
Kimmel, Weygandt, Kieso, Trenholm KIMMEL Prepared by: Barbara Trenholm University of New Brunswick
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Chapter 6 Reporting and Analysing Inventory
After studying Chapter 6, you should be able to: Explain the recording of purchases and sales of inventory under a periodic inventory system. Explain how to determine cost of goods sold under a periodic inventory system. Describe the steps in determining inventory quantities. Identify the unique features of the statement of earnings for a merchandising company under a periodic inventory system.
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Chapter 6 Reporting and Analysing Inventory
After studying Chapter 6, you should be able to: Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Explain the financial statement effects of each of the inventory cost flow assumptions. Explain the lower of cost and market basis of accounting for inventories. Calculate and interpret the inventory turnover ratio.
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Merchandise Inventory
Owned by the company In form ready for sale to customers
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Manufacturing Inventory
Finished goods inventory Work in process Raw materials
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Comparing Periodic and Perpetual Inventory Systems
Inventory Purchased Item Sold End of Period Perpetual Perpetual No Entry Record Purchase of Inventory Record Revenue and Cost of Goods Sold End of Period Inventory Purchased Item Sold Periodic Record Purchase of Inventory Record Revenue Only Compute Cost of Goods Sold
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(Periodic Inventory System)
Sales Revenues (Periodic Inventory System) Record when earned-revenue recognition principle ONLY one entry is made for each sale in a periodic inventory system One to record sale NONE to record cost of goods sold as in a perpetual inventory system
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Merchandise Inventory Sales Returns & Allowances
Sales - assume a sale of $3,800 on account Cash Accounts Receivable Merchandise Inventory X May 4 3,800 Cost of Goods Sold Sales Returns & Allowances Sales X May 4 3,800
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Sales Returns and Allowances
Flip side of purchase returns and allowance On buyer’s books GENERAL JOURNAL Debit Credit May 8 Accounts Payable Purchase Returns and Allowances To record goods returned that were purchased on account On seller’s books GENERAL JOURNAL Debit Credit May 8 Sales Returns and Allowance Accounts Receivable To record return of goods delivered to Sauk Stereo ONLY ONE ENTRY NEEDED IN PERIODIC INVENTORY SYSTEM
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Flip side of purchase discounts
Sales Discounts Flip side of purchase discounts On buyer’s books GENERAL JOURNAL Debit Credit May 14 Accounts Payable , Cash ,430 Purchase Discounts To record payment within discount period On seller’s books GENERAL JOURNAL Debit Credit May 14 Cash , Sales Discounts Accounts Receivable ,500 To record collection within discount period
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Purchases of Merchandise
Perpetual inventory system Merchandise Inventory-one account-used to accumulate the cost of goods purchased Periodic inventory system Separate accounts used to accumulate the cost of goods purchased
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Normal Balances Cost of Goods Purchased Accounts
Account Normal Balance Purchases Debit Purchase Returns and Allowances Credit Purchase Discounts Credit Freight In Debit
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Merchandise Purchases
On May 4 the company bought $ 3,800 worth of merchandise from PW Audio Supply, Inc. Purchases Purchase Returns & All. Purchase Discounts May 4 3,800 Accounts Payable Freight-In Cash May 4 3,800
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Purchase Returns and Allowances
On May 8 the company returned $300 worth of merchandise to PW Audio Supply, Inc. Purchases Purchase Returns & All. Purchase Discounts May 4 3,800 May Accounts Payable Freight-In Cash May 4 3,800
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Freight - In On May 9 the company paid $ 150 to have the merchandise inventory delivered to them. Purchase Returns & All. Purchase Discounts Purchases May 4 3,800 May Accounts Payable Freight-In Cash May May May 4 3,800
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Purchase Discounts Original invoice $3,800 -Returns 300
Review - Company purchased $3,800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period. Original invoice $3,800 -Returns Amount due before discount ,500 2% discount Net due $3,430
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Purchase Discounts Purchase Returns & All. Purchase Discounts
On May 14, the company pays the balance due on the account within the discount period Purchase Returns & All. Purchase Discounts Purchases May May 4 3,800 May Accounts Payable Freight-In Cash May May May 4 3,800 May May 14 3,500 May 14 3,430
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Net Purchases Purchases $325,000 Less: Purchase returns and allowances $ 10,400 Purchase discounts 6, ,200 Net purchases 307,800 Net purchases are gross purchases adjusted for returns and discounts
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Cost of Goods Purchased
Purchases $325,000 Less: Purchase returns and allowances $ 10,400 Purchase discounts 6, ,200 Net purchases 307,800 Add: Freight-in 12,200 Cost of goods purchased 320,000 Cost of goods purchased is net purchases plus freight-in
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Comparison of Seller’s and Buyer’s Entries
Sale of goods Cash (or receivables) xxx Sales xxx Return of goods Sales returns xxx Cash (or receivables) xxx Freight (destination) Delivery expense xxx Cash (or payables) xxx BUYER Purchase of goods Purchases xxx Cash (or payables) xxx Return of goods Cash (or receivables) xxx Purchases returns xxx Freight (shipping point) Freight In xxx Cash (or payables) xxx
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Determining Ending Inventory
A physical inventory count Determines ending inventory Enables cost of goods sold to be computed Companies that use perpetual inventory must also take a physical inventory to check accuracy of “book inventory” to actual inventory-added internal control feature
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Taking a Physical Inventory
Determining inventory quantities by counting, weighting or measuring each type of inventory Determining ownership of goods, including goods in transit, consigned goods
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Goods in Transit Goods on board a truck, train, ship, or plane at the end of the period
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Goods in Transit Who includes goods in transit (on board a truck, train, ship, or plane at the end of the period) in inventory Buyer? Seller? Company with legal title
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Ownership passes to owner here
Illustration 6-4 FOB Shipping Point Public Carrier Co Seller Buyer Ownership passes to buyer here FOB Destination Point Public Carrier Co Seller Buyer
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Consigned Goods Goods in your store that you don’t pay for until they sell Company does not take ownership
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Cost of Goods Sold After taking a physical inventory count, cost of goods sold is determined By calculation in statement of earnings (no journal entry recorded yet) Journal entries (closing or adjusting) are made later in the closing process to record ending inventory
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Computation of Cost of Goods Sold
Beginning inventory $ 36,000 Add: Cost of goods purchased ,000 Cost of goods available for sale ,000 Less: Ending inventory ,000 Cost of goods sold ,000 Remember: Purchases - purchase returns and allowances – purchase discounts = Net purchases + freight-in = Cost of goods purchased
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Statement of Earnings Presentation
Statement of earnings for a merchandising company is the same whether a periodic or perpetual inventory system is used, except for the level of detail in the cost of goods sold section
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INVENTORY SYSTEMS COMPARED PERPETUAL & PERIODIC INVENTORY SYSTEMS
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Perpetual vs. Periodic Journal Entries
Purchase of goods Inventory xxx Cash (or payables) xxx Freight (shipping point) Inventory xxx Cash (or payables) xxx Return of goods Cash (or receivables)xxx Inventory xxx PERIODIC Purchase of goods Purchases xxx Cash (or payables) xxx Freight (shipping point) Freight In xxx Cash (or payables) xxx Return of goods Cash (or Accts Rec) xxx Purchase Returns xxx
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Perpetual vs. Periodic Journal Entries
Sale of goods Cash (or Accts Rec) xxx Sales xxx Cost of goods sold xxx Inventory xxx End of period No entry necessary PERIODIC Sale of goods Cash (or Accts Rec) xxx Sales xxx End of period Closing entry or adjusting entry necessary
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Inventory Costing Changing Prices Specific identification
Cost flow assumptions FIFO (First-in, First-Out) LIFO (Last-in, First-Out) Average cost What makes cost flow assumptions necessary? Changing Prices
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Cost of goods sold = $700 + $800 = $1,500
Illustration 6-7 Specific Identification Cost of goods sold = $700 + $800 = $1,500 An actual physical flow costing method in which items on hand are specifically costed to arrive at the total cost of ending inventory
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FIFO method assumes earliest goods purchased are the first to be sold
Illustration 6-9 FIFO method assumes earliest goods purchased are the first to be sold
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Illustration 6-11 Allocation of the cost of goods available for sale in average cost method is made on the basis of the weighted average unit cost incurred
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Illustration 6-12 Average cost method assumes that goods available for sale are homogeneous
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LIFO method assumes latest goods purchased are the first to be sold
Illustration 6-13 LIFO method assumes latest goods purchased are the first to be sold
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Use of Cost Flow Methods by Canadian Companies
Each of the four methods are acceptable in Canada Very few companies use LIFO
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Factors Used in Selecting Inventory Cost Method
Statement of earnings effects LIFO gives best match of current revenues to current costs Balance sheet effects FIFO gives best measurement of ending inventory (approximates replacement cost) NO cash impact!
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Financial Statement Effects
EI CGS NE FIFO Average LIFO ? What are effects on the balance sheet and statement of earnings if prices are assumed to be rising?
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Financial Statement Effects
EI CGS NE FIFO H L H Average LIFO L H L ? What are effects on the balance sheet and statement of earnings if prices are assumed to be rising?
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Financial Statement Effects
EI CGS NE FIFO Average LIFO ? What are effects on the balance sheet and statement of earnings if prices are assumed to be falling?
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Financial Statement Effects
EI CGS NE FIFO L H L Average LIFO H L H ? What are effects on the balance sheet and statement of earnings if prices are assumed to be falling?
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Financial Statement Effects
EI CGS NE FIFO Average LIFO ? What are effects on the balance sheet and statement of earnings if prices are assumed to be stable?
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Financial Statement Effects
EI CGS NE FIFO Average LIFO All three methods will give same results. ? What are effects on the balance sheet and statement of earnings if prices are assumed to be stable?
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Lower of Cost and Market (LCM)
When the value of the inventory declines below cost, it is written down to its market value Market is defined as current replacement cost or net realizable value, not selling price
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Lower of Cost and Market (LCM)
Departure from cost principle Follows conservatism concept Used only after one of the cost flow methods (Specific identification, FIFO, LIFO, or average cost)
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How Much Inventory Should a Company Have?
Only enough for sales needs Excess inventory costs Storage costs Interest costs Obsolescence
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Inventory Turnover Inventory turnover = Cost of goods sold
Average inventory
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Days in Inventory Days in inventory = 365 days Inventory turnover
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Decision Checkpoints Which inventory costing method should be used?
How long is an item in inventory? Inventory turnover ratio Days in inventory
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COPYRIGHT Copyright © 2001 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.
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