1. BSAD 221 Introductory Financial Accounting Donna Gunn, CA

2. Royal LePage Real Estate Merchandising Company
Income Statements
Service revenue $ XXX
Expenses
Operating and
administrative expense X
Depreciation expense X
Income tax expense X
Net income $ X
Service Company
Royal LePage Real Estate
Income Statement
Year Ended December 31, 2012
Revenue $ 703.2
Cost of goods sold
Gross profit
Operating expenses:
Operating and
administrative expense X
Depreciation expense X
Income tax expense $ X
Net income $
Merchandising Company
Leon’s Furniture Ltd.
Income Statement
Year Ended December 31, 2012
Note that on the service company’s income statement there is no COGS. COGS is something that only applies to companies who sell products and thus deal with inventory.

3. Royal Lepage Real Estate Merchandising Company
Balance Sheets
Current assets:
Cash $ X
Short-term investments X
Accounts receivable, net X
Prepaid expenses X
Service Company
Royal Lepage Real Estate
Balance Sheet
December 31, 2012
Current assets:
Cash $ X
Short-term investments X
Accounts receivable, net X
Inventory
Prepaid expenses X
Merchandising Company
Leon’s Furniture Ltd.
Balance Sheet
December 31, 2012

4. Accounting for Inventory
Cost of inventory on hand
= Inventory (Asset on balance sheet)
Balance Sheet
Inventory =
Number of units on hand × unit cost

5. Accounting for Inventory
Cost of Inventory that’s been sold
= Cost of Goods Sold
(Expense on income statement)
Income Statement
Cost of goods sold
= Number of units sold × unit cost

6. Costs Included in Inventory Purchases
The cost principle requires that inventory be recorded at the price paid or the consideration given.
Include all costs incurred to bring the asset to useable or saleable condition.
Invoice Price
Freight
Your inventory is the complete cost of that item to you. If you have to pay for delivery – that’s a cost of the inventory and you add it in. Anything that is required to make the inventory useable or saleable.
Inspection Costs
Preparation Costs

7. Flow of Inventory Costs
Merchandise Purchases
Cost of Goods Sold
Merchandise Inventory
Merchandiser
Raw Materials
Raw Materials Inventory
Work in Process Inventory
Finished Goods Inventory
Cost of Goods Sold
Manufacturer
Direct Labor
Factory Overhead
There are really two types of companies that deal with inventory.
Merchandisers – just buy it and sell it – E.g. wal-mart, future shop etc.
Manufacturers – make something and then sell it

8. Comparing Merchandising and Manufacturing Activities
Merchandisers . . .
Buy finished goods.
Sell finished goods.
Manufacturers . . .
Buy raw materials.
Produce and sell finished goods.
This is an example of the difference.
The company that produces the bacon wrapped scallop is a manufacturer. They buy raw materials (scallops, bacon, etc.) and make a finished product.
Superstore is a merchandiser. They buy the finished product from the manufacturer and resell it to their customer.
For the manufacturer the bacon and scallops they buy that are untouched are raw materials. As soon as they start working on them to turn them into a finished product they become work in progress. Once all the work is done and they are ready to sell to superstore it is a finished good.

9. Nature of Cost of Goods Sold
Beginning Inventory
Purchases for the Period
Goods available for Sale
Ending Inventory (Balance Sheet)
Cost of Goods Sold (Income Statement)
Beginning inventory + Purchases = Goods Available for Sale
Goods Available for Sale – Ending inventory = Cost of goods sold

10. Perpetual and Periodic Inventory Systems
Provides up-to-date inventory records.
Perpetual
System
Provides up-to-date cost of sales records.
Perpetual systems are fantastic but they are more work for companies that don’t have sophisticated accounting systems. A lot of organizations (most) rely on a perpetual system. Companies who use perpetual tend to fall into two groups – large companies with sophisticated systems, or companies who inventories are high value/high risk and they need to constantly keep track of them. E.g. I had a client who was a pharmacy – they didn’t track everything perpetually but all narcotics were on a perpetual system – they needed to keep stronger controls over them.
In a periodic inventory system, ending inventory and cost of goods sold are determined at the end of the accounting period based on a physical count.

11. Recording Transactions in the Perpetual System
Dr. Cash or Accounts Receivable
Cr. Sales Revenue
To record sales revenue
Dr. Cost of Goods Sold
Cr. Inventory
To record COGS

12. Recording Transactions in the Perpetual System
Purchase price of the inventory $570,000
+ Freight-in ,000
– Purchase discounts – 14,000
= Net purchases of inventory $560,000

13. Recording Transactions
Inventory ,000
Accounts Payable ,000
Purchased inventory on account
Beg. 100,000
560,000
Inventory
Accounts Payable
560,000

14. Recording Transactions and the T-Accounts
Sale on account $900,000 (cost $540,000):
Accounts Receivable 900,000
Sales Revenue ,000
Cost of Goods Sold 540,000
Inventory ,000

15. Recording Transactions
Cost of Goods Sold 540,000
Inventory ,000
Inventory
Cost of Goods Sold
540,000
Beg. 100,000
560,000
120,000
540,000

16. Reporting in the Financial Statements
Income Statement (partial)
Sales revenue $900,000
Cost of goods sold ,000
Gross margin $360,000
Ending Balance Sheet (partial)
Current assets:
Cash $ XXX
Short-term investments XXX
Accounts receivable, net XXX
Inventory ,000

17. Inventory Costing Methods
FIFO
Weighted Average
Specific Identification
There are 3 primary ways to track inventory costing. 24 24 24 24

18. Specific Identification
When units are sold, the specific cost of the unit sold is added to cost of goods sold.
Specific identification means you actually know how much each unit of inventory cost and you track the cost to that individual item. It’s the way most people likely think inventory is cost. In reality this is a lot of work and for a company like Wal-mart for example, this would be impossible.
When it is used in real life is for high value items that the cost is really individual too and can vary significantly. E.g. a house.

19. First-In, First-Out Method
Cost of Goods Sold
Oldest Costs
Ending Inventory
First in first out assumes that what you bought first you sold first. If you are a grocery store and you have 100 cans of soup on a shelf you are going to assume that the one you bought first is sold first, so that is the cost of good sold you will use. In reality the shopper could have picked up any can – not necessarily the oldest, but an assumption is required.
Recent Costs

20. Weighted-Average Cost Method
When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold.
Weighted-average cost (WAC) per unit:
Cost of goods available for sale
Number of units available for sale
Ending Inventory = Ending Units x WAC per Unit
Cost of Good Sold = Units Sold x WAC per Unit

21. Illustration of Costing
Leon’s began the period with 10 lamps costing $10 each;
During the period, Leon’s bought 50 more lamps sold 40 lamps, and ended the period with 20 lamps.
Beginning bal (10 $10) $100
Purchases:
No. 1 (25 $14) $350
No. 2 (25 $18) 450
Ending bal. (20 $?)
Inventory
Cost of goods sold: (40 $?) ?

22. Illustration of Costing
The big accounting questions are:
What is the cost of goods sold for the income statement?
What is the cost of the ending inventory for the balance sheet?

23. Illustration of Costing
Total Dollar Amount of Goods Available for Sale
Inventory Costing Method
Ending Inventory
Cost of Goods Sold

24. Weighted-Average $900 total cost ÷ 60 units = $15/unit
Cost of goods sold = 40 × $15 = $600
Ending inventory = 20 × $15 = $300

25. Assume inventory on hand are from most recent purchase at $18 per unit
First-In, First-Out
Beginning (10 $10) $100
Purchase No. 1 (25 $14)
Purchase No. 2 (25 $18) 450
40 units sold and 20 still on hand
Ending inventory cost
= 20 units × $18 per unit
= $360
Assume inventory on hand are from most recent purchase at $18 per unit

26. First-In, First-Out Cost of Goods Sold
Beginning (10 $10) $100
Purchase No. 1 (25 $14)
Purchase No. 2 (25 $18) 450
40 units sold and 20 still on hand
Cost of Goods Sold
= 10 units x $ units x $ units x $8
= $540
Assume inventory sold was the inventory purchased first

27. First-In, First-Out 10 Units @ $10 Cost of Goods Sold $100 350 90 $540

28. Changing Costs When inventory costs are increasing:
Weighted Average cost of goods sold is highest because it is based on the average of the costs for the period, so includes the new higher costs.
FIFO cost of goods sold is lowest because it is
based on the oldest costs and ignores the most recent costs.

29. Financial Statement Effects of Costing Methods
Advantages of Methods
First-In, First-Out
Weighted Average
Ending inventory approximates current replacement cost.
Smoothes out price changes.

30. Accounting Standards and Inventories
Comparability
(including consistency)
Disclosure

31. Accounting Principles and Inventory
Comparability states that businesses should
use the same accounting methods and
procedures from period to period.
Disclosure Principle holds that a company’s
financial statements should report enough
information for outsiders to make informed
decisions about the company.

32. Lower of Cost or Net Realizable Value
Ending inventory is reported at the lower of cost or net realizable value (LCNRV).
Net Realizable Value =
The expected sales price less selling costs 74 74 74 74

33. Estimating Inventory
The gross margin method of estimating ending inventory is based on the COGS model.
Beginning inventory
+ Purchases
= Goods available for sale
– Ending inventory
= Cost of goods sold

34. Estimating Inventory
Rearranging ending inventory and cost of goods sold makes the model useful for estimating ending inventory.
Beginning inventory
+ Purchases
= Goods available for sale
– Cost of goods sold
= Ending inventory

35. Estimating Inventory Beginning inventory $18,000 Purchases 72,000
Cost of goods available for sale ,000
Cost of goods sold:
Net sales revenue $100,000
Less estimated gross margin of 40.3% – 40,300
Estimated cost of goods sold ,700
Estimated cost of ending inventory $30,300
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36. Effects of Inventory Errors
An error in the ending inventory
creates errors for cost of goods
sold and gross margin.
The current year’s ending inventory
is next year’s beginning inventory.

37. Effects of Inventory Errors
Period 1
Ending
Inventory
Overstated
by $5,000
Period 1
Beginning
Inventory
Overstated
by $5,000
Period 1
Correct
Sales revenue
Cost of goods sold:
Beg. inventory
Purchases
Cost of goods
available for sale
Ending inventory
Cost of goods sold
Gross margin
$100,000
$10,000
50,000
$60,000
(15,000)
45,000
$ 55,000
$100,000
$15,000
50,000
$65,000
(10,000)
55,000
45,000
$100,000
$10,000
50,000
$60,000
(10,000)
$ 50,000

38. Ethical Considerations
Managers of companies whose profits do not meet shareholder expectations are sometimes tempted to “cook the books” to increase reported income.
What are some possibilities?
1. Overstating ending inventory
2. Creating fictitious sales revenue