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Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter 6 Income Statements Service Company Century 21 Real Estate Income Statement Year Ended December 31, 20xx Merchandising Company General Motors Corporation Income Statement Year Ended December 31, 20xx

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Merchandise Inventory, Cost of Goods Sold, and Gross Profit

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Merchandise inventory cost of goods sold and gross profit l.jpg

Merchandise Inventory, Cost of Goods Sold, and Gross Profit

Chapter 6


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Income Statements

Service Company

Century 21 Real Estate

Income Statement

Year Ended December 31, 20xx

Merchandising Company

General Motors Corporation

Income Statement

Year Ended December 31, 20xx

Service revenue$XXX

Expenses

Salary expense X

Depreciation expense X

Income tax expense X

Net income$ X

Sales revenue$185

Cost of goods sold 146

Gross profit 39

Operating expenses:

Salary expense X

Depreciation expense X

Income tax expense$ X

Net income$ 4

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren


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Balance Sheets

Service Company

Century 21 Real Estate

Balance Sheet

Year Ended December 31, 20xx

Merchandising Company

General Motors Corporation

Balance Sheet

Year Ended December 31, 20xx

Current assets:

Cash$X

Short-term investments X

Accounts receivable, net X

Prepaid expenses X

Current assets:

Cash $ X

Short-term investments X

Accounts receivable, netX

Inventory 11

Prepaid expensesX

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren


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Gross Profit (Gross Margin)

Sales Revenue

- Gross Profit

- Operating Expenses

Net Income


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Learning Objective 1

Account for inventory transactions.


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Inventory Accounting Systems

  • Periodic systems do not keep a continuous record of inventory on hand.

  • Perpetual systems maintain a running record to show the inventory on hand at all times.


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Recording Transactionsin the Perpetual System

Purchase price of the inventory$600,000

+ Freight-in4,000

– Purchase returns– 25,000

– Purchase allowances– 5,000

– Purchase discounts – 14,000

= Net purchases of inventory$560,000


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Inventory

Accounts Payable

Beg.100,000

560,000

560,000

Recording Transactionsand the T-Accounts

Inventory560,000

Accounts Payable560,000

Purchased inventory on account

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren


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Recording Transactionsand the T-Accounts

Sale on account $900,000 (cost $540,000):

Accounts Receivable900,000

Sales Revenue900,000

Cost of Goods Sold540,000

Inventory540,000

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren


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Cost of Goods Sold

540,000

Recording Transactionsand the T-Accounts

Inventory

Beg.100,000

560,000

120,000

540,000


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Reporting in theFinancial Statements

Income Statement (partial)

Sales revenue $900,000

Cost of goodssold 540,000

Gross profit$360,000

Ending Balance Sheet (partial)

Current assets:

Cash$ XXX

Short-term investments XXX

Accounts receivable, net XXX

Inventory 120,000

Prepaid expenses XXX


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Reporting in theFinancial Statements

Net purchases

Purchases

+ Freight-in

– Purchase returns & allowances

– Purchases discount

Net sales

Sales revenue

– Sales returns & allowances

– Sales discounts


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Learning Objective 2

Analyze the various inventory methods.


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What Goes Into Inventory Cost?

  • Sum of all costs incurred to bring asset to its intended use

  • Inventory costing methods:

    • Specific unit cost

    • Weighted-average cost

    • First-in, first-out (FIFO)

    • Last-in, first-out (LIFO)


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Illustrative Data

Beginning inventory (10 units @ $10)$ 100

No. 1 (25 units @ $14 per unit)$350

No. 2 (25 units @ $18 per unit) 450

Total purchases 800

Cost of goods available for sale$ 900

Ending inventory: 20 units

Cost of goods sold: 40 units


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5 Units @ $10

25 Units @ $14

10 Units @ $18

Specific Unit Cost

Cost of Goods Sold

$ 50

350

180

$580

$900 – $580 = $320


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Weighted-Average

$900 total cost ÷ 60 units = $15/unit

Ending inventory = 20 × $15 = $300

Cost of goods sold = 40 × $15 = $600


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First-In, First-Out

Ending Inventory Cost:

60 units

Less units sold40

Ending inventory20 units

20 units × $18 per unit = $360


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First-In, First-Out

10 Units @ $10

Cost of Goods Sold

$100

350

90

$540

25 Units @ $14

5 Units @ $18


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Last-In, First-Out

Ending Inventory Cost:

60 units

Less units sold40

Ending inventory20 units

10 units × 10 =$100

10 units × 14 = 140

Total$240


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Last-In, First-Out

Cost of Goods Sold

$450

210

$660

25 Units @ $18

15 Units @ $14


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Income Effects ofInventory Methods

Assumed

Sales

Revenue

Cost of

Goods

Sold

Gross

Profit

Specific unit cost $1,000 – 580= $420

Weighted-average $1,000– 600=$400

FIFO$1,000– 540=$460

LIFO$1,000 – 660=$340

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren


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Learning Objective 3

Identify the income and the tax effects of the inventory methods.


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FIFOLIFO

Gross profit$460$340

Operating expenses 260 260

Income before taxes$200$ 80

Income tax expense (40%)$ 80$ 32

The Tax Advantage of LIFO

The most attractive feature of LIFO is low

income tax payments when prices are

increasing.


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Use of the VariousInventory Methods


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Comparison of Inventory Methods

  • FIFO produces inventory profits during periods of inflation

  • LIFO allows managers to manipulate net income

  • LIFO liquidation


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Consistency Principle

  • Use the same accounting methods and procedures from one period to the next

  • May change inventory methods, but must disclose the effects of the change on net income


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Disclosure Principle

  • Financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company.


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Conservatism

  • The least favorable figures are presented in the financial statements.


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Lower-of-Cost-or-Market Rule

  • Report inventory at the lower of its historical cost or market (replacement) value

  • If the replacement cost falls below its historical cost, write down the value of the inventory


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Learning Objective 4

Use the gross profit percentage and inventory turnover to evaluate business.


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Using the Financial Statementsfor Decision Making

Gross profit percentage

= Gross profit

÷ Net sales revenue

Inventory turnover

= Cost of goods sold

÷ Average inventory


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Learning Objective 5

Estimate inventory by the gross profit method.


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Beginning inventory

+Purchases

=Cost of goods available for sale

–Ending inventory

=Cost of goods sold

Estimating Inventory

Gross profitmethod - based on computation of cost-of-goods-sold

-Cost of goods sold

= Ending inventory


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Objective 6

Show how inventory errors affect cost of goods sold and income.


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Effects of Inventory Errors

  • An error in the ending inventory creates errors for cost of goods sold and gross profit.

  • The current year’s ending inventory is next year’s beginning inventory.


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Reporting Inventory Transactions on the Statement of Cash Flows

  • Inventory transactions are operating activities

  • The purchase of inventory requires a cash payment, and the sale a cash receipt


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End of Chapter 6


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