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Chapter 8. Inventories and Cost of Goods Sold. Financial Accounting 4e by Porter and Norton. Inventory of Wholesalers and Retailers. Purchased in finished form Resold without transformation. Classified as “Merchandise Inventory” on balance sheet.

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Chapter 8

Chapter 8

Inventories and

Cost of Goods Sold

Financial Accounting 4e by Porter and Norton


Inventory of wholesalers and retailers

Inventory of Wholesalers and Retailers

  • Purchased in finished form

  • Resold without transformation

  • Classified as “Merchandise Inventory” on balance sheet


Circuit city consolidated balance sheets partial

CIRCUIT CITYConsolidated Balance Sheets [Partial]

February 28,

20022001

CURRENT ASSETS:

Cash and cash equivalents$1,251,532$ 446,131

Net accounts and notes receivable 726,541 585,761

Merchandise inventory 1,633,327 1,757,664

Prepaid expenses and other current assets 41,311 57,623

TOTAL CURRENT ASSETS 3,652,711 2,847,179

Property, plant and equipment, net 853,778 988,947

Other assets 32,897 35,207

TOTAL ASSETS $4,539,386 $3,871,333

ASSETS (in thousands)

More

than

1/3

of total

assets


Inventory of manufacturers

Inventory of Manufacturers

Costs Included in Inventory

Direct

Materials

Direct

Labor

Manufacturing

Overhead


Inventory of manufacturers1

Inventory of Manufacturers

Balance Sheet

Classifications

Costs Included

in Inventory

Direct

Materials

Raw

Materials

Manufacture

Products

Direct

Labor

Work in

Process

Manufacturing

Overhead

Finished

Goods


Nike inc consolidated balance sheets partial

NIKE, INC.Consolidated Balance Sheets [Partial]

May 31,

20012000

ASSETS (in millions)

Current assets:

Cash and cash equivalents$ 304.0$ 254.3

Accounts receivable less allowance for

doubtful accounts of $72.1 and $65.4 1,621.4 1,569.4

Inventories:

Finished goods 1,399.4 1,416.6

Work in progress 15.1 17.3

Raw materials 9.6 12.1

1,424.1 1,446.0

Deferred income taxes 113.3 111.5

Prepaid expenses 162.5 215.2

Total current assets 3,625.3 3,596.4

Property, plant and equipment, net 1,618.8 1,583.4

Identifiable intangible assets and goodwill 397.3 410.9

Deferred income taxes and other assets 178.2 266.2

TOTAL ASSETS$ 5,819.6$ 5,856.9


Inventory valuation and income measurement

Inventory Valuation and Income Measurement

Value

Assigned to

Inventory

on Balance

Sheet

Value

Expensed

as Cost of

Goods Sold

on Income

Statement

When Sold =


Calculating cost of goods sold

Beginning inventory $ 500

+ Purchases 1,200

= Cost of goods available for sale 1,700

Calculating Cost of Goods Sold

  • Internal calculation

-Ending inventory (600)

= Cost of goods sold $ 1,100


Inventory costs include

Inventory costs include

  • Any freight costs incurred by buyer

  • Cost of insurance for inventory in transit

  • Cost of storing inventory before selling

  • Excise and sales taxes


Inventory costing methods

Inventory Costing Methods

Four costing methods available:

Specific

Identification

Weighted

Average

First-in, First-out

(FIFO)

Last-in, First-out

(LIFO)


Detailed costing method example

Detailed Costing Method Example

Calculate the cost of goods sold and ending inventory under each method using the data below:

Beginning inventory, Jan. 1: 500 units (unit cost $10)

Inventory purchases:

DateUnitsUnit Cost

1/20 300 $ 11

4/8 400 12

9/5 200 13

12/12 100 14

Total purchases1,000

Ending inventory, Dec. 31: 600 units

11


Chapter 8 5616295

Specific Identification Method

Step 1: Identify the specific units in

inventory at the end of the year

and their costs.


Chapter 8 5616295

Specific Identification Method

Units in ending inventory:

Date purchasedUnitsCostTotal cost

1/20 100 $11$1,100

4/8 300 12 3,600

9/5 200 13 2,600

Ending inventory 600$7,300

Units x Cost = Total cost


Chapter 8 5616295

Specific Identification Method

Step 2: Identify the units sold and calculate the cost of goods sold.


Chapter 8 5616295

Specific Identification Method

Date purchasedUnitsCostTotal cost

Beg. Inventory 500 $10$5,000

1/20 200 11 2,200

4/8 100 12 1,200

12/12 100 14 1,400

Cost of goods sold 900$9,800

Units x Cost = Total cost


Chapter 8 5616295

Weighted Average Method

Step 1: Calculate the cost of goods

available for sale.


Chapter 8 5616295

Weighted Average Method

Date purchasedUnitsCostTotal cost

Beg. inventory 500 $10 $ 5,000

1/20 300 11 3,300

4/8 400 12 4,800

9/5 200 13 2,600

12/12 100 14 1,400

Cost of goods

available for sale 1,500 $17,100


Chapter 8 5616295

:

Weighted Average Method

Step 2:Divide the cost of goods available

for sale by the total units to

determine the weighted average

cost per unit.


Chapter 8 5616295

Weighted Average Method

Cost of Goods Available

Units Available

$17,100

1,500

= $ 11.40/unit


Chapter 8 5616295

Avg.

Cost

#

Units

X

Weighted Average Method

Step 3:Calculate ending inventory and COGS by multiplying the weighted average cost per unit by the # of units in ending inventory and the # of units sold.


Chapter 8 5616295

Weighted Average Method

ALLOCATE TO

Ending Cost of

InventoryGoods Sold

Units on hand 600

Units sold 900

Weighted average cost X $11.40$ 11.40

Totalcost of goods

available of $17,100 allocated: $6,840 $10,260


First in first out fifo method

1st

in

First-in, First-out (FIFO) Method

Step 1:Assign the cost of the beginning

inventory to cost of goods sold.


First in first out fifo method1

First-in, First-out (FIFO) Method

ALLOCATE TO

Ending Cost of

UnitsCostInventoryGoods Sold

1/1 500 $10 $5,000

1/20 300 $11

4/8 400 $12

9/5 200 $13

12/12 100 $14


First in first out fifo method2

First-in, First-out (FIFO) Method

Step 2:Continue to work forward until you assign the total # of units sold during the period to cost of goods sold. Allocate the remaining units to ending inventory.

etc.

3rd

2nd


First in first out fifo method3

First-in, First-out (FIFO) Method

ALLOCATE TO

Ending Cost of

UnitsCostInventoryGoods Sold

1/1 500 $10 $5,000

1/20 300 $11 3,300

4/8 300 / 100 $12$3,600 1,200

9/5 200 $13 2,600

12/12 100 $14 1,400

TOTALS$7,600$9,500


Last in first out lifo method

1st

in

Last-in, First-out (LIFO) Method

Step 1: Assign the cost of the last units purchased to cost of goods sold.


Last in first out lifo method1

Last-in, First-out (LIFO) Method

ALLOCATE TO

Ending Cost of

UnitsCostInventoryGoods Sold

1/1 500 $10

1/20 300 $11

4/8 400 $12

9/5 200 $13

12/12 100 $14$1,400


Last in first out lifo method2

1st

in

Last-in, First-out (LIFO) Method

Step 2: Work backward until you assign the total # of units sold during the period to cost of goods sold (allocate the remaining units to ending inventory).


Last in first out lifo method3

Last-in, First-out (LIFO) Method

ALLOCATE TO

Ending Cost of

UnitsCostInventoryGoods Sold

1/1 500 $10 $5,000

1/20 100 / 200 $11 1,100$2,200

4/8 400 $12 4,800

9/5 200 $13 2,600

12/12 100 $14 1,400

TOTALS$6,100 $11,000


Comparison of costing methods

Comparison of Costing Methods

Cost of

Goods

Sold

Goods Available for Sale

Ending

Inventory

Specific Identification

$7,300

9,800

$17,100

Weighted

Average

10,260

6,840

17,100

FIFO

7,600

9,500

17,000

6,100

11,000

LIFO

17,100


Comparison of costing methods1

Comparison of Costing Methods

X

X

X

X

X

Weighted

Avg.FIFOLIFO

In periods of rising

prices:

highest COGS?

lowest COGS?

highest gross margin?

lowestnet income?

lowest income taxes?


Lifo issues

LIFO Issues

  • LIFO Liquidation

    • liquidation can result in high gross margin (and large tax bill)

  • LIFO Conformity Rule

    • if used for tax, LIFO must also be used for books

  • LIFO Reserve

    • difference between inventory value stated at FIFO and value stated at LIFO


Reasons for inventory errors

Reasons for Inventory Errors

  • Mathematical mistakes

  • Physical inventory counting errors

  • Cut-off problems - in-transit

  • Goods on consignment


Lower of cost or market

Lower of Cost or Market

Before After

PricePriceChangeChange

Cost 150 120

Report loss in year market falls below cost…

34


Lower of cost or market1

Lower of Cost or Market

Before After

PricePriceChangeChange

Selling price$200$160

Cost 150 120

Gross margin$ 50$ 40

…to maintain

normal G.M.%

when sold

Gross margin % 25% 25%

35


Lower of cost or market2

Lower of Cost or Market

  • Market = replacement cost (not retail value)

  • Cost determined under one of four methods

  • Justified on basis of conservatism

  • Can be applied to:

    • entire inventory

    • individual items

    • groups of items


Estimating inventory values

Estimating Inventory Values

  • Sometimes impossible or impractical to measure inventory at cost

    • Estimation is necessary

  • Two methods used to estimate ending inventory values:

    • gross profit method

    • retail inventory method


Gross profit method

Gross Profit Method

1 Beginning inventory

2+ Purchases

3= Cost of goods available for sale

4- Ending inventory

5= Cost of goods sold

Use income statement model but

reverse steps 4 and 5


Gross profit method1

Gross Profit Method

Beginning inventory$ 100,000

+Purchases 30,000

=Cost of goods available for sale 130,000

-Cost of goods sold(estimated) * 90,000

=Ending inventory (estimated)$ 40,000

* Cost of goods sold is estimated

as a percentage of sales


Inventory turnover ratio

The number of times per period inventory is turned over (i.e., sold)

Inventory Turnover Ratio

Cost of Goods Sold

Average Inventory


Inventory turnover ratios

Inventory Turnover Ratios

Example:

Circuit City 5.9 times per year

Safeway 9.3 times per year

Can you compare the two ratios?


Days sales in inventory

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

Days’ Sales in Inventory

# of Days in Period

Inventory Turnover

Ratio

The average # of days

inventory is on hand

before its sold.


Days sales in inventory1

Days’ Sales in Inventory

Circuit City365=61 days5.9

Safeway365=39 days9.3

Do these averages seem reasonable?


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