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Merchandise Inventory

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  1. Merchandise Inventory Chapter 9

  2. Account for inventory by the perpetual and periodic systems. Objective 1

  3. Inventory Accounting Systems Perpetual systems maintain a running record to show the inventory on hand at all times. Periodic systems do not keep a continuous record of inventory on hand.

  4. Perpetual System Debit Inventory Credit Cash or Accounts Payable Debit Cash or Accounts Receivable Credit Sales Revenue Debit Cost of Goods Sold Credit Inventory

  5. Perpetual System Item: Teva Sandals Quantity Quantity Quantity Date Received Sold on Hand Nov. 1 5 7 12 26 30 Totals 25 25 50 6 13 21 40 10 4 29 16 41 20 20

  6. Cost of Goods Sold Beginning Inventory $100,000 Net Purchases $560,000 + = Ending Inventory $120,000 Cost of Goods Available for Sale $660,000 Cost of Goods Sold $540,000 – =

  7. Gross Profit Sales revenues – Cost of goods sold = Gross margin (before operating expenses) Gross margin – Operating expenses = Net income

  8. Cost-of-Goods-Sold Model Budgeted Cost of Goods Sold + Budgeted Ending Inventory Budgeted Cost of Goods Available for Sale = – Actual Beginning Inventory = Purchases

  9. Computing the Cost of Inventory • Physical count is made at least once a year, even with a perpetual system. • Consigned goods are excluded. Cost of inventory on hand = Quantity × unit cost

  10. Periodic System • At the end of the period make a physical count and apply unit cost to determine ending inventory. • Inventory purchases are debited to the purchases account. • The inventory account carries the beginning inventory balance until adjusted at period end.

  11. Periodic System Inventory Purchases 100,000 Beginning Balance 100,000 Beginning Balance 560,000 Purchases 560,000 Purchases 120,000 Ending Balance Cost of Goods Sold 120,000 Ending Balance 100,000 560,000 540,000 Accounts Payable 560,000 Purchases

  12. Apply the inventory costing methods: specific unit cost, weighted-average cost, FIFO, and LIFO. Objective 2

  13. Units Purchased in 200X January 8 20 units @ $20 = $ 400 May 19 55 units @ $30 = $1,650 October 23 25 units @ $31 = $ 775 Total units 100 Units sold 70 Units left 30

  14. Units Sold and in Ending Inventory Units sold by date: Jan 5 17 May 19 33 Oct 23 20 Total sales 70 30 units left in inventory

  15. Specific Identification 20 Units @ $31 5 Units @ $31 Cost of Goods Sold Oct 23 $ 620 May 19 990 Jan 5 340 Total $1,950 33 Units @ $30 22 Units @ $30 17 Units @ $20 3 Units @ $20

  16. Specific Identification 20 Units @ $31 5 Units @ $31 Ending Inventory Oct 23 $155 May 660 Jan 60 Total $875 33 Units @ $30 22 Units @ $30 17 Units @ $20 3 Units @ $20

  17. Weighted Average 25 Units @ $31 (Oct) = $ 775 = 1,650 = 400 = $2,825 Total Cost 55 Units @ $30 (May) 20 Units @ $20 (Jan) 100 Total Units

  18. Weighted Average $2,825 total cost/100 units = $28.25/unit Cost of goods sold = 70 × $28.25 = $1977.50 Ending inventory = 30 × $28.25 = $847.50

  19. First-In, First-Out 25 Units @ $31 (Oct) Cost of Goods Sold Jan $ 400 May 1,500 Total $1,900 5 Units @ $30 (May) 50 Units @ $30 20 Units @ $20 (Jan)

  20. First-In, First-Out 25 Units @ $31 (Oct) Ending Inventory Oct $775 May 150 Total $925 5 Units @ $30 (May) 50 Units @ $30 20 Units @ $20 (Jan)

  21. Last-In, First-Out 25 Units @ $31 (Oct) Cost of Goods Sold Oct $ 775 May 1,350 Total $2,125 45 Units @ $30 (May) 10 Units @ $30 20 Units @ $20 (Jan)

  22. Last-In, First-Out 25 Units @ $31 (Oct) Ending Inventory Oct $300 May 400 Total $700 45 Units @ $30 (May) 10 Units @ $30 20 Units @ $20 (Jan)

  23. Comparison of Methods EndingInventory Specific identification $875.00 FIFO $925.00 LIFO $700.00 Weighted-average $847.50

  24. Comparison of Methods Cost of Goods Sold Specific identification $1,965.00 FIFO $1,900.00 LIFO $2,125.00 Weighted-average $1,977.50

  25. Comparison of Methods • Gross Margin from Sales: • Specific identification $1,035.00 • FIFO $1,100.00 • LIFO $ 875.00 • Weighted-average $1,022.50 When prices are rising LIFO produces the lowest income and lowest income tax.

  26. Identify the income effects and the tax effects of the inventory costing methods. Objective 3

  27. The Income Tax Advantage of LIFO • During periods of inflation, LIFO’s income is the lowest. • The most attractive feature of LIFO is reduced income tax payments.

  28. Use of the Various Inventory Costing Methods

  29. LIFO Liquidation • When prices are rising... • the company draws down inventory quantities below the level of the previous period which releases older costs to the income statement.

  30. Perpetual System FIFO Example • Many companies keep their perpetual inventory records in quantities only. • Other companies keep perpetual records in both quantities and dollar cost.

  31. Perpetual System FIFO Example Deckers Outdoor Item: Teva Sandals Received Sold Balance on Hand Unit Unit Unit Date Qty. Cost Total Qty. Cost Total Qty. Cost Total Nov. 1 10 $30 $300 5 6 $30 $180 4 30 120 7 25 $31 $775 4 30 120 25 31 775 12 4 30 120 9 31 279 16 31 496

  32. Perpetual System FIFO Example Deckers Outdoor Item: Teva Sandals Received Sold Balance on Hand Unit Unit Unit Date Qty. Cost Total Qty. Cost Total Qty. Cost Total Nov. 26 25 $32 $ 800 16 $31 $496 25 32 800 30 16 $31 496 25 32 800 5 32 160 20 32 640 Totals 50 $1,575 40 $1,235 20 $32 $640

  33. Accounting Principles: Consistency The business should use the same accounting methods and procedures from one period to the next. A company may change inventory methods, but it must disclose the effects of the change on net income.

  34. Accounting Principles: Disclosure The financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company.

  35. Accounting Principles: Materiality An item is material if it has the potential to alter a statement user’s decision. Materiality is specific to the entity being evaluated.

  36. Accounting Principles: Conservatism Err on the side of caution when reporting any item in the financial statements.

  37. Apply the lower-of-cost- or-market rule to inventory. Objective 4

  38. Lower-of-Cost-or-Market • An asset is reported at the lower of its historical cost or market (replacement) value. • If the replacement cost falls below its historical cost, the business must write down the value of its inventory.

  39. Lower-of-Cost-or-Market Example • Cost of inventory: $3,000 • Market value at balance sheet date: $2,200 • What is the journal entry? December 31 Cost of Goods Sold 800 Inventory 800 Write down inventory to LCM

  40. Determine the effects of inventory errors on cost of goods sold and net income. Objective 5

  41. Inventory Errors • If inventory is computed incorrectly, how many years of financial statements will it affect? • Two years • The current year’s ending inventory is next year’s beginning inventory.

  42. Estimate ending inventory by the gross profit method. Objective 6

  43. Gross Profit Method Example Net Sales $150,000 Gross Profit Margin 31.5% Beginning Inventory $ 18,500 Net Purchases $110,500 Net Sales $150,000 – Gross Profit of 31.5% 47,250 = Cost of Goods Sold $102,750

  44. Gross Profit Method Example Beginning Inventory $18,500 Net Purchases $110,500 + = Ending Inventory $26,250 Cost of Goods Available for Sale $129,000 Cost of Goods Sold $102,750 – =

  45. End of Chapter 9