McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill...
-
Upload
arlene-woodward -
Category
Documents
-
view
219 -
download
0
Transcript of McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill...
![Page 1: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/1.jpg)
McGraw-Hill/Irwin
Chapter 6
Cost of Sales and Inventories
Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.
![Page 2: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/2.jpg)
6-2
What is Inventory?
Asset items held for sale in the ordinary course of business, or
Goods that will be used or consumed in the production of goods or services to be sold.
![Page 3: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/3.jpg)
6-3
Supplies
Tangible items that will be consumed in the course of normal operations. E.g., office and janitorial supplies,
lubricants, repair parts. Will be consumed, not sold as
merchandise. Therefore, not accounted for as part of
inventory or cost of goods sold.
![Page 4: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/4.jpg)
6-4
Types of Companies
• Merchandising company.– Sells goods in same form as acquired.– Merchandising inventory.
• Manufacturing company.– Converts raw material into finished goods.– Materials inventory, work in process inventory,
finished goods inventory.• Service company.
– Provides intangible services.– Supplies, parts inventory, jobs in progress.
![Page 5: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/5.jpg)
6-5
Net Purchase Cost
Cost of merchandise, and Expenditures necessary to make goods
ready for sale: Freight (i.e., freight-in). Handling, processing , assembling, etc.
Adjust for returns and allowances. Adjust for cash (purchase) discounts from
supplier. NOTE: Record purchases when received
(i.e., title transfers) not when ordered.
![Page 6: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/6.jpg)
6-6
Inventory Cost FlowInventory
Beginning (+)
(=) Ending
Net purchases (+)Cost of goods
sold (-)
Net purchases. Gross purchases - purchase returns & allowances + freight-in.
Goods available for sale. Beginning inventory + net purchases.
Cost of goods sold. Goods available for sale – ending inventory. Beginning inventory + net purchases – ending inventory.
![Page 7: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/7.jpg)
6-7
Measurement Issue
• Goods available for sale (i.e., beginning inventory plus purchases).– How much becomes cost of goods sold?– How much becomes ending inventory?
• Two approaches:1.Periodic inventory method.2.Perpetual inventory method.
![Page 8: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/8.jpg)
6-8
Periodic Inventory Method
Goods available for sale. Beginning inventory + Purchases. NOTE: Beginning inventory is the ending
inventory from the previous period. Determine ending inventory.
Physical inventory (count) is taken. Deduce cost of goods sold.
Good available for sale – Ending inventory.
![Page 9: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/9.jpg)
6-9
Perpetual Inventory Method Perpetual (continuous) record is kept for
each item in inventory. When sale is made, cost of goods sold is
immediately updated. Merchandise inventory account is reduced,
cost of goods sold account is increased. Balance in Merchandise Inventory:
Is goods available for sale at all times. Is also ending inventory at all times.
![Page 10: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/10.jpg)
6-10
Periodic vs. Perpetual
Periodic method. Less recordkeeping.
Perpetual method. Detailed record is useful for reordering. Built in check (i.e., identifies shrinkage by
inventory item during physical inventory). Income statement can be prepared
without taking a physical inventory.
![Page 11: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/11.jpg)
6-11
Retail Method
• Approximates use of perpetual method. Steps:
1. Record purchases at both cost and retail. 2. Calculate gross margin (mark-up) percent.3. 100% - Gross margin % = Cost %.4. Cost of goods sold = Cost % x Retail sales.
Variation is gross profit method. Difference is use of an average or normal
gross margin percentage in calculation.
![Page 12: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/12.jpg)
6-12
Manufacturing Inventory Accounts
Materials inventory. Not yet used in production. Adjusted for returns and freight-in.
Work-in-process inventory. Goods started, but not yet finished. Materials + conversion costs.
Finished goods inventory. Manufactured, but not yet shipped.
![Page 13: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/13.jpg)
6-13
Manufacturing Companies
Materials Inventory
Work in Process
Inventory
Direct Labor
Overhead
Finished Goods
Inventory
Cost of Goods Sold
Cost of GoodsManufactured
![Page 14: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/14.jpg)
6-14
Flow Through Accounts
Materials InventoryBeginning (+)
(=) Ending Net purchases (+)
MaterialsUsed (-)
Work in Process Inventory
Beginning (+)
(=) Ending
Cost of Goods Manufactured
(-)
MaterialsUsed (+)
ConversionCosts (+)
![Page 15: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/15.jpg)
6-15
Flow Through Accounts
Work in Process Inventory
Beginning (+)
(=) Ending
Cost of Goods Manufactured
(-)
MaterialsUsed (+)
ConversionCosts (+)
Finished Goods Inventory
Beginning (+)
(=) Ending
Cost of Goods Sold (-)
Cost of Goods Manufactured
(+)
![Page 16: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/16.jpg)
6-16
Manufacturing Companies: Additional Items
• Product costing systems.– Perpetual inventory system for
manufacturing companies (covered in Chapters 17-19).
• Product (inventoriable) costs.– Items of cost used to produce goods (i.e.,
materials, labor, overhead).– Do not impact income until product is
sold.
![Page 17: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/17.jpg)
6-17
Service Companies
Personal services organizations. E.g., hotels, beauty salons, dentists. No inventories, just supplies.
Building trade and repair businesses. May have parts inventory.
Professional service firms. E.g., law and accounting firms. Jobs in progress account (similar to work in
process inventory).
![Page 18: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/18.jpg)
6-18
Inventory Costing Methods(Cost Flow Assumptions)
What if inventory prices fluctuate?• Goods available for sale:• How much becomes cost of goods sold?• How much becomes ending inventory?
Will need to choose a cost flow assumption:• Specific identification.• Average cost.• First-in, first-out (FIFO).• Last-in, last-out (LIFO).
![Page 19: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/19.jpg)
6-19
Specific Identification
Track purchase cost of each item. Used for:
Big ticket items (e.g., automobile). Uniquely identified items (e.g., jewelry).
May offer opportunity to manipulate costs.
![Page 20: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/20.jpg)
6-20
Average Cost
Beginning inventory + PurchasesUnits available for sale
AverageUnit Cost
=
Compute an average cost for all units. Periodic method.
Computed for the entire period.
Multiply average unit cost by units sold (and units in ending inventory) to get total amounts.
For perpetual method, a new unit average cost is calculated after each purchase.
![Page 21: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/21.jpg)
6-21
First-In, First-Out (FIFO)
Expenses costs of oldest purchases first. Most recently purchased goods are in
inventory. Likely to approximate the physical flow of
goods. Ending inventory approximates current cost
of goods. Periodic/perpetual methods produce
identical results.
![Page 22: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/22.jpg)
6-22
Last-In, Last-Out (LIFO)
Assumes most recently purchased goods are sold first.
Inventory based on costs of oldest purchases. Cost of goods sold usually does not reflect
physical flow. Ending inventory may be costed at amounts of
years ago. Not permitted by IFRS.
![Page 23: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/23.jpg)
6-23
Other LIFO Features
Dollar value LIFO. LIFO method that uses inventory pools with dollar
instead of unit calculations. LIFO layers.
Can distort income if company reduces level of inventory (i.e., old costs being expensed).
LIFO Reserve. Difference between LIFO valuation and FIFO (or
average cost) valuation. Disclosed in financial statements.
![Page 24: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/24.jpg)
6-24
Arguments for FIFO
Usually follows physical flow of goods. More realistic for pricing products.
When using cost-plus pricing, these are the units being sold.
Therefore, better matching. More accurate balance sheet valuation.
![Page 25: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/25.jpg)
6-25
Arguments for LIFO
• Conceptually better for pricing products. When using cost-plus pricing, prices will be based
on current costs. Therefore, better matching and a more useful
income statement (i.e., closest to reflecting current or replacement cost of goods sold).
NOTE: LIFO amounts are still historical costs and could differ from current costs.
![Page 26: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/26.jpg)
6-26
Arguments for LIFO
During periods of price increases: Higher costs of goods sold. Lower taxable income. Lower income taxes. Higher cash flows.
NOTE: If LIFO is used for tax purposes, than must also be used for financial reporting (i.e., LIFO conformity rule).
![Page 27: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/27.jpg)
6-27
Why Not More LIFO?
Most countries use IFRS (therefore, do not permit use of LIFO).
Only beneficial in periods of rising prices. Because of LIFO conformity rule, lower
earnings will also be reported to shareholders.
![Page 28: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/28.jpg)
6-28
Lower of Cost or Market (LCM)
Market price may be below cost due to: Physical deterioration. Change in consumer tastes. Technological obsolescence.
LCM is a reflection of the conservatism concept.
Market is defined as replacement cost.
![Page 29: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/29.jpg)
6-29
LCM: Upper and Lower Bounds
Ceiling or upper bound: Net realizable value (i.e., Estimated selling
price – Estimated costs of selling). Reasoning: Inventory not above cash that will
be received. Floor or lower bound:
Net realizable value - normal profit margin. Reasoning: Inventory not written down
artificially low (which could overstate income).
![Page 30: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/30.jpg)
6-30
Steps in Applying LCM
Determine replacement cost; compute floor and ceiling amounts. Select the middle amount as market.
Select lower of cost or market.
![Page 31: McGraw-Hill/Irwin Chapter 6 Cost of Sales and Inventories Copyright © 2011. The McGraw-Hill Companies. All Rights Reserved.](https://reader035.fdocuments.in/reader035/viewer/2022062312/551691ca550346f6208b46e4/html5/thumbnails/31.jpg)
6-31
Analysis of Inventory Inventory turnover.
Cost of goods sold ÷ Inventory. For inventory, can use period average or ending. Measures velocity with which merchandise moves
through business. Days’ inventory.
Inventory turnover expressed in number of days. Inventory ÷ (Cost of goods sold 365).
Gross margin percentage. Gross margin as % of net sales. Profitability measure, earnings before period costs.