2. Inventory and Cost of Goods Sold
Inventory
Products purchased or manufactured for Sale to
Customers
Beginning Inventory
Quantities of Merchandise on hand
Purchases
New Purchases or Manufactured products
Available for Sale = Beginning Inventory +
Purchases
Most that a company can sell during an accounting
period
Ending Inventory
Remaining Unsold Merchandise
Cost of Goods Sold
Cost of Inventory Sold during accounting Period
3. Income Statement
Service Company Merchandising Company
Century 21 Real Estate General Motors Corporation
Income Statement Income Statement
Year Ended December 31, 20xx Year Ended December 31, 20xx
Service revenue $XXX Sales revenue $185
Expenses Cost of goods sold 146
Salary expense X Gross profit 39
Depreciation expense X Operating expenses:
Income tax expense X Salary expense X
Net income $ X Depreciation expense X
Income tax expense $ X
Net income $ 4
4. Balance Sheet
Service Company Merchandising Company
Century 21 Real Estate General Motors Corporation
Balance Sheet Balance Sheet
Year Ended December 31, 20xx Year Ended December 31, 20xx
Current assets: Current assets:
Cash $X Cash $X
Short-term investments X Short-term investments X
Accounts receivable, net X Accounts receivable, netX
Prepaid expenses X Inventory 11
Prepaid expenses X
5. Inventory Accounting Systems
Perpetual
Up-to-date record in inventory account
Cost of goods sold computed for each sale
Periodic
Inventory purchases are recorded as incurred
Inventory and cost of goods sold determined at the
end of each period
Costs and benefits
Perpetual requires more bookkeeping but provides
more useful information
6. Recording Transactions in the
Perpetual System
Purchase price of the inventory $600,000
+ Freight-in (delivery charges) 4,000
– Purchase returns – 25,000
– Purchase allowances – 5,000
– Purchase discounts – 14,000
= Net purchases of inventory $560,000
Net sales
Sales revenue
– Sales returns & allowances
– Sales discounts
7. Calculation
Periodic System Perpetual System
Beginning Inventory Beginning Inventory
+Cost of Purchases +Cost of Purchases
___________________ ___________________
=Cost of Goods =Cost of Goods
Available for Sale Available for Sale
- Ending Inventory - Cost of Goods Sold
___________________ ___________________
=Cost of Goods Sold =Ending Inventory
8. Periodic Vs. Perpetual System
Periodic Perpetual
Purchase Debited as purchase Debited to Inventory
Sales Sale Entry 2 Entries To record sale
& to reduce the inventory
Ending Inventory Not Recorded until the Recorded
end of a period
Cost of Goods Sold Not Recorded until the Recorded
end of a period
9. Relationship between Balance
Sheet and Income Statement
Income Statement Items:
Sales revenue is based on sale price of
Inventory sold.
Cost of goods sold is based on cost of
Inventory sold.
Gross profit (gross margin) is sales revenue
less cost of goods sold.
Balance Sheet Item:
Inventory on the balance sheet is based on
cost.
10. Accounting for Inventory
Sales Number of units of Sale price per unit
= X
(income statement) inventory sold of inventory
Cost of Goods Sold Number of units of Cost per unit
= X
(income statement) inventory sold of inventory
Inventory Number of units of Cost per unit
= X
(balance sheet) inventory on hand of inventory
11. Recording Transactions and the T-
Accounts
General Journal
Date Accounts and Explanations LF Debit Credit
Inventory 560,000
Accounts Payable 560,000
Purchased inventory on account
Inventory Accounts Payable
Beg. 100,000 560,000
560,000
12. Recording Transactions and the T-
Accounts
Sale on account $900,000 of Inventory
which cost $540,000:
General Journal
Date Accounts and Explanations LF Debit Credit
Accounts Receivable 900,000
Sales Revenue 900,000
Cost of Goods Sold 540,000
Inventory 540,000
13. Recording Transactions and the T-
Accounts
Inventory Cost of Goods Sold
Beg. 100,000 540,000 540,000
560,000
120,000
14. Reporting in the Financial
Statements
Income Statement (partial)
Sales revenue $900,000
Cost of goods sold 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
15. Inventory Costing Method
Methods for determining per unit Inventory
Cost
Specific unit cost
Average cost
First-in, first-out (FIFO) cost
Last-in, first-out (LIFO) cost
16. Which Method will a Company
Use?
Decision is up to Management
NOT based on Actual Inventory Movements
A tool for managing Earnings
A tool for managing Taxes
17. 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 60 goods available for sale $ 900
Ending inventory: 20 units
Cost of goods sold: 40 units
18. Specific Unit Cost
5 Units @ $10
Cost of Goods Sold
$ 50
350 25 Units @ $14
180
$580
10 Units @ $18
$900 – $580 = $320
19. Weighted-Average, Average
Costing
Average Cost Cost of Goods Available
=
per unit Number of units available
Inventory (at average cost)
Beg Bal (10 units @ $10) 100
Purchases:
25 units @ $14 350 Cost of goods sold (40 units
25 units @ $18 450 @ average cost of $15
per unit 600
Ending Bal (20 units
@ average cost of $15
per unit 300
20. Weighted-Average
$900 total cost 60 units = $15/unit
Ending inventory = 20 $15 = $300
Cost of goods sold = 40 $15 = $600
21. First In, First Out
First costs into inventory are first costs assigned to cost of
goods sold.
Inventory (at FIFO cost)
Beg Bal (10 units @ $10) 100
Purchases: Cost of goods sold (40 units):
25 units @ $14 350 (10 units @ $10 = 100)
25 units @ $18 450 (25 units @ $14 = 350)
( 5 units @ $18 = 90) 540
Ending Bal
(20 units @ $18) 360
22. First In, First Out
Ending Inventory Cost:
60 units
Less units sold 40
Ending inventory 20 units
20 units $18 per unit = $360
23. First In, First Out
10 Units @ $10
Cost of Goods Sold
$100
350 25 Units @ $14
90
$540
5 Units @ $18
24. Last In, First Out
Last costs into inventory are first costs assigned to cost of
goods sold.
Inventory (at LIFO cost)
Beg Bal (10 units @ $10) 100
Purchases:
25 units @ $14 350
Cost of goods sold (40 units):
25 units @ $18 450
(25 units @ $18 = 450)
(15 units @ $14 = 210) 660
Ending Bal
(10 units @ $10 = 100)
(10 units @ $14 = 140) 240
25. Last In, First Out
Ending Inventory Cost:
60 units
Less units sold 40
Ending inventory 20 units
10 units 10 =$100
10 units 14 = 140
Total $240
26. Last In, First Out
Cost of Goods Sold 25 Units @ $18
$450
210
$660 15 Units @ $14
27. Income Effects of Inventory
Methods
Assumed Cost of
Sales Goods Gross
Revenue Sold Profit
Specific unit cost $1,000 – 640 = $360
Weighted-average $1,000 – 600 = $400
FIFO $1,000 – 540 = $460
LIFO $1,000 – 660 = $340
28. Income Effects
When inventory costs are increasing
LIFO cost of goods sold is highest, gross profit
is lowest.
FIFO cost of goods sold is lowest, gross profit is
highest.
When inventory costs are decreasing
FIFO cost of goods sold is highest.
LIFO cost of goods sold is lowest.
29. Tax Advantage
Tax advantages of LIFO in periods of
rising prices
Higher Cost of Goods Sold = Lower Net Income
= Lower Income Taxes
Tax advantages of FIFO in periods of
falling prices
Higher Cost of Goods Sold = Lower Net Income
= Lower Income Taxes
30. Tax Advantage
FIFO LIFO
Gross profit $460 $340
Operating expenses 260 260
Income before taxes $200 $ 80
Income tax expense (40%) $ 80 $ 32
The most attractive feature of LIFO is low
income tax payments when prices are
increasing.
31. Inventory in Balance Sheet
LIFO, The inventory will be recorded at the
old cost considered to be valued low.
FIFO, The inventory will be recorded at the
latest cost, increasing accuracy of balance
sheet.
33. Inventory Errors
Period 1 Period 2
Cost of Gross Profit Cost of Gross Profit
Inventory Error Goods Sold and Net Income Goods Sold and Net Income
Period 1 Ending
inventory overstated Understated Overstated Overstated Understated
Period 1 Ending
inventory understated Overstated Understated Understated Overstated
34. Accounting Principles
Consistency principle
Same Accounting Methods from Period to Period
Accounting Changes must be disclosed
Effect of accounting Change must be disclosed
Disclosure principle
Enough information must be reported for stakeholders to make
informed decisions
Relevant, Reliable, and Comparable Information
Accounting conservatism
Anticipate or disclose all likely losses, but gains are not reported
until they occur
Assets are recorded as lowest reasonable amount
Liabilities are recorded at highest reasonable amount:
35. Lower of Cost or Market
Lower-of-Cost-or-Market rule (LCM)
Inventory is reported at the lowest value
Historical Cost
Or Market (Replacement Cost)
Inventory is below cost
Record an increase in Cost of Goods Sold (debit)
Record the reduction in Inventory (credit)
To record a $1,000 decline in inventory value
Cost of Goods Sold 1,000
Inventory 1,000
Wrote inventory down to market value
36. Ratios
Gross Profit Gross Profit
=
Percentage Net Sales Revenue
Inventory Cost of goods sold
=
Turnover Average Inventory
37. Ratios
Gross Profit
Profit indicator
Inventory Turnover – Liquidity ratio
How quickly is Inventory Sold?
38. Techniques of Estimating Cost of
Goods Sold and Ending Inventory
The Gross Profit Method
The Retail Method
39. Gross Profit Method
It is assumed that rate of gross profit
earned in the preceding year will remain
the same in current year.
Is based on the gross margin ratio of the
previous year.
Also called gross margin method.
