Merchandise Inventory Cost of Goods Sold and Gross

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Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter 6 © 2006 Prentice

Merchandise Inventory, Cost of Goods Sold, and Gross Profit Chapter 6 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 1

Income Statements Service Company Century 21 Real Estate Income Statement Year Ended December 31,

Income Statements Service Company Century 21 Real Estate Income Statement Year Ended December 31, 20 xx Service revenue Expenses Salary expense Depreciation expense Income tax expense Net income $XXX $ X X Merchandising Company General Motors Corporation Income Statement Year Ended December 31, 20 xx Sales revenue Cost of goods sold Gross profit Operating expenses: Salary expense Depreciation expense Income tax expense Net income © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren $185 146 39 X X $ 4 2

Balance Sheets Service Company Century 21 Real Estate Balance Sheet Year Ended December 31,

Balance Sheets Service Company Century 21 Real Estate Balance Sheet Year Ended December 31, 20 xx Current assets: Cash Short-term investments Accounts receivable, net Prepaid expenses $X X Merchandising Company General Motors Corporation Balance Sheet Year Ended December 31, 20 xx Current assets: Cash $X Short-term investments X Accounts receivable, net X Inventory 11 Prepaid expenses X © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 3

Gross Profit (Gross Margin) Sales Revenue - Gross Profit - Operating Expenses Net Income

Gross Profit (Gross Margin) Sales Revenue - Gross Profit - Operating Expenses Net Income © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 4

Learning Objective 1 Account for inventory transactions. © 2006 Prentice Hall Business Publishing Financial

Learning Objective 1 Account for inventory transactions. © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 5

Inventory Accounting Systems n. Periodic systems do not keep a continuous record of inventory

Inventory Accounting Systems n. Periodic systems do not keep a continuous record of inventory on hand. n. Perpetual systems maintain a running record to show the inventory on hand at all times. © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 6

Recording Transactions in the Perpetual System Purchase price of the inventory + Freight-in –

Recording Transactions in the Perpetual System Purchase price of the inventory + Freight-in – Purchase returns – Purchase allowances – Purchase discounts = Net purchases of inventory © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren $600, 00 4, 00 – 25, 00 – 14, 00 $560, 00 7

Recording Transactions and the T-Accounts Inventory 560, 000 Accounts Payable 560, 000 Purchased inventory

Recording Transactions and the T-Accounts Inventory 560, 000 Accounts Payable 560, 000 Purchased inventory on account Inventory Beg. 100, 000 560, 000 Accounts Payable 560, 000 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 8

Recording Transactions and the T-Accounts Sale on account $900, 000 (cost $540, 000): Accounts

Recording Transactions and the T-Accounts Sale on account $900, 000 (cost $540, 000): Accounts Receivable 900, 000 Sales Revenue 900, 000 Cost of Goods Sold Inventory 540, 000 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 9

Recording Transactions and the T-Accounts Inventory Beg. 100, 000 540, 000 560, 000 120,

Recording Transactions and the T-Accounts Inventory Beg. 100, 000 540, 000 560, 000 120, 000 Cost of Goods Sold 540, 000 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 10

Reporting in the Financial Statements Income Statement (partial) Sales revenue $900, 000 Cost of

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 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 11

Reporting in the Financial Statements Net purchases Purchases + Freight-in – Purchase returns &

Reporting in the Financial Statements Net purchases Purchases + Freight-in – Purchase returns & allowances – Purchases discount Net sales Sales revenue – Sales returns & allowances – Sales discounts © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 12

Learning Objective 2 Analyze the various inventory methods. © 2006 Prentice Hall Business Publishing

Learning Objective 2 Analyze the various inventory methods. © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 13

What Goes Into Inventory Cost? n. Sum of all costs incurred to bring asset

What Goes Into Inventory Cost? n. Sum of all costs incurred to bring asset to its intended use n. Inventory costing methods: n. Specific unit cost n. Weighted-average cost n. First-in, first-out (FIFO) n. Last-in, first-out (LIFO) © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 14

Illustrative Data Beginning inventory (10 units @ $10) $ 100 No. 1 (25 units

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: Cost of goods sold: © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 20 units 40 units 15

Specific Unit Cost 5 Units @ $10 Cost of Goods Sold $ 50 350

Specific Unit Cost 5 Units @ $10 Cost of Goods Sold $ 50 350 180 $580 25 Units @ $14 10 Units @ $18 $900 – $580 = $320 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 16

Weighted-Average $900 total cost ÷ 60 units = $15/unit Ending inventory = 20 ×

Weighted-Average $900 total cost ÷ 60 units = $15/unit Ending inventory = 20 × $15 = $300 Cost of goods sold = 40 × $15 = $600 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 17

First-In, First-Out Ending Inventory Cost: Less units sold Ending inventory 60 units 40 20

First-In, First-Out Ending Inventory Cost: Less units sold Ending inventory 60 units 40 20 units × $18 per unit = $360 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 18

First-In, First-Out 10 Units @ $10 Cost of Goods Sold $100 350 90 $540

First-In, First-Out 10 Units @ $10 Cost of Goods Sold $100 350 90 $540 25 Units @ $14 5 Units @ $18 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 19

Last-In, First-Out Ending Inventory Cost: Less units sold Ending inventory 60 units 40 20

Last-In, First-Out Ending Inventory Cost: Less units sold Ending inventory 60 units 40 20 units 10 units × 10 =$100 10 units × 14 = 140 Total $240 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 20

Last-In, First-Out Cost of Goods Sold $450 210 $660 25 Units @ $18 15

Last-In, First-Out Cost of Goods Sold $450 210 $660 25 Units @ $18 15 Units @ $14 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 21

Income Effects of Inventory Methods Assumed Sales Revenue Specific unit cost Weighted-average FIFO LIFO

Income Effects of Inventory Methods Assumed Sales Revenue Specific unit cost Weighted-average FIFO LIFO $1, 000 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren Cost of Goods Sold Gross Profit – – 6 22

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

Learning Objective 3 Identify the income and the tax effects of the inventory methods. © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 23

The Tax Advantage of LIFO FIFO Gross profit $460 Operating expenses 260 Income before

The Tax Advantage of LIFO FIFO Gross profit $460 Operating expenses 260 Income before taxes $200 Income tax expense (40%) $ 80 LIFO $340 260 $ 80 $ 32 The most attractive feature of LIFO is low income tax payments when prices are increasing. © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 24

Use of the Various Inventory Methods © 2006 Prentice Hall Business Publishing Financial Accounting,

Use of the Various Inventory Methods © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 25

Comparison of Inventory Methods n. FIFO produces inventory profits during periods of inflation n.

Comparison of Inventory Methods n. FIFO produces inventory profits during periods of inflation n. LIFO allows managers to manipulate net income n. LIFO liquidation © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 26

Consistency Principle n. Use the same accounting methods and procedures from one period to

Consistency Principle n. Use the same accounting methods and procedures from one period to the next n. May change inventory methods, but must disclose the effects of the change on net income © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 27

Disclosure Principle n. Financial statements should report enough information to enable an outsider to

Disclosure Principle n. Financial statements should report enough information to enable an outsider to make knowledgeable decisions about the company. © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 28

Conservatism n. The least favorable figures are presented in the financial statements. © 2006

Conservatism n. The least favorable figures are presented in the financial statements. © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 29

Lower-of-Cost-or-Market Rule n. Report inventory at the lower of its historical cost or market

Lower-of-Cost-or-Market Rule n. Report inventory at the lower of its historical cost or market (replacement) value n. If the replacement cost falls below its historical cost, write down the value of the inventory © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 30

Learning Objective 4 Use the gross profit percentage and inventory turnover to evaluate business.

Learning Objective 4 Use the gross profit percentage and inventory turnover to evaluate business. © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 31

Using the Financial Statements for Decision Making Gross profit percentage = Gross profit ÷

Using the Financial Statements for Decision Making Gross profit percentage = Gross profit ÷ Net sales revenue Inventory turnover = Cost of goods sold ÷ Average inventory © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 32

Learning Objective 5 Estimate inventory by the gross profit method. © 2006 Prentice Hall

Learning Objective 5 Estimate inventory by the gross profit method. © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 33

Estimating Inventory Gross profit method - based on computation of cost-of-goodssold Beginning inventory +

Estimating Inventory Gross profit method - based on computation of cost-of-goodssold Beginning inventory + = –= Purchases Cost of goods available for sale Cost of inventory goods sold Ending Cost of goods sold Ending inventory © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 34

Objective 6 Show inventory errors affect cost of goods sold and income. © 2006

Objective 6 Show inventory errors affect cost of goods sold and income. © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 35

Effects of Inventory Errors n. An error in the ending inventory creates errors for

Effects of Inventory Errors n. An error in the ending inventory creates errors for cost of goods sold and gross profit. n. The current year’s ending inventory is next year’s beginning inventory. © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 36

Reporting Inventory Transactions on the Statement of Cash Flows n. Inventory transactions are operating

Reporting Inventory Transactions on the Statement of Cash Flows n. Inventory transactions are operating activities n. The purchase of inventory requires a cash payment, and the sale a cash receipt © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 37

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

End of Chapter 6 © 2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 38

Chapter 7 Inventory and Cost of Goods SoldChapter 7 Inventory and Cost of Goods Sold
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GROSS OR NOT GROSS NOTES Lesson 2 GrossGROSS OR NOT GROSS NOTES Lesson 2 Gross
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