Chapter 6

Weighted-Average Cost is calculated as:

(Cost of Goods available for sale)/(Number of units available for sale)

Inventory for a Manufacturer into 3 Categories

1) Raw Materials 2) Work in Process 3) Finished Goods

Inventory Cost Methods

1) Scientific Identification, 2) First in, First out (FIFO), 3) Last in, First out (LIFO), 4) Weighted Average Cost

Net Income

A company subtracts income tax expense to find its bottom-line net income. Income tax expense is reported separately because it represents a significant expense

Freight Charges

A significant cost associated with inventory for most merchandising companies includes freight (also called shipping or delivery) charges. This includes the cost of shipments of inventory from suppliers, as well as the cost of shipments to customers.

Operating Income

After gross profit, the next items reported are selling, general, and administrative expenses, referred to as operating income. Gross profit reduced by these operating expenses is referred to as operating income.

First-In, First-Out (FIFO)

Assumes first units purchased are first ones sold

When sell a product

D. Accounts recievable C. Sales Revenue D. Cost of Goods Sold C. Inventory

Purchase Discounts

Discounts offered by seller to buyer for quick payment. Sellers often encourage prompt payment by offering discounts to buyers. From the seller's point of view, these are sales discounts; from the buyer's point of view, they are purchase discounts. Purchase discounts allow buyers to trim a portion of the cost of the purchase in exchange for payment within a certain period of time. Buyers are not required to take purchase discounts, but many find it advantageous to do so. Making Purchase: D. Inventory, C. Accounts Payable. Making Payment: D. Accounts payable, C. Cash, C. Inventory.

Service Companies

Earn revenue by providing service

Freight In

Freight charges on incoming shipments from suppliers are commonly referred to as freight-in. We add the cost of freight-in to the balance of Inventory because the cost of freight is considered a cost of the purchased inventory. Later, when that inventory is sold, those freight charges become part of the cost of goods sold. Company pays charge. Dr. Inventory, C. Cash

Additional Inventory Transactions

Freight charges, purchase discounts, purchase returns.

Sequence of Multiple step income statement

Gross profit, operating income, income before income taxes, and net income.

Inventory

Includes items a company intends for sake to customers. Also includes items that are not yet finished products. Generally reported as a current asset in the balance sheet

Scientific Identification

Matches each unit of inventory with its actual cost

Income statements for Merchandising Companies

Net Income = Sales - Cost of Goods Sold - Expenses

Income Statement for Service Companies

Net income = Revenues - Expenses

Gross Profit

Net revenues (or net sales) minus cost of goods sold equals gross profit. Gross profit provides a key measure of profitability for the company's primary business activities.

Merchandising Companies

Purchase products that are primarily in finished form and resell to customers

Perpetual Inventory System

Recording inventory purchases and sales on a continual basis. Most companies use.

Inventory Flow Equation

Relationship between inventory and cost of goods sold (Beginning Inventory+Purchases During the Year) = Total Inventory Available for Sale = (Ending Inventory+Cost of Goods Sold)

Purchase Returns

Returning inventory items that are unacceptable for some reason are referred to as purchase returns. The purchase return is recorded as a reduction in both Inventory and Accounts Payable. Making purchase: D. Inventory, C. Accounts Payable. Returning: D. Accounts Payable, C. Inventory.

The reason why companies choose the multiple step income is...

To show the revenues and expenses that arise from different types of activities. By separating revenues and expenses into their different types, investors and creditors are better able to determine the source of a company's profitability.

Cost of Goods Sold

The cost of the inventory that is sold during the period. Reported as an expense in the income statement

Income before Income Tax

After operating income, a company reports non-operating revenues and expenses. Non Operating expense revenues and expenses arise from activities from activities that are not part of the company's primary operations.

Last-In, First-Out (LIFO)

Assumes last units purchased are first ones sold

Weighted-Average Cost

Assumes units sold come from random mixture. Under this method, we assume: both cost of goods sold and ending inventory consist of a random mixture of all the goods available for sale, each unit of inventory has a cost equal to the weighted-average unit cost of all inventory items.

Periodic Inventory System

Does not continually record inventory amounts. Instead it calculates the balance of inventory once per period, at the end, based on a physical count of inventory on hand.

Manufacturing/Merchandising Companies

Earn revenue by selling products

Effects of Inventory Cost Methods

FIFO: Has a lower value of CGS, higher value of ending inventory. LIFO: Has a higher value of CGS, lower value of ending inventory.

Choice of Inventory Reporting Methods*

FIFO: matches physical flow for most companies, ending inventory reflects current cost, balance sheet approach. LIFO: Cost of goods sold reflect current cost, income statement approach, biggest advantage- less income tax expense. Lifo Conformity Rule: companies that use lifo for tax reporting must also use lifo for financial reporting.

Gross Profit

Sales - Cost of Goods Sold

Freight Out

The cost of freight on shipments to customers is called freight-out. Shipping charges for outgoing inventory are reported in the income statement either as part of cost of goods sold or as an operating expense, usually among selling expenses. Customer pays charge. D. Cost of goods sold/selling expense, C. Cash/Accounts Payable