ACC 210 Chapter 6

3 Inventory Categories for Manufacturing

1) Raw Materials 2) Work-in-Progress 3) Finished Goods

4 Inventory Cost Methods

1) Specific Identification 2) FIFO 3) LIFO 4) Weighted-Average Cost

How Does a Company Record the Sale of Inventory

1) The company Debit A/R or Cash and Credit Sales Revenue (both for units x sale price) 2) The company then Debits COGS and Credits Inventory (both for units x FIFO/LIFO/Weighted Average)

Weighted Average Cost

Assume that both cost of goods sold and ending inventory consist of a random mixture of all the goods available and ending inventory consist of a random mixture of all the goods available for sale. To do this you multiply the "weighted-average unit cost" by the number of units sold and not sold to come up with dollar values

Inventory COGS formula

Beg. Inventory + Purchases - Ending Inventory= COGS or Total Inventory Available - Ending Inventory= COGS

Freight-In

Charges on incoming shipments from the suppliers. The costs of freight-in are added to the balance of Inventory. (Debit Inventory and Credit Cash when you pay the freight-in charges). Later when that inventory is sol, those freight charges become part of the cost of goods sold.

Why Choose FIFO

During periods of rising costs, FIFO results in... 1) higher ending inventory 2) lower cost of goods sold (COGS) 3) higher reported profit (than LIFO) *This will overall report higher assets and increase profitability which managers like cause it can mean higher bonuses. *aka the Balance Sheet Approach

FIFO

First-In, First-Out. Assume that the first units purchased (raw materials that are turned into products) will also be the first units sold.

Multi-Step Income Statement Components

Gross Profit Operating Income Income before Taxes Net Income

Operating Income

Gross Profit - SG&A - Other Operating Expenses = Operating Income

How to Account for a Purchase Discount

If you are the buyer then consider this example... Buy $2700 of goods on account with terms (2/10, n/30) *Debit Inventory (2700) and Credit A/P (2700) Buyer pays seller back in 5 days *Debit A/P $2700, Credit Inventory $54 and Credit Cash $2646 Credit inventory will reduce the COGS for this material in particular resulting in higher profit for these particular goods.

Net Income

Income before Taxes - Income Tax Expense = Net Income

Specific Identification

It matches each unit of inventory with its actual cost. It's only practical for companies that sell unique, expensive products with low sales volumes.

LIFO

Last-In, First-Out. Assume that the last units purchased are the first ones sold.

Gross Profit Formula

Net Sales - Cost of Goods Sold= Gross Profit

Income before Taxes

Operating Income + Nonoperating Revenues - Nonoperating Expenses = Income before Taxes

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 expenses.

Why Choose LIFO

The primary benefit of LIFO is tax savings. When inventory costs are rising, LIFO results in the lowest amount of reported profits (compared to FIFIO). If a company uses LIFO for tax reporting it HAS to use LIFO for financial reporting. Once a company chooses which method it may NOT frequently switch methods. It may use one method for some inventory and the other method for other inventory *also if a company uses LIFO, it has to report the difference in the amount of inventory a company would report if it used FIFO instead. This info will provided in the Notes section of financial statements. *aka Income Statment Approach

FOB Shipping Point

The title of the cargo passes from seller to the purchaser when the seller SHIPS the inventory.

FOB Destination Point

The title of the cargo passes from the seller to the purchaser when the inventory is RECEIVED by the buyer.

Purchase Discounts

This is a buyer's perspective. When a customer buys an item on account and pays the seller back within a certain time frame (2/10, n/30) then they receive a purchase discount.

Sales Discount

This is a seller's perspective. You offer a customer favorable terms, such as (2/10, n/30), in order to encourage them to pay you pack on-time or early.

Perpetual Inventory System

This method involves recording inventory purchases and sales on a continual basis (instead of nose counts at the end of the year or quarter).

Weighted-Average Unit Cost Formula

weighted-average unit cost = cost of goods available for sale / number of units available for sale