Chapter 5- Inventories and Cost of Goods Sold

Advantage of Average Cost Method

-Assigns cost on an equal unit basis to both Ending Inventory and COGS. -Easy to calculate.

Advantages of FIFO

-Assigns current cost to inventory (end. invt.=most recent purchases). -Good method when invt. turnover is rapid (bakery).

Disadvantages of FIFO

-Fails to match most recent costs with revenues. -If prices are rising, matches oldest unit costs with current revenues= overstatement of Net Inc (low COGS). CREATES INVENTORY PROFITS.

Perpetual Method

-Keeps a running total of the inventory on hand -Recognizes a loss (Update during the period) Used in companies with low volume and high priced goods.

Advantages of LIFO

-Matches current costs with current revenues. (current costs on Inc. Stmt.) -In periods of rising prices, Net Inc. is always less (reduces Income taxes!!) Because higher COGS.

Periodic Method

-Update at the end of the period -All items purchased for resale are debited to a "PURCHASES" account -Uses the COGS formula (Loss gets included in COGS) Used in companies with high volume and wide variety of goods.

Average Cost Method

-Uses weighted average of all costs for GAS. -Assigns average cost to both End. Invt. & COGS Step 1: Determine Avg. Cost Per Unit (Avg. Cost Method= Total Cost of GAS/Total # Units GAS) Step 2: Based on Avg. Cost, determine $ COGS and $ Ending Inventory

Primary Uses of Gross Profit Method

1. Estimate Inventory for interim financial statements: quarterly, monthly. 2. Estimate value of inventory destroyed/lost by casualty/theft. Not to be used as a substitute for a physical count at year-end!

Accounting for Inventories (2) Methods

1. Perpetual Method 2. Periodic Method

Inventory Cost Flow Methods (4)

1. Specific Identification 2. Average Cost Method 3. First-In, First-Out (FIFO) 4. Last-In, First-Out (LIFO)

Inventory Costing Methods with a Periodic System

1. Uses COGS Formula. (EI $ amount affects BOTH the BS and the IS). 2. Physical count of # of units on hand at year end (#units x $cost= $EI).

2/10; net 30

2% discount if pay within 10 days- if not total due in 30 days.

Inventory Turnover Ratio

A measure of the number of times inventory is sold during the period. The cost of storage and the lost income from the money tied up in inventory make it very expensive to keep on hand. Thus, the more quickly a company can sell (turn over) its inventory the better.

Goods to Include in Ending Inventory

All goods in which the company has legal title (regardless of location). 1. Goods in Transit 2. Consigned Goods

Periodic Example

All items purchased for resale are debited to a PURCHASES account. Rely on physical count & COGS formula at year-end to determine COGS. Requires adj entry at year-end to record COGS.

Perpetual Example

All items purchased for resale go directly into inventory. This method keeps a running total of COGS and updates inventory. When sale is made, requires (2) entries... one to record sale, one to reduce inventory. This method gives more info to determine inventory losses.

Gross Profit Method

An estimating method. USED TO ESTIMATE INVENTORY.

Average Inventory Formula

Avg. Invt= BEG Invt+End Invt/2

COGS Formula

Beg Invt +Net Purchases =GAS -End Invt (based on phy. count) =COGS

First-In, First-Out (FIFO)

Cost of first item purchased=cost of first item sold (COGS).

Last-In, First-Out (LIFO)

Cost of last item purchased=cost of first item sold.

RISING PRICES

FIFO: Ending Invt=HIGHEST COGS=LOWEST Net Inc=HIGHEST LIFO: Ending Invt=LOWEST COGS=HIGHEST Net Inc=LOWEST

DECLINING PRICES

FIFO: Ending Invt=LOWEST COGS=HIGHEST Net Inc=LOWEST LIFO: Ending Invt=HIGHEST COGS=LOWEST Net Inc=HIGHEST

Disadvantages of LIFO

Gives non-current value to inventory on balance sheet. (Old Costs on Bal. Sheet).

Inventory

Goods held for resale. Reported as a current asset on the balance sheet.

Goods in Transit

Goods ordered but not yet received (FOB Shipping Point, FOB Destination).

LIFO Conformity Rule

If you're using LIFO for income tax return, you have to use it for financial recording.

Sales Discount

Incentives for our customers to pay early. (Results in more cash).

Inventory Turnover Formula

Invt Turnover= COGS/Average Invt

PRICES ARE RISING: Which method gives us the lowest net income?

LIFO because COGS are high.

ADJ Entry (Loss- Perpetual Method)

Loss xx Invt-Shirts xx Invt-Conc xx (Close loss in same closing entry as expenses.)

Purchases

Not an asset!

Buyer Pickup at Seller's Location

Once sorted and separated -> title transfers to buyer.

Net Purchases Formula

Purchases -Purchase R+A -Purchase Disct +Freight-In =Net Purchases

Sales Revenue Formula

Sales Revenue -Sales R+A -Sales Disct =Net Sales Rev

Specific Identification

Small qty of inventory, high-priced items. This method tracks the actual physical flow of the goods. Each item of inventory is marked, tagged, or coded with a specific unit cost.

Gross Profit Method Steps

Step 1: Determine Gross Profit Step 2: Sales x (1-Gross Profit %) = COGS Step 3: GAS-COGS= End. Inventory Estimate

COGS

The amount we paid for goods we have sold. Reported as an expense on the income statement.

Consigned Goods

The owner (consignor) transfers physical goods to agent (consignee) for purposes of selling without giving up legal title. TITLE NEVER TRANSFERS.

Inventory Errors

Their impact on the financial statements.

FOB Shipping Point

Title transfer to buyer when goods are accepted by carrier (@ shipping point). Buyer pays for shipping. Freight-In to buyer- include with net purchases.

FOB Destination

Title transfers when goods are delivered to destination of buyer. Seller pays for shipping. Freight out to the seller- include as selling expense.