merchandise inventory, cost of goods sold, and gross profit chapter 6
TRANSCRIPT
Merchandise Inventory,
Cost of Goods Sold, and
Gross Profit
Chapter 6
Income Statements
Service revenue $XXXExpenses Salary expense X Depreciation expense X Income tax expense XNet income $ X
Service CompanyCentury 21 Real Estate
Income StatementYear Ended December 31, 20xx
Sales revenue $185Cost of goods sold 146Gross profit 39Operating expenses: Salary expense X Depreciation expense X Income tax expense $ XNet income $ 4
Merchandising CompanyGeneral Motors Corporation
Income StatementYear Ended December 31, 20xx
Balance Sheets
Current assets: Cash $X Short-term investments X Accounts receivable, net X Prepaid expenses X
Service CompanyCentury 21 Real Estate
Balance SheetYear Ended December 31, 20xx
Current assets: Cash $ X Short-term investments X Accounts receivable, net X Inventory 11 Prepaid expenses X
Merchandising CompanyGeneral Motors Corporation
Balance SheetYear Ended December 31, 20xx
Accounting for Inventory
Current assets: Cash $ XXX Short-term investments XXX Accounts receivable XXX Inventory (1 truck @$15,000) $15,000 Prepaid expenses XXX
General Motors CorporationBalance Sheet (partial)
Sales revenue (2 trucks @ $20,000) $40,000Cost of goods sold (2 trucks @ $15,000) 30,000Gross profit $10,000
General Motors CorporationIncome Statement (partial)
Sales revenues – Cost of goods sold= Gross profit (before operating expenses)
Sales revenues – Cost of goods sold= Gross profit (before operating expenses)
Gross profit – Operating expenses= Net income
Gross profit – Operating expenses= Net income
Gross Profit (Gross Margin)
Use the cost-of-goods-
sold model.
Cost of Goods Sold Model
Beginninginventory
$20
Purchases$100
Cost of goodsavailablefor sale$120
Endinginventory
$30
Cost ofgoods sold
$90
How Much InventoryShould Be Purchased?
Budgeted cost of goods sold $6,000
+ Budgeted ending inventory 1,500
– Actual beginning inventory 1,200
= Budgeted purchases $6,300
= Budgeted cost of goods available for sale $7,500
How Much InventoryShould Be Purchased?
EI 1500
-BI 1200
+COGS 6000
=P 6300
What is EI or what is COGS?
BI
+P
-COGS
=EI
BI
+P
-EI
=COGS
OR…
Account for inventory
transactions.
Perpetual systems maintain a running recordto show the inventory on hand at all times.
Perpetual systems maintain a running recordto show the inventory on hand at all times.
Periodic systems do not keep acontinuous record of inventory on hand.
Periodic systems do not keep acontinuous record of inventory on hand.
Inventory Accounting Systems
Debit Cash or Accounts ReceivableCredit Sales Revenue
Debit Cash or Accounts ReceivableCredit Sales Revenue
Debit Cost of Goods SoldCredit Inventory
Debit Cost of Goods SoldCredit Inventory
Recording Transactionsin the Perpetual System
Debit InventoryCredit Cash or Accounts Payable
Debit InventoryCredit Cash or Accounts Payable
Recording Transactionsin the Perpetual System
Purchase price of the inventory $600,000+ Freight-in 4,000– Purchase returns – 25,000– Purchase allowances – 5,000– Purchase discounts – 14,000= Net purchases of inventory $560,000
Purchase price of the inventory $600,000+ Freight-in 4,000– Purchase returns – 25,000– Purchase allowances – 5,000– Purchase discounts – 14,000= Net purchases of inventory $560,000
Recording Transactionsand the T-Accounts
Accounts Payable560,000Beg. 100,000
560,000
Inventory
Inventory 560,000Accounts Payable 560,000
Purchased inventory on account
Inventory 560,000Accounts Payable 560,000
Purchased inventory on account
Recording Transactionsand the T-Accounts
Sale on account $900,000 (cost $540,000):Sale on account $900,000 (cost $540,000):
Accounts Receivable 900,000Sales Revenue 900,000
Cost of Goods Sold 540,000Inventory 540,000
Accounts Receivable 900,000Sales Revenue 900,000
Cost of Goods Sold 540,000Inventory 540,000
Recording Transactionsand the T-Accounts
Cost of Goods Sold540,000
InventoryBeg. 100,000
560,000120,000
540,000
Reporting in theFinancial Statements
Income Statement (partial)Sales revenue $900,000Cost of goods sold 540,000Gross 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
Net sales = Sales revenue– Sales returns & allowances– Sales discounts
Net sales = Sales revenue– Sales returns & allowances– Sales discounts
Reporting in theFinancial Statements
Net purchases = Purchases+ Freight-in– Purchase returns & allowances– Purchases discount
Net purchases = Purchases+ Freight-in– Purchase returns & allowances– Purchases discount
Analyze the various
inventory methods.
The cost of any asset, such as inventory,is the sum of all the costs incurred to
bring the asset to its intended use.
What Goes Into Inventory Cost?
Generally accepted inventory costing methods:
Specific unit cost Weighted-average cost
First-in, first-out (FIFO) Last-in, first-out (LIFO)
Beginning inventory (10 units @ $10) $100No. 1 (25 units @ $14 per unit) $350No. 2 (25 units @ $18 per unit 450Total purchases 800Cost of goods available for sale $900Ending inventory: 20 unitsCost of goods sold:40 units
Illustrative Data
Cost of Goods Sold$ 50 350 180$580
Specific Unit Cost
5 Units @ $10
25 Units @ $14
10 Units @ $18
Weighted-Average
$900 total cost ÷ 60 units = $15/unit
Cost of goods sold = 40 × $15 = $600
Cost of Goods Sold$100 350 90$540
First-In, First-Out
10 Units @ $10
25 Units @ $14
5 Units @ $18
Cost of Goods Sold$450 210$660
Last-In, First-Out
25 Units @ $18
15 Units @ $14
Cost of Goods SoldSpecific unit cost $580.00Weighted-average $600.00FIFO $540.00LIFO $660.00
Income Effects ofInventory Methods
Ending InventorySpecific unit cost $320.00Weighted-average $300.00FIFO $360.00LIFO $240.00
Income Effects ofInventory Methods
Income Effects ofInventory Methods
Specific unit cost $1,000 – 580 = $420Weighted-average $1,000 – 600 = $400FIFO $1,000 – 540 = $460LIFO $1,000 – 660 = $340
AssumedSales
Revenue
Cost ofGoodsSold
GrossProfit
Income Effects – InventoryCosts Are Increasing
Gross profit, and net income
LIFO
Weighted-average
FIFO
Income Effects – InventoryCosts Are Decreasing
Gross profit, and net income
LIFOWeighted-
averageFIFO
Identify the income and
the tax effects of the
inventory methods.
The Tax Advantage of LIFO
Gross profit $460 $340Operating expenses 260 260Income before taxes $200 $ 80Income tax expense (40%) $ 80 $ 32
FIFO LIFO
The most attractive feature of LIFOis low income tax payments.
Comparison of Inventory Methods
LIFO liquidation occurs when inventoryquantities fall below the pervious level
resulting in highernet income and increased taxes.
FIFO produces inventory profitsduring periods of inflation.
Businesses should use the sameaccounting methods and procedures
from one period to the next.
Businesses should use the sameaccounting methods and procedures
from one period to the next.
A company may change inventorymethods, but it must disclose the
effects of the change on net income.
A company may change inventorymethods, but it must disclose the
effects of the change on net income.
Accounting Principlesand Inventories
The financial statements shouldreport enough information toenable an outsider to makeknowledgeable decisions
about the company.
The financial statements shouldreport enough information toenable an outsider to makeknowledgeable decisions
about the company.
Accounting Principlesand Inventories
Accounting Principlesand Inventories
An item is material if it has the potentialto alter a statement user’s decision
to invest in the stock of the company.
An item is material if it has the potentialto alter a statement user’s decision
to invest in the stock of the company.
Materiality is differentFor different firms.
Materiality is differentFor different firms.
Err on the sideof caution when
reporting any item inthe financial statements.
Err on the sideof caution when
reporting any item inthe financial statements.
Accounting Principlesand Inventories
Lower-of-Cost-or-Market Rule
Inventory is reported at thelower of its historical cost
or market (replacement) value.
If the replacement cost falls below itshistorical cost, the business must write
down the value of its inventory.
Show how inventory errors
affect cost of goods soldand income.
Effects of Inventory Errors
The current year’s ending inventoryis next year’s beginning inventory.
An error in the ending inventorycreates errors for cost of goods
sold and gross profit.
Effects of Inventory Errors
Sales revenueCost of goods sold: Beg. inventory Purchases Cost of goods available for sale Ending inventory Cost of goods soldGross profit
$100,000
$10,000 50,000
$60,000(15,000)
45,000$ 55,000
$100,000
$15,000 50,000
$65,000(10,000)
55,000$ 45,000
$100,000
$10,000 50,000
$60,000(10,000)
50,000$ 50,000
Period 1Ending
InventoryOverstatedby $5,000
Period 1BeginningInventoryOverstatedby $5,000
Period 1
Correct
Ethical Considerations
Managers of companies whose profitsdo not meet stockholder expectationsare sometimes tempted to “cook thebooks” to increase reported income.
1. Overstating ending inventory
2. Creating fictitious sales revenue
Use the gross profit
percentage and inventory
turnover to evaluate
business.
Inventory turnover= Cost of goods sold÷ Average inventory
Inventory turnover= Cost of goods sold÷ Average inventory
Gross profit percentage= Gross profit
÷ Net sales revenue
Gross profit percentage= Gross profit
÷ Net sales revenue
Using the Financial Statementsfor Decision Making
Gross Profit on $1 of Salesfor Two Merchandisers
Grossprofit $0.21
Grossprofit$0.61
Cost ofgoods sold
$0.79 Cost ofgoods sold
$0.39
$1.00 —
$0.75 —
$0.50 —
$0.25 —
$0.00 GeneralMotors
Pepsi Co.
End of Chapter 6