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chapter 7 inventories and COGS
Terms in this set (43)
7-1 Describe the issues in managing different types of inventory
-make or buy a sufficient quantity of quality products, at the lowest possible COST, so that they can be sold as quickly as possible to ear the desired amount of gross profit
-merchandise inventory is bought by merchandisers in a ready to sell format. when RAW MATERIALS enter a manufacturer's production process, they become WORK IN PROCESS inventory, which is further transformed into FINISHED GOODS that are then sold to customers
7-2 Explain how to report inventory and COGS
-cost of goods PURCHASED are added to Inventory (balance sheet)
-cost of goods SOLD are removed from inventory and reported as an expense called cost of goods SOLD (on income statement)
-the costs remaining in Inventory at the end of a period become the cost of Inventory at the beginning of the next period
The relationship among beginning inventory BI, purchases P, ending inventory EI, and cost of goods sold CGS, are
BI +P - EI = CGS or BI + P - CGS = EI
7-3 Compute costs using four inventory costing methods
-Under GAAP, any of four generally accepted methods can be used to allocate cost of inventory available for sale between goods that are sold and goods that remain on hand at the end of the accounting period
Specific identification assigns costs to ending inventory and cost of goods sold by tracking and identifying each specific item of inventory
-Under FIFO, the costs first in are assigned to Cost of goods sold, and the costs last in
(most recent) are assigned to the inventory that is still on hand in ending inventory
-Under LIFO, the costs last in are assigned to Cost of goods sold, and the costs first in (oldest) are assigned to the inventory that is still on hand in ending inventory
Under weighted average cost, the weighted average cost per unit of inventory is assigned equally to goods sold and those still on hand in ending inventory
7-6 Evaluate inventory management by computing and interpreting the inventory turnover ratio
The inventory turnover ratio measures the efficiency of inventory management. It reflects HOW MANY TIMES average inventory was acquired and SOLD during the period. The inventory turnover ratio calculated by dividing COGS by Ave. Inventory
COGS / Ave Inventory
-days to sell
365/ inv. turn. ratio
7-4 Report inventory at the lower of cost or market
the LCM rule ensures inventory assets are not reported at more than they are worth
7-5 Analyze and record inventory purchases, transportation, returns and allowances, and discounts
the inventory account should include costs incurred to get inventory into a condition and location ready for sale
the cosdt of inventory includes its purchase price and transportation (freight -in) minus cost reductions for purchase returns and allowances and purchase discounts. Costs to deliver inventory to customers (freight-out) are selling expense and are not included in inventory
Cost of goods sold Equation
expresses the relationship between inventory on hand, purchases, and sold;
BI + P - EI = CGS
BI + P - CGS = EI
days to sell
measure of the average number of days from the time inventory is bought to the time it is sold
FIFO (first in, first out)
assumes that the first goods purchased are the first goods SOLD
Goods available for sale
the sum of beginning inventory and purchases for the period
the process of buying and selling inventory
LIFO (last in, first out)
assumes that the most recently purchased units (the last in) are sold first
lower of cost or market (LCM)
valuation method departing from the cost principle; recognizes a loss when asset value drops below cost
cash discount received for prompt payment of an account
purchase returns and allowances
a reduction in the cost of purchases associated with unsatisfactory goods
specific identification method
a method of assigning costs to inventory which identifies the cost of each specific item purchased and sold
weighted average cost method
uses the weighted average unit cost of goods available for sale for calculations of both the cost of goods sold and ending inventory
Cost of goods sold = Cost of sales
Days to sell = days in inventory, days' sales in inventory
helpful reminder #1
the "first out" part of FIFO and LIFO describes the costs going out of inventory into Cost of Goods Sold. To calculate ending inventory cost using LIFO think FIST (first in, still there). For FIFO inventory, think LIST (last in, still there)
helpful reminder #2
purchase discounts are calculataed after taking into account any purchase returns and allowances. A partial payment within the discount period (such as one-half of the total cost) usually entitles the purchaser to a partial discount (apply the discount to one-half of the total cost)
frequent mistake #1
-purchase discounts SHOULD NOT be calculated on transportation costs UNLESS the shipping company offers a purchase discount for early payment.
-Purchase discounts SHOULD NOT be calculated on merchandise returned to supplier
frequent mistake #2
when calculating weighted average cost, DO NOT simply average the costs per unit. Instead, divide the total COST OF GOODS AVAIL. for sale by the number of GOODS AVAIL. for sale
frequent mistake #3
DO NOT use Sales Revenue when calculating inventory turnover (use Cost of Goods sold). Also, use the average inventory, not the ending inventory balance.
what are three goals of inventory management?
1. maintain a sufficient quantity of inventory to meet customers' needs
2. ensure inventory quality meets customers' expectations and company standards
3. minimize the cost of acquiring and carrying inventory (including costs related to purchasing, production, storage, spoilage, theft, obsolescence, and financing)
describe the specific types of inventory reported by merchandisers and manufacturers
merchandise inventory - products acquired in a finished condition, ready for sale
raw materials inventory - (plastic, steel, fabrics) enter the production process and become work in process inventory
finished goods inventory - after work in process inventory is finished, which is ready for sale like merchandise inventory
consignment inventory - goods a company is holding on behalf of the goods' owner
goods in transit - inventory items being transported (FOB destination, FOB shipping point)
if a Chicago-based company ships goods on september 30 to a customer in Hawaii with sales terms FOB destination, does the Chicago-based company include the inventory or the sale in its Sept. financial statements?
This type of inventory is reported on the balance sheet of the owner-- FOB destination means the goods belong to the seller until they reach the destination (customer)-- so, yes the Chicago based company should record the inventory, but not the sale until it reaches the customer.
how does goods available for sale differ from Cost of goods sold?
goods available for sale is the sum of beginning inventory and new purchases
define beginning and ending inventory
beginning inventory - a type of stock that you start off the accounting period with
ending inventory - the goods available for sale that were not sold during the period (the ending inventory for one account period becomes the beginning for the next period)
what are the four inventory costing methods? (briefly explain each)
1. specific identification method individually identifies and records the cost of each item sold as cost of goods sold. this method requires accountants to keep track of the purchase cost of each item. (companies tend to use SI method when accounting for individually expensive and unique items)
(the next 3 inventory methods are not based on the physical flow of goods, instead they are based on assumptions that accts make about the flow of inventory costs)
2. First in, First out (FIFO) - assumes that the inventory costs flow out in the order the goods are received. COGS on the income statement and the remaining units become ending inventory on the balance sheet.
3. Last in, first out (LIFO) - assumes that the inventory costs flow out in the opposite of the order the goods are received.
4. Weighted average cost - uses the weighted average of the costs of goods available for sale for both the cost of each item sold and those remaining in inventory. The average costs is assigned to two items sold, resulting in COGS on the income statement, and then the average cost assigned to the one item in ending inventory reported on the balance sheet.
although they're called "inventory" costing methods, their names actually describe how to calculate the cost of goods sold
which inventory cost flow method is most similar to the flow of products involving
b) bricks off a stack
c) gasoline out of a tank?
A)The first-in, first-out (FIFO) cost flow assumption is most similar to the gumball machine. Gumballs (inventory) placed first in the machine are the first out through the bottom of the machine.
B)The last-in, first-out (LIFO) cost flow assumption most resembles the stack of bricks. Bricks (inventory) placed last on the stack are the first off the stack.
C)The weighted average method is similar to gas in a tank. Although the gas may have been purchased at different times and different costs, it all mixes together in the tank. The gas being used is a 'weighted average' of the various gasoline purchases put into the tank.
should the inventory costing flows mimic actual product flows? explain
Inventory costing does not have to follow the actual flow of a company's products. Due to market prices, income tax effects, and other variables, some companies might want to have more recent costs reported on the balance sheet (FIFO) while others might want more recent costs reported on the income statement (LIFO).
contrast the effects of LIFO versus FIFO on ending inventory and income statement when
a) costs are rising
b) costs are falling
a) when costs are rising, FIFO assumes the oldest goods are the first ones sold, so FIFO would produce a higher inventory value, making the balance sheet appear to be stronger, and reduce the cost of goods sold, resulting in a higher gross profit
when using FIFO, a company will have a higher income tax expense
b) when costs are falling, FIFO produces a lower ending inventory value, reducing the balance sheet and increasing cost of goods sold, making the gross profit smaller
a) LIFO assumes the last items in are the first items sold, so when costs are rising , the company will have a lower inventory value, this reduces the balance sheet, and a higher cost of goods sold decreases the gross profits
b) when costs are falling, LIFO makes inventory costs high, increasing the balance sheet, and a lower cost of goods sold which increases gross profits
Explain the application of the LCM rule to ending inventory. Describe its effect on the balance sheet and income statement when market is lower than cost
when the value of inventory falls below its recorded cost, GAAP require that the inventory be written down to its lower market value, which results in reporting inventory conservatively, at an amount that doesn't exceed its actual value. this also helps companies better match their revenues and expenses of that period
how are transportation costs to obtain inventory (freight-in) are accounted for by a merchandising company using a perpetual inventory system. why this type of accounting treatment?
if the terms are FOB shipping point then the purchaser pays for the shipping, when this happens an additional cost of transporting the goods is added to the Inventory account
freight in journal entry:
dr Inventory (+A)
cr Cash (-A)
value of inventory at lower cost or market
the value of inventory can fall below the recorded cost for two reasons
1. its easily replaced by identical goods at lower costs (high-tech electronics)
2. its become outdated / damaged (seasonal/ fad items)
LCM journal entry
dr Cost of Goods sold (+E, -SE)
cr Inventory (-A)
inventory purchase journal entry
dr inventory (+A)
cr accounts payable (+L)
in general, a purchaser should include in the inventory account any costs needed to get the inventory into a condition and location ready for sale.
Costs incurred after the inventory has been made ready for sale, such as freight-out to deliver goods to customers, should be treated as selling expenses.
purchase returns and allowances journal entry
dr Accounts payable (-L )
cr Inventory (-A)
purchase discounts journal entry
discount - the purchaser accounts for the goods in two stages, first the purchase is accounted for at full cost, then if payment is made within the discount period, the purchaser reduces the inventory acct by the amount of the discount because it reduces the cost of inventory
amt x 2% = discount
discount - amt = amount needed to be paid
dr Accounts payable (-L) orig. amt
cr cash (-A)
cr Inventory (-A)
how to calculate the weighted average
take the average cost of its inventory by adding together the total costs of all purchases and then divide it by the total number of units
to find COGS: multiply the weighted average by the number of units sold
net sales- COGS
goods available for sale
Bi + P = cost of goods available for sale
THIS SET IS OFTEN IN FOLDERS WITH...
Chapter 9 - Long lived tangible/intangible assets
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Accounting ch. 3 - Income statement
Chapter 5 - Financial reporting and analysis
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