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Financial Accounting:
Tools for Business Decision Making
Kimmel, Weygandt, Kieso
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Chapter 6
Reporting and Analyzing Inventory
After studying Chapter 6, you should be able to:
Explain the recording of purchases and sales of
inventory under a periodic inventory system.
Explain how to determine cost of goods sold under a
periodic inventory system.
Describe the steps in determining inventory quantities. Identify the unique features of the income statement for
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Chapter 6
Reporting and Analyzing Inventory
After studying Chapter 6, you should be able to:
Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Explain the financial statement and tax effects of each of the
inventory cost flow assumptions.
Explain the lower of cost or market basis of accounting for
inventories.
Compute and interpret the inventory turnover ratio.
Describe the LIFO reserve and explain its importance for
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Merchandise Inventory
owned by the company
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Manufacturing Inventory
Finished goods inventory
Work in process
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Finished Goods Inventory
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Work in Process
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Raw Materials
The basic goods that will be used in
production, but have not been
Key difference between
periodic and perpetual
inventory…
is the point at which
the costs of goods sold is
No attempt is made on date
of sale to record the cost of
merchandise sold...
A physical count of
inventory is taken at
end
of period
to determine:
Cost of Goods Sold Computed
Cost of Goods Sold
Computed Perpetual
Periodic Perpetual
Point of Sale Item Sold
Inventory
Purchased Item Sold Point of Sale
End of Period
Comparing Periodic and
Perpetual Inventory Systems
Inventory Purchased
End of Period
Businesses that use the periodic method generally do not have sophisticated computer systems
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Merchandise Purchases
On May 4 the company bought $ 3,800 worth of merchandise from PW Audio
Supply, Inc.
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•1. Seller
•2.Invoice Date •3.Purchaser •4.Salesperso n •5.Credit terms •6.Freight terms •7.Goods sold: catalog no.,descriptio n,quantity, price per unit
•8.Total
invoice price
Invoice No. 731
Address 125 Main Street
Attention o f James Hoover, Purchasing Agent
Firm Name: Sauk Stero
City Chelsea State Illinois Zip 60915
Date 8/4/98 Salesperson Maone Terms 2/10,n/30 Freight Paid by Buyer
Merchandise Purchases-Periodic
On May 4 the company bought $ 3,800 worth of merchandise from PW Audio
Supply, Inc.
Purchases
Purchase
Returns & All. DiscountsPurchase
Cash Accounts
Payable Freight-In
May 4 3800
Purchases Returns and Allowances - Periodic
On May 8 the company returned $300 worth of merchandise to PW Audio Supply, Inc.
Purchases
Purchase
Returns & All. DiscountsPurchase
Cash Accounts
Payable Freight-In
May 4 3800
May 4 3,800
May 8 300
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Freight Costs
Freight - In Periodic
On May 9 the company paid $ 150 to have the merchandise inventory delivered to
them.
Purchases
Purchase
Returns & All. DiscountsPurchase
Cash Accounts
Payable Freight-In
May 4 3800
May 4 3,800 May 8 300
May 8 300
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Purchase Discounts
•Credit terms of a purchase on account may permit the buyer to claim a cash discount
for prompt payment.
•Credit terms specify the amount of cash
discounts and the time period during which it is offered.
•2/10,n/30
•1/10 EOM
Purchase Discounts
On May 14, the company pays the balance due on the account within the discount
period
Purchases
Purchase
Returns & All. DiscountsPurchase
Cash Accounts
Payable Freight-In
May 4 3800
May 4 3,800 May 8 300
May 8 300
Purchases Discounts
Review - Company purchased $3800 of merchandise and returned $300. The credit terms are 2/10, n/30 and the invoice was paid within the discount period.
Original Invoice $3,800
-Returns 300
Amount due before discount $3,500
2% discount 70
Purchase Discounts
On May 14, the company pays the balance due on the account within the discount
period
Purchases
Purchase
Returns & All. DiscountsPurchase
Cash Accounts
Payable Freight-In
May 4 3800
May 4 3,800 May 8 300
May 8 300
May 9 150 May 9 150
May 14 3,500
May 14 70
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Sales Revenues
-Under a Periodic System
are recorded when earned-revenue
recognition principle
must be supported by a business
document-written evidence
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Sales Returns and Allowances
Flip side of purchase returns and allowance
On buyer’s books
GENERAL JOURNAL Debit Credit May 8 Accounts Payable 300 Purchase Returns and Allowances 300 To record goods returned that were purchased on account
On seller’s books
Sales - Under a Periodic System
Assume a sale of $ 3,800 on Account
Cash
Accounts
Receivable Merchandise Inventory
Cost of Goods Sold
Sales Returns & Allowances
Sales
May 4 3,800
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What is the Sales Returns
and Allowances Account?
Contra Revenue Account to sales
Used to show how much came in on returns
and allowances
Excessive returns and allowances suggest:
inferior merchandise
inefficiencies in filing orders errors in billing customers
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What Is the Sales Discount
Account?
Contra Revenue Account to sales
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Sales Discounts
Flip side of purchase discounts
On buyer’s books
GENERAL JOURNAL Debit Credit May 14 Accounts Payable 3,500 Cash 3,430 Merchandise Inventory 70
To record payment within discount period
On seller’s books
GENERAL JOURNAL Debit Credit May 14 Cash 3,430
Sales Discounts 70 Accounts Receivable
3500
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Purchases $ 325,000 Less: Purchase returns and allowances $ 10,400
Purchase discounts 6,800 17,200
Net purchases 307,800
Net Purchases
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Cost of Goods Purchased
Purchases $ 325,000 Less: Purchase returns and allowances $ 10,400
Purchase discounts 6,800 17,200
Net purchases 307,800
Add: Freight-in 12,200
Cost of goods purchased 320,000
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Companies that use periodic inventory take a physical count to...
determine ending inventory
compute cost of goods sold
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Taking a Physical Inventory
Counting, weighting or measuring
each type of inventory
Determining ownership of goods
Quantity of each kind of inventory
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Questions Concerning
Ownership
Do all the goods included in the count
belong to the company?
Does the company own any goods not
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Goods in Transit
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Goods in Transit
Who includes these in inventory?
Buyer? Seller?
The
Company
with
Ownership passes to owner here Ownership passes to buyer here Public Carrier Co Public Carrier Co Seller Seller Buyer Buyer
Page 245 in book
FOB Shipping Point
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Shipping Terms
FOB (free on board) shipping point-
ownership of goods passes to buyer when public carrier accepts the goods
FOB (free on board) destination-
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Consigned Goods
Goods in your store that you don’t
pay for until they sell…
the company does not take
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Income Statement Presentation
The income statement for a
merchandising company is the same whether a periodic or perpetual
inventory system is used, except for the
Sales revenues
Sales $ 480,000
Less: Sales returns and allowance $12,000
Sales discounts 8,000 20,000
Net sales 460,000
Cost of goods sold 316,000
Gross profit 144,000
Operating expenses
Store salaries expense 45,000 Rent expense 19,000 Utilities expense 17,000 Advertising expense 16,000
Depreciation expense 8,000 Freight-out 7,000 Insurance expense 2,000
Total operating expenses 114,000
Net Income $ 30,000
PW AUDIO SUPPLY, INC.
Income Statement (Perpetual)
For the Year Ended December 31, 1998
Sales revenues
Sale $ 480,000
Less: Sales returns and allowance $12,000
Sales discounts 8,000 20,000 Net sales 460,000
Cost of goods sold
Inventory, January 36,000 Purchases $ 325,000
Less: Purchase returns and
allowances $10,400
Purchase discounts 6,800 17,200 Net Purchases 307,800 Add: Freight-in 12,200
Cost of goods purchased 320,000 Cost of goods available for sale 356,000 Inventory, December 31 40,000
Cost of goods sold 316,000
Gross profit 144,000
Operating expenses 114,000
Net Income $
30,000
Page 247 in book
Specific Identification
An actual physical flow costing method in which items still in inventory are
specifically costed to arrive at the total cost of ending inventory.
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Inventory Costing
Specific Identification method Assumed Cost Flow methods
FIFO- First-in, First-Out- earliest goods
purchased first to be sold
LIFO- Last-in,First-Out- latest goods
purchased the first to be sold
Average Cost Method- costs are charged on the
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What Makes Cost Flow
Assumptions Necessary?
Use of Cost Flow
The
FIFO method
assumes the
The
LIFO method
assumes the
The average cost method assumes that goods available for sale are
homogeneous.
The allocation of the cost of goods available for sale is made on the
basis of the weighted average
The
average cost method
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Factors Used in Selecting an
Inventory Cost Method
Income statement effects
Balance sheet effects
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Income Statement Effects
In periods of increasing prices
FIFO reports the highest net income LIFO the lowest
average cost falls in the middle. In periods of decreasing prices
FIFO will report the lowest net income LIFO the highest
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Balance Sheet Effects
In a period of increasing prices costs allocated to ending inventory using:
FIFO will approximate current costs
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Why Do Companies Use
Lifo?
Higher cost of goods sold
Lower net income
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The Lower of Cost or Market Basis of Accounting for Inventories
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Lower of Cost or Market (LCM)
departure from cost principle
follows conservatism concept
can be used only after one of the cost
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Market Is...
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How Much Inventory Should a
Company Have?
Only enough for sales needs Excess inventory costs:
storage costs interest costs
Inventory
Turnover Ratio =
Days in Inventory
=
365 days
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Lifo Reserve And Its Importance For
Comparing Results Of Different Companies
Accounting standards require firms using LIFO
to report the amount by which inventory would be increased (or on occasion decreased) if the firm had instead been using FIFO.
This amount is referred to as the LIFO reserve.
COP Y RI GHT
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