CH 7 Inventory for Retailing and Manufacturing
I. Cost of Goods Sold: Expense on Income Statement.
COGS formula: Beg. Invt.
+ Cost of Purchases Goods Available for Sale
- Ending Invt. COGS
Cost of Purchases: Purchases
- Purch Returns Allow.
- Purch Discounts
+ Transportation In Cost of Purchases
Net Sales Calculation: Sales
- Sales Returns Allowances
- Sales Discounts
- Credit Card Discounts
Net Sales Income Statement:
Net Sales -
COGS Gross Profit
- Operating Expenses
Net Income
II. Inventoriable Costs:
Add: Sales Tax
Freight In FOB Shipping Point; i.e. freight-in Insurance during transit
Deduct: Purchase Discounts
Purchase returns Allowances
III. Accounting for Inventories: 2 Systems
A. Periodic: all items purchased for resale inventory are put into a temporary “Purchases”
account. Uses the COGS formula to determine COGS at year end. This method cannot identify any “losses” due to theft, shrinkage, etc. It is used by
companies that have a high volume turnover of inventory, low priced goods
B. Perpetual: Keeps a running total of inventory on hand and COGS is updated with each
sale of an item. Only method that identifies “losses” in inventory. Used by companies with a low volume, slower turnover, higher priced goods.
Goods to include in Inventory
All goods in which the company has “legal title” to location does not matter for goods in transit at year end.
a. Goods In Transit
1. FOB Shipping Point – title transfers to buyer immediately when goods are accepted by common carrier.
2. FOB Destination - title transfers when goods arrive at final destination of buyer.
b. Consigned Goods - the owner consignor transfers physical goods to agent consignee
for purposes of selling without ever giving up legal title. Goods held on consignment should never be included in ending inventory.
V. Reporting and Analyzing Inventory
4 Inventory Cost Flow Methods results in different ending inventories COGS values
1. Specific Identification – specifically identifies each individual item in inventory, the original cost of the
item and when it is sold, it is moved out of inventory for that specific cost and becomes COGS on income statement.
2. Weighted Average Method: Cost of Goods Available for Sale = Avg. costunit
Total units GAS
3. FIFO: First In, First Out
The First Item purchased in should be accounted for as the first item sold out COGS = Start assigning the “cost” of the first units available starting with beginning inventory
as your first layer and work down through the layers of inventory purchases until the number of units sold is accounted for as COGS. Sum the cost of these layers report as COGS expense
on income statement
End. Inventory = The cost of the number of units that remain on hand at year end. Under FIFO this means the last units purchased and still here the bottom layers…last purchases
Advantages: assigns current cost to inventory. Good method with rapid turnover. Disadvantages: fails to match current costs with revenues.
If prices are rising, matches oldest costs with current revenue = higher net income called Inventory Profits higher value of Inventory on Balance Sheet.
If prices are falling, matches oldest more expensive costs with current revenue = lower net income lower value of Inventory on Balance Sheet.
4. LIFO: Last In, First Out
The last item purchased Last in should be accounted for as the first item sold First out COGS = Last Units In bottom layers representing the last purchases, are the first to be
accounted for as “sold” Ending Inventory = First Units In starts with the beginning inventory layers
Advantages: matches current costs with revenue. Disadvantages: gives a non-current value to inventory as an asset on the balance sheet.
LIFO, cont’d. If rising prices, lower Net Inc and therefore less paid in income taxes. LIFO Conformity Rule – if a
company uses LIFO for tax purposes, they must also use LIFO for financial reporting purposes.
VI. Gross Profit Method
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