copyright © 2007 by the mcgraw-hill companies, inc. all rights reserved. reporting and interpreting...
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Reporting and Interpreting
Cost of Goods Sold and Inventory
Chapter 7
7-2
Understanding the Business
Provide sufficient Provide sufficient quantities of high-quantities of high-quality inventory.quality inventory.
Provide sufficient Provide sufficient quantities of high-quantities of high-quality inventory.quality inventory.
Minimize the costs of Minimize the costs of carrying inventory.carrying inventory.
Minimize the costs of Minimize the costs of carrying inventory.carrying inventory.
Primary Goals of Inventory
Management
Primary Goals of Inventory
Management
7-3
Learning Objectives
Apply the cost principle to identify the amounts that should be included in inventory and the
matching principle to determine cost of goods sold for typical retailers, wholesalers, and
manufacturers.
Apply the cost principle to identify the amounts that should be included in inventory and the
matching principle to determine cost of goods sold for typical retailers, wholesalers, and
manufacturers.
7-4
Items Included in Inventory
Inventory
Tangible Held for SaleUsed to
Produce Goods or Services
Merchandise InventoryRaw Materials Inventory
Work in Process InventoryFinished Goods Inventory
7-5
Costs Included in Inventory Purchases
The cost principlecost principle requires that inventory be recorded at the price paid or the
consideration given.
Invoice Price
Freight
Inspection Costs
Preparation Costs
7-6
Flow of Inventory Costs
MerchandiseMerchandisePurchasesPurchases
MerchandiseMerchandisePurchasesPurchases
Cost ofCost ofGoods SoldGoods Sold
Cost ofCost ofGoods SoldGoods Sold
MerchandiseMerchandiseInventoryInventory
MerchandiseMerchandiseInventoryInventory
Merchandiser
RawRawMaterialsMaterials
RawRawMaterialsMaterials
Raw MaterialsRaw MaterialsInventoryInventory
Raw MaterialsRaw MaterialsInventoryInventory
Work in ProcessWork in ProcessInventoryInventory
Work in ProcessWork in ProcessInventoryInventory
Finished GoodsFinished GoodsInventoryInventory
Finished GoodsFinished GoodsInventoryInventory
Cost ofCost ofGoods SoldGoods Sold
Cost ofCost ofGoods SoldGoods Sold
Manufacturer
DirectDirectLaborLaborDirectDirectLaborLabor
FactoryFactoryOverheadOverheadFactoryFactory
OverheadOverhead
7-7
Nature of Cost of Goods Sold
BeginningBeginningInventoryInventory
BeginningBeginningInventoryInventory
PurchasesPurchasesfor the Periodfor the PeriodPurchasesPurchases
for the Periodfor the Period
Ending InventoryEnding Inventory(Balance Sheet)(Balance Sheet)
Ending InventoryEnding Inventory(Balance Sheet)(Balance Sheet)
Goods availableGoods availablefor Salefor Sale
Goods availableGoods availablefor Salefor Sale
Cost of Goods SoldCost of Goods Sold(Income Statement)(Income Statement)
Cost of Goods SoldCost of Goods Sold(Income Statement)(Income Statement)
Beginning inventory + Purchases = Goods Available for SaleBeginning inventory + Purchases = Goods Available for Sale
Goods Available for Sale – Ending inventory = Cost of goods soldGoods Available for Sale – Ending inventory = Cost of goods sold
Beginning inventory + Purchases = Goods Available for SaleBeginning inventory + Purchases = Goods Available for Sale
Goods Available for Sale – Ending inventory = Cost of goods soldGoods Available for Sale – Ending inventory = Cost of goods sold
7-8
Learning Objectives
Report inventory and cost of goods sold using the four inventory costing methods.
Report inventory and cost of goods sold using the four inventory costing methods.
7-9
Inventory Costing Methods
Specific Specific IdentificationIdentification
Specific Specific IdentificationIdentification FIFOFIFOFIFOFIFO
LIFOLIFOLIFOLIFO Weighted Weighted AverageAverage
Weighted Weighted AverageAverage
7-10
Inventory Costing Methods
Total Dollar Amount of Goods Total Dollar Amount of Goods Available for SaleAvailable for Sale
Total Dollar Amount of Goods Total Dollar Amount of Goods Available for SaleAvailable for Sale
Ending InventoryEnding InventoryEnding InventoryEnding Inventory Cost of Goods SoldCost of Goods SoldCost of Goods SoldCost of Goods Sold
Inventory Costing Method
7-11
Specific Identification
When units are sold, the
specific cost of the unit sold
is added to cost of goods
sold.
When units are sold, the
specific cost of the unit sold
is added to cost of goods
sold.
7-12
Cost Flow Assumptions
The choice of an inventory costing method is not based on the physical flow of goods
on and off the shelves.
7-13
First-In, First-Out Method
Cost of Cost of Goods SoldGoods Sold
Cost of Cost of Goods SoldGoods SoldOldest CostsOldest CostsOldest CostsOldest Costs
Ending Ending InventoryInventoryEnding Ending
InventoryInventoryRecent CostsRecent CostsRecent CostsRecent Costs
7-14
First-In, First-Out
Remember: Remember: The costs of The costs of most most recent recent
purchasespurchases are are in ending in ending inventory. inventory. Start with Start with
11/29 and add 11/29 and add units units
purchased purchased until you reach until you reach the number in the number in
ending ending inventory.inventory.
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 ?
Cost of Goods Sold 1,050 ?
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 ?
Cost of Goods Sold 1,050 ?
7-15
First-In, First-Out
Beg. Inv. 1,000 @ 5.25$ Jan. 3 500 @ 5.30 June 20 300 @ 5.60 Sept. 15 250 @ 5.80 Nov. 29 200 @ 5.90 200 @ $5.90
200 Units Units
Ending InventoryCost of Goods
SoldGiven Information
7-16
First-In, First-Out
Now, we have allocated the cost to all Now, we have allocated the cost to all 1,200 units in ending inventory.1,200 units in ending inventory.
Now, we have allocated the cost to all Now, we have allocated the cost to all 1,200 units in ending inventory.1,200 units in ending inventory.
Beg. Inv. 1,000 @ 5.25$ Jan. 3 500 @ 5.30 450 @ $5.30June 20 300 @ 5.60 300 @ $5.60Sept. 15 250 @ 5.80 250 @ $5.80Nov. 29 200 @ 5.90 200 @ $5.90
1,200 Units Units
6,695$ Cost
Ending InventoryCost of Goods
SoldGiven Information
7-17
First-In, First-Out
Now, we have allocated the cost to all Now, we have allocated the cost to all 1,050 units sold.1,050 units sold.
Now, we have allocated the cost to all Now, we have allocated the cost to all 1,050 units sold.1,050 units sold.
Beg. Inv. 1,000 @ 5.25$ 1,000 @ 5.25$ Jan. 3 500 @ 5.30 450 @ $5.30 50 @ 5.30 June 20 300 @ 5.60 300 @ $5.60Sept. 15 250 @ 5.80 250 @ $5.80Nov. 29 200 @ 5.90 200 @ $5.90
1,200 Units 1,050 Units
6,695$ Cost 5,515$ Cost
Ending InventoryCost of Goods
SoldGiven Information
7-18
First-In, First-Out
Here is the Here is the cost of cost of ending ending
inventory inventory and cost and cost of goods of goods
sold using sold using FIFO.FIFO.
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 6,695.00$
Cost of Goods Sold 1,050 5,515.00$
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 6,695.00$
Cost of Goods Sold 1,050 5,515.00$
7-19
Last-In, First-Out Method
Ending Ending InventoryInventoryEnding Ending
InventoryInventory
Cost of Cost of Goods SoldGoods Sold
Cost of Cost of Goods SoldGoods Sold
Oldest CostsOldest CostsOldest CostsOldest Costs
Recent CostsRecent CostsRecent CostsRecent Costs
7-20
Last-In, First-Out
Remember: Remember: The costs of the The costs of the
oldest oldest purchasespurchases are are
in ending in ending inventory. Start inventory. Start with beginning with beginning inventory and inventory and
add units add units purchased until purchased until you reach the you reach the
number in number in ending ending
inventory.inventory.
Remember: Remember: The costs of the The costs of the
oldest oldest purchasespurchases are are
in ending in ending inventory. Start inventory. Start with beginning with beginning inventory and inventory and
add units add units purchased until purchased until you reach the you reach the
number in number in ending ending
inventory.inventory.
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 ?
Cost of Goods Sold 1,050 ?
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 ?
Cost of Goods Sold 1,050 ?
7-21
Last-In, First-Out
Beg. Inv. 1,000 @ 5.25$ 1,000 @ $5.25Jan. 3 500 @ 5.30 June 20 300 @ 5.60 Sept. 15 250 @ 5.80 Nov. 29 200 @ 5.90
1,000 Units Units
Ending InventoryCost of Goods
SoldGiven Information
7-22
Last-In, First-Out
Now, we have allocated the cost to all Now, we have allocated the cost to all 1,200 units in ending inventory.1,200 units in ending inventory.
Now, we have allocated the cost to all Now, we have allocated the cost to all 1,200 units in ending inventory.1,200 units in ending inventory.
Beg. Inv. 1,000 @ 5.25$ 1,000 @ $5.25Jan. 3 500 @ 5.30 200 @ 5.30 June 20 300 @ 5.60 Sept. 15 250 @ 5.80 Nov. 29 200 @ 5.90
1,200 Units Units
6,310$ Cost
Ending InventoryCost of Goods
SoldGiven Information
7-23
Last-In, First-Out
Now, we have allocated the cost to all Now, we have allocated the cost to all 1,050 units sold.1,050 units sold.
Now, we have allocated the cost to all Now, we have allocated the cost to all 1,050 units sold.1,050 units sold.
Beg. Inv. 1,000 @ 5.25$ 1,000 @ $5.25Jan. 3 500 @ 5.30 200 @ 5.30 300 @ 5.30$ June 20 300 @ 5.60 300 @ 5.60 Sept. 15 250 @ 5.80 250 @ 5.80 Nov. 29 200 @ 5.90 200 @ 5.90
1,200 Units 1,050 Units
6,310$ Cost 5,900$ Cost
Ending InventoryCost of Goods
SoldGiven Information
7-24
Last-In, First-Out
Here is the Here is the cost of cost of ending ending
inventory inventory and cost of and cost of goods sold goods sold using LIFO.using LIFO.
Here is the Here is the cost of cost of ending ending
inventory inventory and cost of and cost of goods sold goods sold using LIFO.using LIFO.
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 6,310.00$
Cost of Goods Sold 1,050 5,900.00$
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 6,310.00$
Cost of Goods Sold 1,050 5,900.00$
7-25
Average Cost Method
When a unit is sold, the average cost of each unit in inventory is assigned to cost
of goods sold.
When a unit is sold, the average cost of each unit in inventory is assigned to cost
of goods sold.
Cost of Goods Available for
Sale
Number of Units
Available for Sale
÷
7-26
Average Cost Method
12,210$ 2,250
= $5.42667
Weighted Average Cost
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200
Cost of Goods Sold 1,050
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200
Cost of Goods Sold 1,050
7-27
Average Cost MethodComputers, Inc.
Mouse Pad InventoryDate Units $/Unit Total
Beginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 6,512.00$
Cost of Goods Sold 1,050 5,698.00$
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 6,512.00$
Cost of Goods Sold 1,050 5,698.00$
12,210$ 2,250
= $5.42667
Weighted Average Cost
1,200 × 5.42667$
1,050 × 5.42667$
7-28
Comparison of Methods
FIFO LIFO
Weighted Average
Net sales 25,000$ 25,000$ 25,000$ Cost of goods sold:Merchandise inventory, beginning 5,250$ 5,250$ 5,250$ Net purchases 6,960 6,960 6,960 Goods available for sale 12,210$ 12,210$ 12,210$ Merchandise inventory, ending 6,695 6,310 6,512 Cost of goods sold 5,515$ 5,900$ 5,698$ Gross profit 19,485$ 19,100$ 19,302$ Operating expenses 750 750 750 Income before taxes 18,735$ 18,350$ 18,552$ Income taxes expense (30%)* 5,621 5,505 5,566 Net income 13,114$ 12,845$ 12,986$
* Tax expense amounts were rounded.
Computers, Inc.Income Statement
For Year Ended December 31, 2006
7-29
Financial Statement Effects of Costing Methods
Advantages of MethodsAdvantages of MethodsAdvantages of MethodsAdvantages of Methods
Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with
revenues.revenues.
Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with
revenues.revenues.
Ending inventory Ending inventory approximates approximates
current current replacement cost.replacement cost.
Ending inventory Ending inventory approximates approximates
current current replacement cost.replacement cost.
First-In, First-In, First-OutFirst-OutFirst-In, First-In, First-OutFirst-Out
Last-In, Last-In, First-OutFirst-OutLast-In, Last-In,
First-OutFirst-Out
Smoothes out Smoothes out price changes.price changes.Smoothes out Smoothes out price changes.price changes.
Weighted Weighted AverageAverage
Weighted Weighted AverageAverage
7-30
Learning Objectives
Decide when the use of different inventory costing methods is beneficial to a company.Decide when the use of different inventory
costing methods is beneficial to a company.
7-31
Managers Choice of Inventory Methods
Net Income EffectsNet Income EffectsManagers prefer to report Managers prefer to report higher earnings for their higher earnings for their
companies.companies.
Net Income EffectsNet Income EffectsManagers prefer to report Managers prefer to report higher earnings for their higher earnings for their
companies.companies.
Income Tax EffectsIncome Tax EffectsManagers prefer to pay Managers prefer to pay
the least amount of taxes the least amount of taxes allowed by law as late as allowed by law as late as
possible.possible.
Income Tax EffectsIncome Tax EffectsManagers prefer to pay Managers prefer to pay
the least amount of taxes the least amount of taxes allowed by law as late as allowed by law as late as
possible.possible.
7-32
Choosing Inventory Costing Methods
LIFO for books
LIFO for books
LIFO for taxes
LIFO for taxes
If . . . Then . . .LIFO Conformity
Rule
7-33
Learning Objectives
Report inventory at the lower of cost or market (LCM).
Report inventory at the lower of cost or market (LCM).
7-34
Valuation at Lower of Cost or Market
Ending inventory is reported at the Ending inventory is reported at the lower of cost or market (LCM)lower of cost or market (LCM). .
Ending inventory is reported at the Ending inventory is reported at the lower of cost or market (LCM)lower of cost or market (LCM). .
Replacement CostReplacement CostThe current purchase price The current purchase price
for identical goods.for identical goods.
Replacement CostReplacement CostThe current purchase price The current purchase price
for identical goods.for identical goods.
The company will recognize a “holding” loss in the The company will recognize a “holding” loss in the current period rather than the period in which the current period rather than the period in which the
item is sold.item is sold.This practice is This practice is conservativeconservative..
The company will recognize a “holding” loss in the The company will recognize a “holding” loss in the current period rather than the period in which the current period rather than the period in which the
item is sold.item is sold.This practice is This practice is conservativeconservative..
7-35
Valuation at Lower of Cost or Market
Item Quantity Cost Replacement
Cost LCM Total LCMPentium chips 1,000 250$ 200$ 200$ 200,000$ Disk drives 400 100 110 100 40,000
Item Quantity Cost Replacement
Cost LCM Total LCMPentium chips 1,000 250$ 200$ 200$ 200,000$ Disk drives 400 100 110 100 40,000
7-36
Learning Objectives
Evaluate inventory management using the inventory turnover ratio and the effects of
inventory on cash flows.
Evaluate inventory management using the inventory turnover ratio and the effects of
inventory on cash flows.
7-37
Inventory Turnover
Cost of Goods Sold = Average Inventory
Inventory Turnover
Average Inventory is . . .Average Inventory is . . .(Beginning Inventory + Ending Inventory) ÷ 2(Beginning Inventory + Ending Inventory) ÷ 2
Average Inventory is . . .Average Inventory is . . .(Beginning Inventory + Ending Inventory) ÷ 2(Beginning Inventory + Ending Inventory) ÷ 2
This ratio reflects how many times This ratio reflects how many times average inventory was produced and average inventory was produced and sold during the period. A higher ratio sold during the period. A higher ratio indicates that inventory moves more indicates that inventory moves more quickly thus reducing storage and quickly thus reducing storage and
obsolescence costs. obsolescence costs.
This ratio reflects how many times This ratio reflects how many times average inventory was produced and average inventory was produced and sold during the period. A higher ratio sold during the period. A higher ratio indicates that inventory moves more indicates that inventory moves more quickly thus reducing storage and quickly thus reducing storage and
obsolescence costs. obsolescence costs.
7-38
Inventory and Cash Flows
Add
Subtract
Cash Cash Payment to Payment to SuppliersSuppliers
Cash Cash Payment to Payment to SuppliersSuppliers
Cost of Cost of Goods Goods SoldSold
Cost of Cost of Goods Goods SoldSold
Increase in InventoryIncrease in InventoryDecrease in Accounts Decrease in Accounts
PayablePayable
Increase in InventoryIncrease in InventoryDecrease in Accounts Decrease in Accounts
PayablePayable
Decrease in Inventory Decrease in Inventory Increase in Accounts Increase in Accounts
PayablePayable
Decrease in Inventory Decrease in Inventory Increase in Accounts Increase in Accounts
PayablePayable
7-39
Learning Objectives
Compare companies that use different inventory costing methods.
Compare companies that use different inventory costing methods.
7-40
Inventory Methods and Financial Statement Analysis
Beginning inventory FIFO- Beginning inventory LIFO
Beginning LIFO Reserve(Excess of FIFO over LIFO)
Beginning inventory FIFO- Beginning inventory LIFO
Beginning LIFO Reserve(Excess of FIFO over LIFO)
Ending inventory FIFO- Ending inventory LIFO
Ending LIFO Reserve(Excess of FIFO over LIFO)
Ending inventory FIFO- Ending inventory LIFO
Ending LIFO Reserve(Excess of FIFO over LIFO)
U.S. public companies using LIFO also report beginning and ending inventory on a FIFO basis if the FIFO values
are materially different.
7-41
LIFO and International Comparisons
LIFO Permitted?LIFO Permitted?
YesYesNoNo
ChinaSingapore
Canada
Great Britain
Australia
7-42
Learning Objectives
Understand methods for controlling and keeping track of inventory and analyze the
effects of inventory errors on financial statements.
Understand methods for controlling and keeping track of inventory and analyze the
effects of inventory errors on financial statements.
7-43
Internal Control of Inventory
Separation of inventory accounting and physical
handling of inventory.
Storage in a manner that protects from theft and
damage.
Limiting access to authorized employees.
Maintaining perpetual inventory records.
Comparing perpetual records to periodic
physical counts.
7-44
Perpetual and Periodic Inventory Systems
Provides Provides up-to-dateup-to-date inventory records.inventory records.
Provides Provides up-to-dateup-to-date inventory records.inventory records.
Provides Provides up-to-date up-to-date cost of sales records. cost of sales records. Provides Provides up-to-date up-to-date
cost of sales records. cost of sales records.
Perpetual Perpetual SystemSystem
Perpetual Perpetual SystemSystem
In a periodic inventory system, ending inventory and cost of goods sold are determined at the end of the accounting
period based on a physical count.
7-45
Perpetual and Periodic Inventory Systems
Inventory System
Item Periodic System Perpetual System
Beginning InventoryCarried over
from prior periodCarried over from
prior period
Add: PurchasesAccumulated in the Purchases
account
Accumulated in the Inventory
account
Less: Ending Inventory
Measured at end of period by
physical inventory count
Perpetual record updated at every
sale
Cost of Goods Sold
Computed as a residual amount at end of period
Measured at every sale based
on perpetual record
7-46
Errors in Measuring Ending Inventory
Errors in Measuring InventoryEnding Inventory Beginning Inventory
Overstated Understated Overstated Understated
Ending Inventory + - N/A N/A
Retained Earnings + - - +
Goods Available for Sale N/A N/A + -Cost of Goods Sold - + + -Gross Profit + - - +Net Income + - - +
Effect on Current Period's Balance Sheet
Effect on n Current Period's Income Statement
7-47
LIFO LiquidationsLIFO Liquidations
Chapter Supplement A
7-48
LIFO Liquidations
When a LIFO company sells more inventory than it purchases or manufactures, items from beginning
inventory become part of cost of goods sold. This is called a LIFO liquidation.
When inventory costs are rising, these lower cost items in
beginning inventory produce a higher gross profit, higher
taxable income, and higher taxes when they are sold.
7-49
LIFO Liquidations
Companies must disclose the effects of LIFO liquidations in the notes when they are material.
Many companies avoid LIFO liquidations and the accompanying
increase in tax expense by purchasing sufficient quantities of
inventory at year-end to ensure that ending inventory quantities are
greater than or equal to beginning inventory quantities.
7-50
Additional Issues in Measuring Purchases
Additional Issues in Measuring Purchases
Chapter Supplement B
7-51
Purchase Returns and Allowances
Purchase returns and allowances are a reduction in the cost of purchases associated with unsatisfactory
goods.
Returned goods require a reduction in the cost of
inventory purchases and the recording of a cash refund or a reduction in the liability to the
vendor.
7-52
Purchase Discounts
Terms
Time
Due
Discount Period
Full amountless discount
Credit Period
Full amount due
Purchase or SalePurchase or Sale
A purchase discount is a cash discount received for prompt payment of an account.
7-53
2/10,n/302/10,n/30
Purchase Discounts
Discount Percent
Discount Percent
Number of Days
Discount Is Available
Number of Days
Discount Is Available
Otherwise, Net (or All)
Is Due
Otherwise, Net (or All)
Is Due CreditPeriod
CreditPeriod
7-54
Purchase Discounts
Purchases paid for within the discount period reduce the
Inventory account for the amount of the cash
discount received.
7-55
Chapter Supplement C
Comparison of Perpetual and Periodic Inventory Systems
7-56
Perpetual Inventory System
Jan. 1
Apr. 14 Purchased 1,100 units at a unit cost of $50.Inventory 55,000
Accounts payable 55,000 Nov. 30 Sold 1,300 units at a sales price of $83.
Accounts receivable 107,900 Sales revenue 107,900
Cost of goods sold 65,000 Inventory 65,000
Dec. 31 Use cost of goods sold and inventory amounts.
Had beginning inventory of 800 units at a unit cost of $50.
7-57
Periodic Inventory System
7-58
End of Chapter 7