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    • 1. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-1 INVENTORIES AND THE COST OF GOODS SOLD Chapter 8
    • 2. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-2 InventoryInventory Goods owned and held for sale to customers Goods owned and held for sale to customers Current asset Current asset Inventory DefinedInventory Defined
    • 3. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-3 INCOME STATEMENT Revenue Cost of goods sold Gross profit Expenses Net income As purchase costs (or manufacturing costs) are incurred as goods are sold BALANCE SHEET Current assets: Inventory $ $ $ The Flow of Inventory CostsThe Flow of Inventory Costs
    • 4. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-4 GENERAL JOURNAL Date Account Titles and Explanation P R Debit Credit Entry on Purchase Date Inventory $$$$ Accounts Payable $$$$ Entry on Sale Date Cost of Goods Sold $$$$ Inventory $$$$ In a perpetual inventory system, inventory entries parallel the flow of costs. The Flow of Inventory CostsThe Flow of Inventory Costs
    • 5. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-5 When identical units of inventory have different unit costs, a question naturally arises as to which of these costs should be used in recording a sale of inventory. Which Unit Did We Sell?Which Unit Did We Sell?
    • 6. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-6 A separate subsidiary account is maintained for each item in inventory. A separate subsidiary account is maintained for each item in inventory. How can we determine the unit cost for the Sept. 10 sale? Item LL002 Primary supplier Electronic City Description Laser Light Secondary supplier Electric Company Location Storeroom 2 Inventory level: Min: 25 Max: 200 Purchased Sold Balance Date Units Unit Cost Total Units Unit Cost Cost of Goods Sold Units Unit Cost Total Sept. 5 100 30$ 3,000$ 100 30$ 3,000$ Sept. 9 75 50 3,750 100 30 3,000 75 50 3,750 Sept. 10 10 ? ? ? ? ? ? ? ? Inventory Subsidiary LedgerInventory Subsidiary Ledger
    • 7. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-7 Specific identification LIFO Average cost FIFO We use one of these inventory valuation methods to determine cost of inventory sold. Inventory Cost FlowsInventory Cost Flows
    • 8. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-8 The Bike Company (TBC) Information for the Following Inventory Examples Information for the Following Inventory Examples
    • 9. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-9 Specific IdentificationSpecific Identification When a unit is sold, the specific cost of the unit sold is added to cost of goods sold.
    • 10. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-10 On August 14, TBC sold 20 bikes for $130 each. Nine bikes originally cost $91 and 11 bikes originally cost $106. On August 14, TBC sold 20 bikes for $130 each. Nine bikes originally cost $91 and 11 bikes originally cost $106. Continue Specific Identification – ExampleSpecific Identification – Example
    • 11. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-11 The Cost of Goods Sold for the August 14 sale is $1,985, leaving $515 and 5 units in inventory. The Cost of Goods Sold for the August 14 sale is $1,985, leaving $515 and 5 units in inventory. Continue Let’s look at the entries for the Aug. 14 sale. Specific Identification – ExampleSpecific Identification – Example
    • 12. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-12 Continue RetailRetail CostCost A similar entry is made after each sale. A similar entry is made after each sale. Specific Identification – ExampleSpecific Identification – Example
    • 13. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-13 Additional purchases were made on August 17 and 28. Costs associated with sales on August 31 were as follows: 1 @ $91, 3 @ $106, 15 @ $115, & 4 @ $119. Additional purchases were made on August 17 and 28. Costs associated with sales on August 31 were as follows: 1 @ $91, 3 @ $106, 15 @ $115, & 4 @ $119. Continue Specific Identification – ExampleSpecific Identification – Example Cost of Goods Sold for August 31 = $2,610 Cost of Goods Sold for August 31 = $2,610
    • 14. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-14 Balance Sheet Inventory = $1,395 Income Statement COGS = $4,595 1 @ 106$ = 106$ 5 @ 115$ = 575 6 @ 119$ = 714 End. Inv. 1,395$ Specific Identification – ExampleSpecific Identification – Example
    • 15. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-15 Since specific identification is so easy, can’t we use it all the time? Not really. Specific identification is hard to use when we sell a lot of inventory that has lots of different costs.
    • 16. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-16 Cost of Goods Available for Sale Units on hand on the date of sale ÷ Average-Cost MethodAverage-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.
    • 17. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-17 On August 14, TBC sold 20 bikes for $130 each.On August 14, TBC sold 20 bikes for $130 each. Continue The average cost per unit must be computed prior to each sale. The average cost per unit must be computed prior to each sale. Average-Cost Method – ExampleAverage-Cost Method – Example $100 = $2,500 ÷ 25$100 = $2,500 ÷ 25
    • 18. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-18 Continue The average cost per unit is $100. The average cost per unit is $100. Let’s look at the entries for the Aug. 14 sale. Average-Cost Method – ExampleAverage-Cost Method – Example $100 = $2,500 ÷ 25$100 = $2,500 ÷ 25
    • 19. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-19 Continue RetailRetail CostCost A similar entry is made after each sale. A similar entry is made after each sale. Average-Cost Method – ExampleAverage-Cost Method – Example
    • 20. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-20 Additional purchases were made on August 17 and August 28. On August 31, an additional 23 units were sold. Additional purchases were made on August 17 and August 28. On August 31, an additional 23 units were sold. Continue Average-Cost Method – ExampleAverage-Cost Method – Example
    • 21. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-21 $114 = $3,990 ÷ 35$114 = $3,990 ÷ 35 Average-Cost Method – ExampleAverage-Cost Method – Example
    • 22. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-22 $114 = $3,990 ÷ 35$114 = $3,990 ÷ 35The average cost per unit is $114. The average cost per unit is $114. Average-Cost Method – ExampleAverage-Cost Method – Example
    • 23. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-23 Income Statement COGS = $4,622 Balance Sheet Inventory = $1,368 $114 × 12 = $1,368$114 × 12 = $1,368 Average-Cost Method – ExampleAverage-Cost Method – Example
    • 24. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-24 Costs of Goods Sold Costs of Goods Sold Ending Inventory Ending Inventory Oldest Costs Oldest Costs Recent Costs Recent Costs First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)
    • 25. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-25 On August 14, TBC sold 20 bikes for $130 each.On August 14, TBC sold 20 bikes for $130 each. Continue The Cost of Goods Sold for the August 14 sale is $1,970, leaving $530 and 5 units in inventory. The Cost of Goods Sold for the August 14 sale is $1,970, leaving $530 and 5 units in inventory. FIFO – ExampleFIFO – Example
    • 26. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-26 RetailRetail CostCost Continue A similar entry is made after each sale. A similar entry is made after each sale. FIFO – ExampleFIFO – Example
    • 27. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-27 Additional purchases were made on Aug. 17 and Aug. 28. On August 31, an additional 23 units were sold. Additional purchases were made on Aug. 17 and Aug. 28. On August 31, an additional 23 units were sold. Continue FIFO – ExampleFIFO – Example Cost of Goods Sold for August 31 = $2,600Cost of Goods Sold for August 31 = $2,600
    • 28. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-28 Balance Sheet Inventory = $1,420 Income Statement COGS = $4,570 2 @ 115$ = 230$ 10 @ 119$ = 1,190 End. Inv. 1,420$ FIFO – ExampleFIFO – Example
    • 29. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-29 Costs of Goods Sold Costs of Goods Sold Ending Inventory Ending Inventory Recent Costs Recent Costs Oldest Costs Oldest Costs Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)
    • 30. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-30 On August 14, TBC sold 20 bikes for $130 each.On August 14, TBC sold 20 bikes for $130 each. Continue LIFO – ExampleLIFO – Example The Cost of Goods Sold for the August 14 sale is $2,045, leaving $455 and 5 units in inventory. The Cost of Goods Sold for the August 14 sale is $2,045, leaving $455 and 5 units in inventory.
    • 31. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-31 Continue RetailRetail CostCost A similar entry is made after each sale. A similar entry is made after each sale. LIFO – ExampleLIFO – Example
    • 32. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-32 Continue LIFO – ExampleLIFO – Example Additional purchases were made on Aug. 17 and Aug. 28. On Aug. 31, an additional 23 units were sold. Additional purchases were made on Aug. 17 and Aug. 28. On Aug. 31, an additional 23 units were sold.Cost of Goods Sold for August 31 = $2,685Cost of Goods Sold for August 31 = $2,685
    • 33. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-33 Balance Sheet Inventory = $1,260 Income Statement COGS = $4,730 LIFO – ExampleLIFO – Example 5 @ 91$ = 455$ 7 @ 115$ = 805 End. Inv. 1,260$
    • 34. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-34 Inventory Valuation Methods: A Summary Costs Allocated to: Valuation Method Cost of Goods Sold Inventory Comments Specific Actual cost of Actual cost of units Parallels physical flow identification the units sold remaining Logical method when units are unique May be misleading for identical units Average cost Number of units sold times the Number of units on hand times the Assigns all units the same average unit cost average unit cost average unit cost Current costs are averaged in with older costs First-in, First-out (FIFO) Cost of earliest purchases on Cost of most recently Cost of goods sold is based on older costs hand prior to the sale purchased units Inventory valued at current costs May overstate income during periods of rising prices; may increase income taxes due Last-in, First-out (LIFO) Cost of most recently Cost of earliest purchases Cost of goods sold shown at recent prices purchased units (assumed still in inventory) Inventory shown at old (and perhaps out of date) costs Most conservative method during periods of rising prices; often results in lower income taxes
    • 35. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-35 Once a company has adopted a particular accounting method, it should follow that method consistently, rather than switch methods from one year to the next. The Principle of ConsistencyThe Principle of Consistency
    • 36. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-36 This inventory arrived just in time for us to use in the manufacturing process. Just-In-Time (JIT) Inventory Systems Just-In-Time (JIT) Inventory Systems
    • 37. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-37 The primary reason for taking a physical inventory is to adjust the perpetual inventory records for unrecorded shrinkage losses, such as theft, spoilage, or breakage. The primary reason for taking a physical inventory is to adjust the perpetual inventory records for unrecorded shrinkage losses, such as theft, spoilage, or breakage. Taking a Physical InventoryTaking a Physical Inventory
    • 38. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-38 Reduces the value of the inventory. Reduces the value of the inventory. Adjust inventory value to the lower of historical cost or current replacement cost (market). Adjust inventory value to the lower of historical cost or current replacement cost (market). ObsolescenceObsolescence Lower of Cost or Market (LCM) Lower of Cost or Market (LCM) LCM and Other Write-Downs of Inventory LCM and Other Write-Downs of Inventory
    • 39. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-39 Year End A sale should be recorded when title to the merchandise passes to the buyer. A sale should be recorded when title to the merchandise passes to the buyer. F.O.B. shipping point  title passes to buyer at the point of shipment. F.O.B. shipping point  title passes to buyer at the point of shipment. F.O.B. destination point  title passes to buyer at the point of destination. F.O.B. destination point  title passes to buyer at the point of destination. Goods In TransitGoods In Transit
    • 40. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-40 In a periodic inventory system, inventory entries are as follows. Note that an entry is not made to inventory. Note that an entry is not made to inventory. Periodic Inventory SystemsPeriodic Inventory Systems
    • 41. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-41 In a periodic inventory system, inventory entries are as follows. Periodic Inventory SystemsPeriodic Inventory Systems
    • 42. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-42 The inventory on hand and the cost of goods sold for the year are not determined until year-end. Periodic Inventory SystemsPeriodic Inventory Systems
    • 43. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-43 Specific identification LIFO Average cost FIFO We use one of these inventory valuation methods in a periodic inventory system. Periodic Inventory SystemsPeriodic Inventory Systems
    • 44. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-44 Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25$ 5,250.00$ Purchases: Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$ Ending Inventory 1,200 ? Cost of Goods Sold 600 ? Information for the Following Inventory Examples Information for the Following Inventory Examples
    • 45. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-45 By reviewing actual purchase invoices, Computers, Inc. determines that the 1,200 mouse pads on hand at year-end have an actual total cost of $6,400. Determine the cost of goods sold for the year. Specific Identification – ExampleSpecific Identification – Example
    • 46. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-46 Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25$ 5,250.00$ Purchases: Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$ Ending Inventory 1,200 6,400.00$ Cost of Goods Sold 600 3,325.00$ Cost of Goods Sold $9,725 - $6,400 = $3,325 Cost of Goods Sold $9,725 - $6,400 = $3,325 Specific Identification – ExampleSpecific Identification – Example
    • 47. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-47 Total Cost of Goods Available for Sale Total Number of Units Available for Sale ÷ The average cost is calculated at year- end as follows: The average cost is calculated at year- end as follows: Average-Cost MethodAverage-Cost Method
    • 48. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-48 Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25$ 5,250.00$ Purchases: Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$ Ending Inventory 1,200 ? Cost of Goods Sold 600 ? Avg. Cost $9,725 ÷ 1,800 = $5.40278 Avg. Cost $9,725 ÷ 1,800 = $5.40278 Average-Cost Method – ExampleAverage-Cost Method – Example Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25$ 5,250.00$ Purchases: Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$ Ending Inventory 1,200 6,483.00$ Cost of Goods Sold 600 3,242.00$ Ending Inventory Avg. Cost $5.40278 × 1,200 = $6,483 Ending Inventory Avg. Cost $5.40278 × 1,200 = $6,483 Cost of Goods Sold Avg. Cost $5.40278 × 600 = $3,242 Cost of Goods Sold Avg. Cost $5.40278 × 600 = $3,242
    • 49. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-49 Costs of Goods Sold Costs of Goods Sold Ending Inventory Ending Inventory Oldest Costs Oldest Costs Recent Costs Recent Costs First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)
    • 50. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-50 Remember: Start with the 11/29 purchase and then add other purchases until you reach the number of units in ending inventory. FIFO – ExampleFIFO – Example Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25$ 5,250.00$ Purchases: Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$ Ending Inventory 1,200 ? Cost of Goods Sold 600 ?
    • 51. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-51 Date Beg. Inv. Purchases End. Inv. Cost of Goods Sold Nov. 29 150@$5.90 150@$5.90 Units 150 Now, let’s complete the table. Now, let’s complete the table. FIFO – ExampleFIFO – Example Date Beg. Inv. Purchases End. Inv. Cost of Goods Sold 1,000@$5.25 600@$5.25 400@$5.25 Jan. 3 300@$5.30 300@$5.30 June 20 150@$5.60 150@$5.60 Sept. 15 200@$5.80 200@$5.80 Nov. 29 150@$5.90 150@$5.90 Units 1,200 600 Now, we have allocated the cost to all 1,200 units in ending inventory. Date Beg. Inv. Purchases End. Inv. Cost of Goods Sold 1,000@$5.25 600@$5.25 400@$5.25 Jan. 3 300@$5.30 300@$5.30 June 20 150@$5.60 150@$5.60 Sept. 15 200@$5.80 200@$5.80 Nov. 29 150@$5.90 150@$5.90 Units 1,200 600 Costs $6,575 $3,150 Cost of Goods Available for Sale $9,725
    • 52. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-52 Completing the table summarizes the computations just made. FIFO – ExampleFIFO – Example Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25$ 5,250.00$ Purchases: Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$ Ending Inventory 1,200 6,575.00$ Cost of Goods Sold 600 3,150.00$
    • 53. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-53 Costs of Goods Sold Costs of Goods Sold Ending Inventory Ending Inventory Recent Costs Recent Costs Oldest Costs Oldest Costs Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)
    • 54. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-54 Remember: Start with beginning inventory and then add other purchases until you reach the number of units in ending inventory. LIFO – ExampleLIFO – Example Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25$ 5,250.00$ Purchases: Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$ Ending Inventory 1,200 ? Cost of Goods Sold 600 ?
    • 55. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-55 Date Beg. Inv. Purchases End. Inv. Cost of Goods Sold 1,000@$5.25 1,000@$5.25 Units 1,000 LIFO – ExampleLIFO – Example Date Beg. Inv. Purchases End. Inv. Cost of Goods Sold 1,000@$5.25 1,000@$5.25 Jan. 3 300@$5.30 200@$5.30 100@$5.30 Units 1,200 100 Now, we have allocated the cost to all 1,200 units in ending inventory. Next, let’s complete the table. Next, let’s complete the table. Date Beg. Inv. Purchases End. Inv. Cost of Goods Sold 1,000@$5.25 1,000@$5.25 Jan. 3 300@$5.30 200@$5.30 100@$5.30 June 20 150@$5.60 150@$5.60 Sept. 15 200@$5.80 200@$5.80 Nov. 29 150@$5.90 150@$5.90 Units 1,200 600 Costs $6,310 $3,415 Cost of Goods Available for Sale $9,725
    • 56. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-56 Completing the table summarizes the computations just made. LIFO – ExampleLIFO – Example Computers, Inc. Mouse Pad Inventory Date Units $/Unit Total Beginning Inventory 1,000 5.25$ 5,250.00$ Purchases: Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$ Ending Inventory 1,200 6,310.00$ Cost of Goods Sold 600 3,415.00$
    • 57. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-57 Errors in Measuring Inventory Beginning Inventory Ending Inventory Effect on Income Statement Overstated Understated Overstated Understated Goods Available for Sale + - 0 0 Cost of Goods Sold + - - + Gross Profit - + + - Net Income - + + - Effect on Balance Sheet Ending Inventory 0 0 + - Retained Earnings - + + - An error in ending inventory in a year will result in the same error in the beginning inventory of the next year. An error in ending inventory in a year will result in the same error in the beginning inventory of the next year. Importance of an Accurate Valuation of Inventory Importance of an Accurate Valuation of Inventory
    • 58. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-58 For interim financialstatements, we may needto estimate endinginventory and cost of goods sold.
    • 59. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-59 Determine cost of goods available for sale. Estimate cost of goods sold by multiplying the net sales by the cost ratio. Deduct cost of goods sold from cost of goods available for sale to determine ending inventory. Determine cost of goods available for sale. Estimate cost of goods sold by multiplying the net sales by the cost ratio. Deduct cost of goods sold from cost of goods available for sale to determine ending inventory. The Gross Profit MethodThe Gross Profit Method
    • 60. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-60 In March of 2003, Chemico’s inventory was destroyed by fire. Chemico’s normal gross profit ratio is 30% of net sales. At the time of the fire, Chemico showed the following balances: In March of 2003, Chemico’s inventory was destroyed by fire. Chemico’s normal gross profit ratio is 30% of net sales. At the time of the fire, Chemico showed the following balances: Sales 31,500$ Sales returns 1,500 Beginning Inventory 12,000 Net cost of goods purchased 20,500 Gross Profit Method – ExampleGross Profit Method – Example
    • 61. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-61 Gross Profit Method – ExampleGross Profit Method – Example × 70%   
    • 62. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-62 Measures how quickly a company sells its merchandise inventory. Measures how quickly a company sells its merchandise inventory. A ratio that is low compared to competitors suggests inefficient use of assets. A ratio that is low compared to competitors suggests inefficient use of assets. Average Inventory = (Beg. Inv. + End. Inv.) ÷ 2Average Inventory = (Beg. Inv. + End. Inv.) ÷ 2 Inventory Turnover RateInventory Turnover Rate
    • 63. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-63 Remember that identical companies that use different inventory methods (e.g., FIFO and LIFO) will have different inventory turnover ratios. Accounting Methods Can Affect Analytical Ratios Accounting Methods Can Affect Analytical Ratios
    • 64. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin Slide 8-64 Careful! If you drop the inventory we will have another write down. End of Chapter 8End of Chapter 8

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