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 Principles of Accounting/ Financial and Managerial Accounting Chapter 08
 

Principles of Accounting/ Financial and Managerial Accounting Chapter 08

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     Principles of Accounting/ Financial and Managerial Accounting Chapter 08 Principles of Accounting/ Financial and Managerial Accounting Chapter 08 Presentation Transcript

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