Chapter 6 Merchandising Inventory

Transcription

1 Chapter 6 Merchandising Inventory Account for inventory by the FIFO, LIFO, and average cost methods: Inventory Costing Methods: - Specific Unit Cost. 2- First-In, First-Out (FIFO). 3- Last-In, First-Out (LIFO). 4- Average Cost. Specific Unit Cost: When units are sold, the specific cost of the unit sold is added to cost of goods sold. Used where a small number of costly, distinctive items are sold. It offers the opportunity to manipulate income. Example: Assume that a RMS has the following perpetual inventory record (system): Rocky Mountain Sportswear Parka Number of Units Unit Cost Nov. Beginning inventory $ 5 Purchase 6 5 Sale 4 26 Purchase 7 30 Sale 8 Requirements: - Prepare a perpetual record at: A- FIFO. B- LIFO. C- Average cost. 2- Determine the company s cost of goods sold. 3- Compute gross profit. Solution: - Prepare a perpetual record (FIFO): Use of the FIFO inventory method assumes that the first goods purchased are the first used or sold. In all cases where FIFO is used, the inventory and cost of goods sold would be the same at the end of the month whether a perpetual or periodic system is used. A major advantage of the FIFO method is that the ending inventory is stated in terms of an approximate current cost figure. However, because FIFO tends to reflect current costs on the balance sheet, a basic disadvantage of this method is that current costs are not matched against current revenues on the income statement. Perpetual Inventory Record: FIFO Nov. $ $ 5 6 $ $ $ $ $620 2 $560 2 $00 Notice: We keep separate cost layers as inventory is acquired. Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara Page

2 2- Prepare a perpetual record (LIFO): Use of the LIFO inventory method assumes that the most recent inventory costs are the first costs recorded for goods manufactured or sold. When inventory records are kept on a periodic basis, the ending inventory would be priced by using the total units as a basis of computation, disregarding the exact dates of purchases. The calculation of ending inventory and cost of sales changes somewhat when the LIFO method is used in connection with perpetual inventory records. Perpetual Inventory Record: LIFO Nov. $ $ 5 6 $ $ $ $ $620 2 $575 2 $85 The last inventory costs incurred are the first inventory costs to be assigned to cost of goods sold Prepare a perpetual record (Average Cost): Items in the ending inventory and items sold are priced at the average cost of goods available during the period. Either weighted average (periodic) or moving average (perpetual) procedures may be used. The average cost of each unit in inventory is assigned to cost of goods sold. Cost of Inventory on Hand Number of Units on Hand = Average Cost Every time the company purchases inventory, a new average price per unit is computed: Total cost of goods available for sale Total number of units available for sale Perpetual Inventory Record (Average Cost): Nov. $.00 $ 5 6 $ $ $44.29 $ $620 2 $563 2 $ 97 Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara Page 2

3 Compare the effects of FIFO, LIFO, and average cost: Comparative Results for FIFO, LIFO, and Average Cost: FIFO LIFO Average Sales Revenue $960 $960 $960 Cost of Good Sold Gross Profit $0 $385 $397 - FIFO produces the lowest cost of good sold and highest gross profit. Net income is also the highest under FIFO when inventory costs are rising. 2- LIFO results in the highest. Income Effects: - When inventory costs are increasing: LIFO cost of goods sold is highest, gross profit is lowest. FIFO cost of goods sold is lowest, gross profit is highest. - When inventory costs are decreasing: FIFO cost of goods sold is highest. LIFO cost of goods sold is lowest. Which Method Will a Company Use? - Decision is up to Management. (NOT based on Actual Inventory Movements) - A tool for managing Earnings. - A tool for managing Taxes. Advantage of Each Method: Weighted Average FIFO LIFO Smoothes out price changes Ending inventory approximates Better matching of current costs in current replacement cost cost of goods sold with revenues Accounting Principles and Inventories: - Consistency in Reporting: A company should use the same accounting methods from period to period so that financial statements are comparable across periods. Same Accounting Methods from Period to Period. Accounting Changes must be disclosed (Effect of accounting Change must be disclosed). 2- Disclosure Principle: Report enough information for outsiders to make wise decisions about the company. Enough information must be reported for stakeholders to make informed decisions. Relevant, Reliable, and Comparable Information. 3- Materiality Concept: A company must perform strictly proper accounting only for significant items. 4- Accounting Conservatism Exercise caution in reporting items in the financial statements. Report realistic figures. Anticipate or disclose all likely losses, but gains are not reported until they occur. Assets are recorded as lowest reasonable amount. Liabilities are recorded at highest reasonable amount. Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara Page 3

4 Estimate ending inventory by the gross profit method: Gross Profit Method: Estimate ending inventory by applying the gross profit ratio to net sales. Useful when inventory has been destroyed, lost, or stolen. Gross profit method is a way to estimate inventory based on the cost of goods sold model. Also called gross margin method. Beginning Inventory + Net purchases = Cost of Goods Available for Sale - Cost of Ending Inventory = Cost of Goods Sold Rearranging ending inventory and cost of good sold helps to estimate ending inventory: Sales Cost of Goods Sold = Gross Profit. Gross Profit% = Gross Profit / Sales. Cost of Goods Sold = Sales x (- Gross Profit%). Beginning Inventory + Net purchases = Cost of Goods Available for Sale - Cost of Goods Sold (Sales Gross profit = COGS) = Cost of Ending Inventory Gross Profit Method of Estimating Inventory (amounts assumed): Example: Estimate CGS using GP %: Beginning Inventory = $ 4,000 Purchases = $ 66,000 Sales = $ 00,000 Gross Profit % = % Beginning Inventory $4,000 Net purchases 66,000 Cost of Goods Available for Sale 80,000 Estimated Cost of Goods Sold: Sales revenue $00,000 Less: Estimated gross profit of % (,000) Estimated Cost of Goods Sold (60,000) Estimated Cost of Ending Inventory $20,000 Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara Page 4

5 Exercise 6.: Units Unit Cost Total Cost Dec. Inventory $ 7 $ Purchase $ 8 $ 0 23 Purchase 30 $ 9 $ Sale 00 Requirements: - Prepare a Perpetual record at: FIFO, LIFO, Average Cost. 2- Assume they sold Unit at 2$, Compute the gross profit under each method with your comment. Author; Dr. Helal Afify ~~ Editor; Omar Abu Jbara Page 5