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Inventory and Cost of Goods Sold


									BADM524                                 DeGeorge                                 Inventory
                                                                                Page 1 of 4

Inventory and Cost of Goods Sold

The Nature of Inventory
      Inventory is an asset held for resale in the normal course of business.

       Merchandise Inventory
       Manufactured Inventory        We will cover manufactured inventory in detail
             Raw Material                      during the second part of the course.
             Work In Process
             Finished Goods

Inventory and Cost of Goods Sold
      Beginning Inventory
      Plus Purchases and costs incurred in manufacturing
      Goods Available for Sales
      Less Ending Inventory
      Cost of Goods Sold


There is a direct, dollar per dollar relationship between inventory and Cost of Goods
Sold. Only two things can happen to goods available for sale. They can either remain
with us (Ending Inventory) or they will become an expense (Cost of Goods Sold).

Inventory Errors – because this years ending inventory will become next years
beginning inventory, an error in inventory will affect two fiscal years.
BADM524                                 DeGeorge                                Inventory
                                                                               Page 2 of 4
Inventory Ratios – measure how efficiently a company manages its resources. Also
gives an indication of how flexible a company is.

Inventory Turn = how many times in a fiscal year did we “turn over” our inventory?
                   Annual Cost of Goods Sold
                   Average Inventory (Beginning + Ending)/2

Average Days to Turn = On average, how many days do we hold our inventory?
                   360 days
                   Inventory Turn

               This is also referred to as Average Days Supply of Inventory

Ending Days Supply = How many sales days worth of inventory do we have left at the
end of an accounting period?
                      Ending Inventory
                      Average Daily COGS (Annual COGS / 360)
                                        (Quarterly COGS / 90)

                                      Mylan                 Gateway
             Year Ended               3/31/99               12/31/98
Cost of Goods Sold                    $336,846              $5,921,651
Beginning Inventory                   $146,041              $ 167,924
Ending Inventory                      $136,493              $ 249,224

Inventory Turns                       2.38 times            28.39 times
Average Days to Turn                  151 days              13 days
Ending Days Supply                    146 days              15 days

Net Sales                             $721,123              $7,467,925
Gross Profit                          $384,277              $1,546,274

GP to COGS                        1.14                   0.26
  For every $1 Mylan spends on inventory it generates $1.14 in profit.
  For every $1 Gateway spends on inventory it generates only $0.26 in profit.


Gateway can turn their inventory 28.39 times in a year thus generating $7.41 in profit.
Mylan only turns their inventory 2.38 times in a year thus generating only $2.72 in profit.

What do these ratios tell you about the industries?
What do these ratios tell you about the companies?
How much inventory was purchased by each company during each of their fiscal years?
BADM524                                  DeGeorge                                 Inventory
                                                                                 Page 3 of 4
Merchandise Inventory – What should be included? (Also applies to Raw Material
Inventory in a manufacturing environment)

       Invoice price for goods purchased
       Plus freight and insurance incurred in connection with the receipt of the goods
       Less terms discounts allowed by the vendor for prompt payment.

THINK MATCHING PRINCIPLE. If we did not include these adjustments to the
invoice price, the cost of freight and insurance relating to inventory which will be sold in
a future period thus generating revenue which will be recognized in that future period,
such costs would by default be recorded as an expense in the period in which the
inventory was purchased, without any corresponding revenues.

       Shipping Terms
             FOB shipping point – title passes when product leaves the sellers door.
                   Buyer pays for freight and insurance
             FOB destination – title passes when product is received in the buyers door.
                   Seller pays for freight and insurance

       Payment Terms
             1/10, n/30 = 1% discount if paid within 10 days, if not the net invoice
       amount is due within 30 days.

             2/15, n/45 = 2% discount if paid within 15 days, if not the net invoice
       amount is due within 45 days.

       There are countless different possibilities. Payment terms are normally negotiated
       between the buyer and the seller.

       These percentages are not annual percentages. Accordingly the buyer will
       generally always take advantage of the payment discount even if they have to
       borrow money to do so.
BADM524                                DeGeorge                                Inventory
                                                                              Page 4 of 4
Valuing Ending Inventory
Cost Flow and physical flow do not have to be the same and in most cases it simply is not
possible. However, since the value of ending inventory has a direct impact on Cost of
Goods Sold and therefore Net Income, acceptable methods have been developed to track
cost flow and determine the value of ending inventory. A company may select one of the
acceptable methods and then must apply that method consistently from year to year.

       Acceptable Cost Flow Methods
             Specific Identification
             Weighted Average
             First-in, First-out (FIFO)
             Last-in, First-out (LIFO)

       Periodic versus Perpetual Inventory System
              The same cost flow methods are applied to goods available for sale.

              Under Period we use the GAFS at the end of the accounting period.

              Under a perpetual system we use the GAFS at the time of every sale.
                     Weighted Average becomes the Moving Average
                     FIFO will have the exact same result perpetual and periodic.
                     LIFO will have different results, perpetual versus periodic.

                      Perpetual provides for a good estimate of COGS during an
                       Accounting period. We still have to use the standard formula
                       To determine actual COGS.

Income Tax and Cash Flow Considerations

Lower of Cost or Market – applying the conservatism principle

Estimating Inventory
      Gross Profit Method
      Retail Method

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