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Financial Accounting_ Second Canadian Edition20104612451

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Financial Accounting_ Second Canadian Edition20104612451 Powered By Docstoc
					             Chapter 8
      Reporting and Interpreting Cost
       of Goods Sold and Inventory




8-1                        Financial Accounting, Second Canadian Edition
            Business Background

                             Provides accurate
                                information

Roles of the Accounting
        System              Provides up-to-date
Assign cost to inventory       information
  as it flows through
     organization
                           Provides information
                           to help protect assets
                           (inventory is likely 2nd
                            most succeptable to
                              theft, after cash)
8-2                               Financial Accounting, Second Canadian Edition
      Nature of Inventory and Cost of
                Goods Sold
                   INVENTORY
        tangible property held for sale in the
       normal course of business or used in
      producing goods or services for sale. A
          subset of our accounting system

      A building sale is generally not a normal
                     transaction.

8-3                               Financial Accounting, Second Canadian Edition
      Nature of Inventory and Cost of
                Goods Sold
  Merchandisers (wholesale or retail
  businesses) hold the following:
  (1 main account)
  Merchandise Inventory includes goods held for
  resale in the ordinary course of business. They Sell
  you the goods. Ex: Walmart

  They traditionally don’t make their own inventory



8-4                                   Financial Accounting, Second Canadian Edition
      Nature of Inventory and Cost of
                Goods Sold
Manufacturing businesses hold the following: (4 types of
inventory accounts)

Raw (or Production Materials Inventory) includes items acquired for
the purpose of processing into finished goods.

Work-In-Progress Inventory includes goods in the process of being
manufactured.

Finished Goods Inventory includes manufactured goods that are
completed and ready for sale.

Stores Inventory includes parts held for repair or replacement of
productive or service machinery.



8-5                                              Financial Accounting, Second Canadian Edition
                    Inventory Cost

      The cost principle requires that inventory be recorded at
                  the price paid or the consideration
                              given up.
        Usually we record things qiute easily with their dollar
                                 value.
      We want to record things at their historic cost. Year over
         year the price of raw goods goes up. To account for
             this we report it using the “HISTORIC COST
                              PRINCIPAL”
      We don’t record profit as we build things, we only record
                          profits on the sale.



8-6                                           Financial Accounting, Second Canadian Edition
            Inventory Cost

      Include all costs incurred to bring the
      asset to useable or saleable condition,
                      such as:
                    Invoice price
                  Freight charges
                 Inspection costs
      Preparation costs (ex:setup/assembly)



8-7                           Financial Accounting, Second Canadian Edition
                              Flow of Inventory Costs
 (inventory is a balance sheet item. If we haven’t sold it yet, then it will remain
     on the balance sheet because there will be future income from them.)

Merchandiser
Merchandise                              Merchandise                              Cost of
 Purchases                                Inventory                              Goods Sold


Manufacturer
   Raw                      Raw Materials             Work in Process           Finished Goods
 Materials                    Inventory                 Inventory                  Inventory

  Direct
  Labour                                                                          Cost of
                                                                                 Goods Sold
        Factory Overhead (utlities, etc, but not on
             sales, headquarters, corporate.
  8-8                                                         Financial Accounting, Second Canadian Edition
       Flow of Inventory Costs

  Direct Labour refers to the earnings of
  employees who work directly on the
  products being manufactured.


  Factory Overhead comprises
  manufacturing costs that are not raw
  materials or direct labour costs. (not
  including sales and corporate expense)
8-9                            Financial Accounting, Second Canadian Edition
                 Nature of Inventory and Cost of
                  Goods Sold *IMPORTANT*
                             Beginning                                    Purchases
                             Inventory                                  for the Period


                                                Goods Available
                                                   for Sale

                        Ending Inventory                            Cost of Goods Sold
                          (Balance Sheet)                            (Income Statement)




                      Beginning inventory + Purchases – Ending inventory = Cost of goods sold

   Every year stores have leftovers from the previous year. They still want to sell it + the new purchases, the total is
                                                 the Goods Available for Sale
                        If they don’t sell something, it stays on the balance sheet at the historic cost.
ey did sell it, then they have Sales Revenue (use matching concept to match costs) and move it to the costs of goods s
        8 - 10                                                              Financial Accounting, Second Canadian Edition
         Nature of Inventory and Cost of
                   Goods Sold


          The Cost Of Goods Available For Sale
           refers to the sum of the cost of beginning
            inventory and the cost of purchases (or
          transfers to finished goods) for the period.




8 - 11                                   Financial Accounting, Second Canadian Edition
         Perpetual and Periodic Inventory
                     Systems.

                           Provides up-to-date
          Perpetual         inventory records
           System

We want the dollar
   value of the
 inventory at all          Provides up-to-date
      times                records for cost of
                               goods sold

8 - 12                          Financial Accounting, Second Canadian Edition
            Comparison of Perpetual and Periodic Systems.
                Small businesses often use Periodic because its easier and cheaper



                                                       Source of Information
               Model                      Periodic System                   Perpetual System
                                         Carried over from                 Carried over from
Beginning Inventory
                                           prior period                      prior period
                                        Accumulated in the                Accumulated in the
Add: Purchases
                                        Purchases account                 Inventory account
Equals:                                         Cost of Goods Available for Sale

                                        Measured at end of                Perpetual record
Less: Ending Inventory                  period by physical              updated at every sale
                                         inventory count

                                           Computed as a                   Measured at every
Cost of Goods Sold                       residual amount at                 sale based on
                                            end of period                  perpetual record

   8 - 13                                                       Financial Accounting, Second Canadian Edition
            Comparison of Periodic and
               Perpetual Systems
Transaction               Periodic                            Perpetual
Merchandise
purchased from
supplier on
account.        Purchases                    XX   Inventory                             XX
                  Accounts Payable              XX Accounts Payable                          XX
Merchandise
returned to
supplier.       Accounts Payable             XX   Accounts Payable                      XX
                  Purchases Returns & Allow.    XX Inventory                                 XX
Merchandise
sold to
customer on
                 Purchases Returns and Allowances is
account.      subtracted from Purchases on the income
                Accounts Receivable          XX   Accounts Receivable                   XX
            statement. (contra expense account – we have
                  Sales                         XX Sales                                     XX

                                         Cost of inventory
            to take cost of goods back out ofGoods Sold if                              XX
                                            supplier
                   we return things to the Inventory                                         XX

   8 - 14                                         Financial Accounting, Second Canadian Edition
           Comparison of Periodic and
              Perpetual Systems
Transaction               Periodic                            Perpetual
Merchandise
purchased from
supplier       Purchases                    XX   Inventory                XX
on account.      Accounts Payable              XX Accounts Payable           XX
Merchandise
                                                     This entry is recorded
returned to    Accounts Payable             XX   Accounts Payable         XX
                                                              at retail.
supplier.        Purchases Returns & Allow.    XX Inventory                  XX
Merchandise
sold to        Accounts Receivable          XX   Accounts Receivable      XX
customer on      Sales                         XX Sales                      XX
account.
                This entry is recorded           Cost of Goods Sold       XX
                  at cost. (extra step)             Inventory                XX

  8 - 15                                           Financial Accounting, Second Canadian Edition
            Comparison of Periodic and
               Perpetual Systems
Transaction                Periodic                              Perpetual
Merchandise
returned by
customer.     Sales Returns and Allow.   XX     Sales Returns and Allow.                   XX
                Accounts Receivable           XX Accounts Receivable                            XX

                                                 Inventory                                 XX
                 This is recorded at               Cost of Goods Sold                           XX
                        retail.


                                                This entry is recorded
                                                       at cost.




   8 - 16                                            Financial Accounting, Second Canadian Edition
            Comparison of Periodic and
               Perpetual Systems
Transaction                 Periodic                               Perpetual
Merchandise
returned by
customer.     Sales Returns and Allow.   XX     Sales Returns and Allow.                     XX
                Accounts Receivable           XX Accounts Receivable                              XX

                                                   Inventory                                 XX
                                                     Cost of Goods Sold                           XX
At end of
accounting
period.       Cost of Goods Sold         XX        No entry.
                Inventory (beginning)         XX
                Purchases                     XX

              Inventory (ending)         XX
                Cost of Goods Sold            XX



   8 - 17                                              Financial Accounting, Second Canadian Edition
     Methods for Estimating Inventory
                                     Facts: sales are $200,000,
Sales                     100%       beginning inventory is $4,500,
Cost of goods sold         70%       purchases are $150,000, and
Gross margin               30%       gross margin is 30%, so your
                                     income statement looks like
                                     this . . .

          Sales                                                $ 200,000
          Beginning inventory                $     4,500
          Purchases                              150,000
          Cost of goods available for sale     154,500
          Ending inventory                   ? (14,500)
          Cost of goods sold                                      140,000
          Gross margin                                         $ 60,000

 8 - 18                                            Financial Accounting, Second Canadian Edition
    Methods for Estimating Inventory

         Estimated ending inventory must be $14,500
                   ($154,500 - $140,000).


           Sales                                               $ 200,000
           Beginning inventory                $     4,500
           Purchases                              150,000
           Cost of goods available for sale       154,500
           Ending inventory                        14,500
           Cost of goods sold                                   140,000
           Gross margin                                        $ 60,000



8 - 19                                               Financial Accounting, Second Canadian Edition
                      Errors in Measuring Inventory
             It self corrects itself in 2 full years. Inventory
                   errors are self correcting over time
 Beginning inventory + Purchases – Ending inventory = Cost of goods sold
                       Errors in Measuring Inventory
                               Beginning Inventory            Ending Inventory
                             Overstated Understated Overstated Understated
Effect on Income Statement
Goods Available for Sale         +           -                N/A                   N/A
Cost of Goods Sold               +           -                  -                     +
Gross Profit                     -           +                  +                     -
Net Income                       -           +                  +                     -
Effect on Balance Sheet
Inventory (12/31)               N/A         N/A                 +                     -
Retained Earnings                -           +                  +                     -
    8 - 20                                        Financial Accounting, Second Canadian Edition
                             Exhibit 8.5
         ERROR: UNDERSTATEMENT OF ENDING INVENTORY

                                               Year of the error Following Year
         Beginning Inventory                          NE               U*
         Ending Inventory                              U               NE
         Cost of goods sold                           O                U*
         Gross profit                                  U               O
         Income before income tax                      U               O
         Income tax expense                            U               O
         Net Income                                    U               O
         Retained earnings, end of year                U               NE

         *U = Understated; O = Overstated; NE = No Effect
8 - 21                                                      Financial Accounting, Second Canadian Edition
                        Question

 If the 2005 ending inventory is understated by
  $3,000, which of the following is true for 2005?
                         Inventory Eq’n says:
         Cost of goods sold = begin inv. + purch – End inv.
                => Cost of goods sold is overstated
a. Beginning Inventory was understated.
b. Cost of Goods Sold will be understated.
c. Gross Profit will be overstated. (sales – cost
  goods, will be understated)
d. (TRUE) Net Income will be understated. (NI =
  sales – cost goods sold – op expense)


8 - 22                                          Financial Accounting, Second Canadian Edition
                          Question
                    Errors in Measuring Inventory
                                   Ending is understated
If the 2005 ending inventoryInventory
                   which of the following
    by $3,000,Income Statement Overstated Understated is true
         Effect on
         Goods Available forfor 2005?
                             Sale  N/A       N/A
           Cost of Goods Sold           -             +
           Gross Profit                 +             -
a. Beginning Inventory was understated.
         Net Income                     +             -
         Effect on Balance Sheet
b. Cost of Goods Sold will be understated.
         Inventory (12/31)       +    -
           Profit will
c. GrossRetained Earnings be overstated.
                                 +    -

d. Net Income will be understated.

8 - 23                                       Financial Accounting, Second Canadian Edition
                   Question

  If the 2005 ending inventory is understated by
   $3,000, which of the following is true for 2006?

    In 2005, ending inv. Is understated by 3,000
a. (TRUE) Beginning Inventory was understated.
b. (TRUE) Cost of Goods Sold will be
  understated.
c. (TRUE) Gross Profit will be overstated. (sales
  – cogs)
d. (TRUE) All of the above.


8 - 24                           Financial Accounting, Second Canadian Edition
                           Question
    Remember: The ending
  If the 2005 ending inventory is understated
inventory for 2005 becomes the
      by $3,000, which of
 beginning inventory for 2006. the following is true
                              for 2006?

 a. Beginning Inventory was understated.
                                 Errors in Measuring Inventory
                                                     Beginning Inventory
 b. Cost of Goods Sold will be understated.         Overstated Understated

                          overstated. +
 c. Gross Profit will beEffect on Income for Sale
                        Goods Available
                                          Statement
                                                                    -
 d. All of the above. Cost of Goods Sold                +           -
                                   Gross Profit                             -             +
                                   Net Income                               -             +
                                   Effect on Balance Sheet
                                   Inventory (12/31)                     N/A             N/A
  8 - 25                           Retained Earnings                       -              +
                                                   Financial Accounting, Second Canadian Edition
         Inventory Costing Methods

          FIFO                      LIFO




         Weighted            Specific
         Average          Identification

8 - 26                    Financial Accounting, Second Canadian Edition
         Applying the Four Methods

              Total Dollar Amount of Goods
                    Available for Sale




         Ending Inventory      Cost of Goods Sold




8 - 27                              Financial Accounting, Second Canadian Edition
              First-In, First-Out
               “Conveyor Belt”
                                 Costs of
         Oldest Costs
                                Goods Sold



                                    Ending
         Recent Costs
                                   Inventory


8 - 28                       Financial Accounting, Second Canadian Edition
            First-In, First-Out

The schedule on the next screen shows the mouse
pad inventory for Computers, Inc.
The physical inventory count shows 1,200 mouse
pads in ending inventory.
Use the FIFO inventory method to determine:
          (1) Ending inventory cost.
          (2) Cost of goods sold.

 8 - 29                         Financial Accounting, Second Canadian Edition
                First-In, First-Out
                                                             Remember:
Beginning
                                                             The costs of
Inventory        1,000 $   5.25   $   5,250.00
                                                             most recent
Purchases:                                                  purchases are
Jan. 3            300      5.30       1,590.00                 in ending
June 20           150      5.60         840.00                inventory.
Sept. 15          200      5.80       1,160.00              Start with the
Nov. 29           150      5.90         885.00               purchase on
Goods                                                       11/29 and add
Available for                                                     units
Sale             1,800            $   9,725.00                purchased
Ending                                                       earlier until
Inventory        1200                  ?                    you reach the
                                                              number in
Cost of Goods
                                                                 ending
Sold              600                  ?
  8 - 30
                                                              inventory.
                                           Financial Accounting, Second Canadian Edition
                  First-In, First-Out
                                                           Cost of
         Date    Beg. Inv. Purchases    End. Inv.        Goods Sold
                1000 @5.25                                600@5.25
                                        400 @5.25
                            300 @5.3    300 @5.3
                            150 @5.6    150 @5.6
     Sept 15               200@$5,80 200@5.80
     Nov. 29               150@$5.90 150@$5.90
     Units                              150                       600

                                          total                  total

     cost of goods available for sale                           9,725

8 - 31                                     Financial Accounting, Second Canadian Edition
                 First-In, First-Out
                                                           Cost of
         Date   Beg. Inv.   Purchases   End. Inv.         Goods Sold




     Sept. 15               200@$5.80 200@$5.80
     Nov. 29                150@$5.90 150@$5.90
     Units                               350




8 - 32                                     Financial Accounting, Second Canadian Edition
                 First-In, First-Out
                                                           Cost of
         Date   Beg. Inv.   Purchases   End. Inv.         Goods Sold




     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                               500




8 - 33                                     Financial Accounting, Second Canadian Edition
                 First-In, First-Out
                                                           Cost of
         Date   Beg. Inv.   Purchases   End. Inv.         Goods Sold


     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                                 800




8 - 34                                     Financial Accounting, Second Canadian Edition
                  First-In, First-Out
                                                           Cost of
         Date     Beg. Inv. Purchases   End. Inv.         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.

8 - 35                                     Financial Accounting, Second Canadian Edition
                  First-In, First-Out
                                                           Cost of
         Date     Beg. Inv. Purchases   End. Inv.         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

8 - 36                                     Financial Accounting, Second Canadian Edition
             Last-In, First-Out

                                   Ending
         Oldest Costs
                                  Inventory



                                Cost of
         Recent Costs
                               Goods Sold


8 - 37                     Financial Accounting, Second Canadian Edition
                 Last-In, First-Out

The schedule on the next screen shows the mouse
pad inventory for Computers, Inc.
The physical inventory count shows 1,200 mouse
pads in ending inventory.
Use the LIFO inventory method to determine:
          (1) Ending inventory cost.
          (2) Cost of goods sold.

 8 - 38                                Financial Accounting, Second Canadian Edition
                 Last-In, First-Out
               Computers, Inc.
             Mouse Pad Inventory                            Remember: The
    Date        Units       $/Unit   Total Cost                costs of the
Beginning                                                         oldest
Inventory         1,000 $     5.25   $   5,250.00           purchases are in
Purchases:                                                        ending
Jan. 3             300        5.30       1,590.00            inventory. Start
June 20            150        5.60         840.00            with beginning
Sept. 15           200        5.80       1,160.00             inventory and
Nov. 29            150        5.90         885.00               add units
Goods
                                                            purchased until
Available for
                                                              you reach the
Sale              1,800              $   9,725.00
                                                                number in
Ending                                                            ending
Inventory         1200                    ?                     inventory.
Cost of
   8 - 39                                     Financial Accounting, Second Canadian Edition
Goods Sold         600                    ?
                   Last-In, First-Out
                                                         Cost of
         Date     Beg. Inv. Purchases End. Inv.         Goods Sold
                1,000@$5.25          1,000@$5.25




    Units                               1,000




8 - 40                                    Financial Accounting, Second Canadian Edition
                   Last-In, First-Out
                                                         Cost of
         Date     Beg. Inv. Purchases End. Inv.         Goods Sold
                1,000@$5.25          1,000@$5.25
    Jan. 3                  300@$5.30 200@$5.30




    Units                               1,200

          Now, we have allocated
         the cost to all 1,200 units
            in ending inventory.

8 - 41                                    Financial Accounting, Second Canadian Edition
                   Last-In, First-Out
                                                         Cost of
         Date     Beg. Inv. Purchases End. Inv.         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




8 - 42                                    Financial Accounting, Second Canadian Edition
                   Last-In, First-Out
                                                         Cost of
         Date     Beg. Inv. Purchases End. Inv.         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

8 - 43                                    Financial Accounting, Second Canadian Edition
              Weighted-Average

    Weighted-average cost (WAC) per unit
             Cost of goods available for sale
            Number of units available for sale

                  Ending Inventory
         Units in Ending Inventory  WAC per Unit


                 Cost of Good Sold
               Units Sold  WAC per Unit
8 - 44                                Financial Accounting, Second Canadian Edition
                Weighted-Average

The schedule on the next screen shows the mouse
pad inventory for Computers, Inc.
The physical inventory count shows 1,200 mouse
pads in ending inventory.
Use the weighted-average inventory method to
determine:
          (1) Ending inventory cost.
          (2) Cost of goods sold.
 8 - 45                                Financial Accounting, Second Canadian Edition
                 Weighted-Average
                        Computers, Inc.
                      Mouse Pad Inventory
             Date        Units   $/Unit Total Cost
         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         1200                         ?
         Cost of
8 - 46                                  Financial Accounting, Second Canadian Edition
         Goods Sold         600                         ?
              Weighted-Average

    Weighted-Average Cost per Unit:
        COGAS = $9,725
                          = $5.40278
         # units   1,800

    Ending Inventory:
          1,200 Units × $5.40278 = $6,483*

    Cost of Goods Sold:
          600 Units × $5.40278 = $3,242*
8 - 47   * Rounded               Financial Accounting, Second Canadian Edition
          Specific Identification
 • Specific cost of each
   inventory item is known.

 • Not always used. Used
   for big inventory items.

 • Used with small volume,
   high dollar inventory.
 • Directly trace all the
   costs to that job so that
   the customer pays for the
   options they chose.


8 - 48                         Financial Accounting, Second Canadian Edition
            Comparison of Methods
                            Computers, Inc.
                          Income Statement
                  For Year Ended December 31, 2005
                                   Weighted
                                   Average          FIFO            LIFO
Net sales (always the same)        $ 25,000     $ 25,000        $ 25,000
Cost of goods sold: (same)
Merchandise inventory, 12/31/2004 $     5,250   $ 5,250         $ 5,250
Net purchases                           4,475         4,475            4,475
Goods available for sale           $    9,725   $ 9,725         $ 9,725
Merchandise inventory, 12/31/2005       6,483         6,575            6,310
Cost of goods sold                 $    3,242   $ 3,150         $ 3,415
Gross profit from sales            $ 21,758     $ 21,850        $ 21,585
Operating expenses:                       750           750               750
Income before taxes                $ 21,008     $ 21,100        $ 20,835
Income taxes expense (30%)              6,302         6,330            6,251
  8 - 49
Net income                                      $ Accounting, $ 14,585
                                   $ 14,706 Financial14,770 Second Canadian Edition
          Comparison of Methods
    In periods of rising prices, FIFO
                          Computers, Inc.
      results in the highest ending
                        Income Statement
                For profit, tax expense,
 inventory, gross Year Ended December 31, 2005
                                 Weighted
 and net income, and the lowest cost
                                 Average    FIFO                          LIFO
Net sales    of goods sold. $ 25,000 $ 25,000                           $ 25,000
Cost of goods sold:
Merchandise inventory, 12/31/04   $    5,250      $     5,250           $     5,250
Net purchases                          4,475            4,475                 4,475
Goods available for sale          $    9,725      $     9,725           $     9,725
Merchandise inventory, 12/31/05        6,483            6,575                 6,310
Cost of goods sold                $    3,242      $     3,150           $     3,415
Gross profit from sales           $   21,758      $    21,850           $    21,585
Operating expenses:                      750              750                   750
Income before taxes               $   21,008      $    21,100           $    20,835
Income taxes expense (30%)             6,302            6,330                 6,251
Net income                        $   14,706      $    14,770           $    14,585
* Tax expense amounts were rounded.
8 - 50                                         Financial Accounting, Second Canadian Edition
          Comparison of Methods
                           Computers, Inc.
         In periods of rising prices, LIFO results
                         Income Statement
                 lowest Ended December 31, 2004
          in the For Year ending inventory, gross
                                  Weighted
           profit, tax expense, and net income,
                                  Average      FIFO                       LIFO
Net sales                              goods $ 25,000
           and the highest cost of25,000 sold.
                                 $                                      $ 25,000
Cost of goods sold:
Merchandise inventory, 12/31/04   $    5,250       $    5,250           $      5,250
Net purchases                          4,475            4,475                  4,475
Goods available for sale          $    9,725       $    9,725           $      9,725
Merchandise inventory, 12/31/05        6,483            6,575                  6,310
Cost of goods sold                $    3,242       $    3,150           $      3,415
Gross profit from sales           $   21,758       $   21,850           $     21,585
Operating expenses:                      750              750                    750
Income before taxes               $   21,008       $   21,100           $     20,835
Income taxes expense (30%)             6,302            6,330                  6,251
Net income                        $   14,706       $   14,770           $     14,585
* Tax expense amounts were rounded.
8 - 51                                         Financial Accounting, Second Canadian Edition
                          Exercise 8-12
   •     If fifo was the only method used, then inventories would have
         been 1.2 billion dollars higher.
   •     Lifo/fofo EI = 6818.8
   •     Fifo only EI = 8051.8
   •     That tells us that individual prices were going up, because Fifo
         uses most recent costs for ending inventory




8 - 52                                               Financial Accounting, Second Canadian Edition
                         Exercise 9-13
   •     Lower of cost and market principal
   •     ITEM         QTY             FIFO              MARKET
   •     A            50              x15 = 750         x13 = 650
   •     B            75              x40 = 3000        x40 = 3000
   •     C            10              x50 = 500         x52 = 520
   •     D            30              x30 = 900         x30 = 900
   •     E            400             x8 = 3200         x6 = 2400
                                      8350              7470

   How do we apply “LCM” rule? Inventory wide, division wide,
     individual products? Here we use item by item.
   Most conservative application is the Item by Item application of the
     LCM rule because each individual line item will always be the
     lowest.


8 - 53                                             Financial Accounting, Second Canadian Edition
            Lower of Cost or Market
          Ending inventory is reported at the
            lower of cost or market (LCM).

                          Market is either
  Net Realizable Value                      Replacement Cost
The expected sales price           or     The current purchase
   less selling costs.                   price of identical goods.


     http://www.potashcorp.com/investor_relations/financial_reports/#

 8 - 54                                        Financial Accounting, Second Canadian Edition
                 Inventory Turnover

    Inventory Turnover
                                 Cost of Goods Sold
                Inventory
                          =
                Turnover
                                  Average Inventory

             Average Inventory is . . .
(Beginning Inventory + Ending Inventory) ÷ 2


          This ratio is often used to measure the liquidity
                (nearness to cash) of the inventory.

 8 - 55                                     Financial Accounting, Second Canadian Edition
           Inventory Turnover
Inventory Turnover
          Inventory           Cost of Goods Sold
          Turnover =
                               Average Inventory
           The 2004 inventory turnover ratio
                  for Dell Computer:

                    $40,190
                                      = 102.3
              ($327 + $459) ÷ 2

               2004 Inventory Turnover Comparison
          Dell               Gateway              IBM
         102.80                21.50             20.60
8 - 56                                     Financial Accounting, Second Canadian Edition
            Focus on Cash Flows

             Add   Increase in Inventory
                   Decrease in Accounts
                         Payable

Cost of                                                      Cash
Goods                                                     Payment to
 Sold                                                      Suppliers

                   Decrease in Inventory
                   Increase in Accounts
          Subtract       Payable

8 - 57                               Financial Accounting, Second Canadian Edition