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```									                   MBA
Managerial Accounting

Merchandise Inventory and Cost
of Goods Sold

Atiq ur Rahman
Inventory and Cost of Goods Sold
 Inventory
 Products purchased or manufactured for Sale to
Customers
 Beginning Inventory
 Quantities of Merchandise on hand
 Purchases
 New Purchases or Manufactured products
 Available for Sale = Beginning Inventory +
Purchases
 Most that a company can sell during an accounting
period
 Ending Inventory
 Remaining Unsold Merchandise
 Cost of Goods Sold
 Cost of Inventory Sold during accounting Period
Purchases consist of the following:

Purchase price of the inventory \$600,000
+ Freight-in (delivery charges)     4,000
– Purchase returns               – 25,000
– Purchase allowances            – 5,000
– Purchase discounts             – 14,000
= Net purchases of inventory    \$560,000
Calculation
Cost of Beginning     Cost of Beginning
Inventory              Inventory
+Cost of Purchases      +Cost of Purchases
___________________     ___________________
=Cost of Goods          =Cost of Goods
Available for Sale     Available for Sale
- Cost of Ending        - Cost of Goods Sold
Inventory            ___________________
___________________     =Cost of Ending
=Cost of Goods Sold       Inventory
Inventory vs Cost of Goods Sold

Inventory                           Cost of Goods Sold
Beginning     Inventory Sold         Inventory Sold

Purchases

Ending

As Inventory is Sold we remove it’s cost from the Asset side of A=L+E and
Insert it’s cost into an Expense on the Equity side of A = L + E

This property exists for all Assets: As they are used up or sold the cost
Transfers from the Balance Sheet as a Future Economic Resource (Asset)
To the Income Statement as an Expense incurred to generate Revenue
Relationship between Balance Sheet and
Income Statement
Income Statement Items:
Sales revenue is based on sale price of
Inventory sold.
Cost of goods sold is based on cost of
Inventory sold.
Gross profit (gross margin) is sales revenue
less cost of goods sold.
Balance Sheet Item:
Inventory on the balance sheet is based on
cost.
Inventory Accounting Systems
Periodic system
Does not keep a running record of all goods
bought and sold.
Inventory counted at least once a year
Used for inexpensive goods
Perpetual system
Keeps a running record of all goods bought and
sold.
Inventory counted at least once a year.
Used for all types of goods.
Accounting for Inventory

Inventory          Number of units of       Cost per unit
=                        X
(balance sheet)       inventory on hand        of inventory

Cost of Goods Sold   Number of units of         Cost per unit
=                        X
(income statement)     inventory sold           of inventory
Recording Transactions and the T-Accounts

General Journal
Date        Accounts and Explanations      PR   Debit     Credit
Inventory                                560,000
Accounts Payable                                 560,000
Purchased inventory on account

Inventory                   Accounts Payable
Beg. 100,000                                560,000
560,000
Recording Transactions
and the T-Accounts

Sale on account \$900,000 of Inventory
which cost \$540,000:

General Journal
Date      Accounts and Explanations      PR   Debit     Credit
Accounts Receivable                    900,000
Sales Revenue                                 900,000
Cost of Goods Sold                     540,000
Inventory                                      540,000
Recording Transactions
and the T-Accounts

Inventory       Cost of Goods Sold
Beg. 100,000 540,000     540,000
560,000
120,000
Reporting in the
Financial Statements
Income Statement (partial)
Sales revenue                  \$900,000
Cost of goods sold               540,000
Gross profit                   \$360,000

Ending Balance Sheet (partial)
Current assets:
Cash                            \$ XXX
Short-term investments             XXX
Accounts receivable, net           XXX
Inventory                    120,000
Prepaid expenses                   XXX
Managerial Accounting
Inventory Cost Methods
Inventory Costing

Sum of all costs incurred to bring asset to
its intended use
Methods for determining per unit Inventory
Cost
Specific unit cost
Average cost
First-in, first-out (FIFO) cost
Last-in, first-out (LIFO) cost
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
Illustrative Data

Beginning inventory (10 units @ \$10)     \$ 100
No. 1 (25 units @ \$14 per unit)    \$350
No. 2 (25 units @ \$18 per unit)      450
Total purchases                            800
Cost of goods available for sale         \$ 900

Ending inventory:                      20 units
Cost of goods sold:                    40 units
Specific Unit Cost
 Identify each inventory unit and determine the
cost
Of the 20 Units left, how many came from the:
Of the 40 Units sold, how many came from the:
 \$10, \$14, or \$18 purchase
Multiply each unit by that specific units cost
 For example if we assume:
Inventory: 10@10, 5@14 and 5@18
 Inventory = \$260
Cost of Goods Sold: 20@14 and 20@18
 CGS = \$640
Average Costing
Cost of Goods Available
Average Cost
=
per unit
Number of units available

Inventory (at average cost)
Beg Bal (10 units @ \$10)   100
Purchases:
25 units @ \$14             350      Cost of goods sold (40 units
25 units @ \$18             450      @ average cost of \$15
per unit                     600

Ending Bal (20 units
@ average cost of \$15
per unit                   300
Weighted-Average

\$900 total cost ÷ 60 units = \$15/unit

Ending inventory = 20 × \$15 = \$300

Cost of goods sold = 40 × \$15 = \$600
FIFO
First costs into inventory are first costs assigned to cost of
goods sold.

Inventory (at FIFO cost)
Beg Bal (10 units @ \$10)   100
Purchases:                       Cost of goods sold (40 units):
25 units @ \$14             350   (10 units @ \$10 = 100)
25 units @ \$18             450   (25 units @ \$14 = 350)
( 5 units @ \$18 = 90)        540

Ending Bal
(20 units @ \$18)           360
LIFO
Last costs into inventory are first costs assigned to cost of
goods sold.

Inventory (at LIFO cost)
Beg Bal (10 units @ \$10)   100
Purchases:
25 units @ \$14             350
Cost of goods sold (40 units):
25 units @ \$18             450
(25 units @ \$18 = 450)
(15 units @ \$14 = 210)       660
Ending Bal
(10 units @ \$10 = 100)
(10 units @ \$14 = 140)     240
Income Effects of
Inventory Methods
Assumed                              Cost of
Sales                               Goods         Gross
Revenue                               Sold         Profit
Specific unit cost                                \$1,000                 –           640      =   \$360
Weighted-average                                  \$1,000                 –           600      =   \$400
FIFO                                              \$1,000                 –           540      =   \$460
LIFO                                              \$1,000                 –           660      =   \$340

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.
Other Issues

Tax advantages of LIFO in periods of
rising prices
Higher Cost of Goods Sold = Lower Net Income
= Lower Income Taxes
Inventory Method & managing income
International issue – LIFO not allowed in
some countries
Inventory Errors

Each inventory error affects:
Inventory
Cost of goods sold
Gross profit
Net income
Inventory Errors

Period 1                  Period 2
Cost of      Gross Profit Cost of      Gross Profit
Inventory Error      Goods Sold and Net Income Goods Sold and Net Income
Period 1 Ending
inventory overstated    Understated   Overstated    Overstated    Understated

Period 1 Ending
inventory understated   Overstated    Understated   Understated   Overstated
I. M. Sciences MBA
Managerial Accounting
More accounting Principles and
Concepts
Accounting Principles
 Consistency principle
 Same Accounting Methods from Period to Period
 Accounting Changes must be disclosed
 Effect of accounting Change must be disclosed
 Disclosure principle
 Enough information must be reported for stakeholders to make
informed decisions
 Relevant, Reliable, and Comparable Information
 Accounting conservatism
 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:
Lower of Cost or Market
 Lower-of-Cost-or-Market rule (LCM)
 Inventory is reported at the lowest value
 Historical Cost
 Or Market (Replacement Cost)
 Inventory is below cost
 Record an increase in Cost of Goods Sold (debit)
 Record the reduction in Inventory (credit)

 To record a \$1,000 decline in inventory value

Cost of Goods Sold                                       1,000
Inventory                                                   1,000
Wrote inventory down to market value
MBA I.M. Sciences
Managerial Accounting
Inventory Ratios
Ratios

Gross Profit           Gross Profit
=
Percentage          Net Sales Revenue

Inventory       Cost of goods sold
=
Turnover        Average Inventory
Ratios

Gross Profit
Profit indicator
Inventory Turnover – Liquidity ratio
How quickly is Inventory Sold?
IMSciences MBA
MAnagerial Accounting
Estimating Inventory and/or
Cost of Goods Sold using
Gross Profit
Gross Profit Method

Gross profit method is a way to estimate
inventory based on the cost of goods sold
model.
Also called gross margin method.
Calculation
Cost of Beginning     Cost of Beginning
Inventory              Inventory
+Cost of Purchases      +Cost of Purchases
___________________     ___________________
=Cost of Goods          =Cost of Goods
Available for Sale     Available for Sale
- Cost of Ending        - Cost of Goods Sold
Inventory            ___________________
___________________     =Cost of Ending
=Cost of Goods Sold       Inventory
Calculation Continued

Sales – Cost of Goods Sold = Gross Profit
Gross Profit% = Gross Profit / Sales
Cost of Goods Sold = Sales x (1- Gross Profit%)
Estimate CGS using GP%

We know Beginning Inventory = 14,000
We know Purchases =           66,000
We know Sales =              100,000
We know Gross Profit % =           43%

We Don’t know Cost of Goods Sold
We Don’t know Ending Inventory
Gross Profit Method
Beginning inventory                \$14,000
Purchases                           66,000
Goods available                     80,000
Cost of goods sold:
Net sales revenue \$100,000
Less estimated
gross profit 43%    (43,000)
Estimated cost of goods sold       57,000
Estimated cost of ending inventory \$23,000
The End

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