Slide 1 Chapter 6 Inventories and Cost of Sales Slide 2 Merchandise inventory includes all goods that a company owns and holds for sale regardless of where the goods are located when inventory is counted We must pay special attention to include inventory that we own but that is in transit or on consignment We should also consider the condition of inventory that is damaged or obsolete when determining a cost for the inventory Slide 3 Transportation costs are sometimes included in the cost of Merchandise Inventory The FOB terms designate when title passes and who pays the transportation costs FOB stands for Free On Board So if the shipping terms are Free On Board shipping point that means that ownership transfers from the seller to the buyer when the seller provides the goods to the carrier It also means the buyer will pay all transportation costs In this case the transportation costs will be added to the merchandise inventory account On the other hand if the shipping terms are Free On Board destination that means that ownership transfers from the seller to the buyer when the buyer receives the goods It also means the seller will pay the transportation costs Slide 4 Goods on consignment are goods that we own but that are on display for sale at another place of business Even though these goods are not in our physical possession we still have ownership of them and should include them in our inventory count Slide 5 Damaged and obsolete goods are not counted in inventory if they cannot be sold If these goods can be sold at a reduced price they are included in inventory at a conservative estimate of their net realizable value Net realizable value is the sales price minus the cost of making the sale Slide 6 The cost of inventory includes any cost that is necessary and reasonable to get the inventory to your place of business and to get it in a salable condition We already know that the invoice price and transportation costs are included in the total cost of inventory Other costs to include are insurance storage and import duties Any purchase discounts or allowances received reduce the cost of the inventory purchased Slide 7 Most companies take a physical count of inventory at least once a year Theoretically the physical count should match the number of items in our inventory records In reality this is not the case The physical count may not match our records due to spoilage breakage damage obsolescence and theft The physical count helps us get our records up to date to reflect what we actually have on hand A company has adequate internal controls over the inventory count if 1 it uses pre numbered inventory tags 2 inventory counters have no responsibility for inventory 3 the count confirms the existence amount and quality of inventory items counted 4 a second count of the inventory is made and 5 a count supervisor confirms that all items in inventory have been counted Slide 8 Inventory transactions impact both the balance sheet and the income statement Ending Inventory is reported as a current asset on the balance sheet and cost of goods sold is reported on the income statement The matching principle requires matching costs with sales Slide 9 Management decisions in accounting for inventory involve the following Items included in inventory and their costs Costing method specific identification FIFO LIFO or weighted average Inventory system perpetual or periodic Use of market values or other estimates Choices made concerning these four points affect the reported amounts for inventory cost of goods sold gross profit income current assets and other accounts Four methods are commonly used to assign costs to inventory and to cost of goods sold 1 specific identification 2 first in first out 3 last in first out and 4 weighted average The graph on this slide shows the frequency in the use of these methods Each method assumes a particular pattern for how costs flow through inventory Each of these four methods is acceptable whether or not the actual physical flow of goods follows the cost flow assumption Slide 10 We must make assumptions about the inventory cost flow First in first out assumes costs flow in the order incurred Last in first out assumes costs flow in the reverse order incurred Weighted average assumes costs flow at an average of the costs available Slide 11 Take a minute and review this chart We will use these data throughout our inventory examples so we can compare our results at the end The inventory information is provided by Trekking a sporting goods retailer Data for the month of August includes 1 beginning inventory 2 purchases and 3 sales Slide 12 First let s look at the specific identification method In this method we know the specific cost of each unit that is sold It is most commonly used in businesses that have low sales volume of high dollar items like car dealerships exclusive jewelry stores and custom builders On August 14th Trekking sold 8 bikes that cost 91 each and 12 bikes that cost 106 The total cost of goods sold on this date is 2 000 That leaves in inventory 2 bikes that cost 91 each and 3 bikes that cost 106 each Slide 13 On August 31 Trekking sold 23 bikes with the cost per unit shown on your screen The total cost of good sold on this date is 2 582 Using the specific identification method on August 31 there are 12 units in inventory at 1 408 5 units at 115 each plus 7 units at 119 each Trekking would report Cost of Goods Sold on its August income statement of 4 582 and report Inventory on its balance sheet of 1 408 Slide 14 Here are the entries to record the purchases and sales discussed previously the colored boldface numbers are those impacted by the cost flow assumption All purchases and sales are made on credit The selling price of inventory on August 14 was 130 per unit sold and the selling price for the August 31 sale was 150 per unit sold Slide 15 The first in first out method is abbreviated as FIFO and pronounced as Fifo When using FIFO we assign the older costs to the units sold That leaves the more recent costs to be used to value ending inventory Slide 16 For the August 14 sale the company first assigns the cost of the 10 oldest inventory items from beginning inventory on August 1 at 91 each Now we need 10 more units so we move down to the next purchase on August 3 and include the cost of 10 units from this purchase at 106 The Cost of Goods Sold for August 14 is 1 970 910 plus 1 060 After this sale there are 5 units left in inventory at a cost of