NU ACCT 1201 - Chapter 7: Reporting and interpreting cost of goods sold

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Chapter 7: Reporting and interpreting cost of goods sold and inventoryCost principle: requires that inventory be recorded at the price paid or the consideration given.- Invoice price + Inspection costs + Freight in + Preparation costs Beginning inventory + Purchases = Goods Available for SaleGoods Available for Sale – Ending inventory (inventory remaining) = Cost of goods sold (inventory sold)Inventory systemsPerpetual Periodic (end of accounting period)- Purchase transactions are recorded directly in an inventory account.- No up-to-date record of inventory is maintained during the year.- Sales require two entries to record: (1) the retail sale and (2) the cost of goods sold. - Sales require one entry to record the retail sale. Cost of goods sold is calculated. Beginning Inventory + Net Profit = Ending inventory + COGSBeginning inventory + Net Profit – Ending inventory = COGSPerpetual inventory systems and cost flow assumptions in practice- FIFO inventory and cost of goods sold are the same whether computed on a perpetual or periodic basis.- Accounting systems that keep track of the costs of individual items normally do so on a FIFO or average cost basis.- As a consequence, companies that wish to report under LIFO convert the outputs of their perpetual inventory system to LIFO with an adjusting entry at the end of each period. Valuation at Lower of Cost or Market- Ending inventory is reported at the lower of cost or market (LCM). - Replacement Cost : The current purchase price for identical goods.- Conservative practice: The company will recognize a “holding” loss in the current period rather than the period in which the item is sold.(Beginning Inventory + Ending Inventory) ÷ 2This ratio reflects how many times average inventory was produced and sold during the period. A higher ratio indicates that inventory moves more quickly thus reducing storage and obsolescence costs. This ratio reflects the average time in days it takes a company to produce and deliver inventory to its customers.Cost Flow Assumptions: The choice of an inventory costing method is not based on the physical flow of goods on and off the shelvesFlow of inventory costInventory Costing Methods1. Specific Identification: When units are sold, the specific cost of the unit sold is added to cost of goods sold.2. First-in, First-out (FIFO)Oldest cost = COGSRecent cost = Ending inventory 3. Last-in, First-out (LIFO) Oldest cost = Ending inventoryRecent cost = COGS4. Weighted Average: When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. Cost of Goods Available for SaleNumber of Units Available for SaleManagers Choice of Inventory MethodsNet Income Effects: Managers prefer to report higher earnings for their companies.Income Tax Effects: Managers prefer to pay the least amount of taxes allowed by law as late as possible.LIFO Conformity Rule: If last-in, first-out is used to compute taxable income, it must also be used to calculate inventory and cost of goods sold for financial statements.Advantages of MethodsFirst-In, First-Out Ending inventory approximates current replacement cost.Last-In, First-Out Better matches current costs in cost of goods sold with revenues.Weighted Average Smooths out effects of price changes.Financial statement effects of inventory costing methodsHarley-DavidsonModel A Leather Jacket InventoryDate Units $/Unit TotalBeginning Inventory2 70$ 140$ Purchases:Jan. 12 4 80$ 320$ Jan. 14 1 100$ 100$ Goods Available for Sale7 560$ Harley-DavidsonModel A Leather Jacket InventoryDate Units $/Unit TotalBeginning Inventory2 70$ 140$ Purchases:Jan. 12 4 80$ 320$ Jan. 14 1 100$ 100$ Goods Available for Sale7 560$ Harley-DavidsonModel A Leather Jacket InventoryDate Units $/Unit TotalBeginning Inventory2 70$ 140$ Purchases:Jan. 12 4 80$ 320$ Jan. 14 1 100$ 100$ Goods Available for Sale7 560$ Harley-DavidsonModel A Leather Jacket InventoryDate Units $/Unit TotalBeginning Inventory2 70$ 140$ Purchases:Jan. 12 4 80$ 320$ Jan. 14 1 100$ 100$ Goods Available for Sale7 560$ Harley-DavidsonModel A Leather Jacket InventoryDate Units $/Unit TotalBeginning Inventory2 70$ 140$ Purchases:Jan. 12 4 80$ 320$ Jan. 14 1 100$ 100$ Goods Available for Sale7 560$ Harley-DavidsonModel A Leather Jacket InventoryDate Units $/Unit TotalBeginning Inventory2 70$ 140$ Purchases:Jan. 12 4 80$ 320$ Jan. 14 1 100$ 100$ Goods Available for Sale7 560$ Goods available for sale$560Cost of goods sold$300Ending inventory$260Goods available for sale$560Cost of goods sold$340Ending inventory$220Goods available for sale$560Cost of goods sold$320Ending inventory$240Increasing costs: normal financial statement effects:FIFO LIFOCost of goods sold on income statement↓ ↑Net income↑ ↓Income taxes↑ ↓Inventory on balance sheet↑ ↓International Perspective LIFO and International Comparisons- While U.S. GAAP allows companies to choose between FIFO, LIFO, and weighted average inventory methods, International Financial Reporting Standards (IFRS) currently prohibit the use of LIFO.- GAAP allows different inventory accounting methods to be used for different types of inventory items. - IFRS requires that the same method be used for all inventory items that have a similar nature and use. - These differences can create comparability problems when one attempts to compare companies across international


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NU ACCT 1201 - Chapter 7: Reporting and interpreting cost of goods sold

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