ACCT 209 1nd Edition Lecture 7 Outline of Last Lecture I The Accounting Cycle II Closing Entries III Financial Statements IV Using the Financial Statements V Types of companies VI Inventory systems VII Purchasing Inventory a Example VIII Calculating Costs of goods sold a Example IX Inventory Cost Flow methods Outline of Current Lecture a Example of Inventory Cost Flow b Comparing inventory Cost Flow Methods X Other Inventory Issues a Example of Inventory Errors XI Estimating ending inventory Current Lecture Example Inventory cost flow valuation methods Units Purchase price Total purchase per unit Beginning inventory 10 5 50 Oct 2 8 6 48 Oct 5 5 9 45 Oct 21 GAFS 7 30 10 70 Purchases These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute 213 Ending inventory 12 18 Determine the dollar amount that will be assigned to the ending inventory and cost of goods sold using a weighted average method Weighted average cost unit Total Goods Available for Sale GAFS Total GAFS 213 30 7 1 Cost of goods sold COGS Average cost unit GAFS Ending Inventory units 7 1 18 127 8 Ending Inventory Average Cost Unit Ending Inventory Units 7 1 12 85 20 b FIFO COGS Units Purchase price per unit Total Price Beginning 10 5 50 Oct 2 8 6 48 Must add to 18 98 Ending Inventory Units Purchase price per unit Total Price Oct 21 7 10 70 Oct 5 5 9 45 Must add to 12 115 Note both of these added will be equal to Total Purchase 115 98 213 c LIFO COGS Units Purchase price per unit Total Price Oct 21 Oct 5 Part of Oct 2 Must add to 7 5 6 18 10 9 6 70 45 36 151 Ending Inventory EI Units Purchase price per unit Total Price Rest of Oct 2 2 6 12 Beginning 10 5 50 Must add to 12 62 Note both of these added will be equal to Total Purchase 151 62 213 Consistency Principle Once a Company picks a method they need to stay with the same method FIFO Always expenses oldest costs Most recent costs left in EI LIFO Always expenses most recent costs Oldest costs left in EI This means when costs are going up COGS is going to be lower than EI in FIFO The opposite is true when costs are going down Comparing inventory cost flows methods FIFO Does a good job of reporting current cost on balance sheet Most recent costs assigned to inventory But older costs matched against revenue LIFO Does a good job of matching current cost against revenue on income statement Potentially VERY outdated costs are reported on balance sheet for inventory LIFO liquidation Other inventory issues a Errors Usually in physical count Consignment another party owns it you are merely selling it for them Don t count this in your inventory because you don t own it If COGS is wrong then EI is wrong too Effect of inventory errors on financial statements Year of event Both EI and COGS wrong Next year Since Beginning inventory is wrong COGS wrong Example Inventory Errors Aggie Company s accountant prepared the following partial income statement for the year ended December 31 2011 Original Given Sales revenue Cost of goods sold Beginning inventory 42 Net purchases and freight 266 Less ending inventory 62 Cost of goods sold Gross profit 600 Corrected 600 42 266 38 246 354 270 330 However the company s accountant later learned that ending inventory was accidentally overstated by 24 1 What is the correct amount for cost of goods sold and gross profit COGS 270 Gross Profit 330 2 How would the error described above affect Aggie Company s cost of goods sold and gross profit for 2012 if the error is not discovered and corrected Beginning Inventory This Year Next Year Net Purchases Goods Available for Sale Ending Inventory Cost of Goods Sold COGS is understated while gross profit is over stated b Lost stolen items and inventory shrinkage Periodic System Physical count determines of units left Sodl All units not on hand are assumes to have been sold Perpetual System More control Can compare inventory record with physical count Normal is included in COGS Abnormally high then there was Inventory loss c Lower of cost or market Conservative principle Report the lower cost between Cost What we paid for the inventory Market Current replacement costs Write down inventory inventory loss Periodic and perpetual should have annual inventory count Note Do not worry about retail method Can omit on homework d Estimating ending inventory May be necessary for a interim accounting periods when cost of taking physical inventory is too high b cases of inventory loss due to factors such as theft fire or other casualty Example Gross profit method of estimating ending inventory Doyal Banana Company owns a warehouse in Houston Texas The warehouse is located near railroad tracks to allow for easy access to shipping Recently a traveling circus was traveling by train to their winter home in Florida when the train derailed Fortunately there were no fatalities but the car that housed the circus s monkeys was damaged and all of the monkeys escaped They then broke into the Doyal s Warehouse and ate the entire contents Doyal has the following information available Beginning inventory Purchases Sales to date 400 900 1 600 Last year Doyal reported sales of 7 000 and gross profit of 2 100 Estimate the dollar value of the inventory destroyed by the monkeys GP GP Sales 2100 7000 30 Estimate GP 30 1600 480 Sales COGS GP 1600 X 480 Solve for x x 1120 Estimate Beginning Inventory Net Purchases Goods Available for Sale Ending Inventory Cost of Goods Sold 400 900 1300 X 1120 Solve for x x 180 Using inventory information Measures of efficiency and effectiveness in inventory management Inventory turnover COGS Average Inv COGS Beginning Inv End Inv 2 Days sales in inventory Avg Inv COGS 365