Acct 230 1st Edition Lecture 18 Outline of Last Lecture I Notes Receivable Outline of Current Lecture II Inventory and Cost of Goods Sold a Understanding Inventory and Cost of Goods Sold Current Lecture III Understanding Inventory and Cost of Goods Sold a Trace the flow of inventory costs from manufacturing companies to merchandising companies i Many companies earn revenues by selling inventory rather than a service These companies are either manufacturing or merchandising companies ii Merchandising Companies 1 Merchandising companies purchase inventories that are primarily in finished form for resale to customers 2 These companies may assemble sort repackage redistribute store refrigerate deliver or install the inventory but they don t manufacture it They simply serve as intermediaries in the process of moving inventory from the manufacturer the company that actually makes the inventory to the end user iii Manufacturing Companies 1 These companies manufacture the inventories they sell rather than buying them in finished form from suppliers 2 Manufacturers classify inventory into three categories 3 Raw materials inventory Includes the cost of components that will become part of the finished product but have not yet been used in production 4 Work in process inventory Refers to the products that have started the production process but are not yet complete at the end of the period 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 5 Finished goods inventory It includes the cost of the units that have been completed by the end of the period but not yet sold iv Inventory Paths 1 Inventory s journey begins when manufacturing companies purchase raw materials hire workers and incur manufacturing overhead during production Once the products are finished manufacturers normally pass inventories to merchandising companies whether wholesalers or retailers Merchandising companies then sell inventories to you the end user In some cases manufacturers may sell directly to end users 2 Some companies provide both services and inventories to customers 3 In this chapter we focus on merchandising companies both wholesalers and retailers Still most of the accounting principles and procedures discussed here also apply to manufacturing companies We don t attempt to address all the unique problems of accumulating the direct costs of raw materials and labor and allocating manufacturing overhead We leave those details for managerial and cost accounting courses Instead we focus on the financial reporting implications of inventory cost flows b Calculate cost of goods sold i Inventory represents the cost of inventory not sold while cost of goods sold represents the cost of inventory sold ii Also referred to as cost of sales cost of merchandise sold or cost of products sold iii The costs of beginning inventory plus additional purchases make up the cost of goods or inventory available for sale iv The costs of beginning inventory plus the additional purchases during the year make up the cost of inventory cost of goods available for sale v Remember that inventory represents the cost of inventory not sold while cost of goods sold represents the cost of inventory sold Thus we can see that the amount reported for inventory turns into the amount reported for cost of goods sold once the inventory is sold c Determine the cost of goods sold and ending inventory using different inventory cost methods i To this point we ve discussed the cost of inventory without considering how we determine that cost We do that now by considering four methods for inventory costing 1 First In first Out FIFO a We assume that all units from beginning inventory 100 units and the April 25 purchase 300 units were sold For the final 400 units sold we split the October 19 purchase of 600 units into two groups 400 units assumed sold and 200 units assumed not sold We calculate cost of goods sold as the units of inventory assumed sold times their respective unit costs That is 100 7 300 9 400 11 in our example Similarly ending inventory equals the units assumed not sold times their respective unit costs 200 11 in our example b The amount of cost of goods sold Mario reports in the income statement will be 7 800 The amount of ending inventory in the balance sheet will be 2 200 c You may have realized that we don t actually need to directly calculate both cost of goods sold and inventory Once we calculate one the other is apparent Because the two amounts always add up to the cost of goods available for sale 10 000 in our example knowing either amount allows us to subtract to find the other d Realize too that the amounts reported for ending inventory and cost of goods sold do not represent the actual cost of inventory sold and not sold e Companies are allowed to report inventory costs by assuming which units of inventory are sold and not sold even if this does not match the actual flow 2 Last In first Out LIFO a Using the last in first out LIFO method we assume that the last units purchased the last in are the first ones sold the first out b If Mario sold 800 units we assume all the 600 units purchased on October 19 the last purchase were sold along with 200 units from the April 25 purchase That leaves 100 of the units from the April 25 purchase and all 100 units from beginning inventory assumed to remain in ending inventory not sold c Our calculations of cost of goods sold and ending inventory for the LIFO method are shown in the slide 3 Weighted average cost a Both cost of goods sold and ending inventory consist of a random mixture of all the goods available for sale b Each unit of inventory has a cost equal to the weighted average cost of all inventory items 4 Specific Identification a The specific identification method is the method you might think of as the most logical It matches or identifies each unit of inventory with its actual cost As you might imagine though the specific identification method is practicable only for companies selling unique expensive products For example an automobile has a unique serial number that we can match to an invoice identifying the actual purchase price Fine jewelry and pieces of art are other possibilities Specific identification works well in such cases However the specific identification method is practicable only for companies selling unique expensive products b Specific identification would be very difficult