Inventories

Chapter 5 Income Statement
Chapter 6 Perpetual Inventories, Periodic Inventories, and Internal Controls
Chapter 8 Other Cost Flow Assumptions and Effect of Method Used on Financial Statements

Inventory—an asset representing goods held for sale

Cost of goods sold expense—an expense account representing the cost of goods sold.

Sales—a revenue account used by merchandisers

Perpetual Inventory System— Inventory account is increased for all purchases and decreased for all sales of inventory. Example: Inventory costing $10,000 is sold for $14,000 cash (two journal entries).			Periodic Inventory System— Cost of goods sold expense is computed at the end of the period using a formula A “Purchases” account is used to record inventory purchases Cost of goods sold expense is not recorded at every sale. It is recorded at the end of the period. Beginning Inventory + Purchases Cost of goods available for sale - End inventory Cost of goods sold expense
Cost of goods sold expense	10,000
Inventory		10,000
To reduce inventory
Cash	14,000
Sales		14,000
To record the revenue
Portion of the sale

Inventories like other assets are recorded as assets when inventories are owned. Goods where title has not yet transferred and consigned goods would be excluded from inventory because these goods are not owned. At year end, the accountant would determine ownership of goods in transit by examining shipping documents terms.

FOB shipping point—shipping terms, title to goods transfers at the beginning of shipment

FOB destination—shipping terms, title to goods transfers at destination

2/10, n/30—early payment discount terms; 2% discount on the purchase if it is paid for within 10 days, or the full amount is due in 30 days.

Purchase Discounts and Sales Discounts

Sales returns and allowances—A contra revenue account used to record sales returns. A high sales returns figure may be indicative of employee theft. It is important to keep track of the sales returns amount or level by using this contra revenue account rather than debiting the “sales” account directly upon a sales return. Return detail would be lost if the “sales” account was debited directly.

Internal control—Any procedure that safeguards assets or ensures reliability of accounting data (internal control examples: computer passwords, back up procedures, rotation of personnel, bonding of personnel, etc.). Public companies (companies selling stock to the public as an investment) must have established, documented systems of internal controls in place. This system is reviewed and tested on a sample basis by external auditors in the early stage of each annual audit.

Separation of duties—There are incompatible tasks that one person should not be in charge of performing. One person should not be in charge of performing more than one of the following: authorizing transactions, operations, custody of assets and accounting for the assets. Small businesses often do not have enough personnel for separation of duties. Risk is mitigated in these situations by owner active participation in the business

Separation of duties in the purchasing function	Responsibility
Requesting department	Should not make purchases directly; personnel would complete a *purchase requisition*, initial it for authorization and send the request to the purchasing department.
Purchasing department	Fills out a *purchase order* which it sends to suppliers after having received an authorized purchase requisition from requesting department
Receiving department	Fills out *receiving report* after inspecting goods received
Accounting department	Fills out a *check authorization* after matching copies of the purchase order, receiving report, and supplier invoice; the check authorization is sent to the treasury department for payment
Treasury department	Prepares a *check* after receiving check authorization with documentation

Chapter 5

Income Statement—Financial statement showing revenues and expenses for a period of time. The statement may be presented in a single step format or a multiple step format. In the single step format, all revenues less all expenses equals net income. The multiple step format present revenues and expenses in categories to aid with the analysis of the information.

STARTER MULTIPLE STEP INCOME STATEMENT
Name of Company Income Statement For the year ended _________	Standard label: Name of Company Name of Worksheet Time Frame
Sales - Cost of goods sold expense		$100,000 -55,000
Gross Margin		$45,000
Less Operating Expenses Selling expenses (including freight out) General and administrative expenses		$3,000 $4,000


Income before taxes Income taxes		$38,000 $2,000
Net Income	(double underline)	$36,000

Gross Margin—income figure on the multiple step income statement; sales less cost of goods sold

Operating Expenses—category on the multiple step income statement showing selling, general and administrative expenses

Net Income—last figure on the income statement; it should be double underlined.

Freight In vs. Freight Out

Freight In—treated as part of inventory; it is the cost of shipping inventory into the store before it is sold

Freight Out—treated as an operating expense; it is the cost of shipping inventory out of the store after it has been sold

Chapter 8

Specific identification inventory costing method—recording cost of goods for the actual known cost amount

Other Methods—Cost flow assumptions are appropriate when actual cost of goods sold is not known (small, large quantity, similar inventories like tires, canned goods, etc.)

LIFO Last in First Out—The most recently purchased goods are treated as sold first
FIFO First in First Out—The oldest goods in the inventory records are treated as sold first
Average costing method—Cost of goods sold is recorded at an average figure

In practice, the methods are not blended. Do not blend specific identification method with LIFO or FIFO. So if you know what the actual cost of an inventory item sold is, but you are using the LIFO method, stick with the application of LIFO.

LIFO, FIFO, and average costing method may be applied on a periodic or perpetual basis. For simplification purposes, we will be applying these methods on a periodic basis (we won’t be computing costs of goods sold expense each time units are sold).

Example:

INVENTORY RECORDS
			Unit $
Jan. 1	100	units	1.00	$100.00
Jan. 5	200	units	1.20	$240.00
Jan.10	50	units	1.30	$65.00
Jan. 11	100	units	1.40	$140.00
Jan. 25	90	units	1.50	$135.00
Units available for sale	540		COGAFS	$680.00

End of period inventory is 300.

Units sold is 240.

REQUIRED: Using information provided above, compute cost of goods expense using the following cost flow assumptions:

Periodic LIFO
Periodic FIFO
Periodic Average cost method

Answers:

1.LIFO
Jan. 25		90	units	1.50	$135.00
Jan. 11		100	units	1.40	$140.00
Jan. 10		50	units	1.30	$65.00
Units sold		240		COGS	$340.00

2. FIFO
Jan. 1		100	units	1.00	$100.00
Jan. 5		140	units	1.20	$168.00
Units sold		240		COGS	$268.00

3. AVERAGE COST METHOD

Avg unit cost = COGAFS/ units availablle for sale

COGS = Avg unit cost x number of units sold

	($680		divided by 540) * 240 unitssold
COGS =	$302.22

Checking yourself
COGS					302.22
+ Ending inventory					377.78
Cost of goods available for sale					680.00

Problem One PERIODIC METHOD Beginning inventory is $200,000. Purchases are $50,000. Ending inventory is $40,000. What is cost of goods sold expense?

Problem Two PERIODIC METHOD Beginning inventory is $400,000. Purchases are $30,000. Ending inventory is $10,000. What is cost of goods sold expense?

Problem Three PERPETUAL METHOD Make journal entries for each of the following.

Inventory costing $1,000 is sold for $2,000 cash (two journal entries).
Inventory costing $500 is sold for $800 on account, terms 2/10, n/30 (two journal entries).
Cash is collected from the customer in “b” within the discount period.
Inventory costing $100 is sold for $200 on account, terms 2/10, n/30 (two journal entries).
Cash is collected from the customer in “d” after the discount period.
The customer in “a” returned the goods for a cash refund (two journal entries).

Problem Four PERPETUAL METHOD Make journal entries for each of the following.

Inventory costing $700 is sold for $1,000 cash (two journal entries).
Inventory costing $300 is sold for $400 on account, terms 2/10, n/30 (two journal entries).
Cash is collected from the customer in “b” within the discount period.
Inventory costing $300 is sold for $500 on account, terms 2/10, n/30 (two journal entries).
Cash is collected from the customer in “d” after the discount period.
The customer in “a” returned the goods for a cash refund (two journal entries).

Problem Six MULTIPLE STEP INCOME STATEMENT Prepare a multiple step income statement showing gross margin, operating expenses and net income using the following information.

Sales………………………………………………………………………………	$500,000
Cost of goods sold expense………………………………	$400,000
Administrative expense……………………………………….	$30,000
General expense…………………………………………………	$2,000
Selling expense……………………………………………………….	$1,000
Freight out…………………………………………………………………	$500

Problem Seven MULTIPLE STEP INCOME STATEMENT Prepare a multiple step income statement showing gross margin, operating expenses and net income using the following information.

Sales………………………………………………………………………………	$100,000
Cost of goods sold expense………………………………	$90,000
Administrative expense……………………………………….	$8,000
General expense…………………………………………………	$700
Selling expense……………………………………………………….	$600
Freight out…………………………………………………………………	$500

Problem Eight Which of the following would be included in inventory?

Goods purchased in transit at year end with shipping terms FOB shipping point
Goods purchased in transit at year end with shipping terms FOB destination
Consigned goods
Freight in
Freight out

Problem Nine Specify which department prepares each of the following documents.

Purchase requisition
Purchase order
Receiving report
Check authorization
Check

Problem Ten Compute cost of goods sold expense using periodic (1) LIFO, (2) FIFO, and (3) average cost method cost flow assumptions applied on a periodic basis.

Inventory Records (Inventories had a zero balance prior to these transactions).
Oct. 1	10	units	0.10 each	$1
Oct. 4	20	units	0.20 each	$4
Oct. 5	30	units	0.30 each	$9
Oct. 18	40	units	0.40 each	$16
Oct. 25	50	units	0.50 each	$25
Units available	150	units	COGAFS	$55
Sold	-80	units
End Inventory	70	units

Problem Eleven Compute cost of goods sold expense using periodic (1) LIFO, (2) FIFO, and (3) average cost method cost flow assumptions applied on a periodic basis.

Inventory Records (Inventories had a zero balance prior to these transactions).
Jan. 1	80	units	$1 each	$80
Jan. 3	10	units	$2 each	$20
Jan. 21	30	units	$3 each	$90
Jan. 22	90	units	$4 each	$360
Jan. 28	50	units	$5 each	$250
Units available	260	units	COGAFS	$800
Sold	-80	units
End Inventory	180	units

Problem Twelve EFFECT OF METHODS ON NET INCOME

When recorded cost of goods sold expense is smaller, ending inventory will be _________________.
When recorded costs of goods sold expense is larger, ending inventory will be _________________.
When recorded cost of goods sold expense is smaller, net income will be ______________.
When recorded cost of goods sold expense is larger, net income will be ______________.
To have a low net income figure, companies may select an inventory method with the lowest ending inventory valuation. In periods of rising prices, which method would yield the lowest net income figure (LIFO, FIFO, average cost)?