Financial Accounting Textbook PDF

Financial Accounting Weygandt, Kieso, & Kimmel Prepared by Kurt M. Hull, MBA CPA California State University, Los Angeles John Wiley & Sons, Inc.  CLASSIFYING CLASSIFYING INVENTORY INVENTORY For manufacturers, inventory has three distinct catego...

Financial Accounting Weygandt, Kieso, & Kimmel Prepared by Kurt M. Hull, MBA CPA California State University, Los Angeles John Wiley & Sons, Inc.  CLASSIFYING CLASSIFYING INVENTORY INVENTORY For manufacturers, inventory has three distinct categories. INVENTORY RAW WORK FINISHED MATERIALS IN GOODS PROCESS  STUDY STUDY OBJECTIVE OBJECTIVE 11 DETERMINING DETERMINING INVENTORY INVENTORY QUANTITIES QUANTITIES At the balance sheet date, companies must determine how many units are on hand, and value those units. Two steps are required to achieve this: 1. Take a physical inventory count 2. Determine ownership of goods  DETERMINING DETERMINING OWNERSHIP OWNERSHIP OF OF GOODS GOODS IN IN TRANSIT TRANSIT FOB Shipping Point FOB Destination Point Seller Seller Public Ownership passes to the buyer here Public Carrier Carrier Co. Co. Ownership passes to the buyer here Buyer Buyer  DETERMINING DETERMINING OWNERSHIP OWNERSHIP OF OF CONSIGNED CONSIGNED GOODS GOODS A consignment agreement transfers goods from a consignor to a consignee, who agrees to sell the goods. Sa le Consignor Consignee Consignee remits proceeds (less fee) to consignor when inventory is sold. Inventory on consignment is included in the consignor’s inventory until sold. Customer  SPECIFIC SPECIFIC IDENTIFICATION IDENTIFICATION Tracks actual flow of goods. Each item marked with its unit cost. Inventory Purchases Item 1 SOLD $700 Item #2 Cost of Goods Sold $750 $1,500 1 Item #3 SOLD $800 ASSUMED ASSUMED COST COST FLOW FLOW METHODS METHODS These methods assume cost flows that may be unrelated to the actual physical flow of goods. FIFO LIFO AVERAGE COST These cost flow assumptions do not have to be consistent with the actual flow of goods.  FIFO FIFO FIRST-IN, FIRST-IN, FIRST-OUT FIRST-OUT FIFO ASSUMPTIONS 1. Earliest goods purchased are the first to be sold. 2. Cost of earliest goods purchased are the first to be recognized as cost of goods sold. 3. Ending inventory consists of items purchased late in the year.  ALLOCATION ALLOCATION OF OF COSTS COSTS FIFO FIFO METHOD METHOD Pool of Costs Cost of Goods Available for Sale Unit Total Date Explanation Units Cost Cost 01/01 Beginning inventory 100 $10 $ 1,000 04/15 Purchase 200 11 2,200 08/24 Purchase 300 12 3,600 11/27 Purchase 400 13 5,200 Total 1,000 12,000 Step 1 Step 2 Ending Inventory Cost of Goods Sold Unit Total Date Units Cost Cost 11/27 400 $ 13 $ 5,200 Cost of goods available for sale $ 12,000 08/24 50 12 600 Less: Ending inventory 5,800 450 $5,800 Cost of goods sold $6,200  REVIEW REVIEW QUESTION QUESTION FIFO FIFO METHOD METHOD In a period of rising prices, will FIFO will produce a higher or lower net income than LIFO? Why? Answer: FIFO will produce a higher net income when prices are rising because cost of goods sold is made up of items purchased early in the year at lower prices.  LIFO LIFO LAST-IN, LAST-IN, FIRST-OUT FIRST-OUT LIFO ASSUMPTIONS 1. Latest goods purchased are the first to be sold. 2. Cost of latest goods purchased are the first to be recognized as cost of goods sold. 3. Ending inventory consists of items purchased early in the year.  ALLOCATION ALLOCATION OF OF COSTS COSTS LIFO LIFO METHOD METHOD Pool of Costs Cost of Goods Available for Sale Unit Total Date Explanation Units Cost Cost 01/01 Beginning inventory 100 $10 $ 1,000 04/15 Purchase 200 11 2,200 08/24 Purchase 300 12 3,600 11/27 Purchase 400 13 5,200 Total 1,000 $12,000 Step 1 Step 2 Ending Inventory Cost of Goods Sold Unit Total Date Units Cost Cost 01/01 100 $ 10 $ 1,000 04/15 200 11 2,200 Cost of goods available for sale $ 12,000 08/24 150 12 1,800 Less: Ending inventory 5,000 450 $5,000 Cost of goods sold $7,000  REVIEW REVIEW QUESTION QUESTION LIFO LIFO METHOD METHOD In a period of rising prices, will LIFO will produce a higher or lower ending inventory than FIFO? Why? Answer: LIFO will produce a lower ending inventory than FIFO when prices are rising because ending inventory is made up of items purchased early in the year at lower prices.  AVERAGE AVERAGE COST COST AVERAGE COST ASSUMPTIONS 1. Goods available for sale are homogeneous. 2. Cost of goods available for sale is allocated on the basis of the weighted average unit cost incurred. 3. The weighted average unit cost is applied to the units on hand to determine the cost of ending inventory.  ALLOCATION ALLOCATION OF OF COSTS COSTS AVERAGE AVERAGE COST COST Pool of Costs Cost of Goods Available for Sale Unit Total Date Explanation Units Cost Cost 01/01 Beginning inventory 100 $10 $ 1,000 04/15 Purchase 200 11 2,200 08/24 Purchase 300 12 3,600 11/27 Purchase 400 13 5,200 Total $ 12,000 1,000 Step 1 Step 2 Ending Inventory Cost of Goods Sold $ 12,000 ÷ 1,000 = $12.00 Unit Total Cost of goods available for sale $ 12,000 Units Cost Cost Less: Ending inventory 5,400 450 x $ 12.00 $= 5,400 Cost of goods sold $ 6,600  USE USE COST COST FLOW FLOW METHODS METHODS CONSISTENTLY CONSISTENTLY A company needs to use its chosen cost flow method consistently from one period to another. Consistent application makes more comparable financial statements. Changes in cost flow method should be disclosed in the financial statements.  STUDY STUDY OBJECTIVE OBJECTIVE 44 LOWER LOWER OF OF COST COST OR OR MARKET MARKET IF Market Value Cost The inventory is written down to its market value. When using LCM: Market value = Replacement cost  VALUING VALUING INVENTORY INVENTORY AT AT LOWER LOWER OF OF COST COST OR OR MARKET MARKET Illustration 6-18 Lower of Cost or Cost Market Market Television sets Consoles $ 60,000 $ 55,000 $ 55,000 Portables 45,000 52,000 45,000 Total 105,000 107,000 Video equipment Recorders 48,000 45,000 45,000 Movies 15,000 14,000 14,000 Total 63,000 59,000 Total inventory $ 168,000 $ 166,000 $ 159,000  STUDY STUDY OBJECTIVE OBJECTIVE 55 INVENTORY INVENTORY ERRORS ERRORS Ending inventory Period 1 = Beginning inventory Period 2 Inventory errors thus affect both COGS and NET INCOME.  FORMULA FORMULA FOR FOR COST COST OF OF GOODS GOODS SOLD SOLD Cost of Cost of Beginning _ Ending Inventory + Goods Inventory = Goods Purchased Sold To find the effect of an inventory error using this formula: 1. Input INCORRECT DATA 2. Input CORRECT DATA 3. Compare results.  INCOME INCOME STATEMENT STATEMENT EFFECTS EFFECTS OF OF INVENTORY INVENTORY ERRORS ERRORS INVENTORY ERROR COGS NET INCOME Beginning inventory understated Understated Overstated Beginning inventory understated Overstated Understated Ending inventory understated Overstated Understated Ending inventory overstated Understated Overstated An error in ending inventory in the current period will have the reverse effect on net income in the next period.  INCOME INCOME STATEMENT STATEMENT EFFECTS EFFECTS OF OF INVENTORY INVENTORY ERRORS ERRORS The effect of ending-inventory errors on the balance sheet can be determined by using the accounting equation: ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY Ending Inventory Error Assets Liabilities Stockholders’ Equity Overstated Overstated None Overstated Understated Understated None Understated  INVENTORY INVENTORY DISCLOSURES DISCLOSURES Inventory is classified as a current asset in the balance sheet. COGS is subtracted from sales in the income statement. Notes to financial statements should include: Major inventory classes (if not on balance sheet) Basis of accounting (Cost or LCM) Costing Method (FIFO, LIFO, AVERAGE COST)  STUDY STUDY OBJECTIVE OBJECTIVE 66 INVENTORY INVENTORY TURNOVER TURNOVER Measures the number of times on average the inventory is sold during a period. COGS INVENTORY = TURNOVER AVERAGE INVENTORY $198,747 = 7.79 times ($24,401 +26,612) / 2 Average days to sell = 365 / 7.79 = 47 days  APPENDIX APPENDIX 6A 6A COST COST FLOWS—PERPETUAL FLOWS—PERPETUAL INVENTORY INVENTORY The product data shown below for Bow Valley Electronics will be used to explain perpetual inventory costing using three assumed cost flow methods: FIFO LIFO AVERAGE COST Bow Valley Electronics Z202 Astro Condensers Unit Total Date Explanation Units Cost Cost 01/01 Beginning inventory 100 $10 $ 1,000 04/15 Purchase 200 11 2,200 08/24 Purchase 300 12 3,600 11/27 Purchase 400 13 5,200 Total $ 12,000  APPENDIX APPENDIX 6A 6A PERPETUAL PERPETUAL INVENTORY INVENTORY –– FIFO FIFO Under FIFO, the cost of the earliest goods on hand prior to each sale is charged to cost of goods sold. Therefore, the cost of goods sold on September 10 consists of the units on hand January 1 and the units purchased April 15 and August 24. Date Purchases Sales Balance January 1 (100 @ $10) $1,000 April 15 (200 @ $11) $2,200 (100 @ $10) (200 @ $11) $3,200 August 24 (300 @ $12) $3,600 (100 @ $10) (200 @ $11) (300 @ $12) $6,800 September 10 (100 @ $10) (200 @ $11) $6,200 (50 @ $12) $600 (250 @ $12) November 27 (400 @ $13) $5,200 (50 @ $12) (400 @ $13) $5,800  APPENDIX APPENDIX 6A 6A PERPETUAL PERPETUAL INVENTORY INVENTORY –– LIFO LIFO Under the LIFO method using a perpetual system, the cost of the most recent purchase prior to sale is allocated to the units sold. The cost of the goods sold on September 10 consists entirely of goods from the August 24 and April 15 purchases and 50 of the units in beginning inventory. Date Purchases Sales Balance January 1 (100 @ $10) $1,000 April 15 (200 @ $11) $2,200 (100 @ $10) (200 @ $11) $3,200 August 24 (300 @ $12) $3,600 (100 @ $10) (200 @ $11) (300 @ $12) $6,800 September 10 (300 @ $20) (200 @ $11) $6,300 (50 @ $10) $500 (50 @ $10) November 27 (400 @ $13) $5,200 (50 @ $10) (400 @ $13) $5,700  APPENDIX APPENDIX 6A 6A PERPETUAL PERPETUAL INVENTORY INVENTORY –– AVG AVG COST COST The average cost method in a perpetual inventory system is called the moving average method. Under this method a new average is computed after each purchase. The average cost is computed by dividing the cost of goods available for sale by the units on hand. The average cost is then applied to: Average Cost x Units Sold = COGS Average Cost x Remaining Units = ENDING INVENTORY  APPENDIX APPENDIX 6A 6A PERPETUAL PERPETUAL INVENTORY INVENTORY –– AVG AVG COST COST A new average is computed each time a purchase is made. On April 15, after 200 units are purchased for $2,200, a total of 300 units costing $3,200 ($1,000 + $2,200) are on hand. The average cost is $10.667 ($3,200/300). Date Purchases Sales Balance January 1 (100 @ $10) $1,000 April 15 (200 @ $11) $2,200 (300 @ 10.667) $3,200 August 24 (300 @ $12) $3,600 (600 @ 11.333) $6,800 September 10 (550 @ 11.333) $6,233 (50 @ $11.333) $567 November 27 (400 @ $13) $5,200 (450 @ 12.816) $5,767  APPENDIX APPENDIX 6B 6B INVENTORY INVENTORYESTIMATION ESTIMATION––GROSS GROSSPROFIT PROFITMETHOD METHOD The gross profit method estimates the cost of ending inventory by applying a gross profit rate to net sales. It is used in preparing monthly financial statements under a periodic system. It should NOT be used in preparing the company’s financial statements at year-end. The gross profit rate is assumed to remain constant from one year to the next.  APPENDIX APPENDIX 6B 6B GROSS GROSSPROFIT PROFITMETHOD METHODFORMULAS FORMULAS Estimated Estimated Net Sales Gross Cost of Profit Goods Sold Cost of Estimated Estimated Goods Cost of Cost of Available for Goods Sold Ending Sale Inventory