Accounting For Managers
Professor ZHOU Ning
SCHOOL OF ECONOMICS AND MANAGEMENT
BEIHANG UNIVERSITY
[email protected]
Chapter 6
Cost of Sales and Inventory
The objectives of chapter 6



Inventory costing methods
Lower of cost or market
Analysis of inventory
6-3
Inventory Issues

What is inventory?

What costs are included in inventory?

How do we separate COGS from Ending
Inventory?
6-4
Inventories Definition

Asset items held for sale in the ordinary
course of business or goods that will be
used or consumed in the production of
goods to be sold.
6-5
Merchandising Inventories

Merchandising

Sells goods in same form in which they are
acquired.

Inventory costs (and costs of goods sold)
= acquisition costs.
6-6
Merchandising Inventories
6-7
Relationship of Inventory and Cost
of Goods Sold
Ending inventory
Purchase
AFS
COGS
Beginning inventory
Beginning inventory + net purchases = Goods available for sale
cost of goods sold + ending inventory=Goods available for sale
Cost of goods sold =Beg. inventory + net purchases -ending inventory
Net purchases = gross purchases-purchase returns and allowances
+ freight-in
6-8
Discussion problem 6-1
W
X
Y
Z
$2,250
$1,800
$1,350
$2,100
Beginning inventory
300
225
500
??
300
Plus: Purchases
975
975
??
850
1,200
Less: Ending inventory
225
300
300
??
150
1,050
??
900
1,050
??
1,350
??
1,200
??
900
??
300
??
750
300
400
150
??
800
$ ??
900
$ ??
500
$ 150
Sales
Cost of goods sold:
Cost of good sold
Gross margin
Period expenses
Net income (Loss)
Ending inventory = Beginning Inventory + Purchase – Shipments (COGS)
$ (50)
6-9
Manufacturing Inventories

Manufacturing company converts raw
materials and purchased parts into
finished goods.

3 types of inventories;

Materials.

Work-in-process.

Finished goods.
6-10
3 Types of Manufacturing Inventory
Accounts

Materials inventory or raw materials.



Work-in-process.



Not yet used in production.
Adjusted for returns and freight-in.
Goods started but not yet finished.
Materials + conversion costs.
Finished goods


Manufactured but not yet shipped.
Materials + conversion costs.
6-11
Manufacturing Inventories
6-12
Manufacturing Companies

Product costs or cost of goods sold =
materials and parts used + conversion
costs

Conversion costs = production labor +
overhead (other costs incurred in
manufacturing).
6-13
Product costing systems

Perpetual inventory system for
manufacturing companies.
6-14
Product Costs



inventory costs = inventoriable costs.
Expensed (COGS) in period when FG sold.
GAAP requires full production costing.



Materials cost.
Labor costs incurred directly in producing the
product.
Other production or indirect production or
production overhead costs.
6-15
Period Costs

Costs that are expensed in the period
incurred.

Much of SG&A (Selling, General &
Administrative) Expenses on IS.
6-16
Manufacturing Inventories
6-17
Service Inventories

Service organizations (hotels, beauty
parlors, plumbers)

May have materials inventories.
6-18
Professional Service Inventories

Professional service firms (accounting firms,
legal firms)

Intangible inventory costs are costs
incurred for client but not yet billed called
jobs-in-progress or unbilled costs.
6-19
Inventory Costing Methods
(Cost Flow Assumptions)




Specific identification.
Average cost.
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
6-20
Specific identification


Big ticket items: e.g. automobiles, paintings.
Uniquely identified items.

8.333
9.467
1,250
1,420
9.889
8
890
720
May offer opportunity to manipulate costs.
6-21
Average Cost

(Beginning inventory amount +
purchases) / units available for sale =
per unit inventory costs = per unit cost
of goods sold

Periodic method.


Computed for the entire period.
Perpetual method.

A new unit cost can be calculated after each
purchase.
6-22
Average Cost
6-23
First-in, first-out (FIFO)


Expenses costs of oldest purchases first.
Most recently purchased goods are in
the ending inventory.


Likely but not necessary to follow actual
flow of goods.
Ending inventory approximates current
cost of goods.
6-24
First-in, first-out (FIFO)
6-25
Last-in, first-out (LIFO)


Assumes most recently purchased goods
are sold first
Inventory based on costs of oldest
purchases.


Cost of goods sold usually does not reflect
physical flow.
Ending inventory may be cost at amounts of
years ago.

Inventory may be well below current costs.
6-26
Last-in, first-out (LIFO)
6-27
LIFO Reserve


FIFO (or average for cost) for internal
reporting purposes.
LIFO financial reporting.

LIFO reserve = FIFO inventory amount LIFO inventory amount.
6-28
Comparison of Methods
Cost of
goods sold
Ending
inventory
Total
FIFO
$1,250
$890
$2,140
Average cost
1,338
802
2,140
LIFO
1,420
720
2,140
6-29
Arguments for FIFO




Usually follows physical flow of goods.
If prices are based on oldest cost,
results in best matching.
More accurate balance sheet valuation.
Non-theoretical/practical argument:

Results in highest income during periods of
rising prices.
6-30
Arguments for LIFO


If prices are based on current costs,
results in best matching of revenues
and costs and therefore most useful
income statement.
Closest to reflecting current or
replacement costs of goods sold.

However, it is still historical costs and could
differ from current costs.
6-31
Arguments for LIFO (con.)

During periods of price increases:




Higher costs of goods sold.
Lower taxable income.
Lower income taxes.
Higher cash flows.

If LIFO for tax purposes than also financial
reporting.
6-32
Why not more LIFO?

Most countries do not permit.



Would require a double set of books.
Prices of some items are not increasing.
Because of IRS LIFO conformity
requirement, lower earnings reported to
shareholders.
6-33
Lower of Cost or Market (LCM)

Market price may be below cost due to:





Physical deterioration.
Change in consumer tastes.
Technological obsolescence.
LCM is a reflection of conservatism
concept.
Market is defined as replacement cost.
6-34
Analysis of inventory




Inventory turnover
 Average for period or ending inventory.
 Measures efficiency of asset usage.
Days’ inventory
Gross margin as % of sales.
Ratios differ by industry.
6-35
Summary of Chapter 6



Inventory costing methods
Lower of cost or market
Analysis of inventory
6-36
Assignments of Chapter 6




Problem 6-3
Problem 6-5
Problem 6-6
Case 6-1
6-37
Thank you
6-38