A304 Chapter 6 Inventory and Cost of Goods Sold

Inventory represents

the goods a company holds for sale

Cost of Goods Sold reflects

the cost of turning that inventory into revenue

Together, inventory and cost of goods sold show

both what is available to sell and what has been used to generate profit

How is inventory reported for manufacturing?

• raw materials

• work in progress

• finished goods

How is inventory reported for merchandising?

inventory

ex: best buy, airpods form apple, and sell to customers

How is inventory reported for service?

no inventory

ex: zoom

Cost of Goods Sold

is an expense in the income statement and represents the cost of inventory sold

Inventory

is a current asset reported in the balance sheet and represents the cost of inventory not yet sold at the end of the period

COGS Formula (unit or dollar value)

Beginning Inventory + Purchases = Goods Available for Sale - Ending Inventory = Cost of Goods Sold

Specific ID

matches each unit of inventory with its actual cost

• very costly

• actual, not estimate like the other methods

• only used with high cost items

FIFO (first in first out)

assumes first units purchases are the first unit sold

• balance sheet method

• estimate

• ex: perishable goods, milk

LIFO (last in first out)

assumes last units purchases are the first units sold

• estimate

• income statement method

• more accurate

Weighted Average

assumes each unit of inventory has a cost equal to the weighted average unit cost of all inventory items

Formula for Weighted Average Cost/Unit

Goods Available for Sale $ / Goods Available for Sale Items

Why is the ending inventory $ amounts different for each method?

• different costs per unit

• period of inflation

• different assumptions about each method

Pros for using FIFO

• better reflects physical flow

• shows higher profitability on the income statement

• LIFO is not allowed under IFRS

Pros for using LIFO

• lower taxes

LIFO Conformity Rule

Companies that use LIFO for tax must also use LIFO for financial reporting

• IRS Rule

LIFO Reserve

companies that use LIFO for financial reporting must also report the difference between the LIFO amount reported and the FIFO amount

• comparability is the reason for reporting differences

Can a company use different inventory cost methods for different products/items?

Yes

Can a company change its inventory cost method?

Yes, but its cost by restatement of principles

In order to report ending inventory and cost of goods sold amounts, companies must

tract costs in the accounting system during the period

How do most companies track inventory on a day to day basis?

the majority of companies track inventory in real time using FIFO

• when a product is purchased, inventory is increased

• when a product is sold, inventory is reduced and COGS is increased

How do most companies report inventory on year end financial statements?

FIFO - 55%

LIFO - 20%

WEIGHTED AVERAGE - 20%

SPECIFIC ID - 5%

Inventory is reported at the

lower cost or NRV

Cost

the cost of inventory not yet sold using one of the cost flow methods

Net Realizable Value

the estimated selling price - estimated cost of selling, disposal, and transportation

If NRV < Cost

than an adjustment needs to be made at the end of the period to lower inventory and increase COGS

During the year, record inventory purchases at cost

At the end of the year, which is lower for unsold inventory by item?

Cost or Net Realizable Value

Cost: no year-end adjustment needed, report ending inventory at purchase cost

Net Realizable Value: reduce inventory from cost to meet realizable value and report an expense for the reduction

What happens if the value of inventory increases? Can the company record higher inventory on the balance sheet and a gain on the income statement?

No! revenue higher sold

Inventory Turnover Ratio

cost of goods sold / average inventory

• indicates the number of times the firm sells or turns over, its average inventory balance during a reporting period

Average days in inventory

365 / inventory turnover ratio

• indicates the approximate number of days that inventory is held

Gross profit ratio

gross profit / net sales

• measures the percentage amount by which the sale of inventory exceeds its cost per dollar of sales

Cost of Goods Sold + Ending Inventory =

Cost of Goods Available for Sale

NRV

estimated selling price - cost to sell

If NRV < Cost,

reduce inventory down to NRV and recognize an expense

Never increase value of inventory!

True

What is the least common method used by companies?

Specific ID