ch. 6 - inventory and cost of goods sold

pt. a ) reporting inventory and cost of goods sold

types of inventory

• inventory - items a company intends for sale to customers in the ordinary course of business

  • report as a current asset in the balance sheet b/c it represents a valuable resources to the company; current b/c the company expects to convert it to cash in the near term

obj. 6.1 - understand that inventory flows from manufacturing companies to merchandising companies and is reported as an asset in the balance sheet

manufacturing companies

• manufacturing companies produce the inventories they sell, rather than buying them in finished form from suppliers; they buy the inputs for the products they manufacture

  • inventory is classified for a manufacturer into three categories;

    • raw materials - includes the cost of components that will become part of the finished product but have not yet been used in production

    • work in process - refers to the products that have been started in the production process but are not yet complete at the end of the period; total cost includes raw materials, direct labor, and indirect manufacturing costs called overhead

    • finished goods - the cost of full assembled but unshipped inventory at the end of the reporting period

merchandising companies

• merchandising companies don’t manufacture computers or their components, they purchase finished products to sell to customers; serve as intermediaries

  • they may assemble/sort/repackage/redistribute/store/refrigerate/deliver/install, but do not manufacture

wholesalers and retailers

• merchandising companies can be classified as wholesalers or resalers

  • wholesalers resell inventory to retail companies or professional users

  • retailers purchase inventory from manufacturers or wholesalers and then sell this inventory to end users

multiple-step income statement

• cost of goods sold - cost of the inventory that was sold during the period

obj. 6.2 - understand how cost of goods sold is reported in a multiple-step income statement

example

1. assume that a best buy begins the year with $20k of inventory of headphones = how much best buy spent to purchase inventory of headphones on hand at the beginning of the year

2. during the year, bb purchases additional headphones for $90k,

3. the total cost of headphone inventory is now $110k (=$20,000+$90,000)

4. of the $110k in inventory, by the end of the year the purchase cost of the remaining headphones unsold is $30,000, and $80,000 (= $110,000-$30,000) was sold) this is the amount reported for cost of goods sold as an expense in the income statement

• multiple-step income statement - an income statement that reports multiple levels of income (or profitability)

  • most companies choose to report their income statement to show the revenues and expenses that arise from different types of activities.

  • by separating revenues and expenses into their different types, investors and creditors are better able to determine the source of a company’s profitability.

  • understanding the source of current profitability often enables a better prediction of future profitability

levels of profitability

• gross profit - the difference between net sales and cost of goods sold

  • since inventory transactions are important for merchandising companies, they must report the revenues and expenses directly associated with these transactions in the top section of a multiple-step income statement

    • revenues include the sale of products and services to customers.

      • inventory sales are referred to as sales revenue

      • providing services is referred to as service revenue

      • the net amount of revenues is referred to as net sales

    • cost of goods sold is the cost of inventory sold during the year

• operating income - profitability from normal operations that equals gross profit less operating expenses

  • after gross profit, operating expenses are reported (selling, general, and administrative expenses)

  • measures profitability from primary operations, a key performance measure for predicting the future profit-generating ability of the company

• income before income taxes