INVENTORY AND
COST OF GOODS SOLD
Chapter Six
Types of Inventory

MERCHANDISING

Wholesalers
Buy from manufacturers
 sell to retailer


Retailers
Buy from wholesalers
 Sell to general public

Acctg

101
Merchandise Inventory

MANUFACTURING
Buy from several
suppliers to make a
product
 Sell to wholesalers and
sometimes retailers

Acctg 102
 Raw Materials
 Work in Process
 Finished Goods
Inventory Normal Balance



Inventory is an asset so its normal balance is a
Debit.
To increase inventory – Debit
To decrease inventory – Credit
Purchases Normal Balance




Purchases is like expense
Purchases is always increased with a debit
Purchase returns and allowances – credit balance
Purchase discount – credit balance
Cost of Goods Sold (COGS)

Cost of Goods Sold is an expense so it has a debit
balance
Gross Margin






Sales
-Sales Return and Allowances
-Sales Discount
=Net Sales
-Cost of Goods Sold
=Gross Margin
Cost of Goods Sold

Beginning Inventory
3000
 +Purchases






12000
 -Purchase Discount
-600
 -Purchases Return and Allow
-400
+ Net Purchases
11000
+ Freight In
1000
=Cost of Merchandise Purchased
=Goods Available for Sale
- Ending Inventory (or Goods not Sold)
= Cost of Goods Sold
10000
13000
-4000
9000

Brief Exercise 6-3 page 281
Exercise 6-1 page 283

MUST KNOW THIS FORMULA

MEMORIZE IT

Estimating Inventory-Why important


Sales
Beginning Inventory
150,000
8,000
+Purchases
110,000
 -Purchase Discount
(1,000)
 -Purchases Ret & Allow
(2,000)






+ Net Purchases
Goods Available for Sale
- Ending Inventory (or Goods not Sold)
= Cost of Goods Sold
Gross Margin
107,000
115,000
15,000
100,000
50,000
Overstating/Understating
Ending Inventory

SALES
 Beg Inventory
 + Net Purchases
 =Goods Available
 - Ending Inventory
 = COGS
 =Gross Margin

Over
150
Under
150
Can’t Change
115
115
20
10
95
105
55
45
WHAT EVER I DO TO
ENDING INVENTORY,
I ALSO DO TO NET
INCOME
Two methods to TRACK inventory

Periodic
 At

some period of time
Perpetual
 All
the time--- everytime there is a purchase and
everytime there is a sale
IF YOU KNOW PERIODIC
YOU WILL KNOW PERPETUAL

SO LETS DO PERIODIC
FIRST

4 METHODS TO DETERMINE COST
OF ENDING INVENTORY




Specific Indentification
First in First Out
Last In First Out
Average Cost
Specific Indentification




Not estimated
Actual items
Or specific identification
Page 252 example
First In First Out








GUMBALL MACHINE
Physical Flow matches Cost Flow
First one purchased is first one sold
Page 252
Used if few inventory items
BE 6-4 page 281
Increasing costs --- higher cost in Ending Inventory
Lower cost in COGS so higher net income
Last In First Out








COOKIE JAR
Last one purchased first one sold
Page 253
Used if want to put replacement cost in Cost of Goods
sold
Increasing costs --- higher cost in COGS
Lower cost in Ending Inventory so lower net income
BE 6-5 pg 281
IFRS – Not used US – tax savings
LIFO RESERVE

Additional amount of inventory a company would
report if it used FIFO instead of LIFO
 Cost

of Goods Sold
Inventory
MUST BE CONSISTENT


Can’t change inventory methods without IRS
approval.
Can use different type of methods for different
types of inventory
Average Cost





Weighted Average 500@$10, 600@$11,
800@$12
$50+$66+$96= 212/19 = $11.16
Used if a lot of little inventory items
BE 6-6 page 281
Costs are evenly distributed in COGS and Ending
Inventory
Periodic versus Perpetual



Have been using Periodic
Perpetual uses the periodic method every time there
is a sale and every time there is a sale.
Perpetual needs exact dates it was purchased and
sold.
Perpetual Tracking pg 272

FIFO
 Usually

LIFO
 Usually

not different under perpetual and periodic
different than periodic
Exercise 6-15 pg 286
Recording inventory transactions


Purchase



Purchase
A/P
Sale

A/R
Sales


Return & Allowance



Periodic Method
A/P
Purchase Ret and Allowance
Purchase Discount



A/P
Cash
Purchase Discount


Purchase



Sale

A/R

Sales
COGS
Inventory



Return & Allowance



Inventory
A/P
A/P
Inventory
Purchase Discount



A/P
Cash
Inventory
Perpetual Method
Periodic

Purchase



Perpetual
A/R
Sales




A/P


Sales
COGS
Inventory
Return & Allowance



Cash
Purchase Discount
A/R

Purchase Discount


Sale

Return & Allowance
A/P
Purchase Ret and Allowance

Inventory
A/P




Purchase
Purchase
A/P
Sale



A/P
Inventory
Purchase Discount



A/P
Cash
Inventory
Freight - In
Freight In
Purchases or COGS account
Bringing it into the business
Freight In
A/P

Freight out




Selling Expense
Cost of Sending it to the customer
Freight Expense
Cash or A/P
Exercises


6-6 pg 284
6-7
Perpetual
Periodic
Lower Cost or Market pg 266




Normally Inventory is replacement cost --- cost to
restock the item after identical items are sold
If Market Value is less than Cost (if what you paid
for the item is less than you can sell it for) you must
make an adjustment.
COGS
Inventory
Exercises



Page 285
6-11
6-12
Inventory Ratios



Inventory Turnover pg 269
COGS/ Average Inventory
# of Days in Inventory
365/ Inventory T/O
(Seasons)
6-13 pg 285 Inventory
Gross Profit Ratio
Gross Profit pg 271
Gross Profit/ Net Sales
Exercise 6-14 pg 286
Homework





Problem 6-2
Problem 6-3
Problem 6-4
Problem 6-6
Problem 6-8
COGS, Ending Inventory
Periodic
Perpetual
Lower of Cost or Market
Ratios