Reporting & Interpreting Cost of
Goods Sold & Inventory
Libby, Libby & Short
So far we have learned that Assets are reported on the balance sheet
representing economic resources owned by the company at a point
in time.
We have also learned that resources consumed by a company are
shown on the Income statement as an Expense for a particular
period of time.
What happens when we
consume our own assets?
(i.e. utilize them )
As we consume them they are
transferred from the
balance sheet to the income statement.
Can you think of some examples?
Supplies
Pre-Paid
Insurance
Inventory
Shown as an
Asset while
“waiting to be
used”
Supplies Inventory
Pre-paid Insurance
Inventory
(R/M, WIP, F/G)
Expensed as
consumed in
operations
Supplies Expense
Insurance Expense
Cost of Goods Sold
Inventory
Goods held for sale in the normal course of business
(merchandiser) or goods which are used to produce goods or
services for sale (manufacturer).
Merchandise inventory is ready to be sold without further
processing
Manufacturers Inventory can be identified by it’s stage of production
(1) Raw Materials – product which will be utilized in the production
process
(2) Work In Process- goods in production but not yet completed
Includes Raw Materials, Direct Labor, Manufacturing Overhead
(1) Finished Goods – completed goods ready for resale
When make a sale to a customer we have two separate
transactions to record
First- we must remove the inventory off our books (it’s been
sold…we no longer own it). Inventory like any other asset is
kept on the balance sheet at historical cost.
Inventory is an asset
We must debit it to remove it
from our books
What is the offsetting
part of the entry?
The cost of the inventory sold
should be recorded as an expense
on the income statement
“cost of goods sold” is the title of the
expense account used
When make a sale to a customer we have two separate
transactions to record
Second- We have made a sale to a customer….as such we need
to record Revenue on our income statement The amount of
revenue recorded is based on the price we have charged the
customer (i.e. NOT historical cost) .
Revenue shows up on the I/S
and increases by a “credit”
What is the offsetting
part of the entry?
It depends…have they paid us?
If yes…record the cash
If no…record the receivable
Due to the high volume of traffic on your street you decide to
set up a lemonade stand.
By the time you have purchased the lemonade, sugar & cups
you determine that each cup of lemonade cost you 15¢.
In your first day of business you sell all of your lemonade for a
total of 50 cups. You charge 50¢ per cup of lemonade.
How should we record these transactions?
Debit
Entry 1:
Cash
Credit
$25
Lemonade Sale Revenue
(To record proceeds from lemonade sales)
$25
Entry 2:
Cost of Lemonade Sales
$7.50
Cash
(To record the cost of the lemonade sold)
$7.50
What is your profit on the lemonade stand?
Revenue
Less: Cost of Goods Sold
Gross Profit
Other Operating Expense
Net Income from Operations
$25
(7.50)
$17.50
-O$17.50
What does your balance sheet look like?
Assets
Cash
$17.50
Liabilities
Owners Equity
Retained Earnings
(Earned Capital)
$17.50
During the year we purchase new product and sell old product
5/15 Purchased 4 Lincoln Town Car Automobiles
1.
2.
3.
4.
Blue Leather Interior $45,000
Beige Interior $39,000
Silver Blue with Sunroof $43,000
Beige Leather Interior $47,000
6/24 sold Lincoln Town Car Blue Interior Serial # 4m459P
7/4 sold Lincoln Town Car Beige Interior Serial #J6678P5
8/15 sold Lincoln Town Car w/ sunroof Serial # L7P54730
This situation is pretty straight forward but in real life we can’t
always specifically identify our inventory….
When we can’t “specifically identify” our inventory units (i.e.
imagine an inventory of steel beams) we must perform a “physical
count” to determine how much inventory we have left.
We know how much we had at the beginning of the year & how
much new inventory we purchased…..using this we can calculate
how much we sold
Inventory Equation
Beginning Inventory
Purchases
Goods Available for Sale
(Ending Inventory)
Cost of Goods Sold
Go Over E7-1
#/Units Unit Price
1/1/02
Beg. Inventory
300
$12
2/15/02
Purchase #1
150
$11
7/20/02
Purchase #2
200
$12
10/15/02
Purchase #3
50
$13
12/31/02
End. Inventory
200
How many units did the company sell during the year?
Beg. Inventory 300 + Purchases 400- Ending Inv 200= 500
#/Units Unit Price
1/1/02
Beg. Inventory
300
$12
2/15/02
Purchase #1
150
$11
7/20/02
Purchase #2
200
$12
10/15/02
Purchase #3
50
$13
12/31/02
End. Inventory
200
We sold 500 units….what should the dollar amount of
COGS be for the year?
In most cases, inventory is homogenous and individual
units can not be specifically identified…. we must make
assumptions about which units are being sold..
Two Cost Flow Assumptions
FIFO- First-In-First-Out assumes that the oldest units (i.e.
first in) are the first units “out” (i.e. sold…COGS) and the
newest units (most recently purchased) are left sitting in
inventory
LIFO- Last-In-First-Out assumes that the newest units (i.e.
most recently purchased) are the first units “out” (i.e.
sold…COGS) and the oldest units (i.e. first in) are left
sitting in inventory
#/Units Unit Price
1/1/02
Beg. Inventory
300
$12
2/15/02
Purchase #1
150
$11
7/20/02
Purchase #2
200
$12
10/15/02
Purchase #3
50
$13
12/31/02
End. Inventory
200
FIFO- First-In-First-Out
Cost of goods sold (oldest units)
300 @$12 + 150 @ $11 + 50 @ $12 = $5,850
Ending Inventory is made up of:
150 @$12 + 50 @ $13 = $2,450
#/Units Unit Price
1/1/02
Beg. Inventory
300
$12
2/15/02
Purchase #1
150
$11
7/20/02
Purchase #2
200
$12
10/15/02
Purchase #3
50
$13
12/31/02
End. Inventory
200
LIFO- Last-In-First-Out
Cost of goods sold (newest units)
50 @ $13 + 200@ $12 + 150 @ $11 + 100 @ $12 = $5,900
Ending Inventory is made up of:
200 @ $12 = $2,400
COGS
Ending Inv.
FIFO
$5,850
$2,450
LIFO
$5,900
$2,400
In periods of rising prices, cost of goods sold will be higher
under LIFO than under FIFO, this makes sense….my newest
(highest priced) items are considered sold first
In periods of declining prices the opposite would be true.