Chapter 6 Flashcards
COGS & Inventory: 2 accounts
- COGS- cost of goods sold (also called cost of sales)- the amount we paid for the goods we have sold, an operating expense on income statement
- Inventory- goods held for resale, current asset on balance sheet
COGS Formula
Beginning Inventory. $ xx
+ Net Purchases xx
= Goods available for sale. xx
- (Ending Inventory). ( xx )
= COGS $ xx
How to determine COGS
- Periodic System
- Perpetual System
Periodic System
- debits all inventory items to “purchases” account
- Make NO entry to update COGS & “Inventory” accounts with each sale
- Make a physical count @ year end to determine “COGS” using COGS formula
Perpetual System
- debits all inventory to “Inventory” account
- updates “COGS” & “Inventory” account with each sale (when we make a sale need 2 entires 1. record sale, 2. Update the inventory
- uses physical count @ year end determine “loss of shrinking”
Net purchases Formula
purchases $ xx
- Purchase R&A. ( xx )
- Purchase Discount. ( xx )
+ freight- in xx
= Net purchases $ xx
Freight In
Transportation cost
purchase discount
incentives for us to pay early and get a discount
Periodic system
all items purchases for resale are debited to a “purchases” (not an asset), uses COGS formula, requires an adj. entry at year end to record COGS
Perpetual System
keeps a running total of the inventory on hand, the ONLY system that identifies “losses” due to theft/ shrinkage/ spoilage
Goods to include in Ending Inventory
- Goods in transit: goods orders but not yet received
- Consigned Goods- the owner (consigner) transfers physical goods to agent (consignee) for purposes of selling without giving up legal title (TITLE NEVER TRANSFERS)
Inventory Cost Flow Methods (perpetual method) 4 methods
- Specific Identification
- Average Cost Method
- First in First Out method (FIFO)
- Last in First Out (LIFO)
Specific Identification
small quantity of inventory, high priced items
- this method tracks the actual physical flow of the goods, each item of inventory is marked, tagged, or coded with a specific unit cost
Average (simplified) Cost Method
- uses weighted average of all costs for GAS (“ Goods Available for Sale”)
- assigns average cost to both Ending Inventory & COGS
advantage: assigns cost on an equal unit basis to both ending inventory and COGS and its easy to calculate
formula:
average cost= total cost of GAS / Total # units GAS
First in First Out (FIFO)
cost of first item purchased = cost of first item sold
advantage: assigns current cost to ending inventory (current cost on bal. sheet) and good method when invt. turnover is rapid
disadvantage:
- fails to match most recents costs with revenues
- if prices are rising matching oldest unit costs with current revenues, making net income higher (overstated) called “Inventory Profits”
Last In First Out (LIFO)
cost of last item purchased = cost of first item sold
Advantage:
- matches current cost with current revenues
- in periods of rising prices net income is always less (reduces income taxes) because of the effect on taxes, companies follow the LIFO Conformity Rule
Disadvantage:
- gives non current value to inventory on balance sheet (old cost on bal. sheet)
- if/when International Financial Reporting Standards (IFRS) are adopted in the U.S. LIFO will NOT be allowed as a reporting method
LIFO Conformity Rule
if you use LIFO for tax purposes, you MUST ALSO use this method for financial reporting purposes
Inventory turnover ratio
measures if company keeps excess stock of inventory, excess stock is NOT productive
Invt. turnover ratio = COGS/ Average Inventory
average inventory= (BI+ EI)/2
Income Statement
Sales Revenue. $ xx
- Sales R&A ( xx )
- Sales discounts ( xx )
= Net Sales Revenue. xx
- COGS ( xx )
= Gross Profit. xx
- expenses ( xx )
- freight out ( xx )
= Net Income xx
