Lecture 5 Inventories and merchandising operations Flashcards
Inventories and merchandising operations
Define Inventory
Help: Remember:
-What it consists of, where is it sold and with what goal and when
All items, goods, merchandise and materials held by an entity for selling in the market to earn a profit during the current financial period.
What is Cost of Goods Sold COGS
When inventory is sold it gets shifted into the expense account: COGS or Cost of Sales. It thereby goes from being an asset (on the Balance Sheet) to being an expense (on the Income Statement)
*COGS is the most important/biggest expense item for a retailer
Explain or (just read) the IAS2 on inventories
States that the cost of inventories shall comprise:
-All costs of purchase
-Cost of conversion
-Other cost incurred in bringing the inventory to its present location and condition.
All expenses making the product ready for sale goes on the balance sheet (asset) while the cost of selling the product goes on the income statement (expense)
State the 3 formulas for:
1) Sales revenue
2) COGS
3) Inventory
As well on which financial statement they are reported
1) Sales revenue
= number of units sold x sales price per unit (income statement)
2) COGS
= number of units sold x cost per unit of inventory (income statement)
3) Inventory
= Number of units on hand x cost per unit of inventory (balance sheet)
Consigned goods:
When are they included in inventory?
Help: “Consignment refers to an arrangement where goods are placed in the care of store until the item is bought by a buyer. The owner of the goods — the consignor – retains ownership of the items until they sell.”
-Items held on consignment for another company are not included in inventory as they are owned by the other company
-Items out on consignment are included as these belongs to the company
-The treatment of in-transit goods depends on shipping terms
What does Shipping terms / free on board FOB terms indicate?
And mention to different kinds and what they mean
-Who owns the good in transit at a particular time and therefore who must pay the shipping costs.
1) FOB shipping point:
Ownership changes hands when the goods leave the seller’s shipping dock (the sellers place of business).
=The buyer pays for shipping and includes the good in inventory while it is in transit
2) FOB Destination:
Ownership changes hands when the goods are delivered to the costumer.
=The seller pays for shipping and includes the goods in inventory while they are in transit.
Explain the Basic Inventory Relationship
The value of beginning inventory + purchase
= Cost of goods available for sale
—> Ending inventory + COGS
Explain the elements of the Periodic Inventory System (4) and the Perpetual Inventory System (5) respectively
The Periodic Inventory System
1) Used for inexpensive goods
2) Does not keep a running record of all goods bought, sold and on hand
3) Inventory counted at least once a year
4) The difference in quantity on hand and accounting records is considered used or sold
The Perpetual Inventory System:
1) Used for all types of goods
2) Keeps a running record of all goods bought, sold and on hand to provide better information and control over inventory
3) Inventory counted at least once a year
4) The physical count establishes the correct amount of ending inventory for the financial statements and also serves as a check on the perpetual records
5) Any discrepancy may signal the possibility of inventory theft
Mention the 4 steps of recording Inventory Transactions in the Perpetual System and which accounts should be debited and credited for each.
1) Recording inventory purchasing
-Debit Inventory
-Credit Accounts Payable (or cash)
2) Recording purchase returns
-Debit Accounts Payable (or cash)
-Credit Inventory
3) Recording Inventory sales
-Debit cash (for sales price)
-Credit Sales Revenue (for sales price)
-Debit COGS ( for inventory price)
-Credit Inventory (for inventory price)
4) Recording settlement discount
When receiving the goods:
-Debit inventory
-Credit Accounts Payable
-Write Purchase of inventory on 2/10, n/30 terms (a 2% discount if paid within 10 days, due in 30) in the explanation line
When performing an early settlement:
-Debit accounts payable (full amount)
-Credit cash (amount minus the 2%)
-Credit inventory (for the 2%)
-Explanation: Write ‘Payment for inventory with 2/10 settlement discount
Mention and explain the 4 cost assumptions/methods and why they are necessary
Necessary: Because the unit cost of inventory is not constant and to compute COGS we need to assign unit cost to the inventory items.
1) Specific identification/unit cost method
-Used by businesses with unique inventory items
-Businesses cost their inventories at the specific cost of that particular unit
-Too expensive for inventories with common characteristics
2) First-in, First-out: FIFO
-First cost into inventory are the first costs assigned to COGS
-Ending inventory are based on the latest costs incurred
3) Last-in, first-out: LIFO
-The opposite of FIFO
4) Average cost/ weighted average method
-Based on the average cost of inventory during the period
When comparing the FIFO, LIFO and Average Cost methods how do they affect the financial statements in terms of:
1) Sales revenue
2) COGS
3) Gross profit
4) Inventory (on balance sheet)
*When inventory costs are increasing
And what could be some issues? (3)
1) Sales revenue
All the same
2) COGS
FIFO: lowest
LIFO: highest
3) Gross profit
FIFO: Highest
LIFO: Lowest
4) Inventory (on balance sheet)
FIFO: Highest
LIFO: Lowest
Issues:
1) Comparability - if changing methods
2) LIFO not allowed under IFRS: as it prioritizes income measures over that of assets and liabilities and can create unrealistic profits and lacks faithful representation of inventory flows
3) Net realizable value NRV: is the estimated selling price less the estimated costs of completion and the estimated costs necessary to make the sale.
Under IAS2: Inventories should be measured at the lower of cost and and NRV. Therefore you shall compare the 2 and report the lowest one on the balance sheet.
What is the Gross Profit (margin) Percentage?
What is the formula for Gross Profit and what is the formula for the Gross Profit Percentage?
-A key indicator of a company´s ability to sell inventory at a profit
-Merchandisers strive to increase this ratio
-Gross profit stated as a percentage of net sales
-Watched carefully by managers and investors
Gross Profit = Net sales revenue - COGS
Gross Profit Percentage =
Gross Profit/Net sales revenue
What does the COGS Model capture and how does it look?
*Think of the basic inventory relationship
-It captures all inventory information for an entire accounting period
COGS (in thousands)
Beginning inventory $XXXX
+ Purchases XXXX
= Cost of Goods available XXXX
- Ending inventory (XXXX)
= COGS $XXXX
What is the Gross Profit/Margin Method used for, how is it found and what does it look like
-Often necessary to estimate the value of goods
-Widely used to estimate ending inventory
- Rearrange COGS method
Beginning inventory $38
Purchases 72
Cost of goods available 110
Estimated cost of goods sold:
Net sales revenue $100
Less estimated gross profit 35% 35
Estimated COGS 65
Estimated cost of ending inventory 45
