Chapter 6:

Cost of Sales & Inventories

Presentor: Group 1 - BM 220

Presentor:
Jenice Joy Sumaway
Mike Agencia
Reference: Accounting Text & Cases 11th Ed
by: Robert Anthony ET AL
 Discussion Outline

• Overview & Accounting details for 3 types

of companies
– Merchandising
– Manufacturing
– Service
• Inventory Costing Methods
• Lower of Cost or Market
• Analysis of Inventory
• Case: Browning Manufacturing Company
Cost of Sales & Inventories
Type of Companies
• Merchandising
– Sells good in substantially the same physical form
as that in which it acquires them.
• Manufacturing
– Converts raw materials & purchased parts into
finished goods.
• Service organizations
– Finish intangible services rather than tangible
goods.

Cost of Sales & Inventories

 Merchandising Companies

• The Basic Measurement Problem

• 2 Types of Inventory Method
– Periodic Inventory Method
– Perpetual Inventory Method
• Retail Method

Cost of Sales & Inventories

 Merchandise Inventory & Flows
Cost of
Inventory
Ending Inventory $ ??
(BI+Purch
ased –
Purchases COGS)
$ 7,400
Available Cost of
for Sale Goods
$11,400 Sold
$ ???
(BI+Pur
chases-

$4,000
Beginning EI

Inventory
Cost of Sales & Inventories
Illustration 6-1
Inventory Methods
1. Periodic Inventory
o A physical count is made of merchandise in the
ending inventory & the cost of inventory is
determined
o When goods are purchased, a separate set of
accounts is used to accumulate information on the
net cost of the purchases.
o No entries are made to the inventory account as the
merchandise is bought & sold. Only at the end of
period, when the inventory is counted, will entries be
made to the inventory account to establish proper
balance.

Cost of Sales & Inventories

Periodic Inventory Method
Assume that physical inventory shows the cost of
merchandise remaining at the end of the
period is $2,000

Beginning Inventory $4,000

Plus: Purchases $7,400
Equals: Goods available for sales $11,400
Less: Ending Inventory $ 2,000
Cost of Goods Sold $ 9,400

Cost of Sales & Inventories

 Periodic Inventory Method
Calculation with additional details:

Beginning Inventory $4,000

Plus: Purchases $7,400
Freight-in $ 600
$ 7,600
Less: Purchase Returns $ 200
Net Purchases: $7,400
Goods available for sale $11,400
Less: Ending Inventory $ 2,000
Cost of Goods Sold $ 9,400

Cost of Sales & Inventories

 Periodic Inventory Method
Beginning Balance Entry
Cost of Goods Sold $ 4,000
Merchandising Inventory $4,000
Temporary Purchases, Purchase Returns & Freight-in accounts are closed to COGS by
entries
Cost of Goods Sold $ 7,400
Purchase Returns $ 200
Purchases $7,000
Freight-in $ 600
Merchandise inventory entry
Merchandise Inventory $ 2,000
Cost of Goods Sold $2,000
Finally, COGS closed
Income Summary $ 9,400
Cost of Goods Sold $9,400
Cost of Sales & Inventories
Inventory Methods
2. Perpetual Inventory Method
o A record is maintained of each item carried in the
inventory.
o Inventory account is continuously updated
o Ending inventory should reconcile with the actual
physical count

Cost of Sales & Inventories

Perpetual Inventory Method
• Illustration 6.2 Perpetual Inventory Card
• Ledger Account

Cost of Sales & Inventories

Inventory Methods
2. Perpetual Inventory Method
o A record is maintained of each item carried in the
inventory.
o Inventory account is continuously updated
o Ending inventory should reconcile with the actual
physical count

Cost of Sales & Inventories

 Manufacturing Accounts

• 3 types of Inventory Accounts

• Materials used
• COGS Manufactured
• COGS Sold
• Product Costing System
• Product Costs & Period Costs
Cost of Sales & Inventories
Manufacturing Company:
3 Types of Inventory Accounts
1. Materials Inventory
o acquisition cost
2. Work in Process Inventory
o Materials thus far issued for them
o Conversion costs incurred on these items up to
the end of accounting period
3. Finished Goods Inventory
o Total cost incurred in manufacturing

Cost of Sales & Inventories

 Manufacturing Inventories & Flow
Ending
Inventory
Purchases
Materials
used
Ending
Inventory
Beginning Completed
Inventory Goods
Cost of
Materials
Ending Goods
Inventory Inventory Sold
Beginning
Inventory
Conversion
Work in
Cost
Process
Inventory Finished Beginning
Goods Inventory
Cost of Sales & Inventories Inventory
 Manufacturing Inventories & Flow
• Illustration 6.4
– Flow of Costs Through Inventories

Cost of Sales & Inventories

Costs of Goods Sold
COGS = Finished Goods Invty + Cost of Goods
manufactured – Finished Goods inventory
Example:

Cost of Sales & Inventories

Product Costing Systems
• A system that the cost of each product is
accumulated as it flows through production
process

Cost of Sales & Inventories

Production Costs & Period Costs
• Product Costs & Inventory Costs
– Items of cost included in the cost of producing
goods
• GAAP principles, cost of each product includes:
1. Material cost
2. Cost incurred directly in bringing the product to
its existing condition or location (direct labor
cost)
3. Indirect production cost

Cost of Sales & Inventories

Service Companies
• Personal services organization
– May identify the labor cost of the people directly
providing the service and supplies costs as
elements of cost of sales, to distinguish them from
“office overhead” costs.
• Building trade firms & repair business
• Professional service firms
– Have labor costs but no material costs
• Acctg entries --- Accts receivable, Billings
(Revenues), Project expenses, Jobs in progress
Cost of Sales & Inventories
 INVENTORY COSTING METHODS
- The measurement of inventory and cost of
goods sold when the per – unit cost of one or
more items in inventory changes during the
accounting period

INVENTORY:
- Assets that are intended for sale, are in process
of being produced for sale or are to be used in
producing goods.
Cost of Sales & Inventories
Four Types of Inventory Valuation

1. Specific Identification
2. Average Cost
3. First-in, first-out (FIFO)
4. Last-in, first-out (LIFO)

Cost of Sales & Inventories

EXAMPLE DATA:
Units Unit Cost Total Cost
Inventory 01/01 100 $8 $800
Purchased 06/01 60 9 540
Purchased 10/ 01 80 10 800
Goods available
for sale 240 8.917 2,140
Goods sold 150 - -
Ending Inventory 90
Cost of Sales & Inventories
Inventory Valuation
1. SPECIFIC IDENTIFICATION:
- Common practice w/ certain big-ticket items
such as automobiles & unique items (e.g.
paintings, expensive jewelry & etc.)

- each item that is sold and each item remaining

in inventory is separately identified in respect
to it's purchase cost.

Cost of Sales & Inventories

Example: (specific identification)
Units Unit Cost Total Cost
Units Sold 100 $8 $800
Units Sold 50 9 450
Cost of Goods Sold 150 - 1,250

Cost of Sales & Inventories

2. AVERAGE COST METHOD

- This method is quite straightforward; it takes

the weighted average of all units available for
sale during the accounting period and then uses
that average cost to determine the value
of COGS and ending inventory

Cost of Sales & Inventories

Example (average cost):
Units Unit Cost Total Cost
Inventory 01/01 100 $8 $800
Purchased 06/01 60 9 540
Purchased 10/ 01 80 10 800
Goods available
for sale 240 8.917 2,140/
240 units
Average Cost $8.917
Cost of Sales & Inventories
3. FIFO (First-in, first-out) Method

- This method assumes that the first unit making

its way into inventory is the first sold.
- Cost of goods sold - approximate the physical
flow of the goods
- Ending Inventory – approximates the current
cost of the goods

Cost of Sales & Inventories

 Example (FIFO):
Units Unit Cost Total Cost
Cost of Goods Sold:
From Beginning Inventory 100 $8 $800
From purchases of Jan. 1 50 9 450
COGS 150 $1, 250

Ending Inventory:
From Purchases of June 1 10 $9 $90
From purchase of October 1 80 10 800
Ending Inventory: 90 $890

Cost of Sales & Inventories

4. LIFO (Last-in, first-out) Method

- Opposite of FIFO
- This method assumes that the last unit making
its way into inventory is sold first. The older
inventory, therefore, is left over at the end of
the accounting period
- COGS – based on cost of recent purchases
- Ending Inventory – costed at cost of the oldest
units available

Cost of Sales & Inventories

 Example(LIFO):
Units Unit Cost Total Cost
Cost of Goods Sold:
From purchases of October 1 80 $10 $800
From purchases of June 1 60 9 540
From Inventory Jan. 1 10 8 80
COGS 150 $1, 420

Ending Inventory:
From beginning inventory 90 8 $720

Cost of Sales & Inventories

LIFO Dollar Value Method- method of valuation
used on inventory of physically unlike items.

Inventory Pool – a pool wherein unlike items are

grouped. (example: all hardware products)

LIFO reserve – mathematical difference between

two inventory amounts; one based on LIFO &
the other one based on other valuation
method.

Cost of Sales & Inventories

Summary of illustrative case:
COGS Inventory TOTAL
FIFO $1,250 $890 $2,130
Average Cost 1,338 802 2,130
LIFO 1,420 720 2,130

FIFO – lowest COGS, highest inventory

Average Cost – Somewhere in between
LIFO – highest COGS, lowest inventory
Cost of Sales & Inventories
Arguments for FIFO

1. Cost of goods that are physically sold are

matched with the revenues generated of that
sold goods.(physical flow of inventory is
corrupted if LIFO is used)

2. It should reflect the true value of inventory

w/c is the current cost

Cost of Sales & Inventories

Arguments for LIFO

1. Gross margin should reflect the difference

between sales revenue w/c are current
amounts & the current COGS.
- (Current COGS/ replacement cost inventory
accounting/ NIFO)cost of acquiring identical
items to those sold to replenish the inventory
2. Argument of FIFO regarding current cost of
inventory can be mitigated through disclosure
of LIFO reserves in the notes to FS.

Cost of Sales & Inventories

Income Tax Consideration
- FIFO yields the highest income – tax is higher
- LIFO yields the lowest income – tax is lower

Why not more LIFO if tax is lower?

- in industries where deflation is the trend, LIFO
would yield the highest income resulting to a
higher tax (e.g. technology).
- Cashflow income reported to stockholders will
be low resulting to a smaller earnings/ share.

Cost of Sales & Inventories

Lower of Cost or Market
- general inventory valuation principle deriving
from conservatism concept where inventory is
reported at balance sheet at lower of cost or
market.

Rules in using this valuation:

1. Should not be higher with the NRV.
2. Should not be lower than NRV less normal
profit margin

Cost of Sales & Inventories

 Inventory Analysis
Inventory Turnover = COGS/ *Inventory
*valued at ending invty. or average (beg. + end/ 2)
- A ratio showing how many times a
company's inventory is sold and replaced over a
period

Days Inventory = (Inventory/COGS)(365 days)

= 365/ Inventory turnover
- Period how long inventory is disposed in terms of days

Cost of Sales & Inventories

THANK YOU!..

Cost of Sales & Inventories