MBA Financial Accounting - Chapter 6

Philippine School of Business Administration - Manila
Cost of Sales and Inventories.

From Asset to Expense
21 July 2012
Introduction of Presenter:
Johann Y. Rosales
2 Financial Accounting - Cost of Sales and Inventories 2008 Deloitte & Touche
Introduction of Presenter:
The Younghusbands
Audit Life with MDAC Deloitte PH .
Financial Accounting - Cost of Sales and Inventories
2008 Deloitte & Touche
What is Inventories?
PAS 2 defines inventories as follows: Inventories are assets which are held for sale in the ordinary course of business, in the process of production for such sale or in the form of materials or
supplies to be consumed in the production process or in

the rendering of services.
What is Cost of Sales?

is the cost of the services/goods that
was billed or sold to customers.
Definition of terms:
Beginning Inventory
Quantities of Merchandise on hand at the beginning of the period
Purchases
New Purchases
Available for Sale = Beginning Inventory + Purchases

Most that a company can sell during an accounting period
Ending Inventory
Remaining Unsold Merchandise
Types of Companies
1.) Merchandising
2.) Manufacturing
3.) Service
MERCHANDISING COMPANY
- Sells goods in substantially the same physical form as that in which it acquires them. - their goal is to purchase inventory and resell it at a higher price to customers
P 50
P 150
10
Merchandise Inventory
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Inventory
- Merchandise inventory - Goods that the company own. - Acquisition cost of the unsold goods
Cost of Goods Sold

- The Acquisition cost of the goods that are already sold.
12
When to include the inventories in the books?
F.O.B Destination
F.O.B Shipping Point
But when OWN the When you do you OWN the inventories! inventories?!?
13
Acquisition Cost
Invoice Price Cost
Add: Freight - In
Less: Purchase Discounts Purchase returns and Allowances Total Cost of Purchase
14
Cost of goods sold formula Cost of Beginning Inventory Add: Cost of Purchases Cost of Goods Available for Sale Less: Cost of Ending Inventory
Cost of Goods Sold
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BI + N Purchases = Goods Available for Sale = Inventory, End + COGS
Net Purchases
Cost of Goods Sold
Goods Available for Sale (GAS)

Beginning Inventory Ending Inventory
Now, how do we split the GAS into Inventory, End and COGS???
Systems for Accounting Inventories
Periodic
- Physical count is necessary to determine the ending inventory. - Generally used when the individual inventory items turn over rapidly and have small peso investment.
Perpetual
- Physical count is not necessary to determine the ending inventory. - Commonly used where the inventory items treated individually represent a relatively large peso investment.
17
Periodic
- Does not keep a running record of all goods bought and sold.
Perpetual
- Keeps a running record of all goods bought and sold. Utilizes Perpetual Inventory Card.
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MERCHANDISING COMPANY Sample transactions
Periodic
Perpetual
300,000 300,000
1. Purchase of merchandise on account, P300,000. Purchases 300,000 Merchandise Inventory Account Payable 300,000 Account Payable
2. Payment of freight on the purchase, P20,000 Freight in Cash 20,000 20,000 Merchandise Inventory Cash
20,000 20,000
or
Cost of Goods Sold 20,000 Cash 3. Return of merchandise purchsed to supplier, P30,000 Accounts payable 30,000 Accounts payable 30,000 Purchase return 30,000 Merchandise Inventory
19 Financial Accounting - Cost of Sales and Inventories
20,000
30,000
MERCHANDISING COMPANY Sample transactions Cont
Periodic
Perpetual
4. Sale of merchandise on account, P400,000, at 40% gross profit. Accounts receivable 400,000 SAME ENTRY Sales 400,000 Cost of Goods Sold 240,000 Merchandise Inventory 5. Return of merchandise sold from customer, P25,000. Sales return 25,000 SAME ENTRY Accounts receivable 25,000 Merchandise Inventory 15,000 Cost of goods sold 6. Adjustment of ending inventory, P65,000. Merchandise Inventory 65,000 No Entry COGS/IS 65,000
240,000
15,000
20
MERCHANDISING COMPANY Sample transactions Cont
Cost of Goods Sold - Periodic Method

Purchase Freight in Purchase return Total Goods Available for Sale Inventory, end Cost of goods sold 300,000 20,000 30,000 290,000 65,000 225,000
Less: Less:
21
MERCHANDISING COMPANY Sample transactions Cont Cost of Goods Sold - Perpetual Method
Merchandise Inventory 0 Beg. 300,000 Purchases 20,000 Freight in 15,000 Sales return 335,000 335,000 Ending Purchase Returns Sales 65,000 30,000 240,000
Cost of Goods Sold 240,000 Sales Sales returns 15,000
Balance
225,000
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MERCHANDISING COMPANY Advantages of Perpetual Inventory system 1. Inventory monitoring
2. Strong system controls

3. Availability of Ending Inventory and Cost of Sales balances
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Inventory Estimation
An alternative to physical count
24
INVENTORY ESTIMATION TECHNIQUES 1. Retail Inventory Method In this method, purchases are recorded at both their cost and their retail selling price. The gross margin percentage of the goods available for sale is calculated from these records. 2. Gross Profit Method is based on the assumption that the rate of gross profit remains approximately the same from period to period and therefore the ratio of cost of goods sold to net sales is relatively constant from period to period.
25
Retail Inventory method
Records vital for Retail Inventory method: Beginning inventory valued at cost and retail price Purchases during the period at cost and at retail price Adjustments to the original retail price:
Additional Markup Markup Cancelation Markdown Cancelation
Markdown
Other adjustments
Departmental transfer Breakage Shrinkage Theft
Damaged goods
Employee discount
26
Retail Inventory method Basic Formula
Goods available for sale at ratail or selling price Less: Net Sales (Gross sales minus Sale returns only) Ending Invenory at selling price Multiply by cost ratio xx xx xx xx
Ending Invenory at Cost
xx
Goods available for sale at cost
Cost ratio =
Goods available for sale at selling price
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Retail Inventory method Terminologies
1. Initail markup original markup on the cost of goods. 2. Original retail the sales price at which the goods are first offered for sale. 3. Additional markup increase in sales price above the original sales price. 4. Markup cancelation decrease in sales price above the original sales price. 5. Net additional markup or net markup markup minus markup cancelation. 6. Markdown decrease in sales price below the original sales price. 7. Markdown cancelation increase in sales price that does not increase the sales price above the original sales price. 8. Net markdown markdown minus markdown cancelation. 9. Maintained markup difference between cost and sales price after adjustment for all the above items. Sometimes this is referred to as markon.
Cost 1. Initial markup 2. Original retail or sales price 3. Additional markup 200 40 240 60
New sales price

4. Markup canclation New sales price (not below the original sales price) 5. Net Markup (60-40) If at this point, the item is marked down to 210 Markup canclation 6. Markdown (decrease in sales price below the original sales price) New sales price 7. Markdown cancelation (increase in sales price that does not increase the new sales price above the original sales price of 240) 20 30 20
300
40 260
50 210 20
New sales price 8. Net markdown (30-20) 9. Maintained markup (230 - 200)
230 10 30
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300 New selling price 1 Markup Cancelation
P40
New selling price 2
P10
Net Markdown
260
P60
Additional Markup Original retail price
P20
240
Markup Cancelation
P20
Net Markup
P30
230
Markdown New selling price 4
Maintained markup
P20
210
Markdown Cancelation New selling price 3
P40
Initial Markup
P30
200
Cost
30
Retail Inventory method Treatment of other items
Purchase discount deducted from purchases at cost only. Purchase return deducted from purchases at cost and at retail. Purchase allowance deducted from purchases at cost only. Freight in addition to purchases at cost only Departmental transfer out or debit addition to purchases at cost and at retail. Departmental transfer out or credit deduction from purchases at cost and retail. Sales discount and sales allowance disregarded, meaning, not deducted from sales. Sales return deducted from sales. If the account is sales return and allowance, the same should be deducted from sales. 9. Employee discounts added to sales. Employee discounts are special discounts usually not recorded because they are directly deducted from the sales price. 1. 2. 3. 4. 5. 6. 7. 8. Only the net sales price is recorded. Consequently, the amount of sales is understated. Thus, the employee discounts are added back to sales. 10. Normal shortage, shrinkage, spoilage, breakage This is deducted from goods available for sale at retail. Any normal shortage is usually absorbed or included in cost of goods sold. 11. Abnormal shortage, shrinkage, spoilage, breakage This is deducted from goods available for sale at both cost and retail so as not to distort the cost ratio.
31
Retail Inventory method Approaches
1.Conservative or conventional or lower of cost or market
2.Average cost approach 3.FIFO approach
32
Retail Inventory method Sample problem Crock Buster sells pots that cost $7.50 for $10. This yields a cost-to-retail percentage of 75%. The beginning inventory totaled $200,000 (at cost), purchases were $300,000 (at cost), and sales totaled $460,000 (at retail). The only "givens are highlighted in yellow. These three data points are manipulated by the cost-to-retail percentage to solve for ending inventory cost of $155,000. Be careful to note when the percentage factors are divided and when they are multiplied.
33
Retail Inventory method Sample problem
Retail Inventory method Sample problem

Gross profit method
35
Gross profit method Basic formula
Goods available for sale (GAS) Please refer to slide 14 to 16 Cost of sales (COS) Gross profit based on sales Net sales * Cost ratio = COS Gross profit based on cost Net sales / Sales ratio = COS
36
Gross profit method Basic formula
Multiply by
Divide by
Note: Sales Allowance and Sales Discount are ignored, that is, not deducted from sales.
37
Gross profit method Sample problem Assume that Tiki's inventory was destroyed by fire. Sales for the year, prior to the date of the fire were $1,000,000, and Tiki usually sells goods at a 40% gross profit rate. Therefore, Tiki can readily estimate that cost of goods sold was $600,000. Tiki's beginning of year inventory was $500,000, and $800,000 in purchases had occurred prior to the date of the fire. The inventory destroyed by fire can be estimated via the gross profit method, as shown.
38
Gross profit method Sample problem
39
Types of Companies
1.) Merchandising
2.) Manufacturing
3.) Service
40
41
FS Finance Bill Event 11 December 2008
MANUFACTURING COMPANY
- Converts raw materials and purchased parts into finished goods. - is the use of machines, tools and labor to produce goods for use or sale.
Direct materials
Labor
Overhead
Finish good
42
Inventory
- Materials
Cost of Goods Sold

- The total manufacturing cost of the goods that are sold.
- Work in Process
- Finished Goods - Factory or Manufacturing supplies
43
44
1 2 3 4
6
5
1.
Materials AP/Cash Work in process Materials
400 400 300
4.
Finished Goods Work in process
800 800
2.
300
5.
Cost of goods sold Finished Goods
1000 1000
3.
Work in process 300 Payroll/ Direct labor 100 Factory utilities 50 Factory insurance/Taxes 30 Depreciation 20
6.
Cost of goods sold Work in process
5 5
45
Product Cost and Period Cost Product cost Items of cost included in the cost of producing goods. cost that are related to making or acquiring the products or providing the services that directly generate the revenues of an entity. Period cost Costs that are related to other business functions such as selling and administration. Period costs are generally more closely associated with a particular time period rather than with making or acquiring a product or performing a service.
Types of Companies
1.) Merchandising
2.) Manufacturing
3.) Service
47
SERVICE ORGANIZATION
- refers to a firm engaged in a high or moderate degree of conversion using a significant amount of labor. - A service companys output may be tangible (an architectural drawing) or intangible (insurance protection).
48
SERVICE ORGANIZATION
Three types of Service Organization 1. Personal Service Organization
2. Building trade and repair businesses
3. Professional service firms
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50
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Philippine School of Business Administration - Manila

Cost of Sales and Inventories.

Audit Life with MDAC Deloitte PH .

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

supplies to be consumed in the production process or in

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

What is Cost of Sales?

was billed or sold to customers.

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Available for Sale = Beginning Inventory + Purchases

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Cost of Goods Sold

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

F.O.B Shipping Point

Financial Accounting - Cost of Sales and Inventories

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Cost of Goods Sold

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Cost of Goods Sold

Goods Available for Sale (GAS)

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

MERCHANDISING COMPANY Sample transactions

Systems for Accounting Inventories

MERCHANDISING COMPANY Sample transactions Cont

Systems for Accounting Inventories

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

MERCHANDISING COMPANY Sample transactions Cont

Systems for Accounting Inventories

Cost of Goods Sold - Periodic Method

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Systems for Accounting Inventories

Cost of Goods Sold 240,000 Sales Sales returns 15,000

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

MERCHANDISING COMPANY Advantages of Perpetual Inventory system 1. Inventory monitoring

Systems for Accounting Inventories

2. Strong system controls

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche

Financial Accounting - Cost of Sales and Inventories

2008 Deloitte & Touche