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MGT120H5 (67)
Chapter 6

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Catherine Seguin

Chapter 6- inventory and COGS **SALES - COGS = GROSS PROFIT. COGS is an expense when it is sold. • Merchandise inventory is the heart of a merchandising business, and cost of goods sold is the most important expense for a company that sells goods rather than services. PLEASE LOOK ON PAGE 285 FOR THE NEW INCOMES STATEMENT. • So it goes: Sales revenue 703.2 COGS 419.8 Gross profits 283.4 Operating expenses Operating and administrative XXX Depreciation XXX Income tax XXX Net income XXX • Inventory is listed as an asset on the balance sheet • Manufacturing (raw materials) and service (office supplies and other items) companies both have inventories. • Gross profit/gross margin, is the excess of sales revenue over COGS. It's called gross profit because operating expenses haven't been subtracted. • INVENTORY = # OF UNITS OF INVENTORY ON HAND * COST PER UNIT OF INVENTORY. • COGS = # OF UNITS OF INVENTORY SOLD * COST PER UNIT OF INVENTORY. • The number of units of inventory is determined by a physical count of goods at year end. • *** Determining the ownership of inventory at the time of shipment depends on who has legal title. If inventory is shipped FOB (free on board) shipping point, it should be included on the books of the buyer. If the goods are shipped FOB destination, the inventory in transit still belongs on the books of the seller until it's delivered to the buyer. • FOB SHIPPING: Terms indicating that the buyer must pay to get the goods delivered. (The buyer will record freight-in and the seller will not have any delivery expense.) With terms of FOB shipping point the title to the goods usually passes to the buyer at the shipping point. This means that goods in transit should be reported as a purchase and as inventory by the buyer. The seller should report a sale and an increase in accounts receivable • FOB DESTINATION: Terms indicating that the seller will incur the delivery expense to get the goods to the destination. With terms of FOB destination the title to the goods usually passes from the buyer to the seller at the destination. This means that goods in transit should be reported as inventory by the seller, since technically the sale does not occur until the goods reach the destination. ACCOUNTING FOR INVENTORY IN THE PERPETUAL SYSTEM • There are two types of inventory accounting systems: periodic system and periodic system. • The periodic system is mainly used by businesses that sell inexpensive goods. Like a dollar store or convenience store. They won't keept a running record of every one of the items that they sell. Instead they count their inventory periodically - at least once a year - to determine the quantities at hand. This keeps accounting costs low • Perpetual system uses a computer software to keep a running record of inventory on hand. This system achieves control over goods such as parts at a Buick dealer, lumber at RONA, furniture at Leon's, and grocery stores and more (bar codes). Even if there is a computer system to count, you still have to do a physical count. Inventory is counted at least once a year. • NET PURCHASES OF INVENTORY (cost of inventory) =PURCHASE PRICE OF THE INVENTORY FROM THE SELLER + FREIGHT IN (transportation cost to move the goods from the seller to the buyer) -PURCHASE RETURNS - PURCHASER ALLOWANCES - PURCHASE DISCOUNTS. • FREIGHT IN is the transportation cost paid by the buyer to move goods from the seller to the buyer. • NET SALES = SALES REVENUE - SALES RETURNS AND ALLOWANCES - SALES DISCOUNTS. • FREIGHT OUT paid by the seller isn't part of cost of inventory. It is an expense, the seller's expense of delivering merchandise to customers. Inventory Costing • Inventory's cost includes its basic purchase price, plus freight in, insurance while in transit, and any costs paid to get the inventory ready to sell, less returns, allowances and discounts. • Three generally accepted inventory methods are: specific unit cost, weighted average cost, first-in first-out (FIFO) cost. • Specific unit cost: also called the specific identification method, this method is expensive to use for inventory items that have common characteristics like lumber, liters of paint, or automobile tires. READ ON PAGE 292 • Weighted average: sometimes called the average cost method, is based on the average cost of inventory for the period. o Weighted-average cost per unit = COG available/#of units available. o COGS =#of units sold*weighted average cost per unit o Ending inventory = # of units on hand *weighted-average cost per unit. o UNDER THE PERPETUAL INVENTORY SYSTEM, A NEW AVERAGE COST IS COMPUTED EACH TIME A NEW PURCHASE IS MADE. • FIFO: the first costs into inventory are the first costs assigned to COGS. PLEASE LOOK AT PAGE 294. o Basically for each good you sell, the first goods that your purchased in inventory will be the one you give out to the buyers. o And you match the price that you sold it for to the price you bought it for. • FIFO method results in a lower COGS but higher gross profit. WEIGHTED-AVG results in higher COGS but lower gross profit. • In a period of rising prices, FIFO will lead to higher profits and higher taxes than weighted-avg. THE OPPOSITE IS TRUE IN A PERIOD OF FALLING PRICES. WHEN INVENTORY COSTS ARE DECREASING Income statement effects of COGS Balance sheet effects ending Cash flow effects COGS inventory FIFO FIFO COGS is highest because it's FIFO EI is lowest because it's Less cash paid for taxes so could based on the older costs, which arbased on the most recent costs be used by firms seeking to high. Gross profit is therefore thwhich are low. minimize taxes. lowest. WEIGHTED-AVERAGE It is the lowest because it's baseIs highest because the avg cost foMore cash paid for taxes but still on an average of the costs for thethe period is higher than most may be popular for firms seeking to period, which is lower than the recent ones maximize reported net income. oldest costs. Gross profit is therefore the highest. WHEN INVENTORY COSTS ARE INCREASING Income statement effects of COGS Balance sheet effects ending Cash flow effects COGS
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