Financial Accounting: Chapter 6Ashton Converse

Inventory and Costs of Goods Sold

*Welcome to Week 10

Week 9 Exams are Over!

*Objectives/Schedule*Welcome

*Review/Quick Exam Talk*Collect Homework and Discuss*Discussion Video Clip*Finish Chapter 5*Start Chapter 6*Merchandise Inventory and Cost of Goods Sold*Converse about Concepts*Practice*Application

*Review/Quick Exam Talk

Here are some of the things we have been talking about:

*Short-Term Investments*Principal*Creditor *Debtor*Receivables and Uncollectable Receivables*Interest*Maturity Date*Equity Security and Collateral

*Discuss and Collect Homework

Family Adventures Inc. Financial Statement PracticeFamily Adventures Inc., began operations on April 1, 20X6.

During April, the business provided travel services and ideas for families. It is now April 30, and investors wonder how well Family Adventures Inc. performed during its first month. They also want to know the company’s financial position at the end of April and its cash flows during the month.

The following data are listed in alphabetical order. Prepare the Air & Sea Travel financial statements at the end of April 20X6.

In a group of 2 to 4 work together to help Family Adventures Inc. With the following information on the next PPT slide, create their

Income Statement, Balance Sheet, and Statement of Cash FlowsDo we have all the information we need…do the numbers all

match up?

*Discuss and Collect Homework

oAccounts Payable…$15,800oAccounts Receivable…2,000oOperating Activities…208,000oCash balance at beginning of

April…4,300oCash Balance at end of April…

33,300oSale of land…22,000oInvesting Activities…(77,000)oCommon Stock…50,000oInventory…28,000oDividends…2,100oNotes Payable…8,000oSales…40,000oFinancing Activities…(102,000)

oLand…18,000oOffice Supplies…500oRetained Earnings…3,700oAcquisition of land…40,000oRent Expense…1,100oSalary Expense…1,200oService Revenue…8,500oUtilities Expense…400oCosts of Services…3,740oInterest Expense…12,800oCost of Goods Sold…13,000oBonus Expense…8,000oHoliday Party Expenses…

10,000

Family Adventure Inc.Balance SheetApril 30, 20x6

 Assets Liabilities Cash $30,000.00 Accounts Payable $45,000.00Accounts Receivable 4,000.00 Note Payable 1,300.00 Notes Receivable 1,200.00 Total Liabilities $46,300.00Inventories 300.00

Stockholder’s EquityBuilding 20,000.00 Common Stock $10,000.00

Preferred Stock $0PPE 20,000.00 Retained Earnings 19,200.00 Total S.E. 29,200.00

Total Assets $75,500.00 Total Liabilities $75,500.00 ========= and S.E. =========

*Wrap-Up Chapter 5

Using Two Key Ratios to Make Decisions:* Days’ sales in Receivables*Used to tell how long (days) it takes to collect the

average level of receivables.*Shorter Period is better*Also called Collection Period

*Acid-test Ratio*Helps firms see if they are able to pay all of its current

liabilities if they become due immediately (within a few days)*More stringent measure of ability to pay current

liabilities with current assets than the current ratio*Also called the quick ratio

*Wrap-Up Chapter 5

Days’ Sales in Receivables

*Net Sales comes from the income statement*Receivables amounts are from the balance sheet*This all tells us how long it takes a firm to collect the

average level of receivables

Days’ Sales in Receivables Ford Motor Company

One Day’s Sales = Net Sales/365 Day 138,442/365 = 379

Motorola, Inc.

27,058/365 = 74 day

Days’ sales avg. receivables = Avg. Receivables/1 Day’s Sales

Ford Motor Company: 148,636 / 379 = 392 DaysMotorola Inc. Cell Phone Company = 4,437 / 74 =

60 days

*Wrap-Up Chapter 5

Acid-Test Ratio

*.84 means that Ford has 84 cents of quick assets to pay each $1 of current liabilities.*This is a little low…usually want 1.0 or more, but ok for

auto companies…WHY?

For Ford Motor Company 2003(Dollars in millions)

Acid-test Ratio = Cash + STI + Net Current Receivables

Total Current Liabilities

$21,770 + 17,539 + 2,721 / 50,011 = .84

*Video ClipTry to listen and understand all that you can.

“Wall Street: Money Never Sleeps” @ 10min mark

Afterwards we will discuss some of your thoughts about the economy.

What does this mean for the accountants?

What different parts of the statements will need to change specifically?

*A Look Into Chapter 6

The Two Popular Topics of Chapter 6*What is inventory?*The merchandise, products, and/or goods that a

company sells to customers*What is costs of goods sold?*Cost of the inventory the business has sold to

customers

Examples:*Give me some examples of inventory for Sias…

*Give me some examples of costs of goods sold for Sias…

*Inventory and Costs of Goods

Sold

Gross Profit*Sales revenue minus cost of goods sold*Sounds like Net Income, but a little different *Not all of the expenses included

*Also called gross margin

Two Main Inventory Systems*Only one is really important*Perpetual Inventory System*System in which the business keeps a continuous

records for each item at all times.

*Purchases

Take A GUESS (cai cai)*When there is a decrease in the cost of purchases because the buyer returned the goods to the seller…what is this called?*Purchase Return

*When there is a decrease in the cost of purchases because the seller has granted the buyer a subtraction from the amount owed*Purchase Allowance *All 3 decrease the cost of inventory

*A decrease in the cost of purchases earned by making an early payment*Purchase Discount

*Four Generally Accepted Inventory Methods

To compute costs of goods sold and the cost of ending inventory still on hand, we must assign unit cost to the items.1. Specific Unit Cost2. Average Cost3. First-in, First-out4. Last-in, First-out

*Specific Unit Cost vs. Average Cost

Specific Unit Cost*Businesses with unique inventory use this method*Such inventory may be antiques, jewels, and real estate*Too expensive for common inventory such as groups of wheat, liters of paint, and auto tires

Average-Cost method*Inventory method based on the average cost of inventory during a period*Determined by dividing the cost of goods available by the number of units available

*LIFO vs. FIFO

FIFO*First-in, First out method*Inventory costing method by which the first costs into inventory are the first costs out to cost of goods sold.*The cost of Ending Inventory is based on the costs of the most recent purchases (or latest costs incurred)

LIFO*Last-in, first out*Inventory costing method by which the last cost to enter inventory are the first costs out to cost of goods sold*The cost of ending inventory is always based on the oldest costs – from beginning inventory

*Welcome to Day 2 of Week

10!

*Welcome! What are you doing this weekend?*Any fun events?

*Quick Review*BAKE SALE!*Chapter 6*Deeper Look at Inventory and Costs of Goods Sold*Budgets*Application of Material*Statement of Retained Earnings

*What is the target in Chapter 6?

*Review! Lets see what you may remember…

*What were some key points we talked about on Tuesday?*Inventory*Costs of Goods Sold*Inventory Methods*Inventory Systems

*Specific Unit Cost vs. Average Cost

Specific Unit Cost*Businesses with unique inventory use this method*Such inventory may be antiques, jewels, and real estate*Too expensive for common inventory such as groups of wheat, liters of paint, and auto tires

Average-Cost method*Inventory method based on the average cost of inventory during a period*Determined by dividing the cost of goods available by the number of units available

*LIFO vs. FIFO

FIFO:*First-in, First out method*Inventory costing method by which the first costs into inventory are the first costs out to cost of goods sold.*The cost of Ending Inventory is based on the costs of the most recent purchases (or latest costs incurred)

LIFO: (not used by all countries)*Last-in, first out*Inventory costing method by which the last cost to enter inventory are the first costs out to cost of goods sold*The cost of ending inventory is always based on the oldest costs – from beginning inventory

*Accounting Principles Related

to Inventory

Consistency Principle:*States that businesses must use the same accounting methods and procedures from period to period*Why is this important?*Consistency helps investors compare a company’s

statements from one period to the next.Disclosure Principle:*States that a company’s financial statements should report enough information for outsiders to make informed decisions about the company*Relevant, reliable, and comparable information

*Accounting Principles Continued

Conservatism:*Means reporting the least favorable figures in the financial statements

*What is the advantage?*Accountants like conservatism due to the fact that it brings optimistic managers to reality*The goal is to present reliable data

*Lower-of-cost-or-market rule (LCM)

*Based on accounting conservatism

*This requires that inventory be reported in the financial statements at whichever is lower…*Whether its historical cost*Or its market value

*Converse about Concepts

Gross Profit Percentage*We already learned about Gross Profit*But, this is the gross profit divided by net sales revenue*Also called gross margin percentage*Is markup shown as percentage of sales

*So if the GPP was .43, then each dollar of sales generates 43 cents of gross profit*Meaning, costs of goods sold consumes 57 cent of each sales dollar

*Inventory Turnover

Time for Ratios Again!*Ratio of cost of goods sold to average inventory.*Indicates how rapidly inventory is sold

*Inventory Turnover = Cost of Goods Sold Average Inventory

*AVG Inventory = (Beginning Inventory + Ending Inventory)/2

*So Example for Converse Inc.*$1,001/(333 + 275)/2 = *3.3 times per year every 111 days

*Decisions and COGS Model

Cost of goods sold model*Beginning inventory + Purchases = Goods Available*Then Goods Available – Ending Inventory = Costs of Goods Sold

The 2 main Manager Decisions Guidelines for Companies:*Which inventory system to use?*What type of inventory do we have?

*Which costing method to use?*What minimizes problems and emphasizes reality?

*Pause for the Weekend

Have a great weekend!

I am happy to be your teacher and I am interested in seeing what dreams you chase in the future!

Study Hard and Enjoy the Weekend!Here comes Thanksgiving!!!!