THE COST OF GOODS SOLD
The chapter is a detailed introduction to the cost flow assumptions used to value inventories and measure the cost of goods sold.
Application of specific cost identification, weighted average cost, and FIFO is first examined within the context of a perpetual inventory system. The impact of the flow assumption employed on income taxes is discussed in detail. The need for a physical inventory to assess inventory shrinkage is also reviewed as the accounting procedures necessary to record inventory shrinkage. A brief presentation of lower-of-cost-and-net-realizable-value write downs concludes the discussion of perpetual systems. Application of the flow assumptions within a periodic system is next explained.
The chapter covers a number of additional issues surrounding inventory accounting. These include: the financial statement effects of inventory errors; the retail and gross profit methods for estimating ending inventory; and, an analysis of the inventory turnover ratio.
1. In a perpetual inventory system, determine the cost of goods sold using (a) specific cost identification, (b) weighted average cost, and (c) FIFO. Discuss the advantages and shortcomings of each method.
2. Explain the need for taking a physical inventory.
3. Record shrinkage losses and other year-end adjustments to inventory.
4. In a periodic inventory system, determine the ending inventory and the cost of goods sold using (a) specific cost identification, (b) weighted average cost, and (c) FIFO.
5. Explain the effects on the income statement of errors in inventory valuation.
6. Estimate the cost of goods sold and ending inventory by gross profit method and the retail method. 7. Compute the inventory turnover and explain its uses.
Brief topical outline
A The flow of inventory costs 1 Specific cost identification 2 Cost flow assumptions 3 Weighted average cost method 4 First-in, first-out method 6 Evaluation of the methods a Specific cost identification b Weighted average cost c First-in, first-out
7 Do inventory methods really affect performance? 8 The principle of consistency 9 Just-in-time (JIT) inventory system - see Case in Point (page 353) B Taking a physical inventory 1 Recording shrinkage losses
2 LCNRV and other write-downs of inventory a The lower-of-cost-and-net-realizable-value (LCNRV) rule
3 The year-end cutoff of transactions a Matching revenue and the cost of goods sold b Goods in transit - see Your Turn (page 356) 4 Periodic inventory systems a Applying flow assumption in a periodic system b Specific cost identification c Weighted average cost d FIFO e Receiving the maximum tax benefit from the LIFO method f Pricing the year-end inventory by computer 5 Importance of an accurate valuation of inventory a Effects of an error in valuing ending inventory b Inventory errors affect two years c Effects of errors in inventory valuation: a summary 6 Techniques for estimating the cost of goods sold and the ending inventory 7 The gross profit method
8 The retail method
9 Textbook inventory systems can be modified…and they often are C Financial analysis and decision making
1 Inventory turnover - see Your Turn (page 362)
2 Receivables turnover 3 Length of the operating cycle
4 Accounting methods can affect financial ratios - see Ethics, Fraud & Corporate Governance (page 364) D Concluding remarks Topical coverage and suggested assignment
(To Be Completed Prior to Class)
Class Meetings on Chapter
Topical Outline Coverage
Critical Thinking Cases
2, 3, 4
7, 11, 13, 16
7, 9, 10
5, 6, 7
3 C - D