okay guys welcome to this week we are going to cover chapter six now guys in my opinion chapter six is easier than chapter five we're talking about inventory and the different methods of being able to show costing for inventory along with cost of goods sold so if you have questions those of you online feel free to um you know comment i'm assuming right now everyone can see my screen and hear me correct okay guys so what we're going to start talking about is inventory inventory is the asset that is manufactured or is purchased and the purpose of inventory is to sell it to customers so we're going to talk about various types of inventory and cost of goods sold so we know inventory if you are a manufacturing company you purchase various uh raw materials in order to make products ultimately for sale to sell to customers items that are still not finished are included in an inventory we're going to talk about that inventory is a current asset on the balance sheet once inventory is sold it no longer is on the balance sheet it becomes an expense called cost of goods sold on the income statement remember inventory's an asset it's on the balance sheet as a current asset but when those products do sell it becomes on the goes on to the income statement as an expense called cost of goods sold so we see here that when you are a merchandise company you purchase inventory that is already completed and ultimately you sell that merchandise as a wholesaler or as a retailer manufacturing companies have a couple types of inventory the raw materials would be the would be considered inventory and it's the materials to make the products as the products are being made those raw materials get removed and are put into another inventory account called work in process the work and process account is used until the goods are completed and ready to be sold once those goods have finished all their manufacturing they are moved into finished goods it is these finished goods that are able to be sold so know that merchandising companies versus manufacturing companies have different types of inventory you'll learn a lot more about manufacturing and the various accounts in managerial accounting how many of you have to take that next semester anyone managerial accounting one no one else does a couple okay i'll see you next year in that next fall um so here you see a partial balance sheet showing um how the inventory looks for a manufacturing company intel how they show raw materials work and process and finished goods and then you also see best buy which is a merchandising company how they just have inventory already completed so we know a manufacturing company takes the raw materials adds the direct labor and some manufacturing overhead to produce various types of products in this case it's a computer while it's being completed it is in an inventory account called work in process once that product is completed it then goes into finished goods it's available for sale it can be sold to various manufacturing or merchandising companies who in turn sell it to the end user and use it for in school here use it for services you know it's a piece of equipment that is needed to perform their jobs if i didn't have a computer it would make doing income taxes very difficult so remember guys service companies record revenues when providing services to customers merchandising and manufacturing companies record revenues when they sell inventory to customers so we're going to take this first question which of the following inventory accounts consist of items for which the manufacturing process is complete anyone know is it d what did you say i said d d are you sure you're right excellent finish goods is the inventory account that is used when the product is ready to be sold work in process is the account that is used as the product is being worked on and and completed now cost of goods sold is an income statement item inventory is a balance sheet item inventory is an asset we are going to have beginning inventory along with purchases during the year give you total inventory that's ready to be sold but at the end of the year you either have it's still sitting in ending inventory or it's sold so know this slide inventory plus purchases is total inventory available then the total inventory available will either be sold or will still be in ending inventory the item sitting and ending inventory is an asset current asset on the balance sheet the items that are sold is an expense reported in the income statement again i'm kind of highlighting this but inventory is a current asset the items sitting in that inventory account have not yet been sold but when an item is sold it transfers out of inventory our inventory is credited cost of goods sold is debited okay so what about this one guys cost of goods sold is a reported in the income statement b reported in the balance sheet c a current asset or d the cost of inventory on hand at the end of the period hey a what about everyone else what do you think a a awesome excellent guys it's reported in the income statement here you see something that is called a multiple step income statement and the reason it's called a multiple step income statement is because it shows you different levels of profit it shows you from revenues minus cost of goods sold it shows you gross profit then after various selling and admin expenses it shows you operating income then after various other income and other gains and other expenses it shows you income before income taxes and then with the income tax expense it shows net income this is called a multiple step income statement remember it reports multiple levels of profitability gross profit equals net revenues minus cost of goods sold operating income equals gross profit minus operating expenses income before income taxes equals operating income plus any non-operating revenues and non-operating expenses and then net income equals all revenues minus all expenses okay pretty straightforward again keep a multiple step income statement beside you so you understand the different levels and which profitability is considered profit from normal operating income normal operating from normal operations it's operating income okay sorry about that now here's the key today the focus is on various types of inventory costing methods inventory is unique and diverse there's all kinds of inventory out there but companies are allowed to show the costing of inventory based on a couple specific methods one is called specific identification and this is primarily used when the inventory is very unique so it's not like selling a bunch of dell computers this is where it might be a piece of jewelry or a home or an automobile where specific identification matches each unit of inventory with what it actually cost to produce that piece of inventory another type of method is fifo first in and first out now that assumes the first items that have been purchased are going to be the first items that get sold usually that is physically how it happens but just because it physically happens that way you're allowed different ways in which to account for the cost last in first out we call lifo lifo assumes that the last units purchased are the first ones sold now we know we're not going to sell them that way we're going to get rid of our older inventory first but we can show the costing in the financial statements that way then there's weighted average cost where we take all the units and we put a weighted average on them which we'll talk about in a minute and all of the units get that same price so here we have mario's game shop this shows us we started the year with beginning inventory of 100 units then it shows that we purchased on april 25th 300 units and we also purchased on october 19th another 600 units but as you see they're all different costs so the first hundred units are cost at um seven bucks per unit the next three hundred are at nine bucks a unit and then on october 19 that one is at 11 bucks per unit so we have a thousand units at a total cost of ten thousand dollars does that make sense what if during the year we sold 800 of these units okay that's the plan if we sold 800 of those units and there's a thousand units available then that means if we sold 800 we have 200 remaining in ending inventory so we're going to look at these different methods the first method we're going to talk about is called the fifo method the first inventory in is the first inventory we're going to sell fifo first in is the first out if in fact we sold 800 units wouldn't we sell a hundred units at seven bucks 300 units at nine bucks and then 400 units at 11 bucks the first one's in are the first ones we're selling which means the ending inventory are going to be the very last units because they're still sitting in inventory does that make sense fifo the first units that we purchased are going to be the first units we say were sold so if we have a thousand units the first 800 are what we're going to show was were sold if we use the method called lifo then the last units we purchased are the first units we're getting rid of that we're saying not physically but what we can say for cost purposes so 800 units means the ones we purchased at the very end in october for 600 units at 11 are going to get sold and then the 200 out of the 300 units in april 200 units are going to be sold which means what's left in ending inventory would be the oldest units the units from the beginning inventory and 100 units from the april 25th purchase does that make sense so what this is doing is we've got to earmark which ones are we selling so we can show what went into cost of goods sold and what's staying in the balance sheet as an asset many students find it shocking that companies are allowed to report inventory cost using assumed amounts rather than actual amounts nearly all companies sell their actual inventory in a fifo manner but they're allowed to report it as if they sold it in a lifo manner and we'll explain why that matters in a little bit okay now how about this one i want everyone to attempt this month i'm going to give you a couple minutes to attempt this huh is it b someone said is it b has everyone done it yet i'm going to wait till everyone looks so someone kind of gave you a heads up it could be food um anyone else have another answer anybody anybody it's b okay how did we come up with that again fifo means the first ones in are the first ones we say we sold so if we sold 120 units we take the oldest one sitting in inventory the beginning inventory shows 100 units at four bucks each so we'll take all of those and then the january 15th purchase will take 20 of those units at five bucks apiece does that make sense so our cost of goods sold here would be five hundred dollars so if it was life though i'm just trying to make sure i understand that the one that i have done if it was lifo we would take the oldest 100 units at six dollars right well the newest hundred units yes at six dollars well okay i'm sorry the the most recent purchases okay yeah sorry and then we'll take so basically we'll take the end of it exactly okay exactly so let's do that one okay this one says what would be the cost of goods using lifo is it c c is correct we're going to take a hundred units at six bucks and 20 units at five bucks okay now there's another method this is called the weighted average cost method we're going to take all the units and come up with a weighted average of the inventory items the way we do this is we take a hundred units at seven which means we spent seven hundred bucks to purchase those units three hundred units at nine means we spent twenty seven hundred dollars on the april 25th purchase on october 19th we purchased 600 units at 11 which shows 6600 we have a thousand units at a total cost of 10 bucks if we divide that 10 000 by the number of units available we come up with 10 dollars a unit the reason the weighted average is important is because if we just look at the unit cost of 7 9 and 11 the average here would be 9. but we spent a lot more we have a lot more inventory at 600 units at 11 bucks therefore the weighted average is what we need to take to accurately depict dollars per unit now we'll use that same amount ten dollars per unit is going to get put in the cost of goods sold and ten dollars per unit will be put in the ending inventory so here are the three methods we've talked about you see using fifo we show the cost of goods sold is sitting at 7 800 but the ending inventory sitting at 2200. if we use lifo the cost of goods sold is higher because we're taking the oldest units that are that cost more and our ending inventory are the units that we've had longer if we use the weighted average method it will always be in between the two lipo and fifo does that make sense companies are allowed to report inventory costs by assuming which specific units of inventory are sold and not sold even if this does not match the actual flow the three major inventory cost flow assumptions are fifo lifo and weighted average cost any questions on this before we move on okay now why does all this matter well when we use fifo that's basically matching the flow of goods with what we're truly doing and the cost and the flow to go together most companies do use the fifo method we call the fifo method the balance sheet approach because our balance sheet is going to most accurately reflect the most current costs if we use the lifo method we call that the income statement approach because our income statement is going to use the most current prices the lifo conformity rule basically says if a company uses lifo for income taxes they have to use lifo for financial reporting you can't have it one way and then get to opt to make your financial statements look better so what's all this about well when prices are rising if we use fifo our ending inventory is higher on the balance sheet it makes us look like we have higher assets we're going to also have higher net income when prices are rising if we use lifo we're going to have lower a smaller amount of assets in ending inventory but lower net income on the balance sheet and the weighted average will always be a combination of the two so the lifo versus fifo can make a difference on your assets and can make a difference on net income depending which method you use so most people show their accounting books in fifo but if they choose to record it in lifo they create a journal entry to show the difference the um they report it using fifo but they report the difference called the lifo difference as to how that affects their financial statements which we'll look at okay so guys what do you think during a period of rising prices which inventory cost flow assumption would result in the highest cost of goods sold and thereby the lowest net income lifo exactly what about this and which inventory method or cost flow assumption most closely resembles the actual physical flow of goods excellent bye folk so now let's let's look at the meat and potatoes of how we go about recording these journal entries there's two methods one is called the perpetual method where we keep a track after every transaction and one is called the periodic system it basically adjusts at the end of the year for cost of goods sold so we're going to look at both of them because homework will have both using a perpetual system means we keep the inventory updated after every transaction so on april 25th when mario purchases inventory for 2700 on account we're going to debit our inventory and we'll credit our accounts payable right away okay then this entry shows an increase in inventory and an increase in a liability makes sense next on july 17th mario sells inventory on account for 4 500 what are we going to do there are two transactions we're going to do when inventory is sold using the perpetual method first we're going to show the sale of the inventory and then after that we also have to take into account the cost of goods sold that are no longer in inventory that have gone to cost of goods sold we debit that for 2500 and we reduce our inventory for 2500 okay so sales revenue basically equals the selling price and the cost of goods sold is the expense the selling price is what we're selling the products for the cost of goods sold is what it cost us to purchase or make those goods now this inventory we see mario began with 700 they had purchases of 2700 and 6600 and they sold two different times on january 17 and december 15th we've got sitting in the account fifo based on fifo of 2200. now remember me talking about that lifo adjustment when companies choose to do lifo they usually record their books using fifo but there's a year end adjustment that adjusts it to lifo which we call the lifo reserve remember mario's ending inventory using fifa was 2200 but if they would have used fifo excuse me if they would have used lifo it would have been 1600 so it would have been dollars less so in order to look at the lifo adjustment we would show a debit to cost of goods sold of 600 and we would credit our inventory for 600 to adjust to the lifo method okay does that make sense guys okay now there are some additional items that go into inventory frayed in our shipments from suppliers that we pay for and frayed out shipment to customers we pay for there's also something called purchase discounts and there are purchase returns so we're going to talk about how these various transactions affect our inventory so when there's some terms with shipping that we want to talk about when mario purchases items from the supplier the seller and if the items are shipped saying fob shipping point what that means it's free on board to the shipping point which means the supplier's warehouse what that means is the mario's responsible for paying the shipping cost so because mario's paying the shipping cost the title of those goods passes to mario at the shipping point when they leave the dock of the suppliers if this is the case then mario's going to record this purchase of goods on april 25th because it owns those goods at that time if the shipping shows fob free on board to the destination then what that means is the supplier is responsible for those goods until it gets to mario's warehouse mario stock in that case the title passes to mario when they receive the goods at the destination at mario's warehouse doc if that's the case then mario would record the purchases on april 29th so depending on how the shipping instructions work depends on when we will record this transaction which of the following transactions would increase the balance of the inventory account for a company using the perpetual inventory method what do you guys think anyone which of the filing would increase the balance of inventory costs of incoming freight charged on merchandising inventory that would increase it wouldn't it a return of damaged inventory to the vendor would decrease it a purchase discount taken for prop payment would decrease it and shipping charges for outgoing inventory would decrease it so know what increases it is cost on incoming freight so here you see mario's showing on the income statement the various items excuse me uh this isn't on an income statement it's just showing the detail of the cost of goods sold showing we add freight charges to inventory and we would subtract any purchase discounts we receive because we pay early we talked about that i believe the last chapter or one of these chapters okay so let's look at how the various transactions are recorded with the buyer and with the seller of these goods so when we look at the purchaser the one who's buying these goods we see that when we purchase goods on account the buyer is debiting inventory and crediting a payable the seller debits accounts receivable and credits sales revenue now if the buyer returns some products then their accounts payable is decreased and their inventory also is decreased you see they just reduce their inventory but the seller's side wants to keep track of any returns that happen so they debit sales returns and credit they're receivable when the purchaser finally pays they're going to debit the payable they're going to credit the inventory and credit the cash they're crediting the inventory because the inventory isn't going to cost them as much because they're paying early so the inventory has less cost however the seller wants to keep track of how many people utilize the sales discounts so they will debit the cash they will debit the sales discounts and credit the entire accounts receivable yes so i've noticed well maybe i could be wrong but when there's a return for an item i just feel like i haven't noticed when do you account for in the in the statements when do you show that there was the return right when they receive it so the return will happen on either the purchasers or sellers side right when it when the purchaser sends it back or the seller receives it they will show it now the purchaser will just debit the payable because they now owe less and credit their inventory but the seller is going to be careful and show it was a sales return because they want to keep track of are there certain goods that are getting returned more than other goods maybe something's wrong with them will they still stay balanced even though it still will stay balanced yes it was you don't really because you know how um like when you wrote off debt yeah um for people not paying it yeah what do you what do they i guess this is going overboard overthink stuff what do they do with like the items and stuff at that well the items already sold initially so the sale occurs when the goods transfer when the goods pass so nothing changes because those goods are gone unless the um an auto um an auto dealer goes and confiscates those goods and gets it back but usually speaking in this scenario the goods are gone okay so all we're doing is adjusting the accounts receivable to allowance in this case they are returning the goods so we need to keep track of you know each when they it happens okay so guys we're going to do an exercise here and i'm going to take a quick run to the bathroom while i want you to attempt these you see ds unlimited has the following transactions during august on august 6 it purchased 70 handheld game devices on account on account means accounts payable for 200 each then on august 7th it pays 400 to sure shipping for freight charges then on august 10th it returns two six game devices that were defective august 14th it pays the full amount and then on august 23rd it sells some so i want you to go through this i'm going to just put the recording on so on august 6th when d s unlimited purchases 70 handheld game devices on account we're going to debit our inventory for 14 thousand and we're going to credit our accounts payable for fourteen thousand purchasing inventory on account okay when we pay the freight with cash we're debiting inventory and crediting cash then it says we returned some goods i believe is what it said uh we uh return six game devices that were defective we're going to debit accounts payable for 1200 and credit our inventory for 1200. when we finally pay our bill we utilize the discount so we're going to debit our accounts payable we are going to credit our inventory for the one percent discount because we're not paying as much as we thought in our inventory and then we're going to credit our cash the 128 is coming off the original inventory price the less what we returned less what we returned because we already returned goods and so we're going to um because we started with 14 000 we returned 1200 so we had 12 800 we needed to pay on then when we turned around and sold those goods we're debiting our receivable for 11 000 we're crediting our sales revenue and then there's an additional journal entry getting read of our inventory to show it was sold we debit our cost of goods sold for 10 000 to 1250 and we credit our inventory for 10 000 to 1250. any questions on that guys any questions okay now we're going to look on the other side of the equation here and let's look at game girl prepare the transactions for game girl assuming the company uses a perpetual system assumed the 70 game devices sold on august 6 to ds unlimited had a cost to game girl of 180 bucks each the items returned on august 10th were considered worthless to game girl and were discarded so when we sold the goods we debit the receivable we credit the sales revenue then we also debit our cost of goods sold and credit our inventory for that amount okay next when the products were returned we debit our sales returns and we credit our accounts receivable [Music] then when we received the money we debit our cash we debit our sales discounts and we credit our accounts receivable of twelve thousand eight hundred remember they took the discount okay now there's something else we're going to talk about as it relates to inventory we're we're constant aware of the term cost that's what we usually show the inventory at but there's a new term now we're going to use called net realizable value and basically what that means is cost is what we purchase the items for but net realizable value is the estimated selling price less any cost to sell the goods if net realizable value is lower than cost we will then need to adjust our books to account for the lower price if the lowest prices cost there's nothing we need to do but if it is net realizable value then we're going to have to reduce our inventory from cost to net realizable value and show an expense on the income statement so here's an example guys this game store has two devices a fun station two and a fun station three it looks like the new one is out now so it kind of makes the fun station to a little obsolete so we're going to look at them and we're going to see hey is what's lower cost or net realizable value if the cost is lowest we do nothing but if the net realizable value net realizable value is lower we need to adjust our books by showing a debit to cost of goods sold and we reduce our inventory by that amount remember if cost is lower there's nothing we need to do but if net realizable value is lower than we need to adjust the books okay what teach like show me which part you're saying okay you see here it says cost and this says net realizable value in this example which is lower well the 3000 is lower than the 4 500. so we need to adjust our books to net realizable value and do a journal entry so guys look at this one at the end of the year a company reports the following inventory amounts the amount to report for ending inventory using the lower of cost and net realizable value is what two or b or d okay i want everyone to do tell me what you think [Music] yes anyone have an idea so on item a the cost is for the net realizable value is eight which is lower don't need to do anything item b the cost is eight the net realizable value is six do we need to do something we do we need to reduce it by three hundred dollars right so that would mean that our new cost in inventory is a hundred fifty times six bucks and item a is a hundred times four bucks thirteen hundred does that make sense 100 times four why are you doing it remember it's the cost the lower of cost or net realizable value it's asking us what's our inventory well it's going to be a hundred times four and a hundred fifty times six those are the lowest ones okay how about this one guys at the end of the year a company reports the following inventory amounts the year end adjustment using the lower of cost and net realizable value would include what what's it going to include there come on guys what's it going to use [Music] won't it be a credit to inventory for 300 and a debit to cost of goods sold for 300 right because of the net realizable value won't we be adjusting those okay okay so we're going to look here a company like golf usa that sells golf related inventory typically will have inventory items such as golf clothing and golf equipment as technology advances the design and performance of the next generation of drivers the older models become less marketable and therefore decline in value suppose that in the current year ping introduces the mega driver 2 the new and improved version of the mega driver below are amounts related to golf's usa's inventory at the end of the year calculate ending inventory using the lower of cost or net realizable value record any adjustments to inventory and explain how this affects the financial statements i want everyone to give you five minutes to attempt this okay okay let me pause and angel you're going to remind me okay so guys calculate the ending inventory using the lower of cost or net realizable value the shirts the lower of cost or net realizable values cost the mega driver the net realizable value is the lower number at 250. so that's what we're going to use and the mega drivers at 350. so you see our ending inventory sitting at sixteen thousand three fifty the way we need to adjust it is right down on the mega drive or the difference between the cost and the net realizable value we need to debit to cost of goods sold and reduce our inventory and how does this affect us the write down of inventory basically reduces our assets and also reduces our net income right right decreasing net income and decreasing retained earnings okay now there's a couple ratios i'm going to let you do on your own the the inventory turnover ratio and the gross profit i'll let you do that on your own but there will be some homework on that just so you know but what i want to focus on is this last piece the last piece is using the periodic system so we've talked about how we use the perpetual system but the periodic system has a a bunch of different accounts we're going to use so we need to look at this remember the periodic system doesn't take into account cost of goods sold to the very end okay so what we're going to do using the same information is under the periodic system we don't call it inventory we call the account purchases when we purchase items when we sell items we don't show the reduction of inventory and the increase of cost of goods sold we deal with that at the end we only show the accounts receivable in the revenue then on freight charges instead of increasing the inventory we debit our freight in okay then when we pay with a discount instead of reducing our inventory we type out the word purchase discounts and when we return items instead of just crediting our inventory we credit purchase returns i think it's important that you guys have a little sheet that shows the difference between the perpetual method and the periodic method because the names used are different okay okay does that make sense only under the periodic system do you have to do an adjustment at the end of the period you need to show the ending inventory and the way we do that is we get rid of records the cost of goods sold for the period and these accounts purchase discounts purchase returns frayed in and purchases all get zeroed out okay they all get zeroed out we know what the ending inventory amount is we know what the beginning inventory amount is and the rest goes into cost of goods sold so only under the periodic method do we handle this adjusting urine entry under the perpetual method we keep track of it as we're going along so this shows you using the periodic method how your cost of goods look you have a beginning inventory you add your purchases and frayed in minus purchase discounts and returns to get all your costs ready for se available unless your ending inventory is going to give you what your cost of goods sold is it's different the accounts used are different as you can tell okay got it guys okay when a periodic inventory system and the fifo method are used which of the following is correct what do you guys think uh hmm anyone did you say b go angel the amount of cost of goods sold will be the same under a perpetual system and the fifo method now here's our last exercise we're using that same company again the same transactions but we're going to do this using the periodic system when we make purchases guys we debit our purchases and credit our payable when we have freight we debit freight in in credit cash when we return items we debit our payable and we credit purchase returns when we sell the or when we pay for the product we credit our debit our accounts payable but we also credit purchase discounts then when we sell products we don't handle the cost of goods side we just do the sale portion our accounts receivable and our sales revenue now how do we do the adjustment we know our ending inventory okay so we take we um zero out our purchase returns our purchase discounts our purchases and our freight in transfer that into cost of goods sold and we're going to balance out since there was no beginning inventory here we didn't have to zero that one out now when errors happen in inventory in the end over a two year period it's all going to balance out but one year we'll overstate one item and understate another item so when there is an overstating of your ending inventory what does that do it overstates your ending inventory it understates your cost of goods sold which ultimately makes your in net income higher so you what they're wanting you to understand is there's an effect on the balance sheet and the income statement when the numbers aren't correct if you understate your ending inventory then the asset inventory is understated but your cost of goods sold is overstated which makes you have a lower net income it understates the net income no ultimately it's going to balance out but between the years it's not going to be perfect do you see this if our inventory is overstated from one year to the next here let's say this is the correct amount this is understated if our inventory gets understated then you see our cost of goods sold gets overstated so know that between the years it's all going to balance out fine but between between the over the two years it's going to balance out fine but between year one and year two the numbers aren't going to be correct in the current year inventory errors affect the amounts reported for inventory and retained earnings in the balance sheet and amounts reported for cost of goods sold and gross profit in the income statement at the end of the following year the error has no effect on ending inventory or retained earnings but reverses for the cost of goods sold in gross profit so over that two-year period is going to be fine okay what about this one an inventory error that understates the amount of ending inventory will result in which of the following in the current year hey anyone else someone else today how about you guys online let's say hey awesome guys any questions before i turn off the recording you guys good