MARKET PULSESEC alleges Office Depot made selective disclosureOct. 21, 2010, 3:10 p.m. EDTBy Ronald D. Orol

WASHINGTON (MarketWatch) -- Office Depot Inc. executives selectively shared information with analysts and its largest shareholders, giving some an unfair advantage, the Securities and Exchange Commission said Thursday after launching enforcement actions against the retailer and CEO Stephen A. Odland and then-CFO Patricia A. McKay for violating fair disclosure regulations. “Office Depot executives selectively shared information with analysts and the company's largest shareholders in order to manage earnings expectations,” said SEC Division of Enforcement Director Robert Khuzami. “This gave an unfair advantage to favored investors at the expense of other investors and, as today's action shows, is illegal.” The SEC alleged the pair directed investor relations officials to manage down their guidance for the second quarter of 2007.

Reporting and Interpreting Cost of Reporting and Interpreting Cost of Goods Sold and InventoryGoods Sold and Inventory

Chapter 7

Ch 7 -- Not tested Cash flows (pp. 355-357) Converting Income Statement and Balance Sheet to FIFO

(pp. 358-360) Errors in measuring ending inventory (pp. 362-363) LIFO liquidations (pp. 365-368) Changes in estimates (pp. 428-429)

Practice ProblemPerpetual Inventory

In a perpetual inventory system, a detailed inventory record is maintained, recording each purchase and sale during the accounting period. This up-to-date record is maintained on a transaction-by-transaction basis. To this point in the text, all journal entries for purchase and sale transactions have been recorded using a perpetual inventory system.

In a perpetual inventory system, purchase transactions are recorded directly in an inventory account. When each sale is recorded, a companion cost of goods sold entry is made, decreasing inventory and recording cost of goods sold. As a result, information on cost of goods sold and ending inventory is available on a continuous (perpetual) basis.

Practice ProblemPerpetual Inventory

Sept 30 Made catalog sales during the remainder of the month, as follows:Apparel Gift $2,980 $900The cost of the merchandise was $1,240 and $635, respectively. All catalog sales were made on credit.

EXTREMELY IMPORTANT FORMULAECost of Goods Sold calculation Income from Operations calculation

Beginning inventory Net sales**+ Net purchases* - Cost of goods sold Goods available for sale Gross margin (AKA Gross profit)- Ending inventory - Operating expenses Cost of goods sold Income from operations * Net purchases = Gross purchases

– Purchase returns, allowances, and discounts + Transportation, insurance, storage, taxes, etc.

** Net sales = Gross sales – Sales returns, allowances, and discounts

7-9

Costs Included in Inventory Purchases

The cost principlecost principle requires that inventory be recorded at the price paid or the

consideration given.

Invoice Price

Freight

Inspection Costs

Preparation Costs

7-10

Supplement B: Additional Issues in Measuring Purchases

Purchase returns and allowances are a reduction

in the cost of purchases associated with

unsatisfactory goods.

A purchase discount is a cash discount

received for prompt payment of an account.

7-11

Supplement B: Additional Issues in Measuring Purchases

Terms

Time

Due

Discount Period

Full amountless discount

Credit Period

Full amount due

Purchase or SalePurchase or Sale

2/10,n/302/10,n/30Discount Percent

Discount Percent

Number of Days Discount

Is Available

Number of Days Discount

Is Available

CreditPeriod

CreditPeriod

Purchase Discounts

Accounts Payable 500Cash 495Purchase Discounts 5

To record payment within discount period to

supplier who offers 1% purchase discount.

($ 500 × 1% = $5 discount)

Shipping Terms

When are goods in transit included in the inventory of theSeller?Purchaser?

FOB Shipping Point (p. 284)

Both sale and purchase recorded upon shipment Buyer responsible for (i.e., owns) inventory while in

transit

Seller Buyer

Titlepasses when

shipped

FOB Destination (p. 284)

Both sale and purchase recorded when inventory delivered at destination

Seller responsible for (i.e., owns) inventory while in transit

Seller Buyer

Titlepasses at

destination

FOB Shipping PointAggie sold goods costing $35,000 to Texas Company FOB

Shipping Point on September 1. The goods arrived at Texas Company on September 15.

When would Aggie record sales revenue? Who pays for shipping?

FOB DestinationAggie sold goods costing $40,000 to Waco Company FOB

destination on September 30. The goods were received by Waco Company on October 8.

When would Aggie record sales revenue? Who pays for shipping?

EXTREMELY IMPORTANT FORMULAECost of Goods Sold calculation Income from Operations calculation

Beginning inventory Net sales**+ Net purchases* - Cost of goods sold Goods available for sale Gross margin (AKA Gross profit)- Ending inventory - Operating expenses Cost of goods sold Income from operations * Net purchases = Gross purchases

– Purchase returns, allowances, and discounts + Transportation, insurance, storage, taxes, etc.

** Net sales = Gross sales – Sales returns, allowances, and discounts

7-19

Flow of Inventory Costs

MerchandiseMerchandisePurchasesPurchases

MerchandiseMerchandisePurchasesPurchases

Cost ofCost ofGoods SoldGoods Sold

Cost ofCost ofGoods SoldGoods Sold

MerchandiseMerchandiseInventoryInventory

MerchandiseMerchandiseInventoryInventory

Merchandiser

7-20

Nature of Cost of Goods Sold

BeginningBeginningInventoryInventory

BeginningBeginningInventoryInventory

PurchasesPurchasesfor the Periodfor the PeriodPurchasesPurchases

for the Periodfor the Period

Ending InventoryEnding Inventory(Balance Sheet)(Balance Sheet)

Ending InventoryEnding Inventory(Balance Sheet)(Balance Sheet)

Goods availableGoods availablefor Salefor Sale

Goods availableGoods availablefor Salefor Sale

Cost of Goods SoldCost of Goods Sold(Income Statement)(Income Statement)

Cost of Goods SoldCost of Goods Sold(Income Statement)(Income Statement)

Beginning inventory + Purchases = Goods Available for SaleBeginning inventory + Purchases = Goods Available for Sale

Goods Available for Sale – Ending inventory = Cost of goods soldGoods Available for Sale – Ending inventory = Cost of goods sold

Beginning inventory + Purchases = Goods Available for SaleBeginning inventory + Purchases = Goods Available for Sale

Goods Available for Sale – Ending inventory = Cost of goods soldGoods Available for Sale – Ending inventory = Cost of goods sold

EXTREMELY IMPORTANT FORMULAECost of Goods Sold calculation Income from Operations calculation

Beginning inventory Net sales**+ Net purchases* - Cost of goods sold Goods available for sale Gross margin (AKA Gross profit)- Ending inventory - Operating expenses Cost of goods sold Income from operations * Net purchases = Gross purchases

– Purchase returns, allowances, and discounts + Transportation, insurance, storage, taxes, etc.

** Net sales = Gross sales – Sales returns, allowances, and discounts

QUIZ #2, Ch 6 - WEDNESDAY (10/24)

Quiz # 3, Ch 7 - FRIDAY (10/26)

7-23

Inventory Costing Methods

Total Dollar Amount of Goods Total Dollar Amount of Goods Available for SaleAvailable for Sale

Total Dollar Amount of Goods Total Dollar Amount of Goods Available for SaleAvailable for Sale

Ending InventoryEnding InventoryEnding InventoryEnding Inventory Cost of Goods SoldCost of Goods SoldCost of Goods SoldCost of Goods Sold

Inventory Costing Method

Inventory Costing Methods1. Specific Identification2. First-in, First-out3. Last-in, First-out4. Weighted Average

7-24

Specific Identification

When units are sold, the

specific cost of the unit sold is

added to cost of goods sold.

When units are sold, the

specific cost of the unit sold is

added to cost of goods sold.

7-25

Cost Flow Assumptions

The choice of an inventory costing method is not based on the physical flow of goods

on and off the shelves.

LIFO

FIFOWeightedAverage

7-26

First-In, First-Out Method

Cost of Cost of Goods SoldGoods Sold

Cost of Cost of Goods SoldGoods SoldOldest CostsOldest CostsOldest CostsOldest Costs

Ending Ending InventoryInventoryEnding Ending

InventoryInventoryRecent CostsRecent CostsRecent CostsRecent Costs

7-27

First-In, First-Out

Remember: Remember: The costs of The costs of most most recent recent

purchasespurchases are are in ending in ending inventory. inventory. Start with Start with

11/29 and add 11/29 and add units units

purchased purchased until you reach until you reach the number in the number in

ending ending inventory.inventory.

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$

Ending Inventory 1,200 ?

Cost of Goods Sold 1,050 ?

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$

Ending Inventory 1,200 ?

Cost of Goods Sold 1,050 ?

7-28

First-In, First-Out

Now, we have allocated the cost to all Now, we have allocated the cost to all 1,200 units in ending inventory.1,200 units in ending inventory.

Now, we have allocated the cost to all Now, we have allocated the cost to all 1,200 units in ending inventory.1,200 units in ending inventory.

Beg. Inv. 1,000 @ 5.25$ Jan. 3 500 @ 5.30 450 @ $5.30June 20 300 @ 5.60 300 @ $5.60Sept. 15 250 @ 5.80 250 @ $5.80Nov. 29 200 @ 5.90 200 @ $5.90

1,200 Units Units

6,695$ Cost

Ending InventoryCost of Goods

SoldGiven Information

7-29

First-In, First-Out

Now, we have allocated the cost Now, we have allocated the cost to all 1,050 units sold.to all 1,050 units sold.

Now, we have allocated the cost Now, we have allocated the cost to all 1,050 units sold.to all 1,050 units sold.

Beg. Inv. 1,000 @ 5.25$ 1,000 @ 5.25$ Jan. 3 500 @ 5.30 450 @ $5.30 50 @ 5.30 June 20 300 @ 5.60 300 @ $5.60Sept. 15 250 @ 5.80 250 @ $5.80Nov. 29 200 @ 5.90 200 @ $5.90

1,200 Units 1,050 Units

6,695$ Cost 5,515$ Cost

Ending InventoryCost of Goods

SoldGiven Information

7-30

First-In, First-Out

Here is the Here is the cost of cost of ending ending

inventory inventory and cost and cost of goods of goods

sold using sold using FIFO.FIFO.

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$

Ending Inventory 1,200 6,695.00$

Cost of Goods Sold 1,050 5,515.00$

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$

Ending Inventory 1,200 6,695.00$

Cost of Goods Sold 1,050 5,515.00$

7-31

Last-In, First-Out Method

Ending Ending InventoryInventoryEnding Ending

InventoryInventory

Cost of Cost of Goods SoldGoods Sold

Cost of Cost of Goods SoldGoods Sold

Oldest CostsOldest CostsOldest CostsOldest Costs

Recent CostsRecent CostsRecent CostsRecent Costs

7-32

Last-In, First-Out

Remember: Remember: The costs of the The costs of the

oldest oldest purchasespurchases are are

in ending in ending inventory. Start inventory. Start with beginning with beginning inventory and inventory and

add units add units purchased until purchased until you reach the you reach the

number in number in ending ending

inventory.inventory.

Remember: Remember: The costs of the The costs of the

oldest oldest purchasespurchases are are

in ending in ending inventory. Start inventory. Start with beginning with beginning inventory and inventory and

add units add units purchased until purchased until you reach the you reach the

number in number in ending ending

inventory.inventory.

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$

Ending Inventory 1,200 ?

Cost of Goods Sold 1,050 ?

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$

Ending Inventory 1,200 ?

Cost of Goods Sold 1,050 ?

7-33

Last-In, First-Out

Now, we have allocated the cost to all Now, we have allocated the cost to all 1,200 units in ending inventory.1,200 units in ending inventory.

Now, we have allocated the cost to all Now, we have allocated the cost to all 1,200 units in ending inventory.1,200 units in ending inventory.

Beg. Inv. 1,000 @ 5.25$ 1,000 @ $5.25Jan. 3 500 @ 5.30 200 @ 5.30 June 20 300 @ 5.60 Sept. 15 250 @ 5.80 Nov. 29 200 @ 5.90

1,200 Units Units

6,310$ Cost

Ending InventoryCost of Goods

SoldGiven Information

7-34

Last-In, First-Out

Now, we have allocated the cost Now, we have allocated the cost to all 1,050 units sold.to all 1,050 units sold.

Now, we have allocated the cost Now, we have allocated the cost to all 1,050 units sold.to all 1,050 units sold.

Beg. Inv. 1,000 @ 5.25$ 1,000 @ $5.25Jan. 3 500 @ 5.30 200 @ 5.30 300 @ 5.30$ June 20 300 @ 5.60 300 @ 5.60 Sept. 15 250 @ 5.80 250 @ 5.80 Nov. 29 200 @ 5.90 200 @ 5.90

1,200 Units 1,050 Units

6,310$ Cost 5,900$ Cost

Ending InventoryCost of Goods

SoldGiven Information

7-35

Last-In, First-Out

Here is the Here is the cost of cost of ending ending

inventory inventory and cost of and cost of goods sold goods sold using LIFO.using LIFO.

Here is the Here is the cost of cost of ending ending

inventory inventory and cost of and cost of goods sold goods sold using LIFO.using LIFO.

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$

Ending Inventory 1,200 6,310.00$

Cost of Goods Sold 1,050 5,900.00$

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$

Ending Inventory 1,200 6,310.00$

Cost of Goods Sold 1,050 5,900.00$

7-36

Weighted Average (AKA Average Cost) Method

When a unit is sold, the average cost of each unit in inventory is assigned to cost

of goods sold.

When a unit is sold, the average cost of each unit in inventory is assigned to cost

of goods sold. Cost of Goods

Available for Sale

Units Available for

Sale÷

7-37

Average Cost Method

12,210$ 2,250

= $5.42667

Weighted Average Cost

1,200 × 5.42667$

1,050 × 5.42667$

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$

Ending Inventory 1,200 6,512.00$

Cost of Goods Sold 1,050 5,698.00$

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$

Ending Inventory 1,200 6,512.00$

Cost of Goods Sold 1,050 5,698.00$

7-38

Comparison of Methods

FIFO LIFO

Weighted Average

Net sales 25,000$ 25,000$ 25,000$ Cost of goods sold:Merchandise inventory, beginning 5,250$ 5,250$ 5,250$ Net purchases 6,960 6,960 6,960 Goods available for sale 12,210$ 12,210$ 12,210$ Merchandise inventory, ending 6,695 6,310 6,512 Cost of goods sold 5,515$ 5,900$ 5,698$ Gross profit 19,485$ 19,100$ 19,302$ Operating expenses 750 750 750 Income before taxes 18,735$ 18,350$ 18,552$ Income taxes expense (30%)* 5,621 5,505 5,566 Net income 13,114$ 12,845$ 12,986$

* Tax expense amounts were rounded.

Computers, Inc.Income Statement

For Year Ended December 31, 2009

7-39

Financial Statement Effects of Costing Methods

Advantages of MethodsAdvantages of MethodsAdvantages of MethodsAdvantages of Methods

Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with

revenues.revenues.

Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with

revenues.revenues.

Ending inventory Ending inventory approximates approximates

current current replacement cost.replacement cost.

Ending inventory Ending inventory approximates approximates

current current replacement cost.replacement cost.

First-In, First-In, First-OutFirst-OutFirst-In, First-In, First-OutFirst-Out

Last-In, Last-In, First-OutFirst-OutLast-In, Last-In,

First-OutFirst-Out

Smoothes out Smoothes out price changes.price changes.Smoothes out Smoothes out price changes.price changes.

Weighted Weighted AverageAverage

Weighted Weighted AverageAverage

7-40

Managers Choice of Inventory Methods

Net Income EffectsNet Income EffectsManagers prefer to report Managers prefer to report higher earnings for their higher earnings for their

companies.companies.

Net Income EffectsNet Income EffectsManagers prefer to report Managers prefer to report higher earnings for their higher earnings for their

companies.companies.

Income Tax EffectsIncome Tax EffectsManagers prefer to pay the Managers prefer to pay the

least amount of taxes least amount of taxes allowed by law as late as allowed by law as late as

possible.possible.

Income Tax EffectsIncome Tax EffectsManagers prefer to pay the Managers prefer to pay the

least amount of taxes least amount of taxes allowed by law as late as allowed by law as late as

possible.possible.

LIFO Conformity RuleIf last-in, first-out is used on the

income tax return, it must also be used to calculate inventory and cost

of goods sold for financial statements.

7-41

LIFO and International Accounting

LIFO Permitted?LIFO Permitted?

YesYesNoNo

ChinaSingapore

Canada

Great Britain

Australia

7-43

Perpetual and Periodic Inventory Systems

Provides Provides up-to-dateup-to-date inventory records.inventory records.

Provides Provides up-to-dateup-to-date inventory records.inventory records.

Provides Provides up-to-date up-to-date cost of sales records. cost of sales records. Provides Provides up-to-date up-to-date

cost of sales records. cost of sales records.

Perpetual Perpetual SystemSystem

Perpetual Perpetual SystemSystem

In a periodic inventory system, ending inventory and cost of goods sold are determined at the end of the accounting period based on a physical count.

7-44

Perpetual and Periodic Inventory SystemsInventory System

Item Periodic System Perpetual System

Beginning InventoryCarried over

from prior periodCarried over from

prior period

Add: PurchasesAccumulated in the Purchases

account

Accumulated in the Inventory

account

Less: Ending Inventory

Measured at end of period by

physical inventory count

Perpetual record updated at every

sale

Cost of Goods Sold

Computed as a residual amount at end of period

Measured at every sale based

on perpetual record

7-45

Supplement C: Comparison of Perpetual and Periodic Inventory Systems

Jan. 1

Apr. 14 Purchased 1,100 units at a unit cost of $50.Inventory 55,000

Accounts payable 55,000 Nov. 30 Sold 1,300 units at a sales price of $83.

Accounts receivable 107,900 Sales revenue 107,900

Cost of goods sold 65,000 Inventory 65,000

Dec. 31 Use cost of goods sold and inventory amounts.

Had beginning inventory of 800 units at a unit cost of $50.

Perpetual Inventory System

7-46

Supplement C: Comparison of Perpetual and Periodic Inventory Systems

Periodic Inventory System

7-48

Valuation at Lower of Cost or Market

Ending inventory is reported at the Ending inventory is reported at the lower of cost or market (LCM)lower of cost or market (LCM). .

Ending inventory is reported at the Ending inventory is reported at the lower of cost or market (LCM)lower of cost or market (LCM). .

Replacement CostReplacement CostThe current purchase price The current purchase price

for identical goods.for identical goods.

Replacement CostReplacement CostThe current purchase price The current purchase price

for identical goods.for identical goods.

The company will recognize a “holding” loss in the The company will recognize a “holding” loss in the current period rather than the period in which the current period rather than the period in which the

item is sold.item is sold.This practice is This practice is conservativeconservative..

The company will recognize a “holding” loss in the The company will recognize a “holding” loss in the current period rather than the period in which the current period rather than the period in which the

item is sold.item is sold.This practice is This practice is conservativeconservative..

7-49

Valuation at Lower of Cost or Market

Item Quantity Cost Replacement

Cost LCM Total LCMPentium chips 1,000 250$ 200$ 200$ 200,000$ Disk drives 400 100 110 100 40,000

Item Quantity Cost Replacement

Cost LCM Total LCMPentium chips 1,000 250$ 200$ 200$ 200,000$ Disk drives 400 100 110 100 40,000

7-50

Inventory Turnover Cost of Goods Sold

= Average Inventory

Inventory Turnover

Average Inventory is . . .Average Inventory is . . .(Beginning Inventory + Ending Inventory) ÷ 2(Beginning Inventory + Ending Inventory) ÷ 2

Average Inventory is . . .Average Inventory is . . .(Beginning Inventory + Ending Inventory) ÷ 2(Beginning Inventory + Ending Inventory) ÷ 2

This ratio reflects how many times This ratio reflects how many times average inventory was produced and average inventory was produced and sold during the period. A higher ratio sold during the period. A higher ratio indicates that inventory moves more indicates that inventory moves more quickly thus reducing storage and quickly thus reducing storage and

obsolescence costs. obsolescence costs.

This ratio reflects how many times This ratio reflects how many times average inventory was produced and average inventory was produced and sold during the period. A higher ratio sold during the period. A higher ratio indicates that inventory moves more indicates that inventory moves more quickly thus reducing storage and quickly thus reducing storage and

obsolescence costs. obsolescence costs.

HOMEWORK #3

INVENTORY & COST OF GOODS SOLD

BANK RECONCILIATION

Ch 7 -- Not tested Cash flows (pp. 355-357) Converting Income Statement and Balance Sheet to FIFO

(pp. 358-360) Errors in measuring ending inventory (pp. 362-363) LIFO liquidations (pp. 365-368) Changes in estimates (pp. 428-429)

End of Chapter 7