Download Financial Accounting and Accounting Standards

Inventories
Principles of Financial Accounting,
10th Edition
Slides
7-1
Classifying Inventory
Merchandising
Company
One Classification:
Merchandise
Inventory
Manufacturing
Company
Three Classifications:
Raw Materials
Work in Process
Finished Goods
Regardless of the classification, companies report all
inventories under Current Assets on the balance sheet.
Slides
7-2
Determining Inventory Quantities
Physical Inventory taken for two reasons:
Perpetual System
1. Check accuracy of inventory records.
2. Determine amount of inventory lost (wasted raw
materials, shoplifting, or employee theft).
Periodic System
1. Determine the inventory on hand
2. Determine the cost of goods sold for the period.
Slides
7-3
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Determining Ownership of Goods
Goods in Transit
Purchased goods not yet received.
Sold goods not yet delivered.
Goods in transit should be included in the inventory of
the company that has legal title to the goods. Legal
title is determined by the terms of sale.
Slides
7-4
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Terms of Sale
Illustration 6-1
Ownership of the goods
passes to the buyer when
the public carrier accepts
the goods from the seller.
Ownership of the goods
remains with the seller
until the goods reach the
buyer.
Slides
7-5
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Review Question
Goods in transit should be included in the
inventory of the buyer when the:
a. public carrier accepts the goods from the
seller.
b. goods reach the buyer.
c. terms of sale are FOB destination.
d. terms of sale are FOB shipping point.
Slides
7-6
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Determining Ownership of Goods
Consigned Goods
Goods held for sale by one party although
ownership of the goods is retained by another
party.
Slides
7-7
SO 1 Describe the steps in determining inventory quantities.
Inventory Costing
Unit costs can be applied to quantities on hand
using the following costing methods:
Specific Identification
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
Cost Flow
Assumptions
Average-cost
Slides
7-8
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing
Illustration: Assume that Crivitz TV Company purchases
three identical 46-inch TVs on different dates at costs of
$700, $750, and $800. During the year Crivitz sold two
sets at $1,200 each. These facts are summarized below.
Illustration 6-2
Slides
7-9
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing
“Specific Identification”
If Crivitz sold the TVs it purchased on February 3 and May
22, then its cost of goods sold is $1,500 ($700 + $800),
and its ending inventory is $750.
Illustration 6-3
Slides
7-10
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing
Specific Identification Method
An actual physical flow costing method in which
items still in inventory are specifically costed to
arrive at the total cost of the ending inventory.
Practice is relatively rare.
Most companies make assumptions (Cost Flow
Assumptions) about which units were sold.
Slides
7-11
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
Cost Flow Assumption
does not need to equal
Physical Movement of
Goods
Illustration 6-11
Use of cost flow methods in
major U.S. companies
Slides
7-12
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
Illustration: Data for Houston Electronics’ Astro
condensers.
Illustration 6-4
(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold
Slides
7-13
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Earliest goods purchased are first to be
sold.
Often parallels actual physical flow of
merchandise.
Generally good business practice to sell
oldest units first.
Slides
7-14
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Illustration 6-5
Solution
on notes
page
Slides
7-15
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Latest goods purchased are first to be sold.
Seldom coincides with actual physical flow of
merchandise.
Exceptions include goods stored in piles, such
as coal or hay.
Slides
7-16
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Illustration 6-7
Solution
on notes
page
Slides
7-17
SO 2 Explain the basis of accounting for inventories and apply the
cost flow methods under a periodic inventory system.
inventory
Inventory Costing – Cost Flow Assumptions
“Average Cost”
Allocates cost of goods available for sale on
the basis of weighted average unit cost
incurred.
Assumes goods are similar in nature.
Applies weighted average unit cost to the
units on hand to determine cost of the ending
inventory.
Slides
7-18
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
“Average Cost”
Illustration 6-10
Solution
on notes
page
Slides
7-19
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
Comparative Financial Statement Summary
FIFO
Sales
$9,000 $9,000
LIFO
$9,000
Cost of goods sold
6,200
6,600
7,000
Gross profit
2,800
2,400
2,000
330
330
330
2,470
2,070
1,670
140
120
110
Net income
$2,330
$1,950
$1,560
Inventory balance
$5,800 $5,400
$5,000
Admin. & selling expense
Income before taxes
Income tax expense
Slides
7-20
Average
LO 3 Explain the financial statement and tax effects of
each of the inventory cost flow assumptions.
Inventory Costing – Cost Flow Assumptions
In Period of Rising Prices, FIFO Reports:
FIFO
Lowest
Sales
$9,000
6,200
6,600
7,000
Gross profit
2,800
2,400
2,000
330
330
330
2,470
2,070
1,670
140
120
110
Net income
$2,330
$1,950
$1,560
Inventory balance
$5,800 $5,400
$5,000
Income before taxes
Income tax expense
Slides
7-21
$9,000 $9,000
LIFO
Cost of goods sold
Admin. & selling expense
Highest
Average
LO 3 Explain the financial statement and tax effects of
each of the inventory cost flow assumptions.
Inventory Costing – Cost Flow Assumptions
In Period of Rising Prices, LIFO Reports:
FIFO
Highest
Sales
$9,000
6,200
6,600
7,000
Gross profit
2,800
2,400
2,000
330
330
330
2,470
2,070
1,670
140
120
110
Net income
$2,330
$1,950
$1,560
Inventory balance
$5,800 $5,400
$5,000
Income before taxes
Income tax expense
Slides
7-22
$9,000 $9,000
LIFO
Cost of goods sold
Admin. & selling expense
Lowest
Average
LO 3 Explain the financial statement and tax effects of
each of the inventory cost flow assumptions.
Inventory Costing – Cost Flow Assumptions
Review Question
The cost flow method that often parallels the
actual physical flow of merchandise is the:
a. FIFO method.
b. LIFO method.
c. average cost method.
d. gross profit method.
Slides
7-23
LO 3 Explain the financial statement and tax effects of
each of the inventory cost flow assumptions.
Inventory Costing – Cost Flow Assumptions
Review Question
In a period of inflation, the cost flow method
that results in the lowest income taxes is the:
a. FIFO method.
b. LIFO method.
c. average cost method.
d. gross profit method.
Slides
7-24
LO 3 Explain the financial statement and tax effects of
each of the inventory cost flow assumptions.
Inventory Costing
Using Cost Flow Methods Consistently
Method should be used consistently, enhances
comparability.
Although consistency is preferred, a company
may change its inventory costing method.
Illustration 6-14
Disclosure of change
in cost flow method
Slides
7-25
LO 3 Explain the financial statement and tax effects of
each of the inventory cost flow assumptions.
Inventory Costing
Lower-of-Cost-or-Market
When the value of inventory is lower than its cost
Companies can “write down” the inventory to
its market value in the period in which the
price decline occurs.
Market value = Replacement Cost
Example of conservatism.
Slides
7-26
SO 4 Explain the lower-of-cost-or-market
basis of accounting for inventories.
Inventory Costing
Lower-of-Cost-or-Market
Illustration: Assume that Ken Tuckie TV has the
following lines of merchandise with costs and market
values as indicated.
Inventory
Categories
Cost
Data
Market
Data
$ 60,000
$ 55,000
$ 55,000
Radios
45,000
52,000
45,000
DVD recorders
48,000
45,000
45,000
DVDs
14,000
12,800
12,800
TVs
Total inventory
Slides
7-27
Lower of
Cost or Market
$157,800
SO 4 Explain the lower-of-cost-or-market
basis of accounting for inventories.
Analysis of Inventory
Analysis of Inventory
Inventory management is a double-edged sword
1. High Inventory Levels - may incur high carrying
costs (e.g., investment, storage, insurance,
obsolescence, and damage).
2. Low Inventory Levels – may lead to stockouts and
lost sales.
Slides
7-28
SO 5 Compute and interpret the inventory turnover ratio.
Analysis of Inventory
Inventory turnover measures the number of times
on average the inventory is sold during the period.
Inventory
Turnover
=
Cost of Goods Sold
Average Inventory
Days in inventory measures the average number of
days inventory is held.
Days in Year (365)
Days in
=
Inventory
Inventory Turnover
Slides
7-29
SO 5 Compute and interpret the inventory turnover ratio.
Analysis of Inventory
Illustration: The following data are available for
Wal-Mart.
Inventory
Turnover
2007
Days in
inventory
2007
Slides
7-30
=
=
$264,152
(33,685 + 31,910) / 2
365 Days
8.1
=
8.1 times
= 45.1 Days
SO 5 Compute and interpret the inventory turnover ratio.
Analysis of Inventory
Illustration: The following data are available for
Wal-Mart.
Inventory
Turnover
2006
Days in
inventory
2006
Slides
7-31
=
=
$237,649
(31,910 + 29,419) / 2
365 Days
7.7
= 7.7 times
= 47.4 Days
SO 5 Compute and interpret the inventory turnover ratio.
Cost Flow Methods in Perpetual Systems
Illustration:
Appendix 6A
Illustration 6A-1
Assuming the Perpetual Inventory System, compute Cost of Goods
Sold and Ending Inventory under FIFO, LIFO, and Average cost.
Slides
7-32
SO 7 Apply the inventory cost flow methods to perpetual inventory records.
Cost Flow Methods in Perpetual Systems
“First-In-First-Out (FIFO)”
Cost of Goods Sold
Slides
7-33
Illustration 6A-2
Ending Inventory
SO 7 Apply the inventory cost flow methods to perpetual inventory records.
Cost Flow Methods in Perpetual Systems
“Last-In-First-Out (LIFO)”
Cost of Goods Sold
Slides
7-34
Illustration 6A-3
Ending Inventory
SO 7 Apply the inventory cost flow methods to perpetual inventory records.
Cost Flow Methods in Perpetual Systems
“Average Cost” (Moving-Average System)
Illustration 6A-4
Cost of Goods Sold
Slides
7-35
Ending Inventory
SO 7 Apply the inventory cost flow methods to perpetual inventory records.
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Slides
7-36