Download Inven. - Cost

Inven - Cost - 1
Inventory
Basic Valuation Methods
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IMPORTANCE OF INVENTORIES
 Largest current asset of most manufacturing and
retail firms.
 Significant portion of total assets as well.
 Inventory accounting methods and management
practices can become profit-enhancing tools.
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INVENTORY CATEGORIES
 Merchandise inventory
-- Goods acquired for resale
 Manufacturing inventory
-- Raw materials
-- Work-in-process
-- Finished goods
-- Manufacturing supplies
 Miscellaneous inventories
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COMPONENTS OF INVENTORY COST

Invoice price

Freight-in

Purchase discounts

Other costs to get the inventory ready for
sale
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INVENTORY RECORDING
METHODS
PERIODIC METHOD
vs.
PERPETUAL METHOD
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INVENTORY RECORDING METHODS
n Perpetual inventory system
-- The ongoing physical flow of inventory is monitored,
and the cost of the inventory items is maintained on a
continual basis.
-- Purchases recorded directly in “Inventory” account
-- May be recorded “gross” or “net”
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PERPETUAL INVENTORY SYSTEM
n Sales revenue recorded in normal fashion
n Cost of goods sold recorded immediately upon
sale
n No adjusting entry necessary for Cost of goods
sold
n Cost of goods sold account closed along with
other expenses
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INVENTORY RECORDING METHODS
Periodic inventory system
-- Inventory value is determined only at particular times,
such as end of the accounting period.
-- Purchases recorded in “Purchases” account
-- Purchases discount and purchase returns and
allowances are recorded in their respective accounts.
• These accounts are contra-purchases accounts, i.e.,
they have a credit balance.
-- May be recorded “gross” or “net”
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PERIODIC INVENTORY SYSTEM
Sales revenue recorded in normal fashion
No entry for Cost of goods sold at time of sale
Adjusting entry for Cost of goods sold at end of
the fiscal period
Cost of goods sold then closed with
other expense accounts at year end
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COST OF GOODS SOLD (COGS)
Beginning Inventory
+ Purchases (net)
= Cost of Goods Available for Sale
- Ending Inventory
= Cost of Goods Sold
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PERIODIC SYSTEM
• At the end of the accounting period, the adjusting
entry results in:
• Elimination of:
• Beginning inventory
• Purchases account and any related accounts
( Purchase discounts, Purchase returns and
allowances, etc.)
• Records the ending inventory
• Records COGS.
• COGS is then closed to Income Summary along
with other expenses.
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PERIODIC SYSTEM
EXAMPLE
The following is a partial adjusted trial balance:
Account
Inventory 1/1/X6
Purchases
Purchases Discount
Purchase Returns & Allowances
Sales
Advertising Expense
Salaries Expense
Utilities Expense
Debit
Credit
$175,000
350,000
$
22,000
6,000
1,250,000
7,500
80,000
20,000
The physical inventory count at 12/31/X6 was $125,000.
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PERIODIC SYSTEM
SOLUTION
GENERAL JOURNAL
Page 1
Da te
Descripti on
PR
Debi t
Cost of Goods Sold
372,000
Inventory, 12/31/X6
125,000
Purchases Discount
Purchase Returns & Allowances
Credi t
22,000
6,000
Purchases
350,000
Inventory, 1/1/X6
175,000
To close accounts to COGS
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PERIODIC SYSTEM
SOLUTION
GENERAL JOURNAL
Page 1
Date
Description
Sales
PR
Debit
Credit
1,250,000
Income Summary
1,250,000
To close account
Income Summary
Cost of Goods Sold
Advertising Expense
479,500
372,000
7,500
Salaries Expense
80,000
Utilities Expense
20,000
To close accounts
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COST FLOW METHODS
An allocation of total cost of goods available for sale:
Ending inventory
Cost of goods
available
Cost of goods sold
The cost flow assumption used for accounting purposes
can be different from the physical flow of goods through
the company.
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INVENTORY VALUES
COST FLOW ASSUMPTIONS
Specific cost
identification
Average cost
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
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SPECIFIC COST IDENTIFICATION
Specific cost of each inventory
item must be known
Opportunity to manipulate income
by selection of items at time of
sale
Allows perpetual inventory
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WEIGHTED-AVERAGE
PERIODIC METHOD
Compute weighted-average cost (WAC) per unit
Beginning inventory cost + Current purchase cost
Beginning inventory units + Current purchase units
Compute ending inventory
Ending Inv. = Units in Ending Inv. x WAC per Unit
Compute COGS
COGS = Units Sold x WAC per Unit
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MOVING-AVERAGE
PERPETUAL METHOD
A new weighted-average unit cost must be
calculated after each purchase.
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FIRST-IN, FIRST-OUT
The cost of the oldest inventory items are
charged to COGS when goods are sold.
The cost of the newest inventory items remain
in ending inventory.
The actual physical flow of inventory items may
differ from the FIFO cost flow assumptions.
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FIRST-IN, FIRST-OUT
RESULTS
Periodic ending inventory cost equals perpetual
ending inventory cost.
Periodic COGS equals perpetual COGS.
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EVALUATION OF FIFO





Advantages
Easy to apply
Inventory value
approximates current
cost
Flow of costs tends to
be consistent with
usual physical flow of
goods
Systematic and
objective
Not subject to
manipulation



Disadvantages
Does not match current
cost of goods sold with
current revenues
Inventory (or phantom)
profits
In periods of rising
prices, pay higher
income taxes
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LAST-IN, FIRST-OUT
UNIT COST APPROACH

The cost of the newest inventory items are
charged to COGS when goods are sold.

The cost of the oldest inventory items remain in
ending inventory.

The actual physical flow of inventory items may
differ from the LIFO cost flow assumptions.
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LAST-IN, FIRST-OUT
RESULTS
Periodic ending inventory cost is different from
perpetual ending inventory cost.
Periodic COGS is different from perpetual COGS.
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EVALUATION OF LIFO


Advantages
In periods of rising
prices, pay less
taxes
Matches latest
inventory costs
with current
revenues



Disadvantages
LIFO conformity
rule for tax and
book purposes
Cost of record
keeping higher
Inventory valuation
is at older costs
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IN PERIODS OF RISING PRICES. . .
LIFO



Matches high (newer)
costs with current
(higher) sales
Values inventory on
low (older) cost basis
Results in lower
taxable income
FIFO



Matches low (older)
costs with current
(higher) sales
Values inventory
approximating higher
current costs
Results in higher
taxable income
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POOLED LIFO
Groups items that are used or sold in relatively
constant proportions
Each pool represents a group of different, but
related, inventory items that are considered as a
single entity for inventory accounting purposes
Uses the average cost for the entire pool to
determine COGS and cost of ending inventory
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DOLLAR VALUE (DV) LIFO
Uses price indexes related to the inventory
instead of units and unit costs
Is applied to inventory
individual items
pools rather than
Approximates LIFO results used for income tax
and external reporting purposes
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DOLLAR VALUE (DV) LIFO
ANNUAL PRICE INDEX
¶Calculate internal index:
FIFO ending inv. at current yr. unit cost
FIFO ending inv. at base yr. unit cost
·If an internal index cannot be determined,
use an external index provided by the
Bureau of Labor Statistics .
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DOLLAR VALUE (DV) LIFO
INVENTORY POOLS
¶Single pool
— Used
when overall operations
constitute a so-called natural business
unit.
·Multiple pools
— Separate
inventory pools are formed for
each natural business unit.
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DOLLAR VALUE LIFO
Steps in Application
– Convert ending inventory in end-of-year
dollars to “base year dollars”
(divide by appropriate price index)
–
Determine annual layers in base year dollars
–
Convert to DV LIFO cost using appropriate
price index
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DOLLAR VALUE (DV) LIFO
EVALUATION
Advantages



Reduces probability of
liquidating LIFO layers.
Reduces accounting
costs of using LIFO.
– Pooled approach
– Fewer layers
– Annual index
FIFO or average cost
used for internal
reporting.
Disadvantages


Establishing
appropriate price
index.
Subjective makeup of
inventory pools.
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INVENTORY ERRORS
Inventory errors may have dramatic impacts on
reported financial results
Categories of errors
–
–
–
–
Mistakes in physical counts
Errors in computing cost of inventory
Inappropriate recording of purchases
Inappropriate recording of sales
Evaluate impact of each error
DO NOT MEMORIZE PATTERNS!!
Make correcting entries as necessary
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Average Costing
BI
Purchases
1 2 3
4 5 6
7 8
CGS
BI 1 2 3
4 5 6
7 8
Ending
Inventory
BI 1 2 3
4 5 6
7 8
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FIFO COSTING
BI
CGS
BI 1 2 3
4 5 6
Purchases
1 2 3
4 5 6
7 8
Ending
Inventory
7 8
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LIFO COSTING
BI
Purchases
1
2 3
4 5 6
7 8
CGS
2 3
45 6
7 8
Ending
Inventory
BI 1
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THE
END