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1. General Course Questions
2. Return Discussion Question #4 Revenue Recognition
3. Turn in Columbia Sportswear Annual Report Projects
4. Discuss Final Group Project
5. Chapter 8 Inventory (using assigned homework)
A. When is it Inventory (Ex 1, 3, 5)
B. Inventory Errors (BE 4 and exercise 5)
C. Inventory Costing Methods (Specific Identification, FIFO, LIFO, Weighted/Moving Average) ?12,13,16. BE 5,6,7, P 6
D. Other Inventory Topics (? 3 , 5, 10)
E. Dollar Value LIFO, LIFO effect, LIFO reserve (Ex 21)
Intermediate AccountingIntermediate AccountingNovember 22November 22ndnd, 2010, 2010
Intermediate AccountingIntermediate AccountingNovember 22November 22ndnd, 2010, 2010
1
A company should record purchases when it obtains legal title to the goods.
What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?
Ex 1, 3 and 52
3
Report inventory units at the lower of cost or market (conservatism). What is included in cost for:
- Retailer:- Manufacturing Company:
What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?
4
Report inventory units at the lower of cost or market (conservatism). What is included in cost for:
- Merchandiser: items held for sale (Finished Goods)
- Manufacturing Company:
items held for sale (Finished Goods)
goods to be used in production (Raw Materials)
goods in production (Work in Process)
What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?
Inventory – Cost FlowInventory – Cost FlowMerchandiser vs. Manufacturing Co.Merchandiser vs. Manufacturing Co.
Inventory – Cost FlowInventory – Cost FlowMerchandiser vs. Manufacturing Co.Merchandiser vs. Manufacturing Co.
5
Product Costs - costs directly connected with bringing the goods to the buyer’s place of business and converting such goods to a salable condition.
Period Costs – generally selling, general, and administrative expenses.
Purchase Discounts – Gross vs. Net Method (? 10)
Product Financing (Question 5)
Costs Included in Inventory?Costs Included in Inventory?Costs Included in Inventory?Costs Included in Inventory?
6
Purchase Discounts: Gross or Net
Illustration 8-Illustration 8-1111
* $4,000 x 2% = $80
*
** $10,000 x 98% = $9,800
**
Solution on notes page
Question 107
Purchase Discounts: Gross or Net
Illustration 8-Illustration 8-1111
* $4,000 x 2% = $80** $10,000 x 98% = $9,800
**
Solution on notes page
8
Inventory – Cost FlowInventory – Cost FlowPerpetual vs. Periodic SystemPerpetual vs. Periodic System
Inventory – Cost FlowInventory – Cost FlowPerpetual vs. Periodic SystemPerpetual vs. Periodic System
9
• Purchases are debited to Inventory account
• Freight-in, Purchases Returns & Allowances and Purchase Discounts are recorded in the Inventory account.
• Debit COGS and credit Inventory account for each sale.
• Purchases are debited to Purchases account.
• Freight-in, Purch. R & A and Purch. Disc. are recorded in their respective accounts.
• COGS is computed only periodically:
Cost of Goods Available – Ending Inventory = Cost of Goods Sold
Perpetual Method Periodic Method
The perpetual inventory system provides a continuous record of Inventory and Cost of Goods Sold.
Perpetual vs. Periodic SystemPerpetual vs. Periodic SystemPerpetual vs. Periodic SystemPerpetual vs. Periodic System
Ending Inventory is determined only by physical count at the end of the period. 10
11
Purchase of Inventory:Dr. Inventory 1,000
Cr. A/P, Cash, etc. 1,000Purchase Returns, Purchases DiscountsDr. A/P 100
Cr. Inventory 100Transportation InDr. Inventory 100
Cr. A/P, Cash, etc. 100Sale of Inventory:Dr. Cost of Goods Sold 1,000
Cr. Inventory 1,000Dr. Cash, A/R, etc. 1,500
Cr. Sales Revenue 1,500At Year-End: no j/e required, unless errors are found in inventory count(physical inventory = perpetual inventory, than adjust to physical
Inventory System - Perpetual
12
Purchase of Inventory:Dr. Purchases 1,000
Cr. A/P, Cash, etc. 1,000Purchase Returns, Purchases DiscountsDr. A/P 100
Cr. Purchases Returns or Purchases Discounts 100Transportation InDr. Transportation In 100
Cr. A/P, Cash, etc. 100Sale of Inventory:Dr. Cash, A/R, etc. 1,500
Cr. Sales Revenue 1,500At Year-End:Dr. Ending Inventory (determined by count) 38,000Dr. Cost of Sales (plug) 283,000Dr. Purchase Returns and Purchase Discounts (close balance)Cr. Purchases (also close Transportation In) 286,000Cr. Opening Inventory (carried forward from prior year) 35,000
Inventory System - Periodic
Inventory Control – Physical Count
All companies need periodic verification of the inventory records by actual count, weight, or measurement, with the counts compared with the detailed inventory records.
Companies should take the physical inventory near the end of their fiscal year, to properly report inventory quantities in their annual accounting reports.
Question 313
Error in Effect on Effect onEnding Income Balance sheetInventory Items Items
Under- COGS (over) Inventory (under)stated Net income (under) Retained Earn (under)
Over- COGS (under) Inventory (over)stated Net income (over) Retained Earn (over)
Effect of Inventory Errors
14
Effect of Inventory Errors (U/S Ending)
15
Cost flow assumptions DO NOT Need to be consistent with physical flow of goods. The objective is to most clearly reflect periodic income.
The cost flow assumptions are:1 Specific identification 2 Average cost3 First-in, first-out (FIFO) and 4 Last-in, first-out (LIFO) (prohibited under
IFRS)
Cost Flow Assumptions
16
Spaworld reports the following transactions for 2010 (assume no opening inventory):
Date Purchases Cost/Unit Purchase CostMay 12 100 units @ $10/unit = $1,000Aug 14 200 units @ $11/unit = 2,200Sep 18 120 units @ $15/unit = 1,800
420 units $5,000On December 31, the company had 20 units on hand and uses the periodic inventory system.
What is the cost of goods sold?What is the cost of ending inventory?
Cost Flow Assumptions: Example
17
Date Purchases CostMay 12 100 units $1,000
Aug 14 200 units $2,200
Sep 18 120 units $1,800420 units $5,000
Dec. 31 Ending inventory 20 unitsSteps:
1. Calculate per unit average cost: use four places to right of decimal
2. Apply this per unit average cost to units sold to get COGS: round to nearest dollar
3. Apply the per unit average cost to units remaining in inventory to determine Ending inventory: round to nearest dollar
Average Cost Method
18
Date Purchases CostMay 12 100 units $1,000
Aug 14 200 units $2,200
Sep 18 120 units $1,800420 units $5,000
Dec. 31 Ending inventory 20 units1. Calculate per unit average cost: use four places to right of decimal
Cost per unit: $5000/420 = 11.9047 per unit2. Apply this per unit average cost to units sold to get
COGS: round to nearest dollar
11.9047 x 400 = $4,762 COGS3. Apply the per unit average cost to units remaining in
inventory to determine Ending inventory: round to nearest dollar
11.9047 x 20 = $238 ending inventory
Average Cost Method
19
20
Journal Entry (Periodic Inventory):
Year End Entry – Average Cost
20
21
Journal Entry:
Dr. Ending Inventory 238Dr. Cost of Sales 4,762Cr. Purchases 5,000Cr. Opening Inventory 0
Year End Entry – Average Cost
21
Given data: Date Purchases CostMay 12 100 units @ $10$1,000Aug 14 200 units @ $11$2,200Sep 18 120 units @ $15$1,800 420 $5,000Ending Inventory 20 units
COGS
EI$5,000
GAFS
Ending Inventory (FIFO)
First-In, First-Out (FIFO) Method
“Count” from one direction and “plug” the other
Cost of goods sold (FIFO)
22
Given data: Date Purchases CostMay 12 100 units @ $10$1,000Aug 14 200 units @ $11$2,200Sep 18 120 units @ $15$1,800 420 $5,000Ending Inventory 20 units
COGS $4,700
$300EI$5,000
GAFS
Ending Inventory (FIFO)20 x $15 = $300
First-In, First-Out (FIFO) Method
“Count” from one direction and “plug” the other
Cost of goods sold (FIFO)100 units @ $10 $1,000200 units @ $11 $2,200100 units @ $15 $1,500
23
Given data: Date Purchases CostMay 12 100 units @ $10$1,000Aug 14 200 units @ $11$2,200Sep 18 120 units @ $15$1,800 420 $5,000Ending Inventory 20 units
COGS
EI$5,000
GAFS
Ending Inventory (FIFO)
Last-In, First-Out (LIFO) Method
“Count” from one direction and “plug” the other
Cost of goods sold (FIFO)
24
Given data: Date Purchases CostMay 12 100 units @ $10$1,000Aug 14 200 units @ $11$2,200Sep 18 120 units @ $15$1,800 420 $5,000Ending Inventory 20 units
COGS
EI$5,000
GAFS
Ending Inventory (FIFO)20 x $10 = $200
Last-In, First-Out (LIFO) Method
“Count” from one direction and “plug” the other
Cost of goods sold (FIFO) 80 units @ $10 $ 800200 units @ $11 $2,200120 units @ $15 $1,800
$4,800
$200
25
• The ending inventory in units is the same in all three methods: the cost is different
• The cost of goods available is the same for all methods
• The cost of goods sold and the cost of ending inventory are different
• In periods of rising prices, LIFO would result in the smallest reported net income.
Cost Flow Assumptions: Notes
26
27
Periodic vs. Perpetual
• FIFO: COGS and EI numbers are exactly the same under either periodic or perpetual systems
• BUT – LIFO, Weighted Average will give you different numbers– Under perpetual LIFO, with each sale, you cut into only
existing layers (so you must stop and calculate the cost of goods sold at each sale)
– Under perpetual Weighted Average (more accurately, Moving Average), you stop and calculate a new average cost for every sale
28
Same Example - Perpetual Basis
Unit Total UnitsUnits Cost Cost Sold
12-May 100 10 10001-Jun 85
14-Aug 200 11 22001-Sep 100
18-Sep 120 15 180020-Sep 215
420 5000 400
Unit Extended Unit ExtendedFIFO: Units Cost Value LIFO: Units Cost Value
1-Jun 85 10 850 1-Jun 85 10 8501-Sep 15 10 150 1-Sep 100 11 1100
85 11 935 20-Sep 120 15 180020-Sep 115 11 1265 95 11 1045
100 15 1500COGS 400 4700 COGS 400 4795
EI 20 15 300 EI 15 10 150Same as Periodic 5 11 55
205Different from Periodic
Purchased
29
Same Example - Perpetual BasisSold
Unit ExtendedUnits Cost Cost Units
12-May 100 10 10001-Jun 85
14-Aug 200 11 22001-Sep 100
18-Sep 120 15 180020-Sep 215
420 5000 400
Calculate the average cost at time of each sale
Unit ExtendedWt. Av. Units Cost Value 1-Sep
1-Jun 85 10 850 costs to date 32001-Sep 100 10.9 1093.02 costs expensed 850
20-Sep 215 13 2796.81 0 23500 2150 Av Cost 10.9
COGS 400 4739.83Sept. 20
EI 20 13 260.168 Costs to date 5000Costs expensed 1943Remaining costs 3057Remaining units 235
Different from Periodic Av cost 13
Purchased
• LIFO matches more recent costs with current revenues.
• With increasing prices:– LIFO yields the lowest taxable income
(assuming inventory does not decrease).
– Under LIFO, there is less need to write down inventory down to market
Advantages of LIFO Method
30
LIFO Reserve (Allowance) account is used, when:
LIFO is used for tax & external financial reporting purposes
FIFO, average cost, or standard cost system for internal reporting purposes.
Reasons:
Special Issues Related to LIFO: Special Issues Related to LIFO: Setting up a LIFO ReserveSetting up a LIFO Reserve
Special Issues Related to LIFO: Special Issues Related to LIFO: Setting up a LIFO ReserveSetting up a LIFO Reserve
1. Pricing decisions2. Record keeping easier3. Profit-sharing or bonus arrangements4. LIFO troublesome for interim periods
SEC reporting requirements – disclose the difference between LIFO and current cost of inventory reported on the Balance Sheet which is the LIFO RESERVE
31
Jeppo Inc reports the following balances: Inventory (FIFO basis) on Dec 31, 2004:$50,000 Inventory (LIFO basis) on Dec 31, 2004:$20,000
Adjust the cost of ending inventory to the LIFO basis
Dr. Cost of goods sold $30,000Cr. Allowance to Reduce Inventory
to LIFO $30,000
Balance Sheet (Assets):Inventory (FIFO) $50,000less: Allowance to Reduce Inventory ($30,000)Inventory (LIFO) basis $20,000
LIFO Reserve: Example
32
• Under the LIFO approach, a business may build up layers of inventory from prior periods. A layer liquidation occurs, when:– Earlier costs are matched against current sales
due to a reduction of quantities of inventory during a period (results in “costing” items at older prices)
– Such matching results in distorted income.
LIFO Layers
33
• LIFO yields the lowest net income and therefore reduced earnings (with increasing prices)
• Under LIFO, the ending inventory is understated relative to current costs
• LIFO liquidation (reduction of quantities of inventory during a period – results in “costing” items at older prices):– May result in income that is detrimental from a tax
view– May cause poor buying habits (because of the layer
liquidation problem)
• LIFO Conformity Rule: if you use LIFO for tax purposes, you must use it for financial reporting also.
Disadvantages of LIFO Method
34
35
• Dollar value LIFO applies LIFO procedures to pools of similar goods based on dollars rather than units
• Used for external purposes (i.e., financial statements and taxes)
• Advantages over regular LIFO: – Reduces record keeping (maximum of one layer per year).– Mitigates likelihood of eroding old layers (some decreases in goods in the
pool are offset by increases in other goods in the pool).
• Price index – a measure of the change in prices from a base year (the year dollar value LIFO is adopted in this case) to the current year
– Internal = Ending inventory quantities X current year costs Ending inventory quantities X base year costs
– External – calculated by the Bureau of Labor Statistics
Dollar Value LIFO
36
Compare ending inventory at base year prices to beginning of year inventory, also at base year prices – if there is an increase – we add a new LIFO layer at Current Year prices:
1. Calculate Ending Inventory at current year costs (FIFO)2. Calculate or locate the current year price index.3. Convert the ending inventory at current cost to inventory at base-year
cost by dividing the current year cost by the current price index (1 / 2 )4. Split the ending inventory at current cost into layers depending on the
year the items were acquired by comparing current inventory at base prices to prior inventory at base prices. If there is an increase add an additional layer. If there is a decrease deduct from the most recently purchased layer. Once a layer is eliminated (peeled off), it can not be rebuilt.
5. Multiply each layer by the appropriate price index (price index of the year of acquisition) to obtain the quantity in ending inventory at dollar-value LIFO cost.
Dollar Value LIFO Calculation Steps
37
Given: Base layer (Dec 31, 2009):$20,000 Inventory (current prices) Dec 31, 2010: $26,400 Prices increased 20% during 2010.
Determine dollar value LIFO at Dec 31, 2010
Dollar Value LIFO: Example
38
Dec 31, 2009 Dec 31, 2010
Price increase, 20%
At EOY prices:$26,400
$26,400 / 1.20At base $:$22,000
Net increaseat base $:
$22,000 less$20,000
Restate atcurrent $:
$2,400(layer added)
$2,000 * 1.20
$20,000 plus
$2,400 =$22,400
Dollar valueLIFO Inventory
Dollar Value LIFO: Example
39
When the ending inventory (at base year prices) is less than the beginning inventory (at base year prices) (i.e. in the example above if EI at base year prices was < $20,000):– the decrease must be subtracted from the
most recently added layer. – Once a layer is eliminated (peeled off), it
cannot be rebuilt.
Dollar Value LIFO: Notes