Slides 7-1 Inventories Principles of Financial Accounting, 10th Edition

Slides 7-1

Inventories

Principles of Financial Accounting, 10th Edition

Slides 7-2

Classifying InventoryClassifying InventoryClassifying InventoryClassifying Inventory

One Classification:

Merchandise Inventory

Three Classifications:

Raw Materials

Work in Process

Finished Goods

Merchandising Company

Manufacturing Company

Regardless of the classification, companies report all inventories under Current Assets on the balance sheet.

Slides 7-3

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.

Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities

SO 1 Describe the steps in determining inventory quantities.SO 1 Describe the steps in determining inventory quantities.

Slides 7-4

Goods in Transit

Purchased goods not yet received.

Sold goods not yet delivered.

Determining Ownership of Determining Ownership of GoodsGoods



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 7-5



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.

Terms of SaleTerms of Sale

Slides 7-6

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.

Review Question



Slides 7-7

Consigned Goods

Goods held for sale by one party although ownership of the goods is retained by another party.

Determining Ownership of Determining Ownership of GoodsGoods



Slides 7-8

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)

Average-cost

Inventory CostingInventory CostingInventory CostingInventory Costing

SO 2 SO 2 Explain the basis of accounting for inventories and apply Explain the basis of accounting for inventories and apply the the inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.inventory system.

Cost Flow Assumptio

ns

Slides 7-9

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 7-10

“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


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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.

Specific Identification MethodSpecific Identification Method



Slides 7-12

Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions

Illustration 6-11Use of cost flow methods in major U.S. companies

Cost Flow

Assumption

does not need to

equal

Physical Movement

of Goods


Slides 7-13

Illustration: Data for Houston Electronics’ Astro condensers.


Illustration 6-4

(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold


Slides 7-14

Earliest goods purchased are first to be sold.

Often parallels actual physical flow of merchandise.

Generally good business practice to sell oldest units first.

““First-In-First-Out (FIFO)”First-In-First-Out (FIFO)”



Slides 7-15

“First-In-First-Out (FIFO)”


Illustration 6-5


SolutioSolution on n on

notes notes pagepage

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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.

““Last-In-First-Out (LIFO)”Last-In-First-Out (LIFO)”



Slides 7-17

““Last-In-First-Out Last-In-First-Out (LIFO)”(LIFO)”


Illustration 6-7

SO 2 SO 2 Explain the basis of accounting for inventories and apply the Explain the basis of accounting for inventories and apply the inventory inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.system.



Slides 7-18

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.

““Average Cost”Average Cost”



Slides 7-19

““Average Cost”Average Cost”


Illustration 6-10




Slides 7-20

FIFO

LO 3 LO 3 Explain the financial statement and tax effects Explain the financial statement and tax effects of of each of the inventory cost flow each of the inventory cost flow assumptions.assumptions.


Sales $9,000 $9,000 $9,000

Cost of goods sold 6,200 6,600 7,000

Gross profit 2,800 2,400 2,000

Admin. & selling expense 330 330 330

Income before taxes 2,470 2,070 1,670

Income tax expense 140 120 110

Net income $2,330 $1,950 $1,560

Inventory balance $5,800 $5,400 $5,000

LIFOAverage

Comparative Financial Statement Summary

Slides 7-21

FIFO


Sales $9,000 $9,000$9,000

Cost of goods sold 6,200 6,6007,000

Gross profit 2,800 2,4002,000

Admin. & selling expense 330 330330

Income before taxes 2,470 2,0701,670

Income tax expense 140 120110

Net income $2,330 $1,950$1,560

Inventory balance $5,800 $5,400$5,000

LIFOAverage

In Period of Rising Prices, FIFO Reports:

Highest

Lowest


Slides 7-22

FIFO


Sales $9,000 $9,000$9,000

Cost of goods sold 6,200 6,6007,000

Gross profit 2,800 2,4002,000

Admin. & selling expense 330 330330

Income before taxes 2,470 2,0701,670

Income tax expense 140 120110

Net income $2,330 $1,950$1,560

Inventory balance $5,800 $5,400$5,000

LIFOAverage

In Period of Rising Prices, LIFO Reports:

Lowest

Highest


Slides 7-23

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.

Review Question



Slides 7-24

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.

Review Question



Slides 7-25

Using Cost Flow Methods Using Cost Flow Methods ConsistentlyConsistently


Method should be used consistently, enhances comparability.

Although consistency is preferred, a company may change its inventory costing method.

Illustration 6-14Disclosure of change in cost flow method


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Lower-of-Cost-or-MarketLower-of-Cost-or-Market


SO 4 Explain the lower-of-cost-or-SO 4 Explain the lower-of-cost-or-market basis of accounting for market basis of accounting for inventories.inventories.

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 7-27

Lower-of-Cost-or-MarketLower-of-Cost-or-Market


SO 4 Explain the lower-of-cost-or-SO 4 Explain the lower-of-cost-or-market basis of accounting for market basis of accounting for inventories.inventories.

Illustration: Assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated.

Inventory Cost Market Lower ofCategories Data Data Cost or Market

TVs 60,000$ 55,000$

Radios 45,000 52,000

DVD recorders 48,000 45,000

DVDs 14,000 12,800

Total inventory

$ 55,000

45,000

45,000

12,800

$157,800

Slides 7-28

Analysis of InventoryAnalysis of InventoryAnalysis of InventoryAnalysis 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.

Analysis of InventoryAnalysis of Inventory

SO 5 Compute and interpret the inventory turnover ratio.SO 5 Compute and interpret the inventory turnover ratio.

Slides 7-29

Inventory turnover measures the number of times on average the inventory is sold during the period.

Cost of Goods Sold

Average Inventory

Inventory Turnover

=

Days in inventory measures the average number of days inventory is held.

Days in Year (365)

Inventory Turnover

Days in Inventory

=



Slides 7-30

Illustration: The following data are available for Wal-Mart.

$264,152

(33,685 + 31,910) / 2

Inventory Turnover

2007

=



=

8.1 times

365 Days

8.1

Days in inventory

2007

=

=45.1 Days

Slides 7-31

Illustration: The following data are available for Wal-Mart.

$237,649

(31,910 + 29,419) / 2

Inventory Turnover

2006

=



= 7.7 times

365 Days

7.7

Days in inventory

2006

=

=47.4 Days

Slides 7-32

Illustration:

Cost Flow Methods in Perpetual SystemsCost Flow Methods in Perpetual SystemsCost Flow Methods in Perpetual SystemsCost Flow Methods in Perpetual Systems

SO 7 Apply the inventory cost flow methods to perpetual inventory SO 7 Apply the inventory cost flow methods to perpetual inventory records.records.

Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Average cost.

Appendix 6AAppendix 6AAppendix 6AAppendix 6A

Illustration 6A-1

Slides 7-33



““First-In-First-Out (FIFO)”First-In-First-Out (FIFO)”

Cost of Goods SoldEnding Inventory

Illustration 6A-2

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Cost of Goods SoldEnding Inventory

““Last-In-First-Out (LIFO)”Last-In-First-Out (LIFO)” Illustration 6A-3

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““Average Cost” Average Cost” (Moving-Average (Moving-Average System)System) Illustration 6A-4

Cost of Goods Sold Ending Inventory

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Slides 7-1 Inventories Principles of Financial Accounting, 10th Edition