1. 6-1

2. 6-2 Reporting and Analyzing Inventory Kimmel ● Weygandt ● Kieso Financial Accounting, Eighth Edition 6

3. 6-3 CHAPTER OUTLINE Discuss how to classify and determine inventory. 1 Apply inventory cost flow methods and discuss their financial effects. 2 LEARNING OBJECTIVES Explain the statement presentation and analysis of inventory. 3

4. 6-4 One Classification:   Merchandise Inventory Three Classifications:   Raw Materials   Work in Process   Finished Goods Merchandising Company Manufacturing Company ▼ HELPFUL HINT Regardless of the classification, companies report all inventories under Current Assets on the balance sheet. LEARNING OBJECTIVE Discuss how to classify and determine inventory. 1 LO 1

5. 6-5 Physical Inventory taken for two reasons: Perpetual System 1. 1.Check accuracy of inventory records. 2. 2.Determine amount of inventory lost due to wasted raw materials, shoplifting, or employee theft. Periodic System 1. 1.Determine the inventory on hand. 2. 2.Determine the cost of goods sold for the period. DETERMINING INVENTORY QUANTITIES LO 1

6. 6-6 Involves counting, weighing, or measuring each kind of inventory on hand. Taken,   when the business is closed or business is slow.   at the end of the accounting period. Taking a Physical Inventory LO 1

7. 6-7 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. Determining Ownership of Goods LO 1

8. 6-8 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. Freight costs incurred by the seller are an operating expense. Determining Ownership of Goods ILLUSTRATION 6-2 Terms of sale LO 1

9. 6-9 Review Question Goods in transit should be included in the inventory of the buyer when the:   public carrier accepts the goods from the seller.   goods reach the buyer.   terms of sale are FOB destination.   terms of sale are FOB shipping point. Determining Ownership of Goods LO 1

10. 6-10 Consigned Goods To hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership of the goods. Many car, boat, and antique dealers sell goods on consignment. Why? Determining Ownership of Goods LO 1

11. 6-11 1.Goods of $15,000 held on consignment should be deducted from the inventory count. 2.The goods of $10,000 purchased FOB shipping point should be added to the inventory count. 3.Item 3 was treated correctly. Hasbeen Company completed its inventory count. It arrived at a total inventory value of $200,000. You have been given the information listed below. Discuss how this information affects the reported cost of inventory. 1. Hasbeen included in the inventory goods held on consignment for Falls Co., costing $15,000. 2. The company did not include in the count purchased goods of $10,000, which were in transit (terms: FOB shipping point). 3. The company did not include in the count inventory that had been sold with a cost of $12,000, which was in transit (terms: FOB shipping point). Solution Inventory should be $195,000 ($200,000 - $15,000 + $10,000). Rules of Ownership DO IT! 1 LO 1

12. 6-12 Inventory is accounted for at cost.   Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale.   Unit costs are applied to quantities to determine the total cost of the inventory and the cost of goods sold using the following costing methods: ► ► Specific identification ► ► First-in, first-out (FIFO) ► ► Last-in, first-out (LIFO) ► ► Average-cost Cost Flow Assumptions LEARNING OBJECTIVE Apply inventory cost flow methods and discuss their financial effects. 2 LO 2

13. 6-13 Illustration: Crivitz TV Company purchases three identical 50-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. SPECIFIC IDENTIFICATION ILLUSTRATION 6-3 Data for inventory costing example LO 2

14. 6-14 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. SPECIFIC IDENTIFICATION ILLUSTRATION 6-4 Specific identification method LO 2

15. 6-15 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 LO 2

16. 6-16 Illustration 6-12 Use of cost flow methods in major U.S. companies Cost flow assumption does not need to be consistent with the physical movement of goods COST FLOW ASSUMPTIONS LO 2

17. 6-17 Illustration: Data for Houston Electronics’ Astro condensers. (Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold COST FLOW ASSUMPTIONS ILLUSTRATION 6-5 Data for Houston Electronics LO 2

18. 6-18   Costs of the earliest goods purchased are the first to be recognized in determining cost of goods sold.   Often parallels actual physical flow of merchandise.   Companies determine the cost of the ending inventory by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed. First-In, First-Out (FIFO) LO 2

19. 6-19 First-In, First-Out (FIFO) ILLUSTRATION 6-6 Allocation of costs—FIFO method LO 2

20. 6-20 ▼ HELPFUL HINT Another way of thinking about the calculation of FIFO ending inventory is the LISH assumption—last in still here. First-In, First-Out (FIFO) LO 2

21. 6-21   Costs of the latest goods purchased are the first to be recognized in determining cost of goods 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) LO 2

22. 6-22 Last-In, First-Out (LIFO) ILLUSTRATION 6-8 Allocation of costs—LIFO method LO 2

23. 6-23 ▼ HELPFUL HINT Another way of thinking about the calculation of LIFO ending inventory is the FISH assumption—first in still here. Last-In, First-Out (LIFO) ILLUSTRATION 6-8 Allocation of costs—LIFO method LO 2

24. 6-24   Allocates cost of goods available for sale on the basis of weighted-average unit cost incurred.   Applies weighted-average unit cost to the units on hand to determine cost of the ending inventory. Average-Cost LO 2

25. 6-25 Average-Cost ILLUSTRATION 6-11 Allocation of costs—average-cost method LO 2

26. 6-26 Average-Cost ILLUSTRATION 6-11 Allocation of costs—average-cost method LO 2

27. 6-27 FINANCIAL STATEMENT AND TAX EFFECTS ILLUSTRATION 6-13 Comparative effects of cost flow methods LO 2

28. 6-28 In periods of changing prices, the cost flow assumption can have significant impacts both on income and on evaluations of income, such as the following. 1. 1.In a period of inflation, FIFO produces a higher net income because lower unit costs of the first units purchased are matched against revenue. 2. 2.In a period of inflation, LIFO produces a lower net income because higher unit costs of the last goods purchased are matched against revenue. 3. 3.If prices are falling, the results from the use of FIFO and LIFO are reversed. FIFO will report the lowest net income and LIFO the highest. 4. 4.Regardless of whether prices are rising or falling, average-cost produces net income between FIFO and LIFO. Income Statement Effects LO 2

29. 6-29 Review Question The cost flow method that often parallels the actual physical flow of merchandise is the:   FIFO method.   LIFO method.   average cost method.   gross profit method. COST FLOW ASSUMPTIONS LO 2

30. 6-30 Review Question In a period of inflation, the cost flow method that results in the lowest income taxes is the:   FIFO method.   LIFO method.   average cost method.   gross profit method. COST FLOW ASSUMPTIONS ▼ HELPFUL HINT A tax rule, often referred to as the LIFO conformity rule, requires that if companies use LIFO for tax purposes, they must also use it for financial reporting purposes. This means that if a company chooses the LIFO method to reduce its tax bills, it will also have to report lower net income in its financial statements. LO 2

31. 6-31   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 USING INVENTORY COST FLOW METHODS CONSISTENTLY LO 2

32. 6-32 4,000 units × $3 = $12,000 3,000 units × $4 = 12,000 $24,000 The accounting records of Shumway Ag Implement show the following data. Beginning inventory 4,000 units at $3 Purchases 6,000 units at $4 Sales 7,000 units at $12 Determine the cost of goods sold during the period under a periodic system using FIFO. SOLUTION Cost Flow Methods DO IT! 2 LO 2

33. 6-33 6,000 units × $4 = $24,000 1,000 units × $3 = 3,000 $27,000 The accounting records of Shumway Ag Implement show the following data. Beginning inventory 4,000 units at $3 Purchases 6,000 units at $4 Sales 7,000 units at $12 Determine the cost of goods sold during the period under a periodic system using LIFO. SOLUTION Cost Flow Methods DO IT! 2 LO 2

34. 6-34 $36,000 ÷ 10,000 units = $3.60 average cost per unit $36,000 – ($3,000 ending units × $3.60) = $25,200 The accounting records of Shumway Ag Implement show the following data. Beginning inventory 4,000 units at $3 = $12,000 Purchases 6,000 units at $4 = $24,000 Sales 7,000 units at $12 Determine the cost of goods sold during the period under a periodic system using average cost. SOLUTION Cost Flow Methods DO IT! $36,000 2 LO 2

35. 6-35 PRESENTATION   Inventory is classified in the balance sheet as a current asset immediately below receivables.   In a multiple-step income statement, cost of goods sold is subtracted from net sales.   There also should be disclosure of 1. 1.the major inventory classifications, 2. 2.the basis of accounting (cost, or lower-of-cost-or- market), and 3. 3.the cost method (FIFO, LIFO, or average-cost). LEARNING OBJECTIVE Explain the statement presentation and analysis of inventory. 3 LO 3

36. 6-36 PRESENTATION ILLUSTRATION 6-15 Inventory disclosures by Wal-Mart LO 3

37. 6-37 When the value of inventory is lower than its cost.   Applied to items in inventory after the company has used one of the cost flow methods (specific identification, FIFO, LIFO, or average-cost) to determine 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. LOWER-OF-COST-OR-MARKET LO 3

38. 6-38 Illustration: Assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated. LOWER-OF-COST-OR-MARKET ILLUSTRATION 6-16 Computation of lower-of-cost-or-market LO 3

39. 6-39 Tracy Company sells three different types of home heating stoves (gas, wood, and pellet). The cost and market value of its inventory of stoves are as follows. Cost Market Gas $ 84,000 $ 79,000 Wood 250,000 280,000 Pellet 112,000 101,000 Determine the value of the company’s inventory under the lower-of- cost-or-market approach. SOLUTION LCM Basis DO IT! 3a LO 3

40. 6-40 The lower value for each inventory type is gas $79,000, wood $250,000, and pellet $101,000. The total inventory value is the sum of these figures, $430,000. Tracy Company sells three different types of home heating stoves (gas, wood, and pellet). The cost and market value of its inventory of stoves are as follows. Cost Market Gas $ 84,000 $ 79,000 Wood 250,000 280,000 Pellet 112,000 101,000 Determine the value of the company’s inventory under the lower-of- cost-or-market approach. SOLUTION LCM Basis DO IT! 3a LO 3

41. 6-41 Inventory management is a critical task 1. 1.High Inventory Levels - storage costs, interest cost (on funds tied up in inventory), and costs associated with the obsolescence of technical goods or shifts in fashion. 2. 2.Low Inventory Levels – may lead to lost sales. ANALYSIS LO 3

42. 6-42 Inventory Turnover ILLUSTRATION 6-17 Inventory turnovers and days in inventory LO 3

43. 6-43 Illustration: Data available for Wal-Mart. Inventory Turnover ILLUSTRATION 6-17 Inventory turnovers and days in inventory LO 3

44. 6-44 Early in 2017, Westmoreland Company switched to a just-in-time inventory system. Its sales, cost of goods sold, and inventory amounts for 2016 and 2017 are shown below 2016 2017 Sales revenue $2,000,000 $1,800,000 Cost of goods sold 1,000,000 910,000 Beginning inventory 290,000 210,000 Ending inventory210,00050,000 Determine the inventory turnover and days in inventory for 2016 and 2017. Inventory Turnover DO IT! 3b SOLUTION LO 3