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PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Inventories:

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Presentation on theme: "PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Inventories:"— Presentation transcript:

1 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Inventories: Measurement 8 Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2 8 - 2 Recording and Measuring Inventory Merchandise Inventory Goods acquired for resale Manufacturing Inventory Raw Materials Work-in-Process Finished Goods Types of Inventory

3 8 - 3 Manufacturing Inventories Raw Materials Work in Process Finished Goods Cost of Goods Sold Direct Labor Manufacturing Overhead $XX Raw materials purchased Direct labor incurred Manufacturing overhead incurred Raw materials used Direct labor applied Manufacturing overhead applied Work in process transferred to finished goods Finished goods sold Raw materials purchased Direct labor incurred Manufacturing overhead incurred Raw materials used Direct labor applied Manufacturing overhead applied Work in process transferred to finished goods Finished goods sold

4 8 - 4 Inventory Systems Perpetual Inventory System The inventory account is continuously updated as purchases and sales are made. Periodic Inventory System The inventory account is adjusted at the end of a reporting cycle. Two accounting systems are used to record transactions involving inventory:

5 8 - 5 Perpetual Inventory System Lothridge Wholesale Beverage Company (LWBC) begins 2011 with $120,000 in inventory. During the period it purchases on account $600,000 of merchandise for resale to customers. Returns of inventory are credited to the inventory account. Discounts on inventory purchases can be recorded using the gross or net method Inventory600,000 Accounts payable 600,000 Purchase of merchandise inventory on account

6 8 - 6 Perpetual Inventory System During 2011, LWBC sold, on account, inventory with a retail price of $820,000 and a cost basis of $540,000, to customers Inventory600,000 Accounts payable 600,000 Purchase of merchandise inventory on account Accounts receivable820,000 Sales revenue 820,000 Record sales on account. Cost of goods sold540,000 Inventory 540,000 Record cost of goods sold.

7 8 - 7 Periodic Inventory System The periodic inventory system is not designed to track either the quantity or cost of merchandise inventory. Cost of goods sold is calculated, using the schedule below, after the physical inventory count at the end of the period.

8 8 - 8 Periodic Inventory System Lothridge Wholesale Beverage Company (LWBC) begins 2011 with $120,000 in inventory. During the period it purchases on account $600,000 of merchandise for resale to customers Purchases600,000 Accounts payable 600,000 Purchase of merchandise inventory on account

9 8 - 9 Periodic Inventory System No entry is made to record Cost of Goods Sold. A physical count of Ending Inventory shows a balance of $180,000. Lets calculate Cost of Goods Sold at the end of During 2011, LWBC sold, on account, inventory with a retail price of $820,000 to customers, and a cost basis of $540, Accounts receivable820,000 Sales revenue 820,000 Record sales on account.

10 Periodic Inventory System We need the following adjusting entry to record cost of good sold. December 31, 2011 Cost of goods sold540,000 Inventory (ending)180,000 Inventory (beginning) 120,000 Purchases 600,000 To adjust inventory, close purchases, and record cost of goods sold.

11 Comparison of Inventory Systems

12 What is Included in Inventory? General Rule All goods owned by the company on the inventory date, regardless of their location. Goods in Transit Goods on Consignment Depends on FOB shipping terms.

13 Expenditures Included in Inventory Invoice Price Freight-in on Purchases + Purchase Returns and Allowances Purchase Discounts

14 Purchase Returns November 8, 2011 Accounts payable 2,000Accounts payable 2,000 Purchase returns and allowances 2,000 Inventory 2,000 On November 8, 2011, LWBC returns merchandise that had a cost to LWBC of $2,000, and a cost basis to the seller of 1,600. Periodic Inventory MethodPerpetual Inventory Method Returns of inventory are credited to the Purchase Returns and Allowances account when using the periodic inventory method. The returns are credited to Inventory using the perpetual inventory method. Returns of inventory are credited to the Purchase Returns and Allowances account when using the periodic inventory method. The returns are credited to Inventory using the perpetual inventory method.

15 Purchase Discounts October 5, 2011 Purchases 20,000 Purchases 19,600 Accounts payable 20,000Accounts payable 19,600 October 14, 2011 Accounts payable 14,000 Accounts payable 13,720 Purchase discounts 280Cash13,720 Cash 13,720 November 4, 2011 Accounts payable 6,000 Accounts payable 5,880 Cash 6,000 Interest expense 120 Cash 6,000 Discount terms are 2/10, n/30. $14,000 x 0.02 $ 280 Partial payment not made within the discount period Gross MethodNet Method $20,000 x 0.02 $ $ 280

16 Inventory Cost Flow Assumptions Specific identification Average cost First-in, first-out (FIFO) Last-in, first-out (LIFO) Specific identification Average cost First-in, first-out (FIFO) Last-in, first-out (LIFO)

17 Last-In, First-Out Periodic Inventory System

18 Weighted-Average Periodic System Lets use the same information to assign costs to ending inventory and cost of goods sold using the periodic system. Available for Sale (4,050 units) Available for Sale (4,050 units) Ending Inventory (1,400 units) Goods Sold (2,650) $100,350 ÷ 4,050 = $ weighted- average per unit cost

19 Weighted-Average Periodic System

20 First-In, First-Out (FIFO) 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 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 FIFO method assumes that items are sold in the chronological order of their acquisition.

21 First-In, First-Out (FIFO) Even though the periodic and the perpetual approaches differ in the timing of adjustments to inventory COGS and Ending Inventory Cost are the same under both approaches. Even though the periodic and the perpetual approaches differ in the timing of adjustments to inventory COGS and Ending Inventory Cost are the same under both approaches.

22 First-In, First-Out (FIFO) Periodic Inventory System These are the 1,400 most recently acquired units.

23 First-In, First-Out (FIFO) Periodic Inventory System

24 First-In, First-Out (FIFO) Periodic Inventory System These are the first 2,650 units acquired.

25 First-In, First-Out (FIFO) Periodic Inventory System

26 Last-In, First-Out (LIFO) The cost of the newest inventory items are charged to COGS when goods are sold. The cost of the oldest inventory items remain in inventory. The cost of the newest inventory items are charged to COGS when goods are sold. The cost of the oldest inventory items remain in inventory. The LIFO method assumes that the newest items are sold first, leaving the older units in inventory.

27 Last-In, First-Out (LIFO) Unlike FIFO, using the LIFO method may result in COGS and Ending Inventory Cost that differ under the periodic and perpetual approaches.

28 Last-In, First-Out Perpetual Inventory System These are the oldest units in inventory and are most likely to remain in inventory when using LIFO.

29 Last-In, First-Out Perpetual Inventory System The Cost of Goods Sold for the September 15 sale is $24,550. After this sale, there are 1,650 units in inventory at various costs per unit. The Cost of Goods Sold for the September 15 sale is $24,550. After this sale, there are 1,650 units in inventory at various costs per unit.

30 Last-In, First-Out Perpetual Inventory System The Cost of Goods Sold for the September 15 sale is $18,600. After this sale, there are 1,550 units in inventory at various per unit cost. The Cost of Goods Sold for the September 15 sale is $18,600. After this sale, there are 1,550 units in inventory at various per unit cost.

31 Last-In, First-Out Perpetual Inventory System The Cost of Goods Sold for the September 30 sale is $26,000. After this sale, there are 1,400 units in inventory (1,200 × $22.00) per unit and (200 × $24.00) for a total cost of ending inventory of $31,200. The Cost of Goods Sold for the September 30 sale is $26,000. After this sale, there are 1,400 units in inventory (1,200 × $22.00) per unit and (200 × $24.00) for a total cost of ending inventory of $31,200.

32 Last-In, First-Out Periodic Inventory System

33 Last-In, First-Out Periodic Inventory System

34 Last-In, First-Out Perpetual Inventory System

35 When Prices Are Rising... LIFO Matches high (newer) costs with current (higher) sales. Inventory is valued based on low (older) cost basis. Results in lower taxable income. FIFO Matches low (older) costs with current (higher) sales. Inventory is valued at approximate replacement cost. Results in higher taxable income.

36 U. S. GAAP vs. IFRS LIFO is permitted and used by U.S. Companies. If used for income tax reporting, the company must use LIFO for financial reporting. Conformity with IAS No. 2 would cause many U.S. companies to lose a valuable tax shelter. IAS No. 2, Inventories, does not permit the use of LIFO. Because of this restriction, many U.S. companies use LIFO only for domestic inventories. LIFO is an important issue for U.S. multinational companies. Unless the U.S. Congress repeals the LIFO conformity rule, in inability to use LIFO under IFRS will impose a serious impediment to convergence.

37 Decision Makers Perspective Factors Influencing Method Choice How are income taxes affected by inventory method choice? How closely do reported costs reflect actual flow of inventory? How well are costs matched against related revenues?

38 LIFO Liquidation LIFO inventory costs in the balance sheet are out of date because they reflect old purchase transactions. LIFO inventory costs in the balance sheet are out of date because they reflect old purchase transactions. When prices rise... If inventory declines, these out of date costs may be charged to current earnings. This LIFO liquidation results in paper profits. This LIFO liquidation results in paper profits.


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