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Inven - Cost - 1Inventory Basic Valuation Methods.

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Presentation on theme: "Inven - Cost - 1Inventory Basic Valuation Methods."— Presentation transcript:

1 Inven - Cost - 1Inventory Basic Valuation Methods

2 Inven - Cost - 2 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.

3 Inven - Cost - 3 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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6 Inven - Cost - 6 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

7 Inven - Cost - 7 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 PERPETUAL INVENTORY SYSTEM

8 Inven - Cost - 8 INVENTORY RECORDING METHODS n 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. contra-purchases accounts These accounts are contra-purchases accounts, i.e., they have a credit balance. -- May be recorded gross or net

9 Inven - Cost - 9 PERIODIC INVENTORY SYSTEM n Sales revenue recorded in normal fashion n No entry for Cost of goods sold at time of sale n Adjusting entry for Cost of goods sold at end of the fiscal period n Cost of goods sold then closed with other expense accounts at year end

10 Inven - Cost - 10 COST OF GOODS SOLD (COGS) Beginning Inventory Beginning Inventory + Purchases (net) = Cost of Goods Available for Sale - Ending Inventory = Cost of Goods Sold

11 Inven - Cost - 11 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.

12 Inven - Cost - 12 The following is a partial adjusted trial balance: AccountDebitCredit Inventory 1/1/X6 $175,000 Purchases 350,000 Purchases Discount $ 22,000 Purchase Returns & Allowances 6,000 Sales 1,250,000 Advertising Expense 7,500 Salaries Expense 80,000 Utilities Expense 20,000 The physical inventory count at 12/31/X6 was $125,000.

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15 Inven - Cost - 15 COST FLOW METHODS An allocation of total cost of goods available for sale: Ending inventory Cost of goods sold Cost of goods available cost flow The cost flow assumption used for accounting purposes physical flow can be different from the physical flow of goods through the company.

16 Inven - Cost - 16 INVENTORY VALUES COST FLOW ASSUMPTIONS Specific cost identification Average cost First-in, first-out (FIFO) Last-in, first-out (LIFO)

17 Inven - Cost - 17 n Specific cost of each inventory item must be known n Opportunity to manipulate income by selection of items at time of sale n n Allows perpetual inventory SPECIFIC COST IDENTIFICATION

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20 Inven - Cost - 20 oldest n The cost of the oldest inventory items are charged to COGS when goods are sold. n newest n The cost of the newest inventory items remain in ending inventory. n n The actual physical flow of inventory items may differ from the FIFO cost flow assumptions.

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27 Inven - Cost - 27 POOLED LIFO n Groups items that are used or sold in relatively constant proportions n Each pool represents a group of different, but related, inventory items that are considered as a single entity for inventory accounting purposes n Uses the average cost for the entire pool to determine COGS and cost of ending inventory

28 Inven - Cost - 28 DOLLAR VALUE (DV) LIFO price indexes n Uses price indexes related to the inventory instead of units and unit costs inventory pools n Is applied to inventory pools rather than individual items n Approximates LIFO results used for income tax and external reporting purposes

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31 Inven - Cost - 31 – Convert ending inventory in end-of-year base year dollars dollars tobase year dollars (divide by appropriate price index) (divide by appropriate price index) base year dollars – Determine annual layers in base year dollars – – Convert to DV LIFO cost using appropriate price index DOLLAR VALUE LIFO Steps in Application

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33 Inven - Cost - 33 n Inventory errors may have dramatic impacts on reported financial results n Categories of errors INVENTORY ERRORS – Mistakes in physical counts – Errors in computing cost of inventory – Inappropriate recording of purchases – Inappropriate recording of sales n Evaluate impact of each error DO NOT MEMORIZE PATTERNS!! n Make correcting entries as necessary

34 Inven - Cost - 34 Average Costing CGS BI Ending Inventory BI Purchases BI

35 Inven - Cost - 35 FIFO COSTING Purchases BI CGS BI Ending Inventory 7 8

36 Inven - Cost - 36 LIFO COSTING Purchases BI CGS Ending Inventory BI 1

37 Inven - Cost - 37 THE END

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