2 DefinitionInventories are asset items that a company holds for sale in the ordinary course of business, or goods that it will use or consume in the production of goods to be sold.
3 Classification Merchandise Inventory Raw Materials Inventory Merchandising CompanyWal-MartBalance Sheet31-Jan-04Current assets (in millions)Cash and cash equivalents$ ,199Receivables1,254Inventories26,612Prepaid expenses and other1,356Total current assets$ ,421Manufacturing CompanyCaterpillar31-Dec-04Cash$Accounts Receivable13,969Raw materials$ ,592Work in process664Finished goods2,209Supplies210Total inventories4,675Other current assets1,767$ 20,856Merchandise InventoryRaw Materials InventoryWork In Process InventoryFinished Goods Inventory
4 Basic Issues In Inventory Valuation The physical goods to include inventoryThe costs to include in inventoryThe cost flow assumption to adopt
5 Physical Goods Included in Inventory Goods in TransitConsigned GoodsSpecial Sales Agreements
6 Costs Included in Inventory Product Costs- Those costs that “attach” to the inventory.Period Costs- The costs that are indirectly related to the acquisition or production of the goods.Treatment of Purchase Discounts
7 The Cost Flow Assumption to Adopt Specific Identification- Identifying each item sold and each item in inventory.Average Cost-Prices items in the inventory on the basis of the average cost of all similar goods available during the period.FIFO (First in, First out)LIFO (Last in, First out)The cost flow used goes under the “Significant Accounting Policies” on the disclosures
8 Disclosures: FAS 151 Inventory Costs Amends ARB No. 43 chapter 4 “Inventory Pricing”“..under some circumstances items such as idle facility expense, excessive spoilage, double freight and rehandling costs may be so abnormal as to require treatment as current period charges...”
9 FAS 151 Changes Made to ARB No. 43: 1. Those items must be recognized as current period charges regardless of whether they meet the criterion of “so abnormal”2. Allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities
10 FAS 151Variable overhead costs of production are allocated on the basis of actual useFixed overhead costs of production are allocated on the basis of normal capacityNormal Capacity: Production expected to be achieved over a periodUnallocated overheads are recognized as an expense in the period in which they are incurred
11 FAS 8916. Current cost amounts of inventory and property, plant, and equipment are measured as follows:a. Inventory at current cost or lower recoverable amount at the measurement date
12 FAS 89The current cost of inventory is the current cost to purchase the inventory or the current cost of the materials required to produce the good (including some overhead expenses that are allowed under GAAP).
13 FAS 89: Ways to calculate price a. Indexation(1) Externally generated price indexes for the class of goods or services being measured(2) Internally generated price indexes for the class of goods or services being measuredb. Direct pricing(1) Current invoice prices(2) Vendors’ price lists or other quotations or estimates(3) Standard manufacturing costs that reflect current costs.
14 FAS 89: Current Cost Amounts of Inventory Historical costProperty, plant, and equipment and most inventories are reported at their historical cost, which is the amount of cash or its equivalent, paid to acquire an asset, commonly adjusted after acquisition for amortization or other allocations.Current costSome inventories are reported at their current cost, which is the amount of cash, or its equivalent, that would have to be paid if the same of an equivalent asset were acquired currently.
15 FAS 89: Current Cost Amounts of Inventory The increase or decrease in the current cost amount of inventory represents the difference between the measures of the assets ate their entry dates for the year and the measures of the assets at their exit dates for the year (FAS 89 ¶34).
16 FAS 89: Current Cost Amounts of Inventory Presentation For the current yearThe changes in current cost amount of inventory is reported both before and after eliminating the effects of general inflation.In the five-year summaryIncrease or decrease in the current cost and net of inflation for each of the five most recent years.
17 FAS 89: Current Cost Amounts of Inventory Calculation December 31, 19x51,000,000 units, $58,000,000 of historical costCurrent cost is $58/unitDecember 31, 19x6900,000 units, $65,700,000 of historical costCurrent cost is $73/unit3,036,000 units produced3,136,000 units soldConsumer Price Index for All urban ConsumersDecember 19x5 :Average 19x :December 19x6 :
18 FAS 89: Current Cost Amounts of Inventory Calculation Current Cost of Inventory and Cost of Goods Sold (for 19x6)Current cost at the beginning of year$58/unitCurrent cost at the end of year73/unit$131/unitAverage current cost ($131/2)$65.5/unitUnits sold during the yearX 3,136Average current cost goods sold$205, 408