1. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 7 Reporting and Interpreting Inventories and Cost of Goods Sold

2. 7-2 Learning Objective 1 Describe inventory management goals.

3. 7-3 Inventory Management Decisions The primary goals of inventory managers are to: 1.ensure sufficient quantities of inventory are available to meet customers’ needs, 2.ensure inventory quality meets customers’ expectations and company standards, and 3.minimize the costs of acquiring and carrying inventory The primary goals of inventory managers are to: 1.ensure sufficient quantities of inventory are available to meet customers’ needs, 2.ensure inventory quality meets customers’ expectations and company standards, and 3.minimize the costs of acquiring and carrying inventory

4. 7-4 Learning Objective 2 Describe the different types of inventory.

5. 7-5 Types of Inventory Inventory includes goods that are: 1.held for sale in the normal course of business, or 2.used to produce goods for sale. Inventory includes goods that are: 1.held for sale in the normal course of business, or 2.used to produce goods for sale. Inventory is reported on the balance sheet as a current asset because it normally is used or converted into cash within one year. Balance Sheet Current Assets Inventory

6. 7-6 Types of Inventory Merchandiser Manufacturer Inventory Inventory is acquired in a finished condition and is ready for sale without further processing. Raw materials inventory Raw materials inventory includes materials that are processed further into finished goods. Work in process inventory Work in process inventory includes goods that are in the process of being manufactured. Finished goods inventory Finished goods inventory includes goods that are complete and ready to sell. Raw materials inventory Raw materials inventory includes materials that are processed further into finished goods. Work in process inventory Work in process inventory includes goods that are in the process of being manufactured. Finished goods inventory Finished goods inventory includes goods that are complete and ready to sell.

7. 7-7 Balance Sheet Reporting

8. 7-8 Income Statement Reporting

9. 7-9 Relationship Between Inventory and Cost of Goods Sold $65,500 Beginning Inventory $65,500 $387,800 Purchases $387,800 $453,300 Goods Available for Sale $453,300 + + + + $75,800 Ending Inventory $75,800 Still Here $377,500 Cost of Goods Sold $377,500 Sold

10. 7-10 Cost of Goods Sold Equation

11. 7-11 Learning Objective 3 Compute costs using four inventory costing methods.

12. 7-12 Inventory Costing Methods First-in, first-out (FIFO) Last-in, first-out (LIFO) Weighted average Specific identification

13. 7-13 Inventory Costing Illustration

14. 7-14 Specific Identification When this method is used, the cost of each item sold is individually identified and recorded as cost of goods sold.

15. 7-15 Specific Identification The above purchases were made by Handheld, Inc. in August. On August 14, Handheld sold 8 personal digital assistants (PDAs) originally costing $91 and 12 PDAs originally costing $106.

16. 7-16 The Cost of Goods Sold for the August 14 sale is $2,000. After this sale, there are 5 PDAs in inventory at $500: 2 units at $91; 3 units at $106. The Cost of Goods Sold for the August 14 sale is $2,000. After this sale, there are 5 PDAs in inventory at $500: 2 units at $91; 3 units at $106. Specific Identification

17. 7-17 Additional purchases were made on August 17 and 28. cost The cost of items sold on August 31 were as follows: 2 units at $91; 3 units at $106; 15 units at $115; 3 units at $119. Additional purchases were made on August 17 and 28. cost The cost of items sold on August 31 were as follows: 2 units at $91; 3 units at $106; 15 units at $115; 3 units at $119. Specific Identification

18. 7-18 Specific Identification Cost of Goods Sold on August 31 = $2,582

19. 7-19 Specific Identification After the August 31 sale, there are 12 units in inventory at $1,408: 5 units at $115; 7 units at $119.

20. 7-20 Specific Identification Income Statement COGS = $4,582 Balance Sheet Inventory = $1,408

21. 7-21 First-In, First-Out (FIFO) Cost of Goods Sold Ending Inventory Oldest Costs Recent Costs

22. 7-22 First-In, First-Out (FIFO) The above purchases were made by Handheld in August. On August 14, Handheld sold 20 PDAs. The above purchases were made by Handheld in August. On August 14, Handheld sold 20 PDAs.

23. 7-23 First-In, First-Out (FIFO) The Cost of Goods Sold for the August 14 sale is $1,970. After this sale, there are 5 units at $106 in inventory. The Cost of Goods Sold for the August 14 sale is $1,970. After this sale, there are 5 units at $106 in inventory.

24. 7-24 First-In, First-Out (FIFO) Additional purchases were made on August 17 and 28. Twenty-three PDAs were sold on August 31. Additional purchases were made on August 17 and 28. Twenty-three PDAs were sold on August 31.

25. 7-25 First-In, First-Out (FIFO) Cost of Goods Sold for August 31 = $2,600

26. 7-26 First-In, First-Out (FIFO) After the August 31 sale, there are 12 units in inventory at $1,420: 2 units at $115; 10 units at $119.

27. 7-27 First-In, First-Out (FIFO) Balance Sheet Inventory = $1,420 $4,570 Income Statement COGS = $4,570

28. 7-28 Last-In, First-Out (LIFO) Cost of Goods Sold Ending Inventory Recent Costs Oldest Costs

29. 7-29 Last-In, First-Out (LIFO) The above purchases were made by Handheld in August. On August 14, Handheld sold 20 PDAs. The above purchases were made by Handheld in August. On August 14, Handheld sold 20 PDAs.

30. 7-30 Last-In, First-Out (LIFO) The Cost of Goods Sold for the August 14 sale is $2,045. After this sale, there are 5 units at $91 in inventory. The Cost of Goods Sold for the August 14 sale is $2,045. After this sale, there are 5 units at $91 in inventory.

31. 7-31 Last-In, First-Out (LIFO) Additional purchases were made on August 17 and 28. Twenty-three PDAs were sold on August 31. Additional purchases were made on August 17 and 28. Twenty-three PDAs were sold on August 31.

32. 7-32 Last-In, First-Out (LIFO) Cost of Goods Sold for August 31 = $2,685

33. 7-33 Last-In, First-Out (LIFO) After the August 31 sale, there are 12 units in inventory at $1,260: 5 units at $91; 7 units at $115.

34. 7-34 Last-In, First-Out (LIFO) Balance Sheet Inventory = $1,260 Income Statement COGS = $4,730

35. 7-35 Weighted Average When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. Cost of Goods Available for Sale Units on hand on the date of sale ÷

36. 7-36 Weighted Average The above purchases were made by Handheld in August. On August 14, Handheld sold 20 PDAs. The above purchases were made by Handheld in August. On August 14, Handheld sold 20 PDAs.

37. 7-37 ÷ Weighted Average First, we need to compute the weighted average cost per unit of items in inventory.

38. 7-38 Weighted Average The Cost of Goods Sold for the August 14 sale is $2,000. After this sale, there are 5 units at $100 in inventory. The Cost of Goods Sold for the August 14 sale is $2,000. After this sale, there are 5 units at $100 in inventory.

39. 7-39 Weighted Average Additional purchases were made on August 17 and 28. Twenty-three PDAs were sold on August 31. Additional purchases were made on August 17 and 28. Twenty-three PDAs were sold on August 31. What is the weighted average cost per unit of items in inventory?

40. 7-40 Weighted Average ÷

41. 7-41 Weighted Average Cost of Goods Sold for August 31 = $2,622

42. 7-42 Weighted Average After the August 31 sale, there are 12 units at $114 in inventory.

43. 7-43 Weighted Average Balance Sheet Inventory = $1,368 Income Statement COGS = $4,622

44. 7-44 Financial Statement Effects of Costing Methods Because prices change, inventory methods nearly always assign different cost amounts.

45. 7-45 Financial Statement Effects of Costing Methods Advantages of Methods Smoothes out price changes. Better matches current costs in cost of goods sold with revenues. Ending inventory approximates current replacement cost. First-In, First-Out Weighted Average Last-In, First-Out

46. 7-46 Learning Objective 4 Explain why inventory is reported at the lower of cost or market.

47. 7-47 Reporting Inventory at the Lower of Cost or Market The value of inventory can fall below its recorded cost for two reasons: 1. It’s easily replaced by identical goods at a lower cost, or 2. It’s become outdated or damaged. The value of inventory can fall below its recorded cost for two reasons: 1. It’s easily replaced by identical goods at a lower cost, or 2. It’s become outdated or damaged.

48. 7-48 Reporting Inventory at the Lower of Cost or Market When the value of inventory falls below its recorded cost, the amount recorded for inventory is written down to its lower market value. This is known as the lower of cost or market (LCM) rule.

49. 7-49 Reporting Inventory at the Lower of Cost or Market One item in the ending inventory of Matrix, Inc. is chrome pipes. At December 31, 2008, there are 1,000 pipes in inventory. Each pipe cost $47 and has a replacement cost (market value) of $42 each. How should Matrix value the chrome pipes in its inventory? One item in the ending inventory of Matrix, Inc. is chrome pipes. At December 31, 2008, there are 1,000 pipes in inventory. Each pipe cost $47 and has a replacement cost (market value) of $42 each. How should Matrix value the chrome pipes in its inventory?

50. 7-50 Reporting Inventory at the Lower of Cost or Market 1,000 units × $42 per unit = $42,000

51. 7-51 Reporting Inventory at the Lower of Cost or Market

52. 7-52 Learning Objective 5 Compute and interpret the inventory turnover ratio.

53. 7-53 Inventory Turnover Analysis Inventory Turnover Ratio = Cost of Goods Sold Average Inventory Beginning Inventory Ending Inventory + 2

54. 7-54 Inventory Turnover Analysis Days to Sell 365 Inventory Turnover Ratio =

55. 7-55 Learning Objective 6 Explain how accounting methods affect evaluations of inventory management.

56. 7-56 The Impact of Inventory Cost Methods

57. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 7 Supplement A Applying FIFO and LIFO in a Perpetual Inventory System

58. 7-58 First-In, First-Out 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.

59. 7-59 First-In, First-Out Trekking Bicycle Company

60. 7-60 First-In, First-Out (FIFO) Cost of Goods Sold Ending Inventory Oldest Costs Recent Costs

61. 7-61 First-In, First-Out (FIFO) The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes. The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes.

62. 7-62 First-In, First-Out (FIFO) The Cost of Goods Sold for the August 14 sale is $1,970. After this sale, there are 5 units in inventory at $530: 5 @ $106 The Cost of Goods Sold for the August 14 sale is $1,970. After this sale, there are 5 units in inventory at $530: 5 @ $106

63. 7-63 First-In, First-Out (FIFO) Additional purchases were made on August 17 and 28. Twenty-three bikes were sold on August 31.

64. 7-64 First-In, First-Out (FIFO) Cost of Goods Sold for August 31 = $2,600

65. 7-65 First-In, First-Out (FIFO) After the August 31 sale, there are 12 units in inventory at $1,420: 2 @ $115 10 @ $119

66. 7-66 First-In, First-Out (FIFO) Balance Sheet Inventory = $1,420 Income Statement COGS = $4,570

67. 7-67 Last-In, First-Out (LIFO) Cost of Goods Sold Ending Inventory Recent Costs Oldest Costs

68. 7-68 Last-In, First-Out (LIFO) The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes. The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes.

69. 7-69 Last-In, First-Out (LIFO) The Cost of Goods Sold for the August 14 sale is $2,045. After this sale, there are 5 units in inventory at $455: 5 @ $91 The Cost of Goods Sold for the August 14 sale is $2,045. After this sale, there are 5 units in inventory at $455: 5 @ $91

70. 7-70 Last-In, First-Out (LIFO) Additional purchases were made on August 17 and 28. Twenty-three bikes were sold on August 31. Additional purchases were made on August 17 and 28. Twenty-three bikes were sold on August 31.

71. 7-71 Last-In, First-Out (LIFO) Cost of Goods Sold for August 31 = $2,685

72. 7-72 Last-In, First-Out (LIFO) After the August 31 sale, there are 12 units in inventory at $1,260: 5 @ $91 7 @ $115

73. 7-73 Last-In, First-Out (LIFO) Balance Sheet Inventory = $1,260 Income Statement COGS = $4,730

74. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 7 Supplement B The Effects of Errors in Ending Inventory

75. 7-75 The Effects of Errors in Ending Inventory Let’s assume that Trekking Bicycle Company took a physical inventory and discovered that its ending inventory was in error. The inventory was overstated by $10,000.

76. 7-76 The Effects of Errors in Ending Inventory Now assume that Trekking Bicycle Company discovered that its beginning inventory was in error. The inventory was understated by $10,000.

77. 7-77 End of Chapter 7