6-1 REPORTING AND ANALYZING INVENTORY Accounting, Fifth Edition 6

6-2 After studying this chapter, you should be able to: 1. 1.Determine how to classify inventory and inventory quantities Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system Explain the financial statement and tax effects of each of the inventory cost flow assumptions Explain the lower-of-cost-or-market basis of accounting for inventories Compute and interpret the inventory turnover Describe the LIFO reserve and explain its importance for comparing results of different companies. Learning Objectives

6-3 Classifying and Determining Inventory One Classification:  Merchandise Inventory Three Classifications:  Raw Materials  Work in Process  Finished Goods Merchandising Company Manufacturing Company LO 1 Determine how to classify inventory and inventory quantities. Helpful Hint Regardless of the classification, companies report all inventories under Current Assets on the balance sheet.

6-4 Physical Inventory taken for two reasons: Perpetual System 1.Check accuracy of inventory records. 2.Determine amount of inventory lost due to wasted raw materials, shoplifting, or employee theft. Periodic System 1.Determine the inventory on hand. 2.Determine the cost of goods sold for the period. Determining Inventory Quantities LO 1 Determine how to classify inventory and inventory quantities.

6-5 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 Determining Inventory Quantities LO 1 Determine how to classify inventory and inventory quantities.

6-6 Goods in Transit  Purchased goods not yet received.  Sold goods not yet delivered. Determining Ownership of Goods Determining Inventory Quantities 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. LO 1 Determine how to classify inventory and inventory quantities.

6-7 Illustration 6-2 Terms of sale Determining Inventory Quantities LO 1 Determine how to classify inventory and inventory quantities. Goods in Transit 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.

6-8 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 Inventory Quantities LO 1 Determine how to classify inventory and inventory quantities. Determining Ownership of Goods

6-9 Inventory Costing LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. 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

6-10 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. Inventory Costing Illustration 6-3 LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

6-11 Specific Identification Inventory Costing 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. LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Illustration 6-4

6-12 Inventory Costing LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Specific Identification 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.

6-13 Inventory Costing 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 LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

6-14 Illustration: Data for Houston Electronics’ Astro condensers. Cost Flow Assumptions Illustration 6-5 (Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

6-15  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. Cost Flow Assumptions LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. First-In, First-Out (FIFO)

6-16 Cost Flow Assumptions Illustration 6-6 LO 2 First-In, First-Out (FIFO)

6-17 Cost Flow Assumptions Illustration 6-6 LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. First-In, First-Out (FIFO) Helpful Hint Another way of thinking about the calculation of FIFO ending inventory is the LISH assumption—last in still here.

6-18  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. Cost Flow Assumptions LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Last-In, First-Out (LIFO)

6-19 Illustration 6-8 Cost Flow Assumptions Last-In, First-Out (LIFO) LO 2

6-20 LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Cost Flow Assumptions Last-In, First-Out (LIFO) Illustration 6-8 Helpful Hint Another way of thinking about the calculation of LIFO ending inventory is the FISH assumption—first in still here.

6-21  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. Cost Flow Assumptions LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Average-Cost

6-22 Illustration 6-11 LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Cost Flow Assumptions Average-Cost

6-23 LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Cost Flow Assumptions Average-Cost Illustration 6-11

6-24 Comparative effects of cost flow methods LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions. Financial Statement and Tax Effects Illustration 6-13

6-25 Using Cost Flow Methods Consistently Inventory Costing  Method should be used consistently, enhances comparability.  Although consistency is preferred, a company may change its inventory costing method.

6-26 Lower-of-Cost-or-Market (LCM) Inventory Costing When the value of inventory is lower than its cost  Companies are required to “write down” the inventory to its market value in the period in which the price decline occurs.  Market value = Replacement Cost; Not the Selling Price!  Example of conservatism. Replacement Cost is the cost of purchasing the same goods at the present time from the usual suppliers in the usual quantities.

6-27 Mendel Company has the following four items in its ending inventory as of December 31, The company uses the lower-of-cost-or-market approach for inventory valuation. Item No. Cost Replacement Cost 1320$3,600$3, ,6004, ,8002, ,0004,700 Required: 1. Computation of the ending inventory value to be reported in the financial statements at December 31, Provide the necessary journal entry.

6-28 Mendel Company has the following four items in its ending inventory as of December 31, The company uses the lower-of-cost-or-market approach for inventory valuation. Item No. Cost Replacement Cost 1320$3,600$3, ,6004, ,8002, ,0004,700 The computation of the ending inventory value to be reported in the financial statements at December 31, 2012, is as follows: Item No. Cost Replacement Cost Lower-of-Cost or MKT 1320 $ 3,600 $ 3,400 $ 3, ,600 4,100 4, ,800 2,100 2, ,000 4,700 4,700 Total $16,000 $14,300

6-29 JOURNAL ENTRY: Cost of Goods Sold 1,700 Inventory (16, ,300)1,700

6-30 Inventory Costing 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 JOURNAL ENTRY: Cost of Goods Sold 9,000 Inventory (168, ,000) 9,000

6-31 Analysis of Inventory Inventory management is a critical task 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. Low Inventory Levels – may lead to lost sales. LO 5 Compute and interpret the inventory turnover ratio.