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

Learning Objectives After studying this chapter, you should be able to: Determine how to classify inventory and inventory quantities. Explain the basis of accounting for inventories and apply the inventory cost flow methods under a PERPETUAL inventory system (App 6a). 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 analysis.* (slides 27-30) * Self-study

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

Determining Inventory Quantities Physical Inventory taken for two reasons: Perpetual System – Check accuracy of inventory records. Determine amount of inventory lost due to wasted raw materials, shoplifting, or employee theft. LO 1 Determine how to classify inventory and inventory quantities.

Determining Inventory Quantities Goods in Transit Illustration 6-2 Terms of sale Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. Freight is added to value of the BUYER’s Inventory (asset). Ownership of the goods remains with the seller until the goods reach the buyer. Freight is added to the SELLER’s expense LO 1 Determine how to classify inventory and inventory quantities.

Hasbeen Company completed its inventory count Hasbeen Company completed its inventory count. It arrived at a total inventory value of $200,000. You have been given the information listed below. Discuss how this information affects the reported cost of inventory. 1. Hasbeen included in the inventory goods held on consignment for Falls Co., costing $15,000. 2. The company did not include in the count purchased goods of $10,000, which were in transit (terms: FOB shipping point). 3. The company did not include in the count inventory that had been sold with a cost of $12,000, which was in transit (terms: FOB shipping point). LO 1 Determine how to classify inventory and inventory quantities.

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

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

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

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

does not need to be consistent with the physical movement of goods Inventory Costing Cost Flow Assumption does not need to be consistent with the physical movement of goods Illustration 6-12 Use of cost flow methods in major U.S. companies LO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

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

Perpetual Inventory System Inventory Costing Illustration: Illustration 6A-1 Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Average cost. LO 7 Apply the inventory cost flow methods to perpetual inventory records.

Inventory Costing – E6-12, p 319 Perpetual Inventory System Inventory Costing – E6-12, p 319 First-In, First-Out (FIFO) Balance Date Purchases Cost of Goods Sold (in units & $) June 1 120 @ $5 = $ 600 June 12 370 @ $6 = $2,220 120 @ $5 = $ 600 370 @ $6 = $2,220 Jun 15 120 @ $5 = $600 290 @ $6 = $1,740 80 @ $6 = $ 480 410 June 23 200 @ $7 = $1,400 80 @ $6 = $ 480 200 @ $7 = $1,400 Jun 27 @ $6 = $ 300 30 @ $6 = $ 180 200 @ $7 = $1,400 50 Cost of Goods Sold Ending Inventory $2,640 $1,580 $4,220 LO 7 Apply the inventory cost flow methods to perpetual inventory records.

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

Inventory Costing – E6-12, p 319 Perpetual Inventory System Inventory Costing – E6-12, p 319 Last-In, First-Out (LIFO) Balance Date Purchases Cost of Goods Sold (in units & $) June 1 120 @ $5 = $ 600 June 12 370 @ $6 = $2,220 120 @ $5 = $ 600 370 @ $6 = $2,220 Jun 15 370 @ $6 = $2,220 40 @ $5 = $ 200 80 @ $5 = $ 400 410 June 23 200 @ $7 = $1,400 80 @ $5 = $ 400 200 @ $7 = $1,400 Jun 27 @ $7 = $ 350 80 @ $5 = $ 400 150 @ $7 = $1,050 50 Cost of Goods Sold Ending Inventory $2,770 $1,450 $4,220 LO 7 Apply the inventory cost flow methods to perpetual inventory records.

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

Inventory Costing – E6-12, p 319 Perpetual Inventory System Inventory Costing – E6-12, p 319 Moving Average Balance Date Purchases Cost of Goods Sold (in units & $) June 1 120 @ $5 = $ 600 June 12 370 @ $6 = $2,220 120 @ $5 = $ 600 370 @ $6 = $2,220 $5.755 ($2820/490) Jun 15 $5.755 * 410 = $2,360 $5.755 * 80 = $460 June 23 200 @ $7 = $1,400 80 * 5.755 = $460 200 @ $7 = $1,400 $6.643 ($1860/280) Jun 27 $6.643 * 50 = $332 230 * $6.643 = $1,528 Cost of Goods Sold Ending Inventory $2,692 $1,528 $4,220 LO 7 Apply the inventory cost flow methods to perpetual inventory records.

Financial Statement and Tax Effects Comparative effects of cost flow methods FIFO LIFO Avg Cost Sales revenue @ $8 & $9 $3,730 Cost of goods sold 2,640 2,770 2,692 Gross profit 1,090 960 1,038 Operating expenses Income before taxes Income tax expense (30%) Net income LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

Inventory Cost Flow Assumptions Review Question The cost flow method that often parallels the actual physical flow of merchandise is the: FIFO method. LIFO method. average cost method. gross profit method. Answer = A LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

Inventory Cost Flow Assumptions Review Question In a period of inflation, the cost flow method that results in the lowest income taxes is the: FIFO method. LIFO method. average cost method. gross profit method. Helpful Hint A tax rule, often referred to as the LIFO conformity rule, requires that if companies use LIFO for tax purposes, they must also use it for financial reporting purposes. This means that if a company chooses the LIFO method to reduce its tax bills, it will also have to report lower net income in its financial statements. Answer = B LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

Inventory Costing Using Cost Flow Methods Consistently Method should be used consistently, enhances comparability. Although consistency is preferred, a company may change its inventory costing method. Illustration 6-15 Disclosure of change in cost flow method LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

Inventory Costing Lower-of-Cost-or-Market When the value of inventory is lower than its cost Companies can “write down” the inventory to its market value in the period in which the price decline occurs. Market value = Replacement Cost Example of conservatism. International Note Under U.S. GAAP, companies cannot reverse inventory write-downs if inventory increases in value in subsequent periods. IFRS permits companies to reverse write-downs in some circumstances. LO 4 Explain the lower-of-cost-or-market basis of accounting for inventories.

Inventory Costing Lower-of-Cost-or-Market Illustration: Assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated. Illustration 6-16 LO 4 Explain the lower-of-cost-or-market basis of accounting for inventories.

E6-9, p 318

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

Analysis of Inventory Inventory Turnover Ratio Illustration 6-17 LO 5 Compute and interpret the inventory turnover ratio.

Analysis of Inventory Illustration: Data available for Wal-Mart. LO 5 Compute and interpret the inventory turnover ratio.