© 2009 Cengage Learning. All rights reserved. CHAPTER 16 Inventory © 2009 Cengage Learning. All rights reserved.

PERFORMANCE OBJECTIVES Section I Inventory Valuation 16-1: Pricing inventory by using the first-in, first-out (FIFO) method 16-2: Pricing inventory by using the last-in, first-out (LIFO) method 16-3: Pricing inventory by using the average cost method 16-4: Pricing inventory by using the lower-of-cost-or-market (LCM) rule Section II Inventory Estimation 16-5: Estimating the value of ending inventory by using the retail method 16-6: Estimating the value of ending inventory by using the gross profit method © 2009 Cengage Learning. All rights reserved.

PERFORMANCE OBJECTIVES (cont’d) Section III Inventory Turnover and Targets 16-7: Calculating inventory turnover rate at retail 16-8: Calculating inventory turnover rate at cost 16-9: Calculating target inventories based on industry standards © 2009 Cengage Learning. All rights reserved.

merchandise inventory Inventory Valuation inventory Goods that a company has in its possession at any given time. May be in the form of raw materials, partially finished goods, or goods available for sale. merchandise inventory Goods purchased by wholesalers and retailers for resale. © 2009 Cengage Learning. All rights reserved.

periodic inventory system Inventory Systems periodic inventory system Inventory system in which merchandise is physically counted at least once a year to determine the value of the goods available for sale. perpetual inventory system Inventory system in which goods available for sale are updated on a continuous basis by computer. Purchases by the company are added to inventory, whereas sales to customers are subtracted from inventory. © 2009 Cengage Learning. All rights reserved.

Inventory Systems (cont’d) book inventory Is the balance of a perpetual inventory system at any given time. Must be confirmed with an actual physical count at least once a year. specific identification method Is a valuation method in which each item in inventory is matched or coded with its actual cost. Is feasible only for low-volume merchandise flow such as automobiles, boats, or other expensive items. © 2009 Cengage Learning. All rights reserved.

Methods for Pricing Inventory first-in, first-out (FIFO) method Assumes the items purchased by a company first are the first items to be sold. Items remaining in ending inventory at the end of an accounting period are therefore the most recently purchased. last-in, first-out (LIFO) method Assumes the items purchased by a company last are the first items to be sold. Items remaining in ending inventory at the end of an accounting period are therefore the oldest goods. average cost, or weighted average, method Assumes the cost of each unit of inventory is the average cost of all goods available for sale during that accounting period. © 2009 Cengage Learning. All rights reserved.

Exhibit 16-1 First-In, First-Out—FIFO © 2009 Cengage Learning. All rights reserved.

First-In, First-Out (FIFO) Method © 2009 Cengage Learning. All rights reserved.

FIFO Example Using the FIFO method of inventory pricing for the following data , what is the dollar value of ending inventory if 167 units were on hand on December 31? Date Inventory Units Cost Total Jan 1 Beginning inventory 235 140.00 32,900 March 10 Purchase 152 143.50 21,812 May 16 135 146.80 19,818 Oct 9 78 150.00 11,700 600 86,230 FIFO Inventory Valuation (12/31) 89 13,065.20 167 24,765.20 © 2009 Cengage Learning. All rights reserved.

Inventory Costs and Inventory Valuation When inventory costs are rising: FIFO: Higher gross profit LIFO: Lower gross profit When inventory costs are decreasing: FIFO: Lower gross profit LIFO: Higher gross profit © 2009 Cengage Learning. All rights reserved.

Last-In, First-Out (LIFO) Method © 2009 Cengage Learning. All rights reserved.

Exhibit 16-2 Last-In, First-Out—LIFO © 2009 Cengage Learning. All rights reserved.

Last-In, First-Out (LIFO) Method Example Using the LIFO method of inventory pricing for the following data, what is the dollar value of ending inventory if 167 units were on hand on December 31? Date Inventory Units Cost Total Jan 1 Beginning inventory 235 140.00 32,900 March 10 Purchase 152 143.50 21,812 May 16 135 146.80 19,818 Oct 9 78 150.00 11,700 600 86,230 LIFO Inventory Valuation (12/31) 167 23,380 © 2009 Cengage Learning. All rights reserved.

The Average Cost Method © 2009 Cengage Learning. All rights reserved.

Average Cost Method Example Using the average cost method of inventory pricing for the following data, what is the dollar value of ending inventory if 167 units were on hand on December 31? Date Inventory Units Cost Total Jan 1 Beginning inventory 235 140.00 32,900 March 10 Purchase 152 143.50 21,812 May 16 135 146.80 19,818 Oct 9 78 150.00 11,700 600 86,230 Average Cost Inventory Valuation Average Cost = 143.72 Total Value = 167 × 143.42 = 24,001.24 © 2009 Cengage Learning. All rights reserved.

Lower-of-Cost-or-Market (LCM) Rule © 2009 Cengage Learning. All rights reserved.

Lower-of-Cost-or-Market (LCM) Rule Example Determine the value of the following inventory by using lower-of- cost-or-market rule. Unit Price Valuation Description Quantity Cost Market Basis Amount Lamp 75 9.50 9.20 690.00 Tray 120 26.30 27.15 3,156.00 16’ vase 88 42.40 39.70 3,493.60 12’ vase 64 23.65 21.40 1,369.60 Fruit bowl 42 36.90 42.00 1,549.80 Total Value of Inventory 10,259.00 © 2009 Cengage Learning. All rights reserved.

cost to retail price ratio, or cost ratio Inventory Estimation retail method Is used by most retailers based on a comparison of goods available for sale at cost and at retail. cost to retail price ratio, or cost ratio Is the ratio of goods available for sale at cost to the goods available for sale at retail. Used in the retail method of inventory estimation to represent the cost of each dollar of retail sales. © 2009 Cengage Learning. All rights reserved.

Inventory Estimation: The Retail Method © 2009 Cengage Learning. All rights reserved.

Retail Method Example Using the retail method, estimate the value of the ending inventory at cost on August 31, from the following information: August 1 – August 31 Cost Retail Beginning inventory 600,000 800,000 Net purchases 285,000 380,000 Goods available for sale 885,000 1,180,000 August net sales = $744,000 © 2009 Cengage Learning. All rights reserved.

Retail Method Example (cont’d) August 1 – August 31 Cost Retail Beginning inventory 600,000 800,000 Net purchases 285,000 380,000 Goods available for sale 885,000 1,180,000 Net sales - 744,000 Ending inventory 436,000 Ending inventory at cost = Ending inventory at retail × Cost Ratio Ending inventory at cost = 436,000 × .75 = 327,000 © 2009 Cengage Learning. All rights reserved.

Inventory Estimation: Gross Profit Method gross profit or gross margin method Uses a company’s gross margin percent to estimate the ending inventory. This method assumes that a company maintains approximately the same gross margin from year to year. © 2009 Cengage Learning. All rights reserved.

The Gross Profit Method © 2009 Cengage Learning. All rights reserved.

Gross Profit Method Example A firm maintains a gross margin of 39% on all its inventory. In November, the company had a beginning inventory of $137,000, net purchases of $220,000, and net sales of $410,000. Use the gross profit method to estimate the cost of ending inventory in November. Beginning inventory 137,000 Net Purchases +220,000 Goods available for sale 357,000 Estimated cost of goods sold = Net sales × (100% - Gross margin %)= 410,000 (100% - 39%) = 410,000 (.61) = $250,100 Goods available for sale 357,000 Estimated cost of goods sold -250,100 Estimated ending inventory 106,900 © 2009 Cengage Learning. All rights reserved.

Inventory Turnover and Targets inventory or stock turnover The number of times during an operating period that the average dollars invested in merchandise inventory was theoretically sold out or turned over. May be calculated in retail dollars or in cost dollars. average inventory An estimate of a company’s typical inventory at any given time, calculated by dividing the total of all inventories taken during an operating period by the number of times inventory was taken. © 2009 Cengage Learning. All rights reserved.

Inventory Turnover Rate at Retail © 2009 Cengage Learning. All rights reserved.

Inventory Turnover Rate at Retail Example A firm had net sales of $260,700 for the year. If the beginning inventory at retail was $65,100 and the ending inventory at retail was $52,800, what are (a) the average inventory and (b) the inventory turnover rounded to the nearest tenth? © 2009 Cengage Learning. All rights reserved.

Inventory Turnover Rate At Cost © 2009 Cengage Learning. All rights reserved.

Inventory Turnover Rate At Cost Example A store had a cost of goods sold of $756,400 for the year. If the beginning inventory at cost was $43,500 and the ending inventory at cost was $59,300, what are (a) the average inventory at cost and (b) the inventory turnover rounded to the nearest tenth? © 2009 Cengage Learning. All rights reserved.

target average inventory Target Inventories target average inventory Inventory standards published by trade associations and the federal government for companies of all sizes and in all industries. Used by managers as targets for the ideal amount of inventory to carry for maximum efficiency. © 2009 Cengage Learning. All rights reserved.

Target Inventories Example A firm. had net sales of $2,650,000 for the year. The beginning inventory at retail was $495,000, and the ending inventory at retail amounted to $380,000. The inventory turnover at retail published as the standard for a business of this size is seven times. (a) Calculate the average inventory and actual inventory turnover for the company. (b) If the turnover is less than seven times, calculate the target average inventory needed to come up to industry standards. © 2009 Cengage Learning. All rights reserved.

Target Inventories Example (cont’d) © 2009 Cengage Learning. All rights reserved.