Inventory: Measurement Chapter 8 Inventory: Measurement

Inventory Those assets that a company: 1. Intends to sell in the normal course of business. 2. Has in production for future sale. 3. Uses currently in the production of goods to be sold.

Types of Inventories Merchandise Inventory Manufacturing Inventory Goods acquired for resale Manufacturing Inventory Raw Materials Work-in-process Finished Goods

Inventory Methods Perpetual Inventory System The inventory account is continuously updated as purchases and sales are made. Periodic Inventory System The inventory account is adjusted at the end of a reporting cycle.

Accounting Entries in a Perpetual System Returns of inventory are credited to the inventory account. Discounts on inventory purchases can be recorded using the gross or net method.

Accounting Entries in a Perpetual System

Periodic Cost of Goods Sold Equation

Accounting Entries in a Periodic System

Accounting Entries in a Periodic System

Accounting Entries in a Periodic System In addition to Purchases, the contra-purchase accounts are also closed to COGS at the end of the period: Purchases Discounts Purchase Returns and Allowances

Comparison of Inventory Systems

What is Included in Inventory? General Rule All goods owned by the company on the inventory date, regardless of their location. Goods in Transit Goods on Consignment Depends on FOB shipping terms.

Expenditures Included in Inventory Invoice Price Freight-in on Purchases + Purchase Returns Purchase Discounts

Inventory Cost Flow Methods Specific cost identification Average cost First-in, first-out (FIFO) Last-in, first-out (LIFO)

Specific Cost Identification Items are added to inventory at cost when they are purchased. COGS for each sale is based on the specific cost of the item sold. The specific cost of each inventory item must be known. By selecting specific items from inventory at the time of sale, income can be manipulated.

Average Cost Method

Weighted-Average Periodic Example The following schedule shows the frame inventory for Yore Frame, Inc. for September. The physical inventory count at September 30 shows 600 frames in ending inventory. Use the periodic weighted-average method to determine: (1) Ending inventory cost. (2) Cost of goods sold.

Weighted-Average Periodic Example

Weighted-Average Periodic Example Now, we have to assign costs to ending inventory and cost of goods sold. Beginning Inventory (800 units) Purchases (1,150 units) Available for Sale (1,950 units) Ending Inventory (600 units) Goods Sold (1,350) $47,650 ÷ 1,950 = $24.4359 weighted-average per unit cost

Weighted-Average Periodic Example

Moving-Average Perpetual Example The following schedule shows the Frame inventory for Yore Frame, Inc. for September. The physical inventory count at September 30 shows 600 mouse pads in ending inventory. Use the perpetual weighted-average method to determine: (1) Ending inventory cost. (2) Cost of goods sold.

Moving-Average Perpetual Example

Moving-Average Perpetual Example

Moving-Average Perpetual Example $11,600.00 ÷ (800-600+300) = $23.200

Moving-Average Perpetual Example $27,490.00 ÷ (800-600+300-300+250+200+400) = $26.181

Moving-Average Perpetual Example Sum

First-In, First-Out The FIFO method assumes that items are sold in the chronological order of their acquisition. The cost of the oldest inventory items are charged to COGS when goods are sold. The cost of the newest inventory items remain in ending inventory.

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.

FIFO - Periodic Example The following schedule shows the frame inventory for Yore Frame, Inc. for September. The physical inventory count at September 30 shows 600 mouse pads in ending inventory. Use the periodic FIFO method to determine: (1) Ending inventory cost. (2) Cost of goods sold.

FIFO - Periodic Example These are the 600 most recently acquired units.

FIFO - Periodic Example

FIFO - Periodic Example These are the first 1,350 units acquired.

FIFO - Periodic Example

FIFO - Perpetual Example The following schedule shows the frame inventory for Yore Frame, Inc. for September. The physical inventory count at September 30 shows 600 mouse pads in ending inventory. Use the perpetual FIFO method to determine: (1) Ending inventory cost. (2) Cost of goods sold.

FIFO - Perpetual Example

FIFO - Perpetual Example 200 The ending inventory on 9/1 consists of: 200 units from beginning inventory @ $22.00

FIFO - Perpetual Example 200 The ending inventory on 9/3 consists of: 200 units from beginning inventory @ $22.00 300 units from the 9/3 purchase @ $24.00

FIFO - Perpetual Example 200 The ending inventory on 9/10 consists of: 200 units from the 9/3 purchase @ $24.00

FIFO - Perpetual Example 200 The ending inventory on 9/15 consists of: 200 units from the 9/3 purchase @ $24.00 250 units from the 9/15 purchase @ $25.00

FIFO - Perpetual Example 200 The ending inventory on 9/21 consists of: 200 units from the 9/3 purchase @ $24.00 250 units from the 9/15 purchase @ $25.00 200 units from the 9/21 purchase @ $27.00

FIFO - Perpetual Example 200 The ending inventory on 9/21 consists of: 200 units from the 9/3 purchase @ $24.00 250 units from the 9/15 purchase @ $25.00 200 units from the 9/21 purchase @ $27.00 400 units from the 9/29 purchase @ $28.00

FIFO - Perpetual Example The ending inventory on 9/30 consists of: 200 units from the 9/21 purchase @ $27.00 400 units from the 9/29 purchase @ $28.00.

FIFO - Perpetual Example Note that this is the same COGS computed using the Periodic approach.

Any questions before we run into LIFO? Last-In, First-Out Any questions before we run into LIFO?

Last-In, First-Out The LIFO method assumes that the newest items are sold first, leaving the older units in inventory. The cost of the newest inventory items are charged to COGS when goods are sold. The cost of the oldest inventory items remain in inventory.

Last-In, First-Out Unlike FIFO, using the LIFO method may result in COGS and Ending Inventory Cost that differ under the periodic and perpetual approaches.

LIFO - Periodic Example The following schedule shows the frame inventory for Yore Frame, Inc. for September. The physical inventory count at September 30 shows 600 mouse pads in ending inventory. Use the periodic LIFO method to determine: (1) Ending inventory cost. (2) Cost of goods sold.

LIFO - Periodic Example These are the 600 oldest units in inventory.

LIFO - Periodic Example 200 600 x $22.00

LIFO - Periodic Example 200 These are the most recently acquired 1,350 units. 600 x $22.00

LIFO - Periodic Example 200 200 x $22.00 $4,400 + $30,050

LIFO - Perpetual Example The following schedule shows the frame inventory for Yore Frame, Inc. for September. The physical inventory count at September 30 shows 600 mouse pads in ending inventory. Use the perpetual LIFO method to determine: (1) Ending inventory cost. (2) Cost of goods sold.

LIFO - Perpetual Example

LIFO - Perpetual Example 200 In LIFO, we assume that we sell the newest units in inventory first. In this case, the 600 “newest” units come from beginning inventory, leaving 200 units in the beginning inventory layer.

LIFO - Perpetual Example 200 The ending inventory on 9/3 consists of: 200 units from beginning inventory @ $22.00 300 units from the 9/3 purchase @ $24.00

LIFO - Perpetual Example 200 For the 9/30 sale, we must identify the 300 newest units. They all come from the September 3 purchase. Note that all of the 9/3 units have been “sold” and only 200 of the beginning inventory units remain.

LIFO - Perpetual Example 200 The ending inventory on 9/15 consists of: 200 units from beginning inventory @ $22.00 250 units from the 9/15 purchase @ $25.00

LIFO - Perpetual Example 200 The ending inventory on 9/21 consists of: 200 units from beginning inventory @ $22.00 250 units from the 9/15 purchase @ $25.00 200 units from the 9/21 purchase @ $27.00

LIFO - Perpetual Example 200 The ending inventory on 9/29 consists of: 200 units from beginning inventory @ $22.00 250 units from the 9/15 purchase @ $25.00 200 units from the 9/21 purchase @ $27.00 400 units from the 9/29 purchase @ $28.00.

LIFO - Perpetual Example 200 150 For the 9/30 sale, we must identify the 450 newest units. 400 of them come from the 9/29 purchase. The other 50 come from the 9/21 purchase.

LIFO - Perpetual Example 200 150 The ending inventory on 9/30 consists of: 200 units from beginning inventory @ $22.00 250 units from the 9/15 purchase @ $25.00 150 units from the 9/21 purchase @ $27.00.

When Prices Are Rising . . . FIFO Matches low (older) costs with current (higher) sales. Inventory is valued approximates replacement cost. Results in higher taxable income. LIFO Matches high (newer) costs with current (higher) sales. Inventory is valued based on low (older) cost basis. Results in lower taxable income. Is not officially endorsed by the IASC.

Decision Makers’ Perspective What factors motivate companies to select one inventory method over another? How closely do reported costs reflect actual flow of inventory? How well are costs matched against related revenues? How accurate are the timing of reported income and income taxes?

LIFO Liquidation When prices rise . . . LIFO inventory costs on the balance sheet are “out of date” because they reflect old purchase transactions. If inventory declines, these “out of date” costs may be charged to current earnings. This LIFO liquidation results in “paper profits.”

Using Inventory Pools with LIFO simplifies record keeping. LIFO Inventory Pools Inventory Pools consist of inventory units grouped according to similarities. Using Inventory Pools with LIFO simplifies record keeping. For example, all similar units purchased at the same time can be “pooled” and assigned an average unit cost.

Dollar-Value LIFO (DVL) DVL inventory pools are viewed as layers of value, rather than layers of similar units. DVL simplifies LIFO record-keeping. Example The replacement inventory differs from the old inventory on hand. We just create a new layer. At the end of the period, we determine if a new inventory layer was added by comparing ending inventory to beginning inventory. DVL minimizes the probability of layer liquidation.

Dollar-Value LIFO (DVL) We need to determine if the increase in ending inventory over beginning inventory was due to a price increase or an increase in inventory. 1a. Compute a Cost Index for the year.

Dollar-Value LIFO (DVL) 1b. Deflate the ending inventory value using the cost index. 1c. Compare ending inventory (at base year cost) to beginning inventory.

Dollar-Value LIFO (DVL) Next, identify the layers in ending inventory and the years they were created. Convert each layer’s base year cost to layer year cost by multiplying times the cost index. Sum all the layers to arrive at Ending Inventory at DVL cost.

End of Chapter 8 It’s Over