Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 8 Reporting and Interpreting Inventories and Cost of Goods Sold

8-2 The Business of Inventory Management The primary goals of inventory managers are to: 1.ensure sufficient quantities of inventory are available to meet customer’s 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 customer’s needs, 2.ensure inventory quality meets customers’ expectations and company standards, and 3.minimize the costs of acquiring and carrying inventory

8-3 Items Included in 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

8-4 Items Included in 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.

8-5 Cost of Goods Sold $40,000 Beginning Inventory $40,000 $55,000 Purchases $55,000 $95,000 Goods Available for Sale $95, $35,000 Ending Inventory $35,000 Still Here $60,000 Cost of Goods Sold $60,000 Sold

8-6 Cost of Goods Sold

8-7 Inventory Costing Methods First-in, first-out (FIFO) Last-in, first-out (LIFO) Weighted average Specific identification

8-8 Inventory Costing Illustration

8-9 Specific Identification When this method is used, the cost of each item sold is individually identified and recorded as cost of goods sold.

8-10 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.

8-11 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

8-12 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

8-13 Specific Identification Cost of Goods Sold on August 31 = $2,582

8-14 Specific Identification After the August 31 sale, there are 12 units in inventory at $1,408: 5 units at $115; 7 units at $119.

8-15 Specific Identification Income Statement COGS = $4,582 Balance Sheet Inventory = $1,408

8-16 First-In, First-Out (FIFO) Cost of Goods Sold Ending Inventory Oldest Costs Recent Costs

8-17 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.

8-18 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.

8-19 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.

8-20 First-In, First-Out (FIFO) Cost of Goods Sold for August 31 = $2,600

8-21 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.

8-22 First-In, First-Out (FIFO) Balance Sheet Inventory = $1,420 $4,570 Income Statement COGS = $4,570

8-23 Last-In, First-Out (LIFO) Cost of Goods Sold Ending Inventory Recent Costs Oldest Costs

8-24 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.

8-25 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.

8-26 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.

8-27 Last-In, First-Out (LIFO) Cost of Goods Sold for August 31 = $2,685

8-28 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.

8-29 Last-In, First-Out (LIFO) Balance Sheet Inventory = $1,260 Income Statement COGS = $4,730

8-30 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 ÷

8-31 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.

8-32 ÷ Weighted Average First, we need to compute the weighted average cost per unit of items in inventory.

8-33 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.

8-34 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?

8-35 Weighted Average ÷

8-36 Weighted Average Cost of Goods Sold for August 31 = $2,622

8-37 Weighted Average After the August 31 sale, there are 12 units at $114 in inventory.

8-38 Weighted Average Balance Sheet Inventory = $1,368 Income Statement COGS = $4,622

8-39 Financial Statement Effects of Costing Methods Because prices change, inventory methods nearly always assign different cost amounts. Exh. 6.8

8-40 Financial Statement Effects of Costing Methods Advantages of Methods Smooths 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

8-41 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.

8-42 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.

8-43 Inventory Turnover Analysis Inventory Turnover Ratio = Cost of Goods Sold Average Inventory Beginning Inventory Ending Inventory + 2

8-44 Inventory Turnover Analysis Days to Sell 365 Inventory Turnover Ratio =

8-45 End of Chapter 8