Slides 7-1 Inventories Principles of Financial Accounting, 10th Edition

Slides 7-2 Classifying Inventory One Classification: Merchandise Inventory Three Classifications: Raw Materials Work in Process Finished Goods Merchandising Company Manufacturing Company Regardless of the classification, companies report all inventories under Current Assets on the balance sheet.

Slides 7-3 Physical Inventory taken for two reasons: Perpetual System Check accuracy of inventory records Determine amount of inventory lost (wasted raw materials, shoplifting, or employee theft). Periodic System Determine the inventory on hand Determine the cost of goods sold for the period. Determining Inventory Quantities SO 1 Describe the steps in determining inventory quantities.

Slides 7-4 Goods in Transit Purchased goods not yet received. Sold goods not yet delivered. Determining Ownership of Goods Determining Inventory Quantities SO 1 Describe the steps in 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.

Slides 7-5 Determining Inventory Quantities SO 1 Describe the steps in determining inventory quantities. Illustration 6-1 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. Terms of Sale

Slides 7-6 Goods in transit should be included in the inventory of the buyer when the: a. a.public carrier accepts the goods from the seller. b. b.goods reach the buyer. c. c.terms of sale are FOB destination. d. d.terms of sale are FOB shipping point. Review Question Determining Inventory Quantities SO 1 Describe the steps in determining inventory quantities.

Slides 7-7 Consigned Goods Goods held for sale by one party although ownership of the goods is retained by another party. Determining Ownership of Goods Determining Inventory Quantities SO 1 Describe the steps in determining inventory quantities.

Slides 7-8 Unit costs can be applied to quantities on hand using the following costing methods: Specific Identification First-in, first-out (FIFO) Last-in, first-out (LIFO) Average-cost Inventory Costing SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Cost Flow Assumptions

Slides 7-9 Illustration: Assume that Crivitz TV Company purchases three identical 46-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 6-2 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

Slides 7-10 “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. Illustration 6-3 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

Slides 7-11 An 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. Specific Identification Method Inventory Costing SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

Slides 7-12 Inventory Costing – Cost Flow Assumptions Illustration 6-11 Use of cost flow methods in major U.S. companies Cost Flow Assumption does not need to equal Physical Movement of Goods SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

Slides 7-13 Illustration: Data for Houston Electronics’ Astro condensers. Inventory Costing – Cost Flow Assumptions Illustration 6-4 (Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

Slides 7-14 Earliest goods purchased are first to be sold. Often parallels actual physical flow of merchandise. Generally good business practice to sell oldest units first. “First-In-First-Out (FIFO)” Inventory Costing – Cost Flow Assumptions SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

Slides 7-15 “First-In-First-Out (FIFO)” Inventory Costing – Cost Flow Assumptions Illustration 6-5 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Solution on notes page

Slides 7-16 Latest goods purchased are first to be sold. Seldom coincides with actual physical flow of merchandise. Exceptions include goods stored in piles, such as coal or hay. “Last-In-First-Out (LIFO)” Inventory Costing – Cost Flow Assumptions SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

Slides 7-17 “Last-In-First-Out (LIFO)” Inventory Costing – Cost Flow Assumptions Illustration 6-7 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Solution on notes page

Slides 7-18 Allocates cost of goods available for sale on the basis of weighted average unit cost incurred. Assumes goods are similar in nature. Applies weighted average unit cost to the units on hand to determine cost of the ending inventory. “Average Cost” Inventory Costing – Cost Flow Assumptions SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

Slides 7-19 “Average Cost” Inventory Costing – Cost Flow Assumptions Illustration 6-10 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Solution on notes page

Slides 7-20 FIFO LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions. Inventory Costing – Cost Flow Assumptions Sales$9,000$9,000$9,000 Cost of goods sold6,2006,6007,000 Gross profit2,8002,4002,000 Admin. & selling expense Income before taxes2,4702,0701,670 Income tax expense Net income$2,330$1,950$1,560 Inventory balance$5,800$5,400$5,000 LIFOAverage Comparative Financial Statement Summary

Slides 7-21 FIFO Inventory Costing – Cost Flow Assumptions Sales$9,000$9,000$9,000 Cost of goods sold6,2006,6007,000 Gross profit2,8002,4002,000 Admin. & selling expense Income before taxes2,4702,0701,670 Income tax expense Net income$2,330$1,950$1,560 Inventory balance$5,800$5,400$5,000 LIFOAverage In Period of Rising Prices, FIFO Reports: Highest Lowest LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

Slides 7-22 FIFO Inventory Costing – Cost Flow Assumptions Sales$9,000$9,000$9,000 Cost of goods sold6,2006,6007,000 Gross profit2,8002,4002,000 Admin. & selling expense Income before taxes2,4702,0701,670 Income tax expense Net income$2,330$1,950$1,560 Inventory balance$5,800$5,400$5,000 LIFOAverage In Period of Rising Prices, LIFO Reports: Lowest Highest LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

Slides 7-23 The cost flow method that often parallels the actual physical flow of merchandise is the: a. a.FIFO method. b. b.LIFO method. c. c.average cost method. d. d.gross profit method. Review Question Inventory Costing – Cost Flow Assumptions LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

Slides 7-24 In a period of inflation, the cost flow method that results in the lowest income taxes is the: a. a.FIFO method. b. b.LIFO method. c. c.average cost method. d. d.gross profit method. Review Question Inventory Costing – Cost Flow Assumptions LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

Slides 7-25 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. Illustration 6-14 Disclosure of change in cost flow method LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

Slides 7-26 Lower-of-Cost-or-Market Inventory Costing SO 4 Explain the lower-of-cost-or-market basis of accounting for inventories. 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.

Slides 7-27 Lower-of-Cost-or-Market Inventory Costing SO 4 Explain the lower-of-cost-or-market basis of accounting for inventories. Illustration: Assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated. $ 55,000 45,000 12,800 $157,800

Slides 7-28 Analysis of Inventory Inventory management is a double-edged sword High Inventory Levels - may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage) Low Inventory Levels – may lead to stockouts and lost sales. Analysis of Inventory SO 5 Compute and interpret the inventory turnover ratio.

Slides 7-29 Inventory turnover measures the number of times on average the inventory is sold during the period. Cost of Goods Sold Average Inventory Inventory Turnover = Days in inventory measures the average number of days inventory is held. Days in Year (365) Inventory Turnover Days in Inventory = SO 5 Compute and interpret the inventory turnover ratio. Analysis of Inventory

Slides 7-30 Illustration: The following data are available for Wal-Mart. $264,152 (33, ,910) / 2 Inventory Turnover 2007 = SO 5 Compute and interpret the inventory turnover ratio. Analysis of Inventory = 8.1 times 365 Days 8.1 Days in inventory 2007 = = 45.1 Days

Slides 7-31 Illustration: The following data are available for Wal-Mart. $237,649 (31, ,419) / 2 Inventory Turnover 2006 = SO 5 Compute and interpret the inventory turnover ratio. Analysis of Inventory = 7.7 times 365 Days 7.7 Days in inventory 2006 = = 47.4 Days

Slides 7-32 Illustration: Cost Flow Methods in Perpetual Systems SO 7 Apply the inventory cost flow methods to perpetual inventory records. Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Average cost. Appendix 6A Illustration 6A-1

Slides 7-33 Cost Flow Methods in Perpetual Systems SO 7 Apply the inventory cost flow methods to perpetual inventory records. “First-In-First-Out (FIFO)” Cost of Goods Sold Ending Inventory Illustration 6A-2

Slides 7-34 Cost Flow Methods in Perpetual Systems SO 7 Apply the inventory cost flow methods to perpetual inventory records. Cost of Goods Sold Ending Inventory “Last-In-First-Out (LIFO)” Illustration 6A-3

Slides 7-35 Cost Flow Methods in Perpetual Systems SO 7 Apply the inventory cost flow methods to perpetual inventory records. “Average Cost” (Moving-Average System) Illustration 6A-4 Cost of Goods Sold Ending Inventory

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