Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Student Version Inventories Chapter 7 These slides should be viewed using the presentation mode (click the icon to start presentation).

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objective 1 1.Describe the importance of control over inventory.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Control of Inventory  Two primary objectives of control over inventory are: 1.Safeguarding the inventory from damage or theft. 2. Reporting inventory in the financial statements. LO 1

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Reporting Inventory  A physical inventory or count of inventory should be taken near year-end to make sure that the quantity of inventory reported in the financial statements is accurate. LO 1

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objective 2  Describe the importance of control over inventories.  Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 2 Inventory Cost Flow Assumptions

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Assume that one unit is sold on May 30 for $20. Depending upon which unit was sold, the gross profit varies from $11 to $6 as shown below: LO 2 Inventory Cost Flow Assumptions

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Under the specific identification inventory cost flow method, the unit sold is identified with a specific purchase. LO 2 Inventory Cost Flow Assumptions

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Inventory Cost Flow Assumptions  Under the first-in, first out (FIFO) inventory cost flow method, the first units purchased are assumed to be sold first and the ending inventory is made up of the most recent purchases. LO 2  Under the last-in, first out (LIFO) inventory cost flow method, the last units purchased are assumed to be sold first and the ending inventory is made up of the first units purchased.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Inventory Cost Flow Assumptions  Under the average inventory cost flow method, the cost of the units sold and in ending inventory is an average of the purchase costs. LO 2

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objective 3  Describe the importance of control over inventory.  Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet.  Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and average cost methods.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Inventory Costing Methods  For purposes of illustration, the data for Item 127B are used, as shown below. We will examine the perpetual inventory system first. LO 3

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 3 First-In, First-Out Method

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Last-In, First-Out Method LO 3

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Average Cost Method  When the average cost method is used in a perpetual system, an average unit cost for each item is computed each time a purchase is made.  This unit cost is then used to determine the cost of each sale until another purchase is made and a new average is computed. This averaging technique is called a moving average. LO 3

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 6 Reporting Merchandise Inventory  Cost is the primary basis for valuing and reporting inventories in the financial statements. However, inventory may be valued at other than cost in the following cases:  The cost of replacing items in inventory is below the recorded cost.  The inventory cannot be sold at normal prices due to imperfections, style changes, or other causes.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Valuation at Lower of Cost or Market  Cost and replacement cost can be determined for the following:  Each item in the inventory.  Each major class or category of inventory.  Total inventory as a whole. LO 6  Market, as used in lower-of-cost-or-market method, is the cost to replace the merchandise on the inventory date.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 6 Valuation at Net Realizable Value  Merchandise that is out of date, spoiled, or damaged should be written down to its net realizable value. This is the estimated selling price less any direct costs of disposal, such as sales commissions or special advertising.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. LO 6 Valuation at Net Realizable Value  Assume the following data about an item of damaged merchandise: Original cost$1,000 Estimated selling price800 Selling expenses150  The merchandise should be valued at its net realizable value of $650 ($800 – $150).

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Merchandise Inventory on the Balance Sheet  Merchandise inventory is usually presented in the Current Assets section of the balance sheet, following receivables. LO 6

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Merchandise Inventory on the Balance Sheet  The method of determining the cost of the inventory (FIFO, LIFO, or weighted average) and the method of valuing the inventory (cost or the lower of cost or market) should be shown. LO 6

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Inventory Errors  Some reasons that inventory errors may occur include the following:  Physical inventory on hand was miscounted.  Costs were incorrectly assigned to inventory.  Inventory in transit was incorrectly included or excluded from inventory.  Consigned inventory was incorrectly included or excluded from inventory. LO 6

Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Student Version Inventories The End