C8 - 1 Learning Objectives Power Notes 1.Internal Control of Inventories 2.Effect of Inventory Errors 3.Inventory Cost Flow Assumptions 4.Perpetual Inventory Costing Methods 5.Periodic Inventory Costing Methods 6.Comparing Inventory Costing Methods 7.Inventory Valuation Other Than Cost 8.Balance Sheet Presentation of Merchandise 9.Estimating Inventory Cost 10. Financial Analysis and Interpretation Chapter F8 Inventories Inventories C8

C8 - 2 Inventory Control and Relationships Perpetual Inventory Accounting LIFO and FIFO Cost Flow Assumptions Inventory at Lower-of-Cost-or-Market Retail and Gross Profit Methods Inventory Turnover Ratio Slide #Power Note Topics Power Notes Chapter F8 Inventories Inventories Note: To select a topic, type the slide # and press Enter.

C8 - 3 Why is Inventory Control Important?  Inventory is a significant asset and for many companies the largest asset.  Inventory is central to the main activity of merchandising and manufacturing companies. 4 Mistakes in determining inventory cost can cause critical errors in financial statements. 4 Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.

C8 - 4 LIABILITIES OWNER’S EQUITY REVENUES ASSETS COSTS & EXPENSES Inventory Costs and Relationships MerchandiseInventory Cost of Mdse. Sold If merchandise inventory is overstated Cost of merchandise sold is Gross profit and net income are... Ending owner’s equity is If merchandise inventory is overstated Cost of merchandise sold is Gross profit and net income are... Ending owner’s equity is understated overstated Net Income

C8 - 5 LIABILITIES OWNER’S EQUITY REVENUES ASSETS COSTS & EXPENSES Inventory Costs and Relationships MerchandiseInventory Cost of Mdse. Sold If merchandise inventory is understated Cost of merchandise sold is Gross profit and net income are... Ending owner’s equity is If merchandise inventory is understated Cost of merchandise sold is Gross profit and net income are... Ending owner’s equity is overstated understated Net Income

C8 - 6 Merchandising and Inventory  Merchandising involves selling inventory.  Inventory is usually an important asset. 4 Inventory must be accounted for periodically or perpetually. 4 Traditional periodic method is often being replaced by perpetual inventory accounting.

C Continuous determination of inventory value 4 Continuous determination of gross profit 4 Affordable with computers, scanners, and bar codes on most products 4 Perpetual inventory accounting provides management controls. 4 Managers know which items are selling fastest and the profit margin on those items. Advantages of Using Perpetual Inventory

C8 - 8 Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Item 127B Units Cost Price Jan. 1Inventory10$20 4Sale7$30 10Purchase821 22Sale431 28Sale232 30Purchase1022 Item 127B Units Cost Price Jan. 1Inventory10$20 4Sale7$30 10Purchase821 22Sale431 28Sale232 30Purchase1022 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

C8 - 9 Jan Item 127B FIFO Perpetual Inventory Account PurchasesCost of Mdse. SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCost The sale of 7 units leaves a balance of 3 units.

C Jan Item 127B FIFO Perpetual Inventory Account PurchasesCost of Mdse. SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost Because the purchase price of $21 is different than the cost of the previous 3 units on hand, the inventory balance of 11 units is accounted for separately.

C Item 127B FIFO Perpetual Inventory Account PurchasesCost of Mdse. SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty.CostCostQty.CostCost Qty.CostCost Of the 4 units sold, 3 come from the first units in (FIFO) at a cost of $20. Jan

C Item 127B FIFO Perpetual Inventory Account PurchasesCost of Mdse. SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty.CostCost Qty.CostCost Qty.CostCost Jan Sold 2 units from the 7 units on hand. No allocation is necessary.

C Jan Item 127B FIFO Perpetual Inventory Account Purchases Cost of Mdse. Sold Inventory Balance UnitTotalUnitTotalUnitTotal DateQty. CostCostQty.CostCost Qty.CostCost Totals18$38813$26315$325

C Totals18$38813$26315$325 Jan Item 127B FIFO Perpetual Inventory Account Purchases Cost of Mdse. Sold Inventory Balance UnitTotalUnitTotalUnitTotal Date Qty.CostCostQty.CostCostQty.CostCost

C DateDescriptionDebitCredit DateDescriptionDebitCredit FIFO Perpetual Inventory Accounting Accounts Receivable390 Sales390 Cost of Merchandise Sold 263 Merchandise Inventory263 Gross Profit = Sales ($390) minus Cost of Merchandise Sold ($263) = $127 Jan. 31 To record January sales of item 127B. (7 4 2 To record cost of January sales of item 127B. Jan. 31

C Purchases Cost of Mdse. Sold Inventory Balance UnitTotalUnitTotalUnitTotal DateQty.CostCostQty.CostCost Qty.CostCost Item 127B LIFO Perpetual Inventory Account Jan The sale of 7 units leaves a balance of 3 units.

C Purchases Cost of Mdse. Sold Inventory Balance UnitTotalUnitTotalUnitTotal DateQty.CostCost Qty.CostCost Qty. CostCost Jan Item 127B LIFO Perpetual Inventory Account The purchase price of $21 is different than the cost of the previous 3 units on hand; therefore, the inventory balance of 11 units is accounted for separately.

C Purchases Cost of Mdse. Sold Inventory Balance UnitTotalUnitTotalUnitTotal DateQty.CostCost Qty.CostCost Qty.CostCost Jan Item 127B LIFO Perpetual Inventory Account Of the 4 units sold, all come from the last units in (LIFO) at a cost of $21.

C PurchasesCost of Mdse. SoldInventory Balance UnitTotalUnitTotalUnitTotal DateQty.CostCost Qty.CostCostQty.CostCost Jan Item 127B LIFO Perpetual Inventory Account Of the 2 units sold, all come from the last units in (LIFO) at a cost of $21, leaving 2 units from that group.

C PurchasesCost of Mdse. SoldInventory Balance UnitTotalUnitTotalUnitTotal DateQty.CostCost Qty.CostCostQty.CostCost Jan Item 127B LIFO Perpetual Inventory Account

C PurchasesCost of Mdse. SoldInventory Balance UnitTotalUnitTotalUnitTotal DateQty.CostCostQty.CostCostQty.CostCost Jan Item 127B Totals18$38813$26615$322 LIFO Perpetual Inventory Account

C DateDescriptionDebitCredit DateDescriptionDebitCredit LIFO Perpetual Inventory Accounting Accounts Receivable390 Sales390 Cost of Merchandise Sold 266 Merchandise Inventory266 Gross Profit = Sales ($390) minus Cost of Merchandise Sold ($266) = $124 Jan. 31 To record January sales of item 127B. (7 4 2 To record cost of January sales of item 127B. Jan. 31

C Jan units at $9 First-In, First-Out Flow of Costs Mar units at $10 Sep units at $11 Nov units at $12 $1,800 $3,000 $4,400 $1,200 Purchases Merchandise Available for Sale $10,400 Using FIFO costing, which units are assumed to be sold first?

C Jan units at $9 First-In, First-Out Flow of Costs Mar units at $10 Sep units at $11 Nov units at $12 $1,800 $3,000 $4,400 $1,200 Purchases Merchandise Available for Sale $1,800 $3,000 $2,200 Cost of Merchandise Sold 200 units at $9 $10,400 $7, units at $ units at $11 FIFO cost flow assumes merchandise acquired first is sold first.

C Jan units at $9 First-In, First-Out Flow of Costs Mar units at $10 Sep units at $11 Nov units at $12 $1,800 $3,000 $4,400 $1,200 Purchases Merchandise Available for Sale $1,800 $3,000 $2,200 Cost of Merchandise Sold 200 units at $9 $10,400 $2,200 $1,200 $7,000 Merchandise Inventory $3, units at $ units at $ units at $12

C Jan units at $9 First-In, First-Out Flow of Costs Mar units at $10 Sep units at $11 Nov units at $12 $1,800 $3,000 $4,400 $1,200 Purchases Merchandise Available for Sale $1,800 $3,000 $2,200 Cost of Merchandise Sold 200 units at $9 $10,400 $2,200 $1,200 $7,000 Merchandise Inventory $3, units at $ units at $ units at $ units 1,000 units 300 units

C Jan units at $9 Last-In, First-Out Flow of Costs Mar units at $10 Sep units at $11 Nov units at $12 $1,800 $3,000 $4,400 $1,200 Purchases Merchandise Available for Sale $10,400 1,000 units total Using LIFO costing, which units are assumed to be sold first?

C Jan units at $9 Last-In, First-Out Flow of Costs Mar units at $10 Sep units at $11 Nov units at $12 $1,800 $3,000 $4,400 $1,200 Purchases Merchandise Available for Sale Cost of Merchandise Sold $10,400 $4,400 $1,200 $7, units at $ units at $ units at $12 $2,000 LIFO cost flow assumes merchandise acquired last is sold first. 1,000 units total

C Jan units at $9 Last-In, First-Out Flow of Costs Mar units at $10 Sep units at $11 Nov units at $12 $1,800 $3,000 $4,400 $1,200 Purchases Merchandise Available for Sale $1,800 $1,000 Cost of Merchandise Sold 200 units at $9 $10,400 $4,400 $1,200 $2,800 Merchandise Inventory $7, units at $ units at $ units at $ units at $12 $2,000

C Jan units at $9 Last-In, First-Out Flow of Costs Mar units at $10 Sep units at $11 Nov units at $12 $1,800 $3,000 $4,400 $1,200 Purchases Merchandise Available for Sale $1,800 $1,000 Cost of Merchandise Sold 200 units at $9 $10,400 $4,400 $1,200 $2,800 Merchandise Inventory $7, units at $ units at $ units at $ units at $12 $2, units 1,000 units 300 units

C $ 3,800 2,700 4,650 3,920 Total $15,520$15,472$15,070 The market decline is either: 1. Based on total inventory ($15,520 – $15,472) = $48 2. Based on individual items ($15,520 – $15,070) = $450 The decline is reported on the income statement as a separate item or included in the cost of merchandise sold. Valuation of Inventory at Lower-of-Cost-or-Market A400$10.25$ 9.50$ 4,100$ 3,800 B ,7002,892 C ,8004,650 D ,9204,130 Unit InventoryCostMarketTotalTotalLower ItemQuantityPricePriceCostMarketC or M

C Assets Current assets: Cash$ 19,400 Accounts receivable$80,000 Less allowance 3,00077,000 Merchandise inventory at lower of cost (first-in, first-out method) or market216,300 Afro-Arts Balance Sheet December 31, 2004

C Retail Method of Estimating Inventory Cost  Retail method is based on relationship between cost of merchandise available for sale and the retail price.  Retail prices of all merchandise must be accumulated. 4 Inventory at retail is calculated as retail price of merchandise available for sale less sales. 4 Ratio is calculated as cost divided by retail price. 4 Inventory at retail price times cost ratio equals estimated cost of inventory.

C $62,000$100,000 ($62,000 / $100,000 = 62%) $30,000 ($30,000 x 62%)$18,600 Retail Inventory Method Calculation CostRetail Merchandise inventory, January 1$19,400$36,000 Purchases in January (net)42,60064,000 Merchandise available for sale Ratio of cost to retail price: Sales for January (net)70,000 Merchandise inventory, January 31, at retail Merchandise inventory, January 31, at est. cost

C Gross Profit Method of Estimating Inventory Cost 1.A gross profit percentage rate is estimated based on previous experience adjusted for known changes. 2.Estimated gross profit is calculated by multiplying the estimated gross profit rate times the actual net sales. 3.Estimated cost of merchandise sold is calculated by subtracting the gross profit from actual sales. 4.The cost of merchandise sold estimate is deducted from actual merchandise available for sale to determine the estimated cost of merchandise inventory.

C Merchandise inventory, January 1 $ 57,000 Purchases in January (net)180,000 Merchandise available for sale Sales in January (net)$250,000 Less: Estimated gross profit Estimated cost of merchandise sold Estimated merchandise inventory, January 31 Gross Profit Method Calculation $237,000 ($250,000 x 30%)75, ,000 $ 62,000 Many firms generate a surprisingly stable and predictable gross profit as a percentage of sales.

C Inventory Turnover Ratios SUPERVALUZale Cost of goods sold$15,620,127,000$ 737,188,000 Inventories: Beginning of year$1,115,529,000$478,467,000 End of year 1,067,837,000571,669,000 Average$1,091,683,000$525,068,000

C Inventory Turnover Ratios SUPERVALUZale Cost of goods sold$15,620,127,000$ 737,188,000 Inventories: Beginning of year$1,115,529,000$478,467,000 End of year 1,067,837,000571,669,000 Average$1,091,683,000$525,068,000 Inventory turnover14.3 times1.4 times

C Inventory Turnover Ratios SUPERVALULa-Z-Boy Cost of goods sold$15,620,127,000$ 737,188,000 Inventories: Beginning of year$1,115,529,000$478,467,000 End of year 1,067,837,000571,669,000 Average$1,091,683,000$525,068,000 Inventory turnover14.3 times1.4 times Average selling period25 days283 days Use:To assess the efficiency in the management of inventory

C Note: To see the topic slide, type 2 and press Enter. This is the last slide in Chapter F8. Power Notes Inventories Inventories Chapter F8