Chapter 6 Reporting and Analyzing Inventory

6 Manufacturing Inventory Finished goods inventory Work in process Raw materials

7 Finished Goods Inventory Manufactured items that are complete and ready for sale.

8 Work in Process Manufactured inventory that has been placed into production but is not yet complete.

9 Raw Materials The basic goods that will be used in production, but have not been placed in production.

Key difference between periodic and perpetual inventory… is the point at which the costs of goods sold is computed.

7 Determine Inventory Quantities Determine inventory quantities by counting, weighting or measuring each type of inventory. Determine ownership of goods, including goods in transit, consigned goods.

8 Questions Concerning Ownership Do all the goods included in the count belong to the company? Does the company own any goods not included in the count?

9 Goods in Transit Goods are on board a truck, train, ship, or plane at the end of the period. 36 Who includes them in inventory?  Seller?  Buyer? The Company with Legal Title

Terms of Sale- FOB (free-on-board)

Consigned Goods Goods of others you hold. You do not pay for the goods until they sell. The company does not take ownership.

What Is a Cost Flow Assumption? To presume the order in which goods are sold even if flow of costs is unrelated to the physical flow of goods.

Inventory Cost Flows Specific Identification--The tracking of actual costs for specifically identified units. FIFO (first-in, first-out)--Assumption that the first goods bought are the first goods sold. LIFO (last-in, first-out)--Assumption that the last goods purchased are the first goods sold. Weighted Average Cost –Assumption that when similar units are combined in inventory the costs are merged and averaged between all parts.

Specific Identification Used by companies that sell limited products at a high price. Requires that each unit has a specific cost associated with it.

Data for Examples Beginning Inventory10 $10 each = $100 Purchases (February)15 $15 each = $225 Sales (June)20 hats Purchases (July)10 $18 each = $180 Ending Inventory15 hats Use the following data to show the journal entry for the sales in June and the value of ending inventory using the FIFO Perpetual method.

FIFO 2007 Inventory Purchase Sale Balance ` DateUnitsTotalUnitsTotalUnitsCostTotal Jan 1 10$10 $100 Feb 15$225 10$10 $100 15$15 $225 June 10 $ $150 5$15 $ 75 July 10$180 5$15 $ 75 10$18 $180

FIFO Perpetual Cost of Goods Sold: Beginning $10 =$ 100 February $15 =$ 150 Total$ 250 Ending Inventory: February Purchases $15 = $ 75 December $18 = $ 180 Total $ 255

FIFO Perpetual Journal Entry In June, the Hat Company sold 20 hats for $25 each. The entry is as follows: Accounts Receivable Sales Revenue To recognize revenues from June sales.

In June, the Hat Company sold 20 hats for $25 each. The entry is as follows: Accounts Receivable Sales Revenue To recognize revenues from June sales. Cost of Goods Sold Inventory To recognize expenses from selling hats. FIFO Perpetual Journal Entry

Using FIFO both perpetual and periodic inventory systems result in the same results. FIFO Periodic Inventory Beg. 10 Jan Purch. 15 Feb Purch. 10 July Sale 20 June

LIFO Perpetual Inventory Purchase Sale Balance ` DateUnitsTotalUnitsTotalUnitsCostTotal Jan 1 10$10 $100 Feb 15$225 10$10 $100 15$15 $225 June 15 $225 5 $ 50 5$10 $ 50 Dec 10$180 5$10 $ 50 10$18 $180

Using LIFO perpetual removes the latest items received at the time of each sale. LIFO Perpetual Inventory Beg. 10 Jan Purch. 15 Feb Purch. 10 July Sale 20 June

LIFO Perpetual Journal Entry In June, the Hat Company sold 20 hats for $25 each. The entry is as follows: Accounts Receivable Sales Revenue To recognize revenues from June sales.

LIFO Perpetual Journal Entry In June, the Hat Company sold 20 hats for $25 each. The entry is as follows: Accounts Receivable Sales Revenue To recognize revenues from June sales. Cost of Goods Sold Inventory To recognize expenses from selling hats.

Inventory Costing - Periodic 1.Determine quantity of units of inventory 2.Apply unit costs to the quantities 3.Determine total cost of inventory 4.Determine cost of goods sold Process can be complicated if units are purchased at different times and at different prices!

LIFO Periodic Cost of Goods Sold: July $18 = $ 180 February Purch $15 = $ 150 Total $ 330 Ending Inventory: Beginning $10 = $ 100 February Purchases $15 = $ 75 Total $ 175

Using LIFO periodic removes the latest items received as of the end of the period. LIFO Periodic Inventory Beg. 10 Jan Purch. 15 Feb Purch. 10 July Sale 20 June

Weighted-Average Perpetual In June, the Hat Company sold 20 hats for $25 each. The entry is as follows: Accounts Receivable Sales Revenue To recognize revenues from June sales.

Weighted-Average Perpetual In June, the Hat Company sold 20 hats for $25 each. The entry is as follows: Accounts Receivable Sales Revenue To recognize revenues from June sales. Cost of Goods Sold Inventory To recognize expenses from selling hats.

Weighted-Average 2007 Inventory Purchase Sale Balance ` DateUnitsTotalUnitsTotalUnitsCostTotal Jan 1 10$10.00 $100 Feb 15$ $13.00 $325 June 20 $260 5$13.00 $ 65 July 10$ $16.33 $245

Weighted Average Cost of Goods Sold: Units $13.00 =$ 260 Total$ 260 Ending Inventory: Units $16.33 = $ 245 Total $ 245

Using Weighted Average perpetual removes units at the average cost of all goods on hand. Weighted Average Inventory Beg. 10 Jan Purch. 15 Feb Purch. 10 July Sale 20 June

Question 1 Which inventory cost flow method produces the highest net income in a period of rising prices? a. Weighted average cost b.Lifo c.Fifo d.Specific Identification.

Question 1 Which inventory cost flow method produces the highest net income in a period of rising prices? a. Weighted average cost b.Lifo c.Fifo d.Specific Identification.

Which inventory cost flow method produces the lowest income taxes in a period of rising prices? Question 2 a. Weighted average cost b. Lifo c. Fifo d. Specific Identification.

Which inventory cost flow method produces the lowest income taxes in a period of rising prices? Question 2 a. Weighted average cost b. Lifo c. Fifo d. Specific Identification.

Comparison of Inventory Costing Methods -- Perpetual Weighted FIFOLIFO Average Ending Inventory$255$230 $245

Comparison of Inventory Costing Methods -- Perpetual Weighted FIFOLIFO Average Ending Inventory$255$230 $245 Cost of Goods Sold$250$275 $260

Income Statement Effects

The Lower of Cost or Market Basis of Accounting for Inventories When the value of inventory is lower than its cost, the inventory is written down to its market value by valuing the inventory at the lower of cost or market (LCM) in the period in which the price decline occurs.

Lower of Cost or Market (LCM) departure from cost principle follows conservatism concept can be used only after one of the cost flow methods ( Specific Identification FIFO, LIFO, or Average Cost)

57 Market Is... CURRENT REPLACEMENT COST

How Much Inventory Should a Company Have? –Only enough for sales needs –Excess inventory costs: storage costs interest costs obsolescence - technology, fashion

Inventory Turnover Ratio = An indication of how quickly a company sells its goods. Higher is better.

Inventory Turnover Ratio = Cost of Goods Sold Average Inventory

Days in Inventory = An indication of how quickly a company sells its goods. Lower is better.

Days in Inventory = 365 days Inventory Turnover Ratio

Lifo Reserve And Its Importance For Comparing Results Of Different Companies Accounting standards require firms using LIFO to report the amount by which inventory would be increased (or on occasion decreased) if the firm had instead been using FIFO. This amount is referred to as the LIFO reserve. Reporting the LIFO reserve enables analysts to make adjustments to compare companies that use different cost flow methods.