6-1 REPORTING AND ANALYZING INVENTORY 6 Determine the cost of goods sold and ending inventory

6-2 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.

6-3 Physical Inventory is taken for two reasons: In a Perpetual System 1.To compare the accuracy of inventory accounting records to the actual inventory on hand. 2.To determine the amount of lost inventory from wasted raw materials, customer shoplifting, or employee theft. In a Periodic System 1.To determine ending inventory 2.To determine the cost of goods sold for the period. 3.The periodic inventory is not very accurate at identifying the amount of inventory lost. The amount not counted in ending inventory is simply assumed to have been sold or missing. Determining Inventory Quantities

6-4 Taking a Physical Inventory: Involves counting (boxes), weighing (topsoil), or measuring (fabric, liquids) each kind of inventory on hand usually when the business is slow, closed or at the end of the accounting period. Note: when you count a box that’s supposed to have a TV in it, you must make sure there actually is a TV in it and it matches with the one listed in the accounting records! Determining Inventory Quantities Consigned Goods: Goods held for sale by one party even though ownership is still retained by another party. Someone else’s goods in on consignment at your store are not included as your inventory! Your goods out on consignment are still included in your inventory!

6-5 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 Cost Flow Assumptions Management decides which inventory costing method is best to use!

6-6 Assume that Frank N. Furter TV Company purchases three identical 50-inch TVs on different dates at costs of $700, $750, and $800. During the year Furter sold two sets at $1,200 each. These facts are summarized below. Inventory Costing

6-7 Specific Identification Inventory Costing – Specific Indentification If Furter sold 2 of the TVs it purchased on February 3 and May 22 for $2,400 ($1,200 each), then its cost of goods sold is $1,500 ($700 + $800), and its ending inventory is $750.

6-8 A physical flow costing method: items in inventory each have their own cost, they are added together to arrive at the total cost of the ending inventory. Use of this method is rare: used for unique items such as precious gems, custom-made cars, antiques, one-of-a-kinds. On the other hand, for similar type items, most companies make assumptions called Cost Flow Assumptions about which units were sold. Inventory Costing – Specific Indentification Specific Identification

6-9 Inventory Costing The Cost Flow Assumption The recorded cost does not need to match the physical movement of goods From a survey of large corporations

6-10 Assume this data for Houston Electronics’ Astro condensers. Inventory Cost Flow Assumptions Remember: 450 units are in ending inventory and 550 units were sold!

6-11  Allocates cost of goods available for sale on the basis of weighted-average unit cost incurred.  Assumes goods are similar in nature (gas, oil).  Applies weighted-average unit cost to the units on hand to determine cost of the ending inventory. Average Cost Inventory Cost Flow Assumptions Average-Cost “What’s my GPA?”

6-12 Average Cost Inventory Cost Flow Assumptions Average-Cost: 550 Sold in Ending Inventory 450 units were in ending inventory and 550 units were sold. 550 units x $12

6-13  The costs of the earliest goods purchased are assumed to be the first to be sold – “FIFO”  The costs of the last goods purchased and not yet sold are assumed to still be in ending inventory. Last in stays here “LISH”  FIFO often parallels actual physical flow of merchandise. It’s generally good business practice to sell the oldest units first. “GOT MILK?” FIFO Inventory Cost Flow Assumptions First-In-First-Out (FIFO) Last-in Stays-here (LISH) “Eat more Chikin?”

6-14 FIFO Inventory Cost Flow Assumptions Illustration 6-5 First-In-First-Out (550 Sold) Last In Stays Here (450 in End. Inv.) Remember 450 units were counted as ending inventory! Another method would be to count the 550 units sold starting with the beginning inventory and working down. (100 x $10) + (200 x $11) + (250 x $12)

6-15  The costs of the latest goods purchased are assumed to be the first to be sold – “LIFO”  The costs of the first goods purchased and not yet sold are assumed to still be in ending inventory. First in stays here “FISH”  LIFO seldom coincides with actual physical flow of merchandise. Exceptions include goods stored in piles such as coal, mulch, hay, etc. LIFO Inventory Cost Flow Assumptions Last-In-First-Out (LIFO) First-In-Stays-Here (FISH) “Sound Fishy?”

6-16 LIFO Inventory Cost Flow Assumptions Last-In-First-Out (550 Sold) First-In-Stays-Here (450 in End. Inv.) Remember 450 units were counted as being in ending inventory! Another method would be to count the 550 units sold starting with the last purchase and working up. (400 x $13) + (150 x $12)

6-17 FIFO * Sales$9,000$9,000$9,000 Cost of goods sold6,2006,6007,000 Gross profit2,8002,4002,000 * Operating expenses Income before taxes2,4702,0701,670 Income tax expense Net income $2,330 $1,950 $1,560 Ending Inventory $5,800 $5,400 $5,000 *Assume no differences in Sales or Operating Expenses LIFOAverage In Periods of Rising Prices FIFO Has The Highest Ending Inventory! Financial Statement and Tax Effects

6-18 Using Cost Flow Methods Consistently Inventory Costing  Method should be used consistently because it enhances comparability from one year to the next.  However, although consistency is preferred, a company may change its inventory cost method.

6-19 Lower-of-Cost-or-Market (LCM) Inventory Costing When the value of inventory is lower than its cost  Companies can “write down” the inventory to its new market value in the period in which the price decline occurs (e.g., items become obsolete). The company would record a loss or expense in the period of the write down (see the next slide).  Market value is considered to be the replacement cost to purchase more inventory - not the new selling price. Using LCM is an example of conservatism.

6-20 Inventory Costing Assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated. Lower-of-Cost-or-Market The original total inventory cost was $168,000. After the adjustment we would write down the value of the inventory to $159,000 by crediting inventory for $9,000 and debiting a Loss on Reduction of Inventory or debiting the COGS as an expense $168,000$166,000

6-21 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. Shipping Terms Review! Shipping Point Destination 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.

6-22 Goods in transit should be included in the inventory of the buyer when the: a.public carrier accepts the goods from the seller. b.goods reach the buyer. c.terms of sale are FOB destination. d.terms of sale are FOB shipping point. Review Question Determining Inventory Quantities

6-23 The cost flow method that often parallels the actual physical flow of merchandise is the: a.FIFO method. b.LIFO method. c.average cost method. d.gross profit method. Review Question Inventory Cost Flow Assumptions

6-24 In a period of inflation (rising prices), the cost flow method that results in the lowest income taxes is the: a.FIFO method. b.LIFO method. c.average cost method. d.gross profit method. Inventory Cost Flow Assumptions Review Question