1. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-1 5 5 Reporting and Analyzing Inventories

2. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-2 Assigning Costs to Inventory Inventory affects... The matching principle requires matching cost of sales with sales. Balance Sheet Income Statement

3. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-3 Assigning Costs to Inventory Accounting for inventory requires several decisions... Costing Method. FIFO, LIFO, Weighted Average, Specific ID FIFO, LIFO, Weighted Average, Specific ID Inventory System. Perpetual or Periodic Perpetual or Periodic Items included in costs. Use of market or other estimates. Costing Method. FIFO, LIFO, Weighted Average, Specific ID FIFO, LIFO, Weighted Average, Specific ID Inventory System. Perpetual or Periodic Perpetual or Periodic Items included in costs. Use of market or other estimates.

4. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-4 Assigning Costs to Inventory Use of Inventory Methods in Practice Exh. 5.1

5. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-5 Example Inventory Information Exh. 5.2,3

6. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-6 Perpetual Inventory

7. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-7 Specific Identification When units are sold, the specific cost of the unit sold is added to cost of goods sold.

8. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-8 Specific Identification The above purchases were made by Trekking in August. On August 14, Trekking sold 8 bikes originally costing $91 and 12 bikes originally costing $106.

9. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-9 The Cost of Goods Sold for the August 14 sale is $2,000, leaving $500 and 5 units in inventory. Specific Identification Exh. 5.4

10. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-10 Additional purchases were made on August 17 and 28. Cost of sales on August 31 were as follows: 2 @ $91, 3 @ $106, 15 @ $115, & 3 @ $119. Additional purchases were made on August 17 and 28. Cost of sales on August 31 were as follows: 2 @ $91, 3 @ $106, 15 @ $115, & 3 @ $119. Specific Identification Exh. 5.4

11. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-11 Specific Identification Cost of Goods Sold for August 31 = $2,582 Exh. 5.4

12. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-12 Specific Identification Balance Sheet Inventory = $1,408 Income Statement COGS = $4,582 Exh. 5.4

13. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-13 First-In, First-Out (FIFO) Cost of Goods Sold Ending Inventory Oldest Costs Recent Costs

14. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-14 First-In, First-Out (FIFO) The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes. Exh. 5.5

15. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-15 First-In, First-Out (FIFO) The Cost of Goods Sold for the August 14 sale is $1,970, leaving $530 and 5 units in inventory. Exh. 5.5

16. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-16 Additional purchases were made on August 17 and August 28. On August 31, an additional 23 units were sold. First-In, First-Out (FIFO) Exh. 5.5

17. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-17 First-In, First-Out (FIFO) Cost of Goods Sold for August 31 = ($530 + $2,070) = $2,600 Exh. 5.5

18. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-18 First-In, First-Out (FIFO) Balance Sheet Inventory = $1,420 Income Statement COGS = $4,570 Exh. 5.5

19. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-19 Last-In, First-Out (LIFO) Recent Costs Cost of Goods Sold Oldest Costs Ending Inventory

20. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-20 The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes. Last-In, First-Out (LIFO) Exh. 5.6

21. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-21 Last-In, First-Out (LIFO) The Cost of Goods Sold for the August 14 sale is ($1,590 + $455) $2,045, leaving $455 and 5 units in inventory. Exh. 5.6

22. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-22 Additional purchases were made on August 17 and August 28. On August 31, an additional 23 units were sold. Last-In, First-Out (LIFO) Exh. 5.6

23. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-23 Last-In, First-Out (LIFO) Cost of Goods Sold for August 31 = ($1,190 + $1,495) = $2,685 Exh. 5.6

24. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-24 Last-In, First-Out (LIFO) Balance Sheet Inventory = $1,260 Income Statement COGS = $4,730 Exh. 5.6

25. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-25 Weighted Average When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. Cost of Goods Available for Sale Units on hand on the date of sale ÷

26. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-26 The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes. Weighted Average Exh. 5.7

27. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-27 The weighted average cost per unit is computed prior to each sale. Weighted Average ÷ Exh. 5.7

28. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-28 Additional purchases were made on August 17 and August 28. On August 31, an additional 23 units were sold. Weighted Average Exh. 5.7

29. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-29 Weighted Average ÷ Exh. 5.7

30. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-30 Weighted Average Balance Sheet Inventory = $1,368 Income Statement COGS = $4,622 Exh. 5.7

31. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-31 Cost of Merchandise Inventory Include all expenditures necessary to bring an item to a salable condition and location. Invoice Price Import Duties Freight-inFreight-in StorageStorage InsuranceInsurance

32. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-32 Financial Reporting Because prices change, the choice of an inventory method is important. Exh. 5.8

33. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-33 Financial Reporting Advantages of Each Method Smooths out price changes. Better matches current costs in cost of goods sold with revenues. Ending inventory approximates current replacement cost. First-In, First-Out Weighted Average Last-In, First-Out

34. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-34 Tax Reporting The Internal Revenue Service (IRS) identifies several acceptable methods for inventory costing for financial reporting and reporting taxable income. If LIFO is used for tax purposes, the IRS requires it be used in financial statements. The Internal Revenue Service (IRS) identifies several acceptable methods for inventory costing for financial reporting and reporting taxable income. If LIFO is used for tax purposes, the IRS requires it be used in financial statements.

35. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-35 Consistency in Reporting The consistency principle requires a company to use the same accounting methods period after period so that financial statements are comparable across periods.

36. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-36 Errors in Reporting Inventory Income Statement Effects Exh. 5.10

37. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-37 Errors in Reporting Inventory Exh. 5.12 Balance Sheet Effects

38. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-38 FOB Destination Point Public Carrier SellerBuyer Items in Merchandise Inventory Public Carrier SellerBuyer FOB Shipping Point Ownership passes to the buyer here.

39. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-39 Items in Merchandise Inventory Goods on Consignment  Goods shipped by the owner (consignor) to another party (consignee).  Merchandise is included in the inventory of the consignor. Goods Damaged or Obsolete  Damaged or obsolete goods are not counted in inventory.  Cost should be reduced to net realizable value. Goods on Consignment  Goods shipped by the owner (consignor) to another party (consignee).  Merchandise is included in the inventory of the consignor. Goods Damaged or Obsolete  Damaged or obsolete goods are not counted in inventory.  Cost should be reduced to net realizable value.

40. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-40 Physical Count of Merchandise Inventory  Most companies take a physical count of inventory at least once each year.  When the physical count does not match the Merchandise Inventory account, an adjustment must be made.  Most companies take a physical count of inventory at least once each year.  When the physical count does not match the Merchandise Inventory account, an adjustment must be made. Quantity ___ Inventory Count Tag Counted by _______

41. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-41 Lower of Cost or Market Inventory must be reported at market value when market is lower than cost. Can be applied three ways: (1)separately to each individual item. (2)to major categories of assets. (3)to the whole inventory. Can be applied three ways: (1)separately to each individual item. (2)to major categories of assets. (3)to the whole inventory. Defined as current replacement cost (not sales price). Consistent with the conservatism principle. Defined as current replacement cost (not sales price). Consistent with the conservatism principle.

42. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-42 A motorsports retailer has the following items in inventory: Lower of Cost or Market Exh. 5.14

43. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-43 Here is how to compute lower of cost or market for individual inventory items. Lower of Cost or Market Exh. 5.14

44. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-44 Lower of Cost or Market Here is how to compute lower of cost or market for the two groups of inventory items. Exh. 5.14

45. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-45 Lower of Cost or Market Here is how to compute lower of cost or market for the entire inventory. Exh. 5.14

46. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-46 Retail Inventory Method Often used to estimate inventory for interim period reporting. Needed Information includes: Often used to estimate inventory for interim period reporting. Needed Information includes: Net purchases at cost and retail Beginning inventory at cost and retail Net sales

47. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-47 Retail Inventory Method Step 3 Cost to retail ratio Ending inventory at retail Estimated ending inventory at cost = × Step 2 Goods available for sale at retail Goods available for sale at cost = ÷ Cost to retail ratio Step 1 Net sales at retail Goods available for sale at retail – = Ending inventory at retail Exh. 5.15

48. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-48 Retail Inventory Method

49. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-49 Retail Inventory Method

50. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-50 Retail Inventory Method Exh. 5.16

51. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-51 Gross Profit Method  Estimate ending inventory by applying the gross profit ratio to net sales (at retail).  Useful when inventory has been destroyed, lost, or stolen.  Estimate ending inventory by applying the gross profit ratio to net sales (at retail).  Useful when inventory has been destroyed, lost, or stolen.

52. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-52 Gross Profit Method Step 1 1.0 – the gross profit ratio Net sales at retail × = Estimated cost of goods sold Step 2 Estimated cost of goods sold Goods available for sale at cost – = Estimated ending inventory at cost Exh. 5.17

53. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-53 In March of 2002, Chemical Company’s inventory was destroyed by fire. Chemical’s normal gross profit ratio is 30% of net sales. At the time of the fire, Chemical showed the following balances: Gross Profit Method

54. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-54 Gross Profit Method Step 1

55. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-55 Gross Profit Method Step 2 Exh. 5.18

56. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-56 Inventory Turnover Shows how many times a company turns over its inventory during a period. Indicator of how well management is controlling the amount of inventory available. Inventory Turnover = Cost of goods sold Avg. inventory Exh. 5.19

57. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-57 Days’ Sales in Inventory Reveals how much inventory is available in terms of the number of days’ sales. Days' Sales in Inventory = Ending Inventory Cost of goods sold × 365 Exh. 5.20

58. © The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Slide 5-58 End of Chapter 5