1. Topics for Today: discuss inventory reporting
discuss inventory analysis
review & practice simple calculations

2. Inventories What do financial statement users want to know?
(items owned by a company and held for sale, or processing before being sold, as part of ordinary business operations)
Balance Sheet
ASSETS
Cash
A/R
Inventories
Income Statement
Sales revenues
COGS
Gross profit
Etc. (other expenses/income)
What do financial statement users want to know?
1. how much inventory is held by the company?
2. what is the value of the inventory?
can it be sold for more than cost?
3. for how long does the company hold inventory?

3. Inventories What do the financial statements tell users?
how much inventory is held by the company?
the $$$ amount of inventory is reported on the B/S
the number of units is not reported
what is the value of the inventory?
the $$$ amount represents the lower of cost and market
look at gross profit on I/S for (historical) estimate of price mark-up
for how long does the company hold inventory?
can be determined using the $$$ amount of inventory and cost of goods sold
inventory turnover ratio = Cost of Goods Sold / Average Inventory
higher turnover means faster sales and less obsolescence risk

4. Accounting for Inventories
Accounting Challenges
What costs go into additions?
What costs come out when goods are sold?
What happens when the value of inventory drops below cost?
How do we track inventory manufacturing costs?
Inventories
Opening
Additions
Available for Sale
Goods Sold
Ending
OI + Additions – COGS = Ending Inventory

5. Inventories Opening Additions Available for Sale Goods Sold Ending
Accounting Challenges
What costs go into additions?
Opening
Additions
Available for Sale
Goods Sold
Ending
If purchased, include any costs related to “getting the inventory in a condition and location for sale.”
If manufactured …. (we’ll talk about that later)

6. Inventories Opening Additions Available for Sale Goods Sold Ending
Accounting Challenges
What costs go into additions?
Opening
Additions
What costs come out when goods are sold?
Available for Sale
Goods Sold
Ending
That depends …
What cost flow assumption is adopted
Is the accounting system perpetual or periodic

7. Cost Flow Assumptions What's the issue? Why is it an issue?
what costs should be removed from inventory when goods are sold?
OR ... what costs should remain in inventory after goods are sold?
Why is it an issue?
in most cases, the cost of inventory additions changes from time to time
if the costs going into inventory are changing, how do we know which ones should be removed when goods are sold?

8. Cost Flow Assumptions Example: Possible Solutions Include:
inventory includes 40 items, with the following costs:
October: 10 $13 each
September: 10 $12 each
August: 10 $11 each
July: 10 $10 each
$460 total cost
40 units available
Q: 10 units are sold in November ... what is the cost of goods sold?
Possible Solutions Include:
1. whatever those 10 units cost
2. assume first-in, first-out (FIFO)
3. assume last-in, first-out (LIFO)
4. assume average cost of all (Weighted Average)
(any of $120, $110, etc.)
($100)
Assumptions
Cost-Flow
($130)
($460 / 40 = $11.50 per unit x 10 units = $115)
notice that COGS under LIFO > WA > FIFO because costs are rising

9. Example Income Statement Balance Sheet Inventories Specific
Identification
FIFO
LIFO
Weighted
Average
Sales
COGS
Gross Profit
150
(120) 30
(100) 50
(130) 20
(115) 35
Balance Sheet
Specific
Identification
FIFO
LIFO
Weighted
Average
Current Assets
Inventories
340
360
330
345

10. Cost Flow Assumptions 1. Specific Identification
each specific unit's cost is identified and expensed as COGS
used most often for expensive & separately identifiable products
2. First-in, First-Out (FIFO)
cost of units acquired early are expensed until all of those units are
gone, and then the cost of the next "oldest" units also are expensed, etc.
the income statement (COGS) gets the old costs
the balance sheet (inventory) gets the most recent costs (LISH)
3. Last-In, First-Out (LIFO)
cost of units acquired most recently are expensed until all of those units
are gone, and then the cost of the next most recent units are expensed
the income statement (COGS) gets the most recent costs
the balance sheet (inventory) gets the old costs (FISH)
4. Weighted Average
for each product, the total units and costs are accumulated to determine
an average unit cost
per unit costs on the B/S and I/S are the same

11. Cost Flow Assumptions Notes
the cost flow assumption need not match actual product flow
the cost flow assumption must remain consistent over time
costs calculated under LIFO and Weighted Average are
affected by the use of perpetual vs. periodic systems

12. Perpetual vs. Periodic Systems
What's the issue?
when should costs be removed from inventory?
- physically count the goods on hand at the end of the accounting period
- assign costs to EI only at the end of the accounting period ("forces-out" the COGS = OI + Purchases - EI)
cost information may not be timely
cheap to monitor costs
Periodic
Perpetual
- determine costs of inventory and goods sold after every sale
cost information is more timely
more expensive to monitor costs
Why do we care about the issue?
the choice of system is an important management decision
the choice of system can affect which costs are assigned to inventories and to goods sold (under LIFO or Weighted Average)

13. Cost Flow Assumptions Notes
the cost flow assumption need not match actual product flow
the cost flow assumption must remain consistent over time
costs calculated under LIFO and Weighted Average are affected
by the use of perpetual vs. periodic systems
Specific Identification is not affected by perpetual vs. periodic systems because the actual cost of each product is expensed when it is sold
FIFO is not affected because the first goods in are assumed to be sold first, so it doesn't matter when the sale occurs or is recorded because it's always the first purchase that is expensed first

14. Cost Flow & Periodic/Perpetual
assume 3 bricks are bought ...
January $10
and 1 brick is sold January
What is the COGS in January?
January $15
FIFO-periodic?
$10
FIFO-perpetual?
$10
LIFO-periodic?
$20
January $20
LIFO-perpetual?
$15
WA-periodic?
$15
WA-perpetual?
$12.50

15. How do you compare a company that uses FIFO with a company that uses LIFO?
You have to calculate the COGS and Inventory amounts using the SAME cost flow assumption.
Most companies that use LIFO provide enough information to convert to FIFO – so, to compare, convert LIFO to FIFO.
Remember that the cost flow assumption affects OI, COGS, and EI, but it does NOT affect the cost of inventory purchases (i.e., additions).
Inventories
Opening
Purchases
Goods Sold
Ending

16. Inventories (LIFO) How to Convert LIFO to FIFO? Example
Ford Motor Company recently reported cost of goods sold of $74,315 (million) in the current year, and total inventories of $6816 and $6638 in the current and prior years, respectively, using the LIFO cost flow assumption. Their f/s notes indicated that had they used FIFO, their current and prior year inventories would have been $1,235 and $1,246 higher.
Inventories (LIFO)
Opening
Purchases
Goods Sold
Ending
6638
X = 74493
74315
6816

17. Inventories (LIFO) Inventories (FIFO)
How to Convert LIFO to FIFO?
Example
Ford Motor Company recently reported cost of goods sold of $74,315 (million) in the current year, and total inventories of $6816 and $6638 in the current and prior years, respectively, using the LIFO cost flow assumption. Their f/s notes indicated that had they used FIFO, their current and prior year inventories would have been $1,235 and $1,246 higher. What is COGS using FIFO?
Inventories (LIFO)
Inventories (FIFO)
Opening
Purchases
Goods Sold
Ending
6638
=7884
X = 74493
74315
74493
X=74326
6816
=8051