1. 6-1 REPORTING AND ANALYZING INVENTORY Financial Accounting, Sixth Edition 6

2. 6-2 1. 1.Describe the steps in determining inventory quantities. 2. 2.Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. 3. 3.Explain the financial statement and tax effects of each of the inventory cost flow assumptions. 4. 4.Explain the lower-of-cost-or-market basis of accounting for inventories. 5. 5.Compute and interpret the inventory turnover ratio. Study Objectives

3. 6-3 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.

4. 6-4 Physical Inventory taken for two reasons: Perpetual System 1.Check accuracy of inventory records. 2.Determine amount of inventory lost (wasted raw materials, shoplifting, or employee theft). Periodic System 1.Determine the inventory on hand 2.Determine the cost of goods sold for the period. Determining Inventory Quantities SO 1 Describe the steps in determining inventory quantities.

5. 6-5 Involves counting, weighing, or measuring each kind of inventory on hand. Taken,  when the business is closed or business is slow.  at end of the accounting period. Taking a Physical Inventory Determining Inventory Quantities SO 1 Describe the steps in determining inventory quantities.

6. 6-6 Goods in Transit  Purchased goods not yet received.  Sold goods not yet delivered. Determining Ownership of Goods Determining Inventory Quantities SO 1 Describe the steps in determining inventory quantities. 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.

7. 6-7 Illustration 6-1 Terms of sale 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. Goods in Transit Determining Inventory Quantities

8. 6-8 Consigned Goods Goods held for sale by one party although ownership of the goods is retained by another party. Determining Inventory Quantities SO 1 Describe the steps in determining inventory quantities. Determining Ownership of Goods

9. 6-9 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 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Cost Flow Assumptions

10. 6-10 Illustration: Assume that Crivitz TV Company purchases three identical 50-inch TVs on different dates at costs of $700, $750, and $800. During the year Crivitz sold two sets at $1,200 each. These facts are summarized below. Inventory Costing Illustration 6-2 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

11. 6-11 “Specific Identification” Inventory Costing If Crivitz sold the TVs it purchased on February 3 and May 22, then its cost of goods sold is $1,500 ($700 + $800), and its ending inventory is $750. Illustration 6-3 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

12. 6-12 Actual physical flow costing method in which items still in inventory are specifically costed to arrive at the total cost of the ending inventory. Practice is relatively rare. Most companies make assumptions (Cost Flow Assumptions) about which units were sold. Inventory Costing SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. “Specific Identification”

13. 6-13 Inventory Costing Illustration 6-11 Use of cost flow methods in major U.S. companies Cost Flow Assumption does not need to equal Physical Movement of Goods SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

14. 6-14 Illustration: Data for Houston Electronics’ Astro condensers. Inventory Cost Flow Assumptions Illustration 6-4 (Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

15. 6-15  Earliest goods purchased are first to be sold.  Often parallels actual physical flow of merchandise.  Generally good business practice to sell oldest units first. Inventory Cost Flow Assumptions SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. “First-In-First-Out (FIFO)”

16. 6-16 Inventory Cost Flow Assumptions Illustration 6-5 SO 2 “First-In-First-Out (FIFO)”

17. 6-17 Inventory Cost Flow Assumptions Illustration 6-5 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. “First-In-First-Out (FIFO)”

18. 6-18  Latest goods purchased are first to be sold.  Seldom coincides with actual physical flow of merchandise.  Exceptions include goods stored in piles, such as coal or hay. Inventory Cost Flow Assumptions SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. “Last-In-First-Out (LIFO)”

19. 6-19 Illustration 6-7 Inventory Cost Flow Assumptions “Last-In-First-Out (LIFO)”

20. 6-20 Illustration 6-7 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Inventory Cost Flow Assumptions “Last-In-First-Out (LIFO)”

21. 6-21  Allocates cost of goods available for sale on the basis of weighted-average unit cost incurred.  Assumes goods are similar in nature.  Applies weighted-average unit cost to the units on hand to determine cost of the ending inventory. Inventory Cost Flow Assumptions SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. “Average-Cost”

22. 6-22 Illustration 6-10 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Inventory Cost Flow Assumptions “Average-Cost”

23. 6-23 Illustration 6-10 SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Inventory Cost Flow Assumptions “Average-Cost”

24. 6-24 FIFO Sales$9,000$9,000$9,000 Cost of goods sold6,2006,6007,000 Gross profit2,8002,4002,000 Admin. & selling expense330330330 Income before taxes2,4702,0701,670 Income tax expense140120110 Net income$2,330$1,950$1,560 Inventory balance$5,800$5,400$5,000 LIFOAverage Comparative Financial Statement Summary LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions. Financial Statement and Tax Effects

25. 6-25 FIFO Sales$9,000$9,000$9,000 Cost of goods sold6,2006,6007,000 Gross profit2,8002,4002,000 Admin. & selling expense330330330 Income before taxes2,4702,0701,670 Income tax expense140120110 Net income$2,330$1,950$1,560 Inventory balance$5,800$5,400$5,000 LIFOAverage In Period of Rising Prices, FIFO Reports: Highest Lowest LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions. Financial Statement and Tax Effects

26. 6-26 FIFO Sales$9,000$9,000$9,000 Cost of goods sold6,2006,6007,000 Gross profit2,8002,4002,000 Admin. & selling expense330330330 Income before taxes2,4702,0701,670 Income tax expense140120110 Net income$2,330$1,950$1,560 Inventory balance$5,800$5,400$5,000 LIFOAverage In Period of Rising Prices, LIFO Reports: Lowest Highest LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions. Financial Statement and Tax Effects

27. 6-27 Using Cost Flow Methods Consistently Inventory Costing  Method should be used consistently, enhances comparability.  Although consistency is preferred, a company may change its inventory costing method. Illustration 6-14 Disclosure of change in cost flow method LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

28. 6-28 Lower-of-Cost-or-Market Inventory Costing SO 4 Explain the lower-of-cost-or-market basis of accounting for inventories. When the value of inventory is lower than its cost  Companies “write down” the inventory to its market value in the period in which the price decline occurs.  Market value = Replacement Cost  Example of conservatism.

29. 6-29 Inventory Costing SO 4 Explain the lower-of-cost-or-market basis of accounting for inventories. Illustration: Assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated. Lower-of-Cost-or-Market Illustration 6-15

30. 6-30 Analysis of Inventory Inventory management is a double-edged sword 1. High Inventory Levels - may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage). 2. Low Inventory Levels – may lead to stockouts and lost sales. SO 5 Compute and interpret the inventory turnover ratio.

31. 6-31 Analysis of Inventory SO 5 Compute and interpret the inventory turnover ratio. Inventory Turnover Ratio Illustration 6-16

32. 6-32 Illustration: Data available for Wal-Mart. Analysis of Inventory SO 5 Compute and interpret the inventory turnover ratio. Illustration 6-16