1. ©CourseCollege.com 1 14 Inventory Inventory held for sale by retailers, manufacturers and wholesalers. Learning Objectives 1.Identify all costs and apply the lower of cost or market to merchandise inventory 2.Assign costs to sold inventory using four different methods 3.Compare periodic with perpetual inventory systems 4.Estimate ending inventory 5.Analysis: Calculate and explain inventory turnover and days sales in inventory

2. ©CourseCollege.com 2 Inventory subsidiary ledgers are separate records for each item of inventory. Control Ledger Inventory Acct #150 Subsidiary Ledgers Inventory Brass Chimes #150.236822 Balance The Subsidiary Ledgers must add up to the Control Ledger Overview Subsidiary example

3. ©CourseCollege.com 3 The number of units and the cost paid per unit are collected for each purchase and sale Overview Subsidiary Ledgers Inventory Brass Chimes #150.236822 With a Perpetual Inventory system, sales and purchases are updated as they happen to the Inventory Control Ledger

4. ©CourseCollege.com 4 Objective 14.1: Identify all costs and apply the lower of cost or market to inventory O14.1 The Cost Concept guides the initial valuation of inventory. Purchases are recorded at cost less any purchase discounts earned.

5. ©CourseCollege.com 5 Cost of Inventory However, Inventory values should also include any incidental costs incurred to bring inventory to the sales location and into a saleable condition including: Freight In, storage and insurance costs Costs to prepare, condition and assemble inventory for sale However, Inventory values should also include any incidental costs incurred to bring inventory to the sales location and into a saleable condition including: Freight In, storage and insurance costs Costs to prepare, condition and assemble inventory for sale

6. ©CourseCollege.com 6 Freight In is the cost incurred to bring inventory to the sale location FOB (for Free On Board) describes shipping terms 1.FOB shipping point means freight is free to the purchaser only to the shipping point 2.FOB destination means freight is free to the purchaser to the purchaser’s destination Freight In is the cost incurred to bring inventory to the sale location FOB (for Free On Board) describes shipping terms 1.FOB shipping point means freight is free to the purchaser only to the shipping point 2.FOB destination means freight is free to the purchaser to the purchaser’s destination Freight In Shipping Point Destination O14.1

7. ©CourseCollege.com 7 FOB terms also indicate ownership of the inventory in transit 1.For FOB shipping point, the purchaser owns the inventory from the shipping point on 2.FOB destination means the seller owns the inventory in transit until it arrives at the seller’s location FOB terms also indicate ownership of the inventory in transit 1.For FOB shipping point, the purchaser owns the inventory from the shipping point on 2.FOB destination means the seller owns the inventory in transit until it arrives at the seller’s location Inventory ownership while in transit Shipping Point Destination FOB Destination Seller owns FOB Shipping Point Purchaser owns In transit O14.1

8. ©CourseCollege.com 8 Inventory in transit owned by the seller Inventory on consignment (for sale by the firm but owned by others ) Damaged or obsolete goods that are not saleable* Inventory in transit owned by the seller Inventory on consignment (for sale by the firm but owned by others ) Damaged or obsolete goods that are not saleable* Items not included in Inventory *If saleable, the Conservatism Concept argues that damaged & obsolete goods should be recorded at their net realizable value O14.1

9. ©CourseCollege.com 9 Many firms rely on both the materiality and the cost benefit concept to argue that the incidental inventory acquisition costs of freight, storage, insurance, etc. are not material and further, the cost of appropriately assigning these costs to items of inventory outweigh any benefits received. They justify recording inventory costs using invoice prices only. Inventory and the Cost Benefit Concept O14.1

10. ©CourseCollege.com 10 The Conservatism Concept governs the issue of changing market values for inventory When preparing end of fiscal period financial statements the Lower of Cost or Market values should be used when the end of period inventory adjusting entry is considered. The Conservatism Concept governs the issue of changing market values for inventory When preparing end of fiscal period financial statements the Lower of Cost or Market values should be used when the end of period inventory adjusting entry is considered. Lower of cost or market O14.1

11. ©CourseCollege.com 11 In practice, lower of cost or market can be applied to inventory on the following bases: An item by item  Category by category  Inventory as a whole  In practice, lower of cost or market can be applied to inventory on the following bases: An item by item  Category by category  Inventory as a whole  Lower of cost or market Example O14.1

12. ©CourseCollege.com 12 Lower of cost or market The item total column brings over the lower from the total cost or total market column for each inventor y item. O14.1

13. ©CourseCollege.com 13 Lower of cost or market Adjusting Entry (assumes item by item analysis) The value of inventory is reduced by the adjustment. O14.1 Total cost of $22,321 minus Total market value on an item by item basis of $21,830 = $491

14. ©CourseCollege.com 14 LIFO FIFO Weighted Average Specific Identification Objective 14.2: Assign costs to sold inventory using four different methods O14.2

15. ©CourseCollege.com 15 Cost of sold inventory Cost Concept -followed in recording the value of inventory purchased for sale in the ordinary course of business Matching Concept -match expenses with the revenue those expenses helped to generate during any fiscal period. One of those expenses of course is the cost of inventory sold during the period. O14.2

16. ©CourseCollege.com 16 Which cost? Prices paid for identical inventory items change often. Which cost should be expensed when an item is sold? O14.2

17. ©CourseCollege.com 17 Methods used to determine which cost to expense include: Specific Identification Weighted Average Last in First Out –LIFO First in First Out –FIFO Methods used to determine which cost to expense include: Specific Identification Weighted Average Last in First Out –LIFO First in First Out –FIFO Which cost? O14.2

18. ©CourseCollege.com 18 Specific Identification expense as Cost of Goods Sold the costs incurred to purchase the exact inventory item sold Which cost? This may be impractical if inventory includes a large number of items which are difficult to match to the actual cost paid without considerable effort. O14.2

19. ©CourseCollege.com 19 LIFO –Last in First Out FIFO –First in First Out Weighted Average LIFO –Last in First Out FIFO –First in First Out Weighted Average Which cost? If identifying the specific cost paid for an item of inventory is excessive, these methods may be used: O14.2

20. ©CourseCollege.com 20 Which cost? LIFO method expenses the most recent inventory costs first FIFO method expenses the oldest inventory costs first Weighted average method expenses the average of all inventory costs incurred for the category O14.2

21. ©CourseCollege.com 21 $10.00 $10.25 $10.40 $10.50 $10.60 Note the need to record purchase information when accounting for inventory The price paid and the date purchased is recorded for each item of inventory. LIFO O14.2

22. ©CourseCollege.com 22 $10.00 $10.25 $10.40 $10.50 $10.60 Regardless of which item was sold, What cost should be expensed with LIFO method? One blue hockey puck is sold. Which cost should be expensed? LIFO ? O14.2

23. ©CourseCollege.com 23 $10.00 $10.25 $10.40 $10.50 $10.60 Using LIFO method, take the most recent purchase cost out to match with a sale. Cost expensed LIFO O14.2

24. ©CourseCollege.com 24 $10.00 $10.25 $10.40 $10.50 $10.60 $10.00 Using FIFO method, take the oldest purchase cost out to match with a sale. Cost expensed FIFO O14.2

25. ©CourseCollege.com 25 $10.00 $10.25 $10.40 $10.50 $10.60 $10.35 Using weighted average method, a moving average cost is expensed. Cost expensed Weighted Average $51.75/5 = $10.35 O14.2

26. ©CourseCollege.com 26 $10.00 $10.25 $10.40 $10.50 $10.60 $10.40 Using the Specific ID method, the physical item sold is matched with its cost Cost expensed Specific Identification I want that green one. O14.2

27. ©CourseCollege.com 27 LIFO -example Karin’s Gifts sells a special punch bowl which is purchased regularly as required. Using the LIFO method, record the purchase of 10 Units of inventory at $23 per unit on April 3. O14.2

28. ©CourseCollege.com 28 LIFO Next record the sale of 2 units on April 8 O14.2

29. ©CourseCollege.com 29 LIFO Next record the sale of 20 units on April 12 O14.2

30. ©CourseCollege.com 30 LIFO Next record the purchase of 20 units @ $24 on April 15 O14.2

31. ©CourseCollege.com 31 LIFO Next record the sale of 23 units on April 20 O14.2

32. ©CourseCollege.com 32 LIFO Finally record the purchase of 25 units @ $25 on April 25 O14.2

33. ©CourseCollege.com 33 LIFO O14.2

34. ©CourseCollege.com 34 FIFO -example Karin’s Gifts sells a special punch bowl which is purchased regularly as required. Using the FIFO method, record the purchase of 10 Units of inventory at $23 per unit on April 3. O14.2

35. ©CourseCollege.com 35 FIFO Next record the sale of 2 units on April 8 O14.2

36. ©CourseCollege.com 36 FIFO Next record the sale of 20 units on April 12 O14.2

37. ©CourseCollege.com 37 FIFO Next record the purchase of 20 units @ $24 on April 15 O14.2

38. ©CourseCollege.com 38 FIFO Next record the sale of 23 units on April 20 O14.2

39. ©CourseCollege.com 39 FIFO Record the purchase of 25 units for $25 on April 25 O14.2

40. ©CourseCollege.com 40 FIFO O14.2

41. ©CourseCollege.com 41 Weighted Average -example Karin’s Gifts sells a special punch bowl which is purchased regularly as required. Using the weighted average method, record the purchase of 10 units of inventory at $23 per unit on April 3. O14.2

42. ©CourseCollege.com 42 Weighted Average ($230 + $440 = $670/30 = $22.33) Next record the sale of 2 units on April 8 O14.2

43. ©CourseCollege.com 43 Weighted Average Next record the sale of 20 units on April 12 O14.2

44. ©CourseCollege.com 44 Weighted Average Next record the purchase of 20 units @ $24 on April 15 O14.2

45. ©CourseCollege.com 45 Weighted Average Next record the sale of 23 units on April 20 O14.2

46. ©CourseCollege.com 46 Weighted Average Finally record the purchase of 25 units @ $25 on April 25 O14.2

47. ©CourseCollege.com 47 Weighted Average O14.2

48. ©CourseCollege.com 48 Specific Identification For Specific Identification: Date Specific Units Sold 4/82 @ $22 4/1212 @ $22 8 @ $23 4/20 3 @ $22 20 @ $24 For Specific Identification: Date Specific Units Sold 4/82 @ $22 4/1212 @ $22 8 @ $23 4/20 3 @ $22 20 @ $24 O14.2

49. ©CourseCollege.com 49 Specific Identification O14.2

50. ©CourseCollege.com 50 14.3 Objective 14.3: Compare periodic with perpetual inventory systems Perpetual –the inventory account is updated with each purchase, sale and return that affects inventory. Periodic –the inventory account is updated only at the end of the fiscal period

51. ©CourseCollege.com 51 Perpetual Inventory account updated with each transaction Cost of Goods Sold account is used Inventory account is used to record inventory purchases Periodic Inventory account updated at the end of the fiscal period Cost of Goods Sold is not used, COGS is calculated Purchases account used to record inventory purchases Perpetual vs Periodic 14.3

52. ©CourseCollege.com 52 Why Periodic? Before the technology advances of computerization, the periodic method was a reliable and simple method of calculating Cost of Goods Sold using the following formula: 14.3

53. ©CourseCollege.com 53 Beginning Inventory Beginning Inventory Net Purchases Ending Inventory Ending Inventory Cost of Goods Sold Cost of Goods Sold Goods Available For sale Goods Available For sale + + Goods Available For sale Goods Available For sale Periodic formula 14.3

54. ©CourseCollege.com 54 Note the beginning inventory total Record purchases of inventory during the period Count the inventory remaining at the end of the period Using Periodic formula 14.3

55. ©CourseCollege.com 55 Beginning inventory + net purchases – ending inventory = Cost of Goods Sold Using Periodic formula This allows the firm to simplify the tracking of inventory changes during the period and rely on the ending count to establish Cost of Goods Sold. 14.3

56. ©CourseCollege.com 56 Disadvantages of Periodic During the fiscal period, Cost of Goods Sold must be estimated Inventory management efforts may have limited day to day sales information 14.3

57. ©CourseCollege.com 57 Beginning Inventory Ending Inventory Periodic Inventory System Goods Available for Sale Purchases PIPELINE Cost of Goods Sold This amount must be physically counted. Periodic Inventory System 14.3

58. ©CourseCollege.com 58 Using a Periodic Inventory System, the Cost of Goods Sold is not an separate expense account, it is an amount that must be computed using the COGS formula. Income Statement –Periodic System 14.3

59. ©CourseCollege.com 59 14.4 The following methods can be used to estimate ending inventory: Gross Profit Method Retail Inventory Method The following methods can be used to estimate ending inventory: Gross Profit Method Retail Inventory Method Objective 14.4: Estimate ending inventory These provide estimates, not actual ending inventory totals

60. ©CourseCollege.com 60 Gross Profit Method This method uses the firm’s historic gross profit percentage to estimate Cost of Goods Sold With Cost of Goods Sold (estimated), ending Inventory can also be estimated using the Periodic formula: Ending Inventory = Beg Inv. + Purchases - COGS With Cost of Goods Sold (estimated), ending Inventory can also be estimated using the Periodic formula: Ending Inventory = Beg Inv. + Purchases - COGS 14.4

61. ©CourseCollege.com 61 This is our guess at what the Gross Profit actually was:.3 x$234,500 = $70,350. Sales = COGS + Gross Profit We know what Beg. Inv. and Net Purchases are. Gross Profit Method - example Historically, Lin’s Supply has experienced a Gross Profit percentage of 30%. (est.) Ending Inventory = Goods Available for Sale – (est.) Cost of Goods Sold or 723,500 - 164,150 = 559,350 14.4

62. ©CourseCollege.com 62 Retail Inventory Method With this method, Inventory is recorded at expected retail sales price. Using the percentage gross profit used to “mark up” the inventory to retail, Cost of Goods Sold can be estimated: Cost of Goods Sold = Sales x (1- % [expected]Gross Profit) Using the percentage gross profit used to “mark up” the inventory to retail, Cost of Goods Sold can be estimated: Cost of Goods Sold = Sales x (1- % [expected]Gross Profit) 14.4

63. ©CourseCollege.com 63 Retail Inventory Method 1- % [expected]Gross Profit Can be described as the Cost to Retail ratio. 1- % [expected]Gross Profit Can be described as the Cost to Retail ratio. If inventory records are maintained at the marked up retail price, we can divide the historic cost of the inventory by the retail values and arrive at the Cost to Retail ratio. 14.4

64. ©CourseCollege.com 64 % COST TO RETAIL RATIO $ COST OF PURCHASED INVENTORY $STATED RETAIL VALUE OF INVENTORY What we paid for it For inventory sold when marked at retail, this becomes the estimate of % Cost of Goods Sold at retail. 14.4 Cost to Retail ratio What we hope to sell it for

65. ©CourseCollege.com 65 We can simply convert Ending Inventory at Retail to Ending Inventory at Cost by applying the Cost to Retail ratio: 73.1% x 1,429,024 = 1,045,177 Retail Method - example

66. ©CourseCollege.com 66 Retail Inventory Method Although this is an effective method for internal use, it is not acceptable under GAAP

67. ©CourseCollege.com 67 Objective 14.5: Calculate & explain inventory turnover and days sales in inventory O14.5

68. ©CourseCollege.com 68 Inventory turnover answers the following question: How many times did the firm sell their average inventory during the year? Inventory Turnover COGS Average Inventory Inventory Turnover O14.5 Remember to use the Average Inventory

69. ©CourseCollege.com 69 Days Sales in Inventory answers the following question: How many days sales of inventory remain in the present balance of inventory? Days Sales in Inventory COGS Ending Inventory Days Sales in Inventory O14.5 Remember to use the ending Inventory X 365

70. ©CourseCollege.com 70 Example –Inventory ratios O14.5

71. ©CourseCollege.com 71 End Unit 14