1. Chapter 6-1

2. Chapter 6-2 Chapter 6 Inventories Accounting Principles, Ninth Edition

3. Chapter 6-3 1. 1.Describe the steps in determining inventory quantities. 2. 2.Explain the accounting for inventories and apply the inventory cost flow methods. 3. 3.Explain the financial effects of the inventory cost flow assumptions. 4. 4.Explain the lower-of-cost-or-market basis of accounting for inventories. 5. 5.Indicate the effects of inventory errors on the financial statements. 6. 6.Compute and interpret the inventory turnover ratio. Study Objectives

4. Chapter 6-4 Statement Presentation and Analysis Reporting and Analyzing Inventory Taking a physical inventory Determining ownership of goods Classifying Inventory Determining Inventory Quantities Inventory Costing Inventory Errors Finished goods Work in process Raw materials Specific identification Cost flow assumptions Financial statement and tax effects Consistent use Lower-of- cost-or- market Income statement effects Balance sheet effects PresentationAnalysis

5. Chapter 6-5 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. Chapter 6-6

7. Chapter 6-7 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.

8. Chapter 6-8 Involves counting, weighing, or measuring each kind of inventory on hand. Taken, when the business is closed or when 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.

9. Chapter 6-9 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.

10. Chapter 6-10 Determining Inventory Quantities SO 1 Describe the steps in determining inventory quantities. Illustration 6-1 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. Terms of Sale

11. Chapter 6-11 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 SO 1 Describe the steps in determining inventory quantities.

12. Chapter 6-12 Consigned Goods In some lines of business, it is common to hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership of goods. These are called consigned goods. Determining Ownership of Goods Determining Inventory Quantities SO 1 Describe the steps in determining inventory quantities.

13. Chapter 6-13 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 accounting for inventories and apply the inventory cost flow methods. Cost Flow Assumptions

14. Chapter 6-14 An 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. Specific Identification Method Inventory Costing SO 2 Explain the accounting for inventories and apply the inventory cost flow methods.

15. Chapter 6-15 Young & Crazy Company makes the following purchases: 1. One item on 2/2/10 for $10 2. One item on 2/15/10 for $15 3. One item on 2/25/10 for $20 Young & Crazy Company sells one item on 2/28/10 for $90. What would be the balance of ending inventory, cost of goods sold, and net income for the month ended Feb. 28, 2010, assuming the company used the Specific Identification method to cost inventories and the item purchased on 2/15/10 is sold? Example Inventory Costing SO 2 Explain the accounting for inventories and apply the inventory cost flow methods.

16. Chapter 6-16 Purchase on 2/2/10 for $10 Young & Crazy Company Income Statement For the Month of Feb. 2010 Sales $ 90 Cost of goods sold 0 Gross profit 90 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 57 Taxes 17 Net Income $ 40 Inventory Costing SO 2 Explain the accounting for inventories and apply the inventory cost flow methods. Inventory Balance = $ 30 Purchase on 2/15/10 for $15 Purchase on 2/25/10 for $20 Assume one item is sold for $90

17. Chapter 6-17 Purchase on 2/2/10 for $10 Young & Crazy Company Income Statement For the Month of Feb. 2010 Sales $ 90 Cost of goods sold 15 Gross profit 75 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 42 Taxes 13 Net Income $ 29 “Specific Identification” Inventory Costing SO 2 Explain the accounting for inventories and apply the inventory cost flow methods. Inventory Balance = $ 30 Purchase on 2/15/10 for $15 Purchase on 2/25/10 for $20

18. Chapter 6-18 SO 2 Explain the accounting for inventories and apply the inventory cost flow methods. Inventory Costing – Cost Flow Assumptions 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

19. Chapter 6-19 Young & Crazy Company makes the following purchases: 1. One item on 2/2/10 for $10 2. One item on 2/15/10 for $15 3. One item on 2/25/10 for $20 Young & Crazy Company sells one item on 2/28/10 for $90. What would be the balance of ending inventory, cost of goods sold, and net income for the month ended Feb. 2010, assuming the company used the FIFO, LIFO, and Average-cost flow assumptions? Assume a tax rate of 30%. Example Inventory Costing – Cost Flow Assumptions SO 2 Explain the accounting for inventories and apply the inventory cost flow methods.

20. Chapter 6-20 Earliest goods purchased are first to be sold. Often parallels actual physical flow of merchandise. Generally good business practice to sell oldest units first. “First-In-First-Out (FIFO)” SO 2 Explain the accounting for inventories and apply the inventory cost flow methods. Inventory Costing – Cost Flow Assumptions

21. Chapter 6-21 Purchase on 2/2/10 for $10 Purchase on 2/15/10 for $15 Purchase on 2/25/10 for $20 Inventory Balance = $ 35 “First-In-First-Out (FIFO)” SO 2 Explain the accounting for inventories and apply the inventory cost flow methods. Inventory Costing – Cost Flow Assumptions Young & Crazy Company Income Statement For the Month of Feb. 2010 Sales $ 90 10 Cost of goods sold 10 Gross profit 80 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 47 Income before tax 47 14 Taxes 14 $ 33 Net Income $ 33

22. Chapter 6-22 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. “Last-In-First-Out (LIFO)” SO 2 Explain the accounting for inventories and apply the inventory cost flow methods. Inventory Costing – Cost Flow Assumptions

23. Chapter 6-23 Purchase on 2/2/10 for $10 Purchase on 2/15/10 for $15 Inventory Balance = $ 25 Purchase on 2/25/10 for $20 “Last-In-First-Out (LIFO)” SO 2 Explain the accounting for inventories and apply the inventory cost flow methods. Inventory Costing – Cost Flow Assumptions Young & Crazy Company Income Statement For the Month of Feb. 2010 Sales $ 90 20 Cost of goods sold 20 Gross profit 70 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 37 Income before tax 37 11 Taxes 11 $ 26 Net Income $ 26

24. Chapter 6-24 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. “Average-Cost” SO 2 Explain the accounting for inventories and apply the inventory cost flow methods. Inventory Costing – Cost Flow Assumptions

25. Chapter 6-25 Purchase on 2/2/10 for $10 Purchase on 2/15/10 for $15 Purchase on 2/25/10 for $20 Inventory Balance = $ 30 “Average Cost” SO 2 Explain the accounting for inventories and apply the inventory cost flow methods. Inventory Costing – Cost Flow Assumptions Young & Crazy Company Income Statement For the Month of Feb. 2008 Sales $ 90 15 Cost of goods sold 15 Gross profit 75 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 42 Income before tax 42 13 Taxes 13 $ 29 Net Income $ 29

26. Chapter 6-26 FIFO SO 3 Explain the financial effects of the inventory cost flow assumptions. Inventory Costing – Cost Flow Assumptions Sales$90$90$90 Cost of goods sold101520 Gross profit807570 Admin. & selling expense333333 Income before taxes474237 Income tax expense141311 Net income$33$29$26 Inventory balance$35$30$25 LIFOAverage Comparative Financial Statement Summary

27. Chapter 6-27 In Period of Rising Prices, FIFO Reports: FIFO Inventory Costing – Cost Flow Assumptions Highest Lowest Sales$90$90$90 Cost of goods sold101520 Gross profit807570 Admin. & selling expense333333 Income before taxes474237 Income tax expense141311 Net income$33$29$26 Inventory balance$35$30$25 LIFOAverage SO 3 Explain the financial effects of the inventory cost flow assumptions.

28. Chapter 6-28 In Period of Rising Prices, LIFO Reports: FIFO Inventory Costing – Cost Flow Assumptions Highest Lowest Sales$90$90$90 Cost of goods sold101520 Gross profit807570 Admin. & selling expense333333 Income before taxes474237 Income tax expense141311 Net income$33$29$26 Inventory balance$35$30$25 LIFOAverage SO 3 Explain the financial effects of the inventory cost flow assumptions.

29. Chapter 6-29 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 Costing – Cost Flow Assumptions SO 2 Explain the accounting for inventories and apply the inventory cost flow methods.

30. Chapter 6-30 In a period of inflation, 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. Review Question Inventory Costing – Cost Flow Assumptions SO 3 Explain the financial effects of the inventory cost flow assumptions.

31. Chapter 6-31 Q6-12 Casey Company has been using the FIFO cost flow method during a prolonged period of rising prices. During the same time period, Casey has been paying out all of its net income as dividends. What adverse effects may result from this policy? Discussion Question See notes page for discussion Inventory Costing – Cost Flow Assumptions SO 3 Explain the financial effects of the inventory cost flow assumptions.

32. Chapter 6-32 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 SO 3 Explain the financial effects of the inventory cost flow assumptions.

33. Chapter 6-33

34. Chapter 6-34 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 can “write down” the inventory to its market value in the period in which the price decline occurs. Market value = Replacement Cost Example of conservatism.

35. Chapter 6-35 Lower-of-Cost-or-Market Inventory Costing SO 4 Explain the lower-of-cost-or-market basis of accounting for inventories. BE6-7: Alou Appliance Center accumulates the following cost and market data at December 31. Compute the lower-of-cost-or-market valuation for the company’s total inventory. $ 12,000 9,500 12,800 $ 34,300

36. Chapter 6-36 Inventory Errors SO 5 Indicate the effects of inventory errors on the financial statements. Common Cause: Failure to count or price inventory correctly. Not properly recognizing the transfer of legal title to goods in transit. Errors affect both the income statement and balance sheet.

37. Chapter 6-37 Inventory Errors SO 5 Indicate the effects of inventory errors on the financial statements. Inventory errors affect the computation of cost of goods sold and net income. Income Statement Effects Illustration 6-17 Illustration 6-16

38. Chapter 6-38 Inventory Errors SO 5 Indicate the effects of inventory errors on the financial statements. Inventory errors affect the computation of cost of goods sold and net income in two periods. An error in ending inventory of the current period will have a reverse effect on net income of the next accounting period. Over the two years, the total net income is correct because the errors offset each other. The ending inventory depends entirely on the accuracy of taking and costing the inventory. Income Statement Effects

39. Chapter 6-39 Inventory Errors SO 5 Indicate the effects of inventory errors on the financial statements. ($3,000) Net Income understated $3,000 Net Income overstated Combined income for 2-year period is correct. Illustration 6-18

40. Chapter 6-40 Understating ending inventory will overstate: a.assets. b.cost of goods sold. c.net income. d.owner's equity. Review Question Inventory Errors SO 5 Indicate the effects of inventory errors on the financial statements.

41. Chapter 6-41 Inventory Errors SO 5 Indicate the effects of inventory errors on the financial statements. Effect of inventory errors on the balance sheet is determined by using the basic accounting equation:. Balance Sheet Effects Illustration 6-16 Illustration 6-19

42. Chapter 6-42 Statement Presentation and Analysis Balance Sheet - Inventory classified as current asset. Income Statement - Cost of goods sold subtracted from sales. There also should be disclosure of 1) major inventory classifications, 2) basis of accounting (cost or LCM), and 3) costing method (FIFO, LIFO, or average). Presentation

43. Chapter 6-43 Statement Presentation and Analysis 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. Analysis SO 6 Compute and interpret the inventory turnover ratio.

44. Chapter 6-44 Inventory turnover measures the number of times on average the inventory is sold during the period. Cost of Goods Sold Average Inventory Inventory Turnover = Statement Presentation and Analysis Days in inventory measures the average number of days inventory is held. Days in Year (365) Inventory Turnover Days in Inventory = SO 6 Compute and interpret the inventory turnover ratio.

45. Chapter 6-45 BE6-9 At December 31, 2011, the following information was available for J. Graff Company: ending inventory $40,000, beginning inventory $60,000, cost of goods sold $270,000, and sales revenue $380,000. Calculate inventory turnover and days in inventory for J. Graff Company. Statement Presentation and Analysis SO 6 Compute and interpret the inventory turnover ratio. $270,000 ($60,000 + 40,000) / 2 5.4 = Inventory Turnover 365 5.4 67.59 days = Days in Inventory

46. Chapter 6-46 Example Cost Flow Methods in Perpetual Systems SO 7 Apply the inventory cost flow methods to perpetual inventory records. Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Average cost. Appendix 6A

47. Chapter 6-47 Perpetual Inventory FIFO Method + Cost Flow Methods in Perpetual Systems SO 7 Apply the inventory cost flow methods to perpetual inventory records.

48. Chapter 6-48 LIFO Method Cost Flow Methods in Perpetual Systems SO 7 Apply the inventory cost flow methods to perpetual inventory records. Perpetual Inventory +

49. Chapter 6-49 Perpetual Inventory Moving Average Cost per unit sold is determined by dividing total inventory $ by total units on hand after each purchase. + Cost Flow Methods in Perpetual Systems SO 7 Apply the inventory cost flow methods to perpetual inventory records.

50. Chapter 6-50 Perpetual Inventory Moving Average Cost per unit sold is determined by dividing total inventory $ by total units on hand after each purchase. + Cost Flow Methods in Perpetual Systems SO 7 Apply the inventory cost flow methods to perpetual inventory records.

51. Chapter 6-51 Estimating Inventories The gross profit method estimates the cost of ending inventory by applying a gross profit rate to net sales. Gross Profit Method SO 8 Describe the two methods of estimating inventories. Illustration 6B-1

52. Chapter 6-52 Estimating Inventories *BE6-11 At May 31, Creole Company has net sales of $330,000 and cost of goods available for sale of $230,000. Compute the estimated cost of the ending inventory, assuming the gross profit rate is 35%. SO 8 Describe the two methods of estimating inventories.

53. Chapter 6-53 Estimating Inventories Company applies the cost-to-retail percentage to ending inventory at retail prices to determine inventory at cost. Retail Inventory Method SO 8 Describe the two methods of estimating inventories. Illustration 6B-3

54. Chapter 6-54 Estimating Inventories *BE6-12 On June 30, Fabre Fabrics has the following data pertaining to the retail inventory method: Goods available for sale: at cost $35,000, at retail $50,000; net sales $40,000, and ending inventory at retail $8,000. Compute the estimated cost of the ending inventory using the retail inventory method. SO 8 Describe the two methods of estimating inventories.

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