1. Chapter 5 Accounting for Inventories: (OMIT pgs 276-277 & page 282) McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2. LO 1 Determine the amount of cost of goods sold and ending inventory using the FIFO, LIFO, weighted average, and specific identification cost flow methods. 5-1

3. Inventory Cost Flow Methods Four Acceptable Inventory “Cost Flow” Methods Specific Identification First-in, First- Out (FIFO) Last-in, First- Out (LIFO) Weighted Average 5-2

4. Specific Identification When a company’s inventory consists of many high-priced, low-turnover goods the record keeping necessary to use specific identification is more practical. 5-3

5. Specific Identification Assume TMBC Company purchased two identical inventory items: the first for $100 and the second for $110. Using specific identification, when the first item is sold, cost of goods sold would be $100. When the second item is sold, cost of goods sold would be $110. 5-4

6. First-in, First-out The first-in, first-out cost flow method requires that the cost of the items purchased first be assigned to Cost of Goods Sold. 5-5

7. First-in, First-out Assume TMBC Company purchased two identical inventory items: the first for $100 and the second for $110. Using first-in, first-out, the cost assigned to the first item sold would be $100 (the first cost in). The cost of goods sold assigned to the second item sold would be $110. 5-6

8. Last-in, First-out The last-in, first-out cost flow method requires that the cost of the items purchased last be assigned to Cost of Goods Sold. 5-7

9. Last-in, First-out Assume TMBC Company purchased two identical inventory items: the first for $100 and the second for $110. Using last-in, first-out, the cost assigned to the first item sold would be $110 (the last cost in). The cost of goods sold assigned to the second item sold would be $100. 5-8

10. Weighted Average The weighted average cost flow method assigns the average cost of the items available to Cost of Goods Sold. 5-9

11. Weighted Average Assume TMBC Company purchased two identical inventory items: the first for $100 and the second for $110. Using weighted average, the cost assigned to the first item sold would be $105 (the average cost). Total Cost Total Number = $210 2 = $105 5-10

12. Physical Flow Note: Our discussions about inventory cost flow methods pertain to the flow of costs through the accounting records, NOT the actual physical flow of goods! Cost flows can be done on a different basis than physical flow. 5-11

13. Effect of Cost Flow on Income Statement The cost flow method a company uses can significantly affect the gross margin reported in the income statement. 5-12

14. Effect of Cost Flow on Balance Sheet Since total product costs are allocated between costs of goods sold and ending inventory, the cost flow method used affects its balance sheet as well. 5-13

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16. Inventory Cost Flow Under a Perpetual System First-in, First-Out (FIFO) Last-in, First- Out (LIFO) Weighted Average Sold 43 bikes for $350 each 5-15

17. Inventory Cost Flow Under a Perpetual System Goods Available for Sale must be allocated between the Cost of Goods Sold and Ending Inventory We use one of these three methods: 5-16 First-in, First-Out (FIFO) Last-in, First- Out (LIFO) Weighted Average

18. First-in, First-out Inventory Cost Flow (FIFO) 5-17

19. Last-in, First-out Inventory Cost Flow (LIFO) 5-18

20. Weighted Average Inventory Cost Flow (WAVG) Total Cost Total Number = $12,650 55 = $230 5-19

21. Comparative Financial Statements and the Impact of Income Taxes 5-20

22. LO 2 Apply the lower-of-cost- or-market rule to inventory valuation. 5-21

23. Lower of Cost or Market (LCM) Inventory must be reported at lower of cost or market. Applied three ways: (1)separately to each individual item. (2)to major classes or categories of assets. (3)to the whole inventory. Applied three ways: (1)separately to each individual item. (2)to major classes or categories of assets. (3)to the whole inventory. Market is defined as current replacement cost (not sales price). Consistent with the conservatism principle. Market is defined as current replacement cost (not sales price). Consistent with the conservatism principle. 5-22

24. Lower of Cost or Market (LCM) To illustrate lower of cost or market, assume The Mountain Bike Company has in ending inventory 100 t-shirts purchased at a cost of $14 each. 5-23

25. 5-24

26. LO 3 Explain how fraud can be avoided through inventory control. 5-25

27. Fraud Avoidance in Merchandising Businesses Because inventory and cost of goods sold accounts are so significant, they are attractive targets for concealing fraud. Because of this, auditors and financial analysts carefully examine them for signs of fraud. 5-26

28. If Ending Inventory is overstated then Cost of Goods Sold will be understated. 5-27

29. If Cost of Goods Sold is understated, then Gross Margin is overstated. Resulting in overstatement of Net Income. 5-28

30. Then, on the balance sheet Inventory is overstated and Retained Earnings is overstated. 5-29

31. LO 5 Explain the importance of inventory turnover to a company’s profitability. 5-30

32. Inventory Turnover Cost of Goods Sold Inventory This measures how quickly a company sells its merchandise inventory. This is the first step in calculating the average number of days to sell inventory. 5-31

33. Average Number of Days to Sell Inventory 365 Inventory Turnover This measures how many days, on average, it takes to sell inventory. Other things being equal, the company with the lower average number of days to sell inventory is doing better. 5-32

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35. End of Chapter Five 5-34