1. Inventory Costs What costs are in the inventory account? –all costs incurred to acquire goods and prepare them for sale. How is inventory valued on the Balance Sheet? Lower of Cost or Market (LCM) –item-by-item or aggregate

2. Inventory Equation Beginning Inventory + inflows - outflows = Ending Inventory BI + P - CGS = EI BI + P = CGS + EI CG Available for Sale = CGS + EI –Known: the amount of inventory you started with and the amount of inventory purchased (goods available for sale). –Determine: how much was sold and how much remains.

3. When do you determine CGS? Periodic Method –Count inventory at end of the period (EI) to determine the amount sold (CGS). –Since CGS is a plug, there is no control for shrinkage. Perpetual Method –Record CGS when each sale is made. –Periodic inventory counts determine any shrinkage.

4. Which inventory was sold? Inventory Flow Assumptions FIFO: First-In, First-Out –Oldest inventory is sold first Oldest costs are in CGS Most recent costs are in EI LIFO: Last-In, First-Out –Most recent inventory is sold first Most recent costs are in CGS Oldest costs are in EI

5. Other Inventory Flow Assumptions Weighted Average (Average Cost) –No assumption made. –Add all costs and divide by number of items available for sale to get an average price. Specific Identification

6. Summary of Cost Flow Assumptions Conceptual Advantages Disadvantages Specificspecifically costly to Identifi- identifies cost of implement cation goods sold FIFObalance sheet income statement approximates out of date current costs LIFOincome statement balance sheet approximates out of date current costs

7. LIFO is Special! LIFO Conformity Rule: –There is a tax effect and thus a real cash effect from this accounting choice LIFO Liquidations: More cash effects –Higher net income, but more taxes paid –Purchases made to avoid liquidations LIFO Disclosures: –LIFO Reserve: What would EI be using FIFO? –LIFO Liquidations: Did they occur?

8. Converting LIFO to FIFO Formulas: EI(F) = EI(L) + LIFO Reserve CGS(F) = CGS(L) - Increase in LIFO Reserve NI(F) = NI(L) + (1-t) [COGS(L) -COGS(F)] NI(F) = NI(L) + (1-t) [Increase in LIFO Reserve] Note: F = FIFO, L = LIFO