7-1 M EASURING A ND R EPORTING I NVENTORIES CHAPTER 7.

7-1

MEASURING AND

REPORTING INVENTORIES

CHAPTER 7CHAPTER 7

.

7-2

InventoryInventory

“Inventory is often the largest and most important asset owned by a merchandising company.”

What is the biggest expense on the income statement?

Cost of Goods Sold

What are the two major factors in determining Cost of Goods Sold?

(Beg. Inventory + Purchases - End. Inventory)

7-3

InventoryInventory

Inventory is where the action is! It’s a real can of worms.

7-4

Balance Sheet AmountBalance Sheet Amount

The inventory dollar amount on the balance sheet is the product of what two factors? (i.e., What? x What?)

Balance Sheet Amount = Quantity x Cost

“War stories” aboutinventory observations

7-5

Inventory Costs IncludeInventory Costs Include

Invoice price

Insurance while in transit

Transportation

Handling costs to get the inventory ready for salee.g., washing cars

(i.e., all costs to get the inventory into a position and condition for resale.)

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7-6

Errors in inventory may cause misstatements in the following areas:

Income StatementCOGS, Gross Margin,

Net Income

Balance SheetInventory, Retained Earnings

Impact of Inventory ErrorsImpact of Inventory Errorson Financial Statementson Financial Statements

7-7


Assume that the inventory at the end of 19A is misstated.

What is the impact of the error on the Income Statements and Balance Sheets for 19A and 19B?

19A 19B

Error

12-31 12-31

Income Statement: Impact of Error? Year Ended 12-31-19A Year Ended 12-31-19BBalance Sheet: 12-31-19A 12-31-19B

Wrong End Inv, COGS, GM, Net IncomeWrong Beg Inv, COGS, GM, Net Income

Wrong Inventory and Retained EarningsNothing wrong! The error "washes out" (i.e., counterbalances)

7-8


O.K.O.K.

5k over

O.K.

5k over

5k over

5k over

5k over

5k under

O.K.

7-9


O.K.

O.K.5k over

O.K.

5k over5k under

5k under

5k over

5k over

O.K.!!!

O.K.

5k under

7-10


Additional proof that Retained Earnings at the end of Year 2 are O.K.

Retained Earnings

5,000 over5,000 underO.K.!!!

120,000 Balance 1-1-98 55,000 Net Income - 1998 86,500 Net Income - 1999261,500 Balance 12-31-99

As recordedAs recorded

Proof that sometimes, in fact, two wrongs do make a right!

7-11

Effects of Errors in InventoryEnding Inventory Beginning Inventory

Understated Overstated Understated OverstatedCost of Goods Sold Overstated Understated Understated OverstatedNet Income Understated Overstated Overstated Understated

Here is a summary of the the material we just finished.

250

Why

bother?


7-12


There is a much simpler way of getting the effect of an error on net income.

I call it the “sneaky way” because it uses the balance sheet equation.

As before in ILL. 7.1, if inventory at 12-31-98 is overstated by $5,000, determine the effect on 1998 net income as follows:

12-31-98A = L + S/E

OverstatedOverstated by 5K by 5K Overstated Overstated

by 5Kby 5K

7-13

Methods of DeterminingMethods of DeterminingInventory CostInventory Cost

Perpetual Method

vs.

Periodic Method

7-14

Perpetual Inventory ProcedurePerpetual Inventory Procedure

The inventory account is continuouslyupdated for . . .

Inventory purchases Purchase returns Inventory sales Sales returns

7-15

Comparing Journal EntriesComparing Journal Entries

For comparison, let’s make the journal entries for each of the following transactions using both the

periodic and perpetual methods. Keep in mind that sales under the perpetual method require sales under the perpetual method require

two journal entriestwo journal entries.

7-16


On September 5, Worley Co. purchased 100 units of inventory for $30 per unit.

GENERAL JOURNAL Page 1Date Description PR Debit Credit

PERIODIC

PERPETUAL

7-17


On September 5, Worley Co. purchased 100 units of inventory for $30 per unit.


9/5 Purchases 3,000 Accounts Payable 3,000

9/5 Merchandise Inventory 3,000 Accounts Payable 3,000

PERIODIC

PERPETUAL

7-18


On September 7, Worley Co. sold 10 of the previously purchased units for $50 each.


PERIODIC

PERPETUAL

7-19


On September 7, Worley Co. sold 10 of the previously purchased units for $50 each.


9/7 Accounts Receivable 500

Sales 500

9/7 Accounts Receivable 500

Sales 500

Cost of Goods Sold 300

Merchandise Inventory 300

PERIODIC

PERPETUAL

AT SALES PRICE

AT COST

The Cost of Goods Sold account is an expense account and is closed to Income Summary at the end

of the period just like all other expense accounts.

The Cost of Goods Sold account is an expense account and is closed to Income Summary at the end

of the period just like all other expense accounts.

7-20


On Sept. 8, Worley Co. returned 2 of the previously purchased units as defective.


Periodic

Perpetual

7-21


On Sept. 8, Worley Co. returned 2 of the previously purchased units as defective.


9/8 Accounts Payable 60

Purchase Returns and Allowances 60

( 2 @ $30 per units = $60)

9/8 Accounts Payable 60

Merchandise Inventory 60

Periodic

Perpetual

7-22

Inventory Cost Flow MethodsInventory Cost Flow Methods

Specific identification

First-in, first-out (FIFO)

Last-in, first-out (LIFO)

Weighted average

7-25

Reminder from the “Saturday Night Page”


Calculation of Cost of Goods Sold

Beginning Inventory

+ Purchases, etc

Cost of Goods Available for Sale

- Ending Inventory

Cost of Goods Sold

So, GAS - EI = CGS Or, GAS = EI + CGS

(The top part is not relevant to this discussion.)

7-26

Ending Inventory Cost of Goods Sold

Cost of Goods Available for Sale


7-27

Specific IdentificationSpecific Identification

Attaches actual cost to an identifiable unit of product

Used for relatively large inventory items Frequently identified by serial number

7-28

First-In, First-OutFirst-In, First-Out

COST OF GOODS

AVAILABLE FOR SALE

7-29


Cost of Goods Sold

Cost of Goods Sold

Ending InventoryEnding

Inventory

Oldest CostsOldest Costs

Newest CostsNewest Costs

7-30

First-In, First-OutFirst-In, First-OutPeriodic Inventory ProcedurePeriodic Inventory Procedure

The following schedule shows the mouse pad inventory for Computers, Inc. for September.

The physical inventory count shows 800800 mouse pads in ending inventory.

Use the FIFO procedure to determine:

(1) Ending inventory

(2) Cost of goods sold

7-31

First-In, First-OutFirst-In, First-OutPeriodic Inventory ProcedurePeriodic Inventory Procedure Computer, Inc. Mouse Pad Inventory

Date Units Unit Cost TotalBI 1,000 5.25$ 5,250.00$

9/3 Pur. 100 5.30 530.00 9/15 Pur. 150 5.60 840.00 9/21 Pur. 200 5.80 1,160.00 9/29 Pur. 100 5.90 590.00

Goods available for sale 1,550 8,370.00$ Ending inventory 800 Cost of goods sold 750

7-32

First-In, First-OutFirst-In, First-OutPeriodic Inventory ProcedurePeriodic Inventory Procedure Computer, Inc. Mouse Pad Inventory

Date Units Unit Cost TotalBI 1,000 5.25$ 5,250.00$ 9/3 100 5.30 530.00

9/15 150 5.60 840.00 9/21 Pur. 200 5.80 1,160.00 9/29 Pur. 100 5.90 590.00


Remember: Remember: FIFO ending inventory is calculated using the cost of the newest purchases. Start with 9/29 and then add other purchases until

you reach the number of units in ending inventory.

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Cost of

Computer, Inc.Mouse Pad Inventory

Date Beg. Inv. Purchases End Inv. Goods Sold

9/29 100@$5.90 100@$5.90Units 100

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Cost of



9/21 200@$5.80 200@$5.809/29 100@$5.90 100@$5.90Units 300

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Cost of



9/15 150@$5.60 150@$5.609/21 200@$5.80 200@$5.809/29 100@$5.90 100@$5.90Units 450

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Cost of



9/3 100@$5.30 100@$5.309/15 150@$5.60 150@$5.609/21 200@$5.80 200@$5.809/29 100@$5.90 100@$5.90Units 550

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Cost of


Date Beg. Inv. Purchases End Inv. Goods SoldBI 1000@$5.25

250@$5.259/3 100@$5.30 100@$5.309/15 150@$5.60 150@$5.609/21 200@$5.80 200@$5.809/29 100@$5.90 100@$5.90

800Units

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Cost of


Date Beg. Inv. Purchases End Inv. Goods SoldBI 1000@$5.25 750@$5.25

250@$5.259/3 100@$5.30 100@$5.309/15 150@$5.60 150@$5.609/21 200@$5.80 200@$5.809/29 100@$5.90 100@$5.90Units 800 750Costs 4,432.50$ 3,937.50$

Cost of Goods Available for Sale $8,370.00

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Cost of


Date Beg. Inv. Purchases End Inv. Goods SoldBI 1000@$5.25 750@$5.25

250@$5.259/3 100@$5.30 100@$5.309/15 150@$5.60 150@$5.609/21 200@$5.80 200@$5.809/29 100@$5.90 100@$5.90Units 800 750Costs 4,432.50$ 3,937.50$

Cost of Goods Available for Sale $8,370.00

7-40

Last-In, First-OutLast-In, First-Out

7-41


Ending InventoryEnding

Inventory

Cost of Goods Sold

Cost of Goods Sold

Oldest CostsOldest Costs

Newest CostsNewest Costs

7-42

Last-In, First-OutLast-In, First-OutPeriodic Inventory ProcedurePeriodic Inventory Procedure



Use the LIFO periodic procedure to determine:



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Last-In, First-OutLast-In, First-OutPeriodic Inventory ProcedurePeriodic Inventory Procedure Computer, Inc. Mouse Pad Inventory


9/3 Pur. 100 5.30 530.00 9/15 Pur. 150 5.60 840.00 9/21 Pur. 200 5.80 1,160.00 9/29 Pur. 100 5.90 590.00

Goods available for sale 1,550 8,370.00$

Ending inventory 800 Cost of goods sold 750

7-44

Last-In, First-OutLast-In, First-OutPeriodic Inventory ProcedurePeriodic Inventory Procedure Computer, Inc. Mouse Pad Inventory


9/3 Pur. 100 5.30 530.00 9/15 Pur. 150 5.60 840.00

9/21 200 5.80 1,160.00 9/29 100 5.90 590.00


Remember: Remember: LIFO ending inventory is calculated using the cost of the oldest

purchases. Start with beginning inventory and then add other

purchases until you reach the number of units in ending inventory.

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Date Beg. Inv. Purchases End Inv.Cost of

Goods SoldBI 1000@$5.25 800@$5.25

Units 800

7-46




Goods SoldBI 1000@$5.25 800@$5.25

200@$5.25

Units 800 200

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Goods SoldBI 1000@$5.25 800@$5.25

200@$5.259/3 100@$5.30 100@$5.30

800 300

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Goods SoldBI 1000@$5.25 800@$5.25

200@$5.259/3 100@$5.30 100@$5.309/15 150@$5.60 150@$5.609/21 200@$5.80 200@$5.809/29 100@$5.90 100@$5.90Units 800 750

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Goods SoldBI 1000@$5.25 800@$5.25

200@$5.259/3 100@$5.30 100@$5.309/15 150@$5.60 150@$5.609/21 200@$5.80 200@$5.809/29 100@$5.90 100@$5.90Units 800 750Costs 4,200.00$ 4,170.00$

Cost of goods available for sale $8,370.00

7-50

Weighted-AverageWeighted-AveragePeriodic Inventory ProcedurePeriodic Inventory Procedure

7-51

Weighted-AverageWeighted-AveragePeriodic Inventory ProcedurePeriodic Inventory Procedure

Cost per unit Goods Available for Sale in $_ Goods Available for Sale in units

Ending InventoryEnding Inv. = Cost per unit x No. Units in Ending Inv.

7-52

Weighted-AverageWeighted-Average Periodic Inventory ProcedurePeriodic Inventory Procedure



Use the weighted-average periodic procedure to determine:



7-53



Date Units $/Unit TotalBeg. Inventory 1,000 $5.25 $5,250.00

9/3 100 5.30 530.00 9/15 150 5.60 840.00 9/21 200 5.80 1,160.00 9/29 100 5.90 590.00

Goods Available for Sale 1,550 $8,370.00

Ending Inventory - 800 Goods Sold 750

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9/3 100 5.30 530.00 9/15 150 5.60 840.00 9/21 200 5.80 1,160.00 9/29 100 5.90 590.00


Ending Inventory - 800 Goods Sold 750


$8,370 ÷ 1,550 = $5.40 weighted-average

7-55




9/3 100 5.30 530.00 9/15 150 5.60 840.00 9/21 200 5.80 1,160.00 9/29 100 5.90 590.00


Ending Inventory - 800 5.40 = - 4,320.00 Goods Sold 750 $4,050.00

×

$8,370 ÷ 1,550 = $5.40 weighted-average

7-56

Effect of Different Cost Flow Effect of Different Cost Flow Methods on Inventory and CGSMethods on Inventory and CGS

FIFO LIFO Wtd. Avg.Goods Available for

Sale $8,370.00Ending Inventory 4,320.00 Cost of Goods Sold $4,050.00

$8,370.004,200.00

$4,170.00

$8,370.004,432.50

$3,937.50


In the previous examples of the three cost flow methods, what are the two possibilities for

what happened to GAS as of year end? Became either: (1) Ending Inventory or

(2) Cost of Goods Sold

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255

Facts for all 4 Cost Flow Examples

Goods Available for Sale

Also see Illustrations 7.7, 7.8, 7.10 & 7.12

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ILL. 7.18 (Periodic)

264

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7-60

Perpetual Inventory ProcedurePerpetual Inventory Procedure

Now let’s turn our attention to the perpetual inventory procedure.

7-61

FIFOFIFOPerpetual Inventory ProcedurePerpetual Inventory Procedure

Let’s start with some fresh information. Computers, Inc. has 1,2001,200 units in inventory on November 30. The company started the

month of November with 1,000 units on hand at a cost of $5.25 per unit.

The company uses the FIFO perpetual procedure to determine:



7-62


To calculate the FIFO cost for ending inventory and cost of goods sold, we we

must know when each unit must know when each unit was soldwas sold. In this example

we will provide information for purchases and sales as it is needed.

7-63


Date Beg. Bal. Purchases BalanceCost of

Goods SoldBI 1,000@$5.25 1,000@$5.25


On November 3rd, 300units were purchased

at $5.30 per unit. We needto update the inventory.

On November 3rd, 300units were purchased


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Goods SoldBI 1,000@$5.25 1,000@$5.2511/3 300@$5.30 300@$5.30

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Goods SoldBI 1,000@$5.25 1,000@$5.2511/3 300@$5.30 300@$5.30

On November 5th, 600units were sold. We needto update the inventory.


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Goods SoldBI 1,000@$5.25 400@$5.2511/3 300@$5.30 300@$5.3011/5 600@$5.25

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FIFO FIFO Perpetual Inventory ProcedurePerpetual Inventory Procedure



Goods SoldBI 1,000@$5.2511/3 300@$5.3011/5

On November 10th, 150units were purchased




400@$5.25300@$5.30

600@$5.25

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Goods SoldBI 1,000@$5.2511/3 300@$5.3011/511/10 150@$5.60 150@$5.60

400@$5.25300@$5.30

600@$5.25

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Goods SoldBI 1,000@$5.2511/3 300@$5.3011/511/10 150@$5.60 150@$5.60





400@$5.25300@$5.30

600@$5.25

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Goods SoldBI 1,000@$5.2511/3 300@$5.3011/511/10 150@$5.60 150@$5.6011/14 200@$5.80 200@$5.80

400@$5.25300@$5.30

600@$5.25

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Goods SoldBI 1,000@$5.2511/3 300@$5.3011/511/10 150@$5.60 150@$5.6011/14 200@$5.80 200@$5.80



400@$5.25300@$5.30

600@$5.25

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Goods SoldBI 1,000@$5.2511/3 300@$5.3011/511/10 150@$5.6011/14 200@$5.8011/17 400@$5.25

200@$5.30600@$5.25

100@$5.30

150@$5.60200@$5.80

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Goods SoldBI 1,000@$5.2511/3 300@$5.3011/511/10 150@$5.6011/14 200@$5.8011/17

On November 23rd, 400units were sold. We needto update the inventory.

On November 23rd, 400units were sold. We needto update the inventory.

400@$5.25

200@$5.30600@$5.25

100@$5.30

150@$5.60200@$5.80

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Goods SoldBI 1,000@$5.2511/3 300@$5.3011/511/10 150@$5.6011/14 200@$5.8011/17

11/23

400@$5.25

600@$5.25

100@$5.30

150@$5.80

200@$5.30150@$5.60 50@$5.80

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Goods SoldBI 1,000@$5.2511/3 300@$5.3011/511/10 150@$5.6011/14 200@$5.8011/17

11/23

400@$5.25

600@$5.25

100@$5.30

150@$5.80

200@$5.30150@$5.60 50@$5.80







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Goods SoldBI 1,000@$5.2511/3 300@$5.3011/511/10 150@$5.6011/14 200@$5.8011/17

11/23

400@$5.25

600@$5.25

100@$5.30

150@$5.80

200@$5.30150@$5.60 50@$5.80

11/30 150@$5.90 150@$5.90

7-77

LIFOLIFOPerpetual Inventory ProcedurePerpetual Inventory Procedure

You are not responsible for this method.

260

7-78


PeriodicInventorySystem


PerpetualInventorySystem


Cost of Goods Sold Cost of Goods SoldSame

EndingInventory

EndingInventory

Same

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Cost of Goods Sold Different

EndingInventory

Cost of Goods Sold

Different Ending Inventory

7-80

Weighted-AverageWeighted-AveragePerpetual Inventory ProcedurePerpetual Inventory Procedure

You are not responsible for this method.

261

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Advantages and Disadvantages Advantages and Disadvantages of FIFOof FIFO

AdvantagesAdvantages Easy to apply. Inventory value

approximates current cost.

Flow of costs tends to be consistent with usual physical flow of goods.

Systematic and objective.

Not subject to manipulation.

262

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Advantages and Disadvantages Advantages and Disadvantages of FIFOof FIFO

AdvantagesAdvantages Easy to apply. Inventory value

approximates current cost.

Flow of costs tends to be consistent with usual physical flow of goods.

Systematic and objective.

Not subject to manipulation.

DisadvantagesDisadvantages Does not match current

cost of goods sold with current revenues.

Inventory (or paper) profits.

In periods of rising prices, pay higher income taxes.

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Advantages and Disadvantages Advantages and Disadvantages of LIFOof LIFO

Advantages In periods of rising

prices, pay less taxes. Matches latest

inventory costs with current revenues.

Disadvantages LIFO conformity rule

for tax and book purposes.

Cost of record keeping higher.

Inventory valuation is at older costs.

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In Periods of Rising Prices. . .In Periods of Rising Prices. . .

LIFOLIFO Matches high

(newer) costs with current (higher) sales.

Values inventory on low (older) cost basis.

Results in lower taxable income.

FIFOFIFO Matches low (older)

costs with current (higher) sales.

Values inventory approximating higher current costs.

Results in higher taxable income.

7-85

GAAP requires inventory be valued at the Lower of Cost or Market (LCM). Cost Cost refers to the invoice price and other costs

such as transportation. It is determined by one of the four inventory cost flow methods previously discussed.

Market Market generally refers to the replacement cost of the inventory.

LCM is called the inventory “valuation method”

Departures From Cost Basis of Departures From Cost Basis of Inventory ValuationInventory Valuation

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Departures From Cost Basis of Departures From Cost Basis of Inventory ValuationInventory Valuation

Lower-of-Cost-or-Market Method (LCM)

Item Quantity Unit CostUnit

Market Total Cost

Total Market LCM**

Mouse pad 800 5.75$ 4.50$ 4,600$ 3,600$ 3,600$ Diskettes 1,000 2.19 2.25 2,190 2,250 2,190 Keyboard 75 27.00 29.00 2,025 2,175 2,025

8,815$ 8,025$ 7,815$

**LCM applied on an item-by-item basis.

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Estimating InventoryEstimating Inventory

Necessary due to fire, theft, and interim reporting, primarily when

using the periodic inventory method.

Methods for Estimating Gross Margin Method Retail Inventory Method

Not responsible for this one

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Gross Margin MethodGross Margin Method

To use this method we must know the following:

Net sales for the period. Cost of beginning inventory. Net purchases for the period. The historical gross margin rate.

7-89

Because of a May 31st fire at its warehouse, DonCo, Inc. must use the gross margin method to estimate the value of its lost inventory. The controller develops the following information: gross profit 43% of sales; Inventory at May 1

$237,400; net purchases for May $728,300; net sales for May $1,213,000.

Let’s estimate inventory at May 31.


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Gross Margin MethodGross Margin MethodBeginning inventory, May 1 237,400$ Net purchases for May 728,300 Cost of goods available for sale 965,700$

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Net sales for May 1,213,000$ Estimated gross profit percentage 43%

Estimated gross profit 521,590$

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Net sales for May 1,213,000$ Estimated gross profit 521,590 Estimated cost of goods sold 691,410$

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Net sales for May 1,213,000$ Estimated gross profit 521,590 Estimated cost of goods sold 691,410$

Cost of goods available for sale 965,700$ Less: Estimated cost of goods sold 691,410 Estimated inventory, May 31 274,290$

7-94


Proof of EstimateSales for May 1,213,000$ Cost of goods sold: Beginning inventory 237,400$ Net purchases 728,300 Cost of goods available for sale 965,700 Estimated ending inventory 274,290

Cost of goods sold 691,410 Gross profit for May 521,590$

269

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THEEND(Almost)

7-1 M EASURING A ND R EPORTING I NVENTORIES CHAPTER 7.

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Transcript of 7-1 M EASURING A ND R EPORTING I NVENTORIES CHAPTER 7.