Chapter 6-1. Chapter 6-2 Reporting and Analyzing Inventory Financial Accounting, Fifth Edition.

Chapter 6-1

Chapter 6-2

Reporting and Analyzing Inventory

Financial Accounting, Fifth Edition

Chapter 6-3

1. Describe the steps in determining inventory quantities.

2. Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.

3. Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

4. Explain the lower-of-cost-or-market basis of accounting for inventories.

5. Compute and interpret the inventory turnover ratio.

6. Describe the LIFO reserve and explain its importance for comparing results of different companies.

7. Apply the inventory cost flow methods to perpetual inventory records.

8. Indicate the effects of inventory errors on the financial statements.

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Chapter 6-4

Illustration 2-2

The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet

Chapter 6-5

Classifying InventoryClassifying InventoryClassifying InventoryClassifying 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.

Chapter 6-6

Physical Inventory taken for two reasons:Perpetual System

1. Check accuracy of inventory records.

2. Determine amount of inventory lost.

Periodic System

1. Determine the inventory on hand.

2. Determine the cost of goods sold for the period.

Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities

SO 1 Describe the steps in determining inventory quantities.SO 1 Describe the steps in determining inventory quantities.

Chapter 6-7

when the business is closed or when business is slow.

at end of the accounting period.

Taking a Physical InventoryTaking a Physical Inventory



Chapter 6-8

Goods in Transit

Purchased goods not yet received.

Sold goods not yet delivered.

Determining Ownership of Determining Ownership of GoodsGoods



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.

Chapter 6-9



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 SaleTerms of Sale

Chapter 6-10

Consigned Goods

Goods held for sale by one party although ownership of the goods is retained by another party.

Determining Ownership of Determining Ownership of GoodsGoods



Chapter 6-11

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 CostingInventory CostingInventory CostingInventory Costing

SO 2 SO 2 Explain the basis of accounting for inventories and apply Explain the basis of accounting for inventories and apply the the inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.inventory system.

Cost Flow Assumptio

ns

Chapter 6-12

An actual physical flow costing method.

Practice is relatively rare.

Most companies make assumptions (Cost

Flow Assumptions) about which units were

sold.

Specific Identification MethodSpecific Identification Method



Chapter 6-13

Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions

Illustration 6-11Use of cost flow methods in major U.S. companies

Cost Flow

Assumption

does not need to

equal

Physical Movement

of Goods


Chapter 6-14

Illustration: Data for Houston Electronics’ Astro condensers.


Illustration 6-4

(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold


Chapter 6-15

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)”First-In-First-Out (FIFO)”



Chapter 6-16

“First-In-First-Out (FIFO)”


Illustration 6-5


SolutioSolution on n on

notes notes pagepage

Chapter 6-17

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)”Last-In-First-Out (LIFO)”



Chapter 6-18

““Last-In-First-Out Last-In-First-Out (LIFO)”(LIFO)”


Illustration 6-7

SO 2 SO 2 Explain the basis of accounting for inventories and apply the Explain the basis of accounting for inventories and apply the inventory inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.system.



Chapter 6-19

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”Average Cost”



Chapter 6-20

““Average Cost”Average Cost”


Illustration 6-10




Chapter 6-21

FIFO

LO 3 LO 3 Explain the financial statement and tax effects Explain the financial statement and tax effects of of each of the inventory cost flow each of the inventory cost flow assumptions.assumptions.


Sales $9,000 $9,000 $9,000

Cost of goods sold 6,200 6,600 7,000

Gross profit 2,800 2,400 2,000

Admin. & selling expense 330 330 330

Income before taxes 2,470 2,070 1,670

Income tax expense 140 120 110

Net income $2,330 $1,950 $1,560

Inventory balance $5,800 $5,400 $5,000

LIFOAverage

Comparative Financial Statement Summary

Chapter 6-22

FIFO


Sales $9,000 $9,000$9,000

Cost of goods sold 6,200 6,6007,000

Gross profit 2,800 2,4002,000

Admin. & selling expense 330 330330

Income before taxes 2,470 2,0701,670

Income tax expense 140 120110

Net income $2,330 $1,950$1,560

Inventory balance $5,800 $5,400$5,000

LIFOAverage

In Period of Rising Prices, FIFO Reports:

Highest

Lowest


Chapter 6-23

FIFO


Sales $9,000 $9,000$9,000

Cost of goods sold 6,200 6,6007,000

Gross profit 2,800 2,4002,000

Admin. & selling expense 330 330330

Income before taxes 2,470 2,0701,670

Income tax expense 140 120110

Net income $2,330 $1,950$1,560

Inventory balance $5,800 $5,400$5,000

LIFOAverage

In Period of Rising Prices, LIFO Reports:

Lowest

Highest


Chapter 6-24

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



Chapter 6-25

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



Chapter 6-26

Lower-of-Cost-or-MarketLower-of-Cost-or-Market


SO 4 Explain the lower-of-cost-or-SO 4 Explain the lower-of-cost-or-market basis of accounting for market basis of accounting for inventories.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.

Chapter 6-27

Lower-of-Cost-or-MarketLower-of-Cost-or-Market


SO 4 Explain the lower-of-cost-or-SO 4 Explain the lower-of-cost-or-market basis of accounting for market basis of accounting for inventories.inventories.

Illustration: Assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated.

Inventory Cost Market Lower ofCategories Data Data Cost or Market

TVs 60,000$ 55,000$

Radios 45,000 52,000

DVD recorders 48,000 45,000

DVDs 14,000 12,800

Total inventory

Chapter 6-28

Analysis of InventoryAnalysis of InventoryAnalysis of InventoryAnalysis of Inventory

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 of InventoryAnalysis of Inventory

SO 5 Compute and interpret the inventory turnover ratio.SO 5 Compute and interpret the inventory turnover ratio.

Chapter 6-29

Inventory turnover measures the number of times on average the inventory is sold during the period.

Cost of Goods Sold

Average Inventory

Inventory Turnover

=

Days in inventory measures the average number of days inventory is held.

Days in Year (365)

Inventory Turnover

Days in Inventory

=



Chapter 6-30

Illustration: The following data are available for Wal-Mart.

Inventory Turnover

2007

=



=

Days in inventory

2007

=

=

Chapter 6-31

Illustration: The following data are available for Wal-Mart.

$237,649

(31,910 + 29,419) / 2

Inventory Turnover

2006

=



= 7.7 times

365 Days

7.7

Days in inventory

2006

=

=47.4 Days

Chapter 6-32

Illustration:

Cost Flow Methods in Perpetual SystemsCost Flow Methods in Perpetual SystemsCost Flow Methods in Perpetual SystemsCost Flow Methods in Perpetual Systems

SO 7 Apply the inventory cost flow methods to perpetual inventory SO 7 Apply the inventory cost flow methods to perpetual inventory records.records.

Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Average cost.

Appendix 6AAppendix 6AAppendix 6AAppendix 6A

Illustration 6A-1

Chapter 6-33

Cost Flow Methods in Perpetual Cost Flow Methods in Perpetual SystemsSystemsCost Flow Methods in Perpetual Cost Flow Methods in Perpetual SystemsSystems


“First-In-First-Out (FIFO)”

Cost of Goods SoldEnding Inventory

Illustration 6A-2

Solution on notes page

Chapter 6-34



Cost of Goods SoldEnding Inventory

“Last-In-First-Out (LIFO)” Illustration 6A-3


Chapter 6-35



““Average Cost”Average Cost” (Moving-Average (Moving-Average System)System) Illustration 6A-

4

Cost of Goods Sold Ending Inventory


Chapter 6-36

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Chapter 6-1. Chapter 6-2 Reporting and Analyzing Inventory Financial Accounting, Fifth Edition.

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Transcript of Chapter 6-1. Chapter 6-2 Reporting and Analyzing Inventory Financial Accounting, Fifth Edition.