PowerPoint Presentation

Inventories (ToA.203)

L. R. CabarlesProfessional Review and Training CenterPRTC1This chapter assumes only an introductory level of understanding regarding auditing and reporting.

Additional help in your text includes:Appendix B (p. 36) with the common acronyms/abbreviations used in Ch. 1Appendix C (p.37) with a much more detailed chronology than required.Relevant Standard PAS 2 InventoriesPRTC2Objectives (text, p. 2) continued on next slide.Nature of Inventories Inventories includeAssets held for sale in the ordinary course of business (finished goods) Assets in the production process for sale in the ordinary course of business (work in process), andMaterials and supplies that are consumed in production (raw materials) PRTC3Objectives (text, p. 2) continued on next slide.What should be included in inventories? All items substantially owned by the entity should be included in inventory regardless of location.PRTC4Objectives (text, p. 2) continued on next slide.Measurement of inventoriesInventories are required to be stated at the lower of cost and net realizable value (NRV).PRTC5Objectives (text, p. 2) continued on next slide.Items included in cost costs of purchase

costs of conversion(Direct labor and overhead)

other costs incurred in bringing the inventories to their present location and condition(e.g. costs of designing products for specific customers)PRTC6Objectives (text, p. 2) continued on next slide.Costs of Purchase Purchase price

Import duties and other non-refundable taxes

Transport, handling and other costs directly attributable to the acquisition of finished goods, materials and services

Trade discounts, rebates and other similar items are deducted in determining the costs of purchasePRTC7Objectives (text, p. 2) continued on next slide.

Recording of Purchases Gross and Net MethodGrossNetCash discountsPRTC8Objectives (text, p. 2) continued on next slide.

Recording of Purchases Gross and Net MethodGrossNetCash discountsDeducted from purchases when takenPRTC9Objectives (text, p. 2) continued on next slide.

Recording of Purchases Gross and Net MethodGrossNetCash discountsDeducted from purchases when takenDeducted from purchases whether taken or notPRTC10Objectives (text, p. 2) continued on next slide.

Recording of Purchases Gross and Net MethodGrossNetCash discountsDeducted from purchases when takenDeducted from purchases whether taken or notCash discounts takenAccounts payable (Gross) xxCash (Net) xxPurchase discounts xxPRTC11Objectives (text, p. 2) continued on next slide.

Recording of Purchases Gross and Net MethodGrossNetCash discountsDeducted from purchases when takenDeducted from purchases whether taken or notCash discounts takenDeducted from purchases (purchase discounts)Accounts payable (Gross) xxCash (Net) xxPurchase discounts xxAccounts payable (Net) xxCash (Net) xxPRTC12Objectives (text, p. 2) continued on next slide.

Recording of Purchases Gross and Net MethodGrossNetCash discountsDeducted from purchases when takenDeducted from purchases whether taken or notCash discounts takenDeducted from purchases (purchase discounts)Already deducted from purchasesAccounts payable (Net) xxCash (Net) xxPRTC13Objectives (text, p. 2) continued on next slide.

Recording of Purchases Gross and Net MethodGrossNetCash discountsDeducted from purchases when takenDeducted from purchases whether taken or notCash discounts takenDeducted from purchases (purchase discounts)Already deducted from purchasesCash discounts not taken Accounts payable (Gross) xxCash (Gross) xxPRTC14Objectives (text, p. 2) continued on next slide.

Recording of Purchases Gross and Net MethodGrossNetCash discountsDeducted from purchases when takenDeducted from purchases whether taken or notCash discounts takenDeducted from purchases (purchase discounts)Already deducted from purchasesCash discounts not taken Included in purchases(part of inventory cost)Accounts payable (Gross) xxCash (Gross) xxAccounts payable (Net) xxPurchase discounts lost xxCash (Gross) xxPRTC15Objectives (text, p. 2) continued on next slide.

Recording of Purchases Gross and Net MethodGrossNetCash discountsDeducted from purchases when takenDeducted from purchases whether taken or notCash discounts takenDeducted from purchases (purchase discounts)Already deducted from purchasesCash discounts not taken Included in purchases(part of inventory cost)Reported as other expenseAccounts payable (Net) xxPurchase discounts lost xxCash (Gross) xxPRTC16Objectives (text, p. 2) continued on next slide.Cost FormulasSpecific identificationFor items that are not ordinarily interchangeableGoods or services produced and segregated for specific projects

FIFO or Weighted Average CostFor all other itemsPRTC17Objectives (text, p. 2) continued on next slide.Cost FormulasSpecific identificationCost of EI = Units on hand x Specific UC

FIFO Cost of EI:Units on hand x UC of latest purchases

Weighted Average Cost of EI = Units on hand x WAUCWAUC = Total cost of GAS/ Total units available for salePRTC18Objectives (text, p. 2) continued on next slide.Measurement of inventoriesInventories are required to be stated at the lower of cost and net realizable value (NRV).PRTC19Objectives (text, p. 2) continued on next slide.What is net realizable value (NRV)? Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

NRV = ESP ECTC - ECTS PRTC20Objectives (text, p. 2) continued on next slide.Purchase CommitmentThis purchase commitment is an executory contract. It is not recognized in the financial statements unless it is an onerous contract.PRTC21Objectives (text, p. 2) continued on next slide.Inventory Estimation Techniques- Gross profit rate

- Retail inventory

- Standard cost

PRTC22Objectives (text, p. 2) continued on next slide.Gross Profit Rate (GPR) MethodPRTC23Objectives (text, p. 2) continued on next slide.GPR MethodTechnique based on a relationship between gross profit and sales that is assumed to be fairly stable

Its use is not appropriate for financial reporting purposes

However, it may be useful when auditors need approximations or when inventory and inventory records are destroyed by fire or some other catastrophePRTC24Objectives (text, p. 2) continued on next slide.COS Formula (Trading)Inventory, beginning P xxPurchases, net xxTGAS xxInventory, ending ( xx)Cost of sales P xxTGAS P xxCost of sales ( xx)Estimated inventory P xxPRTC25Objectives (text, p. 2) continued on next slide.COS ComputationGPR based on SALESCOS = Net Sales x Cost RatioCost ratio = 1 - GPR

GPR based on COST

COS = Net Sales / (1+GPR)PRTC26Objectives (text, p. 2) continued on next slide.Retail Inventory MethodTechnique based upon an observable pattern between cost and sales price that exists in most retail concerns.

Basically requires the computation of the cost-to-retail ratio of inventory available for sale.PRTC27Objectives (text, p. 2) continued on next slide.Retail Inventory MethodCost ratio = GAS@cost / GAS@retail

EI at retail = GAS@retail Sales (+/- other invty adj.)

EI at cost = EI at retail x cost ratio

Methods:- Conventional/Conservative/LCM- Average- FIFOMethodMarkdownBeg. Invty.Conventional Exclude IncludeAverage Include Include (Deduct)FIFO Include Exclude (Deduct)PRTC28Objectives (text, p. 2) continued on next slide.Retail Inventory MethodThe percentage used takes into consideration inventory that has been marked down to below its original selling price.

An average percentage for each retail department is often used.Original selling price150Cost100Initial markup 50New selling price180Additional markup 30New selling price160Markup cancellation 20New selling price130Markup cancellation 10Markdown 20New selling price145Markdowncancellation 15PRTC29Objectives (text, p. 2) continued on next slide.STQ Answers A C A B B

PRTC30Objectives (text, p. 2) continued on next slide.STQ Answers B D D D D

PRTC31Objectives (text, p. 2) continued on next slide.STQ Answers C D D B D

PRTC32Objectives (text, p. 2) continued on next slide.STQ Answers B A A D C

PRTC33Objectives (text, p. 2) continued on next slide.STQ Answers D B B C D

PRTC34Objectives (text, p. 2) continued on next slide.STQ Answers B D D C D

PRTC35Objectives (text, p. 2) continued on next slide. end of ToA.203 PRTC