6-2
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.
6-3
Physical Inventory is taken for two reasons:
In a Perpetual System
1. To compare the accuracy of inventory accounting records to
the actual inventory on hand.
2. To determine the amount of lost inventory from wasted raw
materials, customer shoplifting, or employee theft.
In a Periodic System
1. To determine ending inventory
2. To determine the cost of goods sold for the period.
3. The periodic inventory is not very accurate at identifying the
amount of inventory lost. The amount not counted in ending
inventory is simply assumed to have been sold or missing.
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
6-4
Taking a Physical Inventory: Involves counting (boxes), weighing (topsoil), or measuring (fabric, liquids) each kind of inventory on hand usually when the business is slow, closed or at the end of the accounting period. Note: when you count a box that’s supposed to have a TV in it, you must make sure there actually is a TV in it and it matches with the one listed in the accounting records!
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
Consigned Goods: Goods held for sale by one party even though ownership is still retained by another party. Someone else’s goods in on consignment at your store are not included as your inventory! Your goods out on consignment are still included in your inventory!
6-5
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 Inventory CostingCostingInventory Inventory CostingCosting
Cost Flow Assumptions
Management decides which inventory costing method is best to use!
6-6
Assume that Frank N. Furter TV Company purchases three
identical 50-inch TVs on different dates at costs of $700,
$750, and $800. During the year Furter sold two sets at
$1,200 each. These facts are summarized below.
Inventory CostingInventory CostingInventory CostingInventory Costing
6-7
Specific Identification
Inventory Costing – Specific IndentificationInventory Costing – Specific IndentificationInventory Costing – Specific IndentificationInventory Costing – Specific Indentification
If Furter sold 2 of the TVs it purchased on February 3 and May 22
for $2,400 ($1,200 each), then its cost of goods sold is $1,500
($700 + $800), and its ending inventory is $750.
6-8
A physical flow costing method: items in inventory each
have their own cost, they are added together to arrive at the
total cost of the ending inventory.
Use of this method is rare: used for unique items such as
precious gems, custom-made cars, antiques, one-of-a-kinds.
On the other hand, for similar type items, most companies
make assumptions called Cost Flow Assumptions about
which units were sold.
Inventory Costing – Specific IndentificationInventory Costing – Specific IndentificationInventory Costing – Specific IndentificationInventory Costing – Specific Indentification
Specific Identification
6-9
Inventory CostingInventory CostingInventory CostingInventory Costing
The Cost Flow
Assumption
The recorded cost
does not need to
match the physical
movement of goods
From a survey of large corporations
6-10
Assume this data for Houston Electronics’ Astro condensers.
Inventory Inventory CostCost Flow Assumptions Flow AssumptionsInventory Inventory CostCost Flow Assumptions Flow Assumptions
Remember: 450 units are in ending inventory and 550 units were sold!
6-11
Allocates cost of goods available for sale on the
basis of weighted-average unit cost incurred.
Assumes goods are similar in nature (gas, oil).
Applies weighted-average unit cost to the units
on hand to determine cost of the ending
inventory.
Average Cost Average Cost Inventory Cost Flow AssumptionsInventory Cost Flow AssumptionsAverage Cost Average Cost Inventory Cost Flow AssumptionsInventory Cost Flow Assumptions
Average-Cost
“What’s my
GPA?”
6-12
Average Cost Average Cost Inventory Cost Flow AssumptionsInventory Cost Flow AssumptionsAverage Cost Average Cost Inventory Cost Flow AssumptionsInventory Cost Flow Assumptions
Average-Cost: 550 Sold - 450 in Ending Inventory
450 units were in ending inventory and 550 units were sold.
550 units x $12
6-13
The costs of the earliest goods purchased are assumed to
be the first to be sold – “FIFO”
The costs of the last goods purchased and not yet sold are
assumed to still be in ending inventory. Last in stays here
“LISH”
FIFO often parallels actual physical flow of merchandise. It’s
generally good business practice to sell the oldest units first.
“GOT MILK?”
FIFOFIFO Inventory Cost Flow Assumptions Inventory Cost Flow AssumptionsFIFOFIFO Inventory Cost Flow Assumptions Inventory Cost Flow Assumptions
First-In-First-Out (FIFO) Last-in Stays-here (LISH)
“Eat more
Chikin?
”
6-14
FIFOFIFO Inventory Cost Flow Assumptions Inventory Cost Flow AssumptionsFIFOFIFO Inventory Cost Flow Assumptions Inventory Cost Flow Assumptions
Illustration 6-5
First-In-First-Out (550 Sold) Last In Stays Here (450 in End. Inv.)
Remember 450 units were counted as ending inventory! Another method would be to count the 550 units sold starting with the beginning inventory and working down.
(100 x $10) + (200 x $11) + (250 x $12)
6-15
The costs of the latest goods purchased are assumed to
be the first to be sold – “LIFO”
The costs of the first goods purchased and not yet sold
are assumed to still be in ending inventory. First in stays
here “FISH”
LIFO seldom coincides with actual physical flow of
merchandise. Exceptions include goods stored in piles
such as coal, mulch, hay, etc.
LIFOLIFO Inventory Cost Flow Assumptions Inventory Cost Flow AssumptionsLIFOLIFO Inventory Cost Flow Assumptions Inventory Cost Flow Assumptions
Last-In-First-Out (LIFO) First-In-Stays-Here (FISH)
“Sound
Fishy?”
6-16
LIFOLIFO Inventory Cost Flow Assumptions Inventory Cost Flow AssumptionsLIFOLIFO Inventory Cost Flow Assumptions Inventory Cost Flow Assumptions
Last-In-First-Out (550 Sold) First-In-Stays-Here (450 in End. Inv.)
Remember 450 units were counted as being in ending inventory! Another method would be to count the 550 units sold starting with the last purchase and working up.
(400 x $13) + (150 x $12)
6-17
FIFO* Sales $9,000 $9,000
$9,000
Cost of goods sold 6,200 6,6007,000
Gross profit 2,800 2,4002,000
* Operating expenses 330 330330
Income before taxes 2,470 2,0701,670
Income tax expense 140 120110
Net income $2,330 $1,950 $1,560
Ending Inventory $5,800 $5,400 $5,000
*Assume no differences in Sales or Operating Expenses
LIFOAverage
In Periods of Rising Prices FIFO Has The Highest Ending Inventory!
Financial Statement and Financial Statement and Tax EffectsTax EffectsFinancial Statement and Financial Statement and Tax EffectsTax Effects
6-18
Using Cost Flow Methods Consistently
Inventory CostingInventory CostingInventory CostingInventory Costing
Method should be used consistently because it
enhances comparability from one year to the next.
However, although consistency is preferred, a
company may change its inventory cost method.
6-19
Lower-of-Cost-or-Market (LCM)
Inventory CostingInventory CostingInventory CostingInventory Costing
When the value of inventory is lower than its cost
Companies can “write down” the inventory to its new market
value in the period in which the price decline occurs (e.g., items
become obsolete). The company would record a loss or
expense in the period of the write down (see the next slide).
Market value is considered to be the replacement cost to
purchase more inventory - not the new selling price. Using LCM
is an example of conservatism.
6-20
Inventory CostingInventory CostingInventory CostingInventory Costing
Assume that Ken Tuckie TV has the following lines of
merchandise with costs and market values as indicated.
Lower-of-Cost-or-Market
The original total inventory cost was $168,000. After the adjustment we would write down the value of the inventory to $159,000 by crediting inventory for $9,000 and debiting a Loss on Reduction of Inventory or debiting the COGS as an expense
$168,000 $166,000
6-21
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.
Shipping Terms Shipping Terms ReviewReview!!Shipping Terms Shipping Terms ReviewReview!!
Shipping Point Destination
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.
6-22
Goods in transit should be included in the inventory of
the buyer when the:
a. public carrier accepts the goods from the seller.
b. goods reach the buyer.
c. terms of sale are FOB destination.
d. terms of sale are FOB shipping point.
Review Question
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
6-23
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
Inventory Cost Flow AssumptionsInventory Cost Flow AssumptionsInventory Cost Flow AssumptionsInventory Cost Flow Assumptions
6-24
In a period of inflation (rising prices), 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.
Inventory Cost Flow AssumptionsInventory Cost Flow AssumptionsInventory Cost Flow AssumptionsInventory Cost Flow Assumptions
Review Question
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