Accounting principles 8th weygars kieso kimmel chapter 06

Reporting and Analyzing Inventory Reporting and Analyzing InventoryTaking a physical inventoryDetermining ownership of goods Determining Inventory Quantities Inventory Costing Inventory

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Chapter 6-1

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CHAPTER 6

INVENTORIES

Accounting Principles, Eighth Edition

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Chapter

6-3

1 Describe the steps in determining inventory

quantities.

2 Explain the accounting for inventories and apply the

inventory cost flow methods.

3 Explain the financial effects of the inventory cost

flow assumptions.

4 Explain the lower-of-cost-or-market basis of

accounting for inventories.

5 Indicate the effects of inventory errors on the

financial statements.

6 Compute and interpret the inventory turnover ratio.

Study Objectives

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Reporting and Analyzing Inventory Reporting and Analyzing Inventory

Taking a physical inventoryDetermining ownership of goods

Determining Inventory Quantities

Inventory Costing

Inventory Errors

Statement Presentation and Analysis

Income statement effectsBalance sheet effects

PresentationAnalysis

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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.

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Physical Inventory taken for two reasons:

Perpetual System

1 Check accuracy of inventory records.

2 Determine amount of inventory lost (wasted raw

materials, shoplifting, or employee theft).

Periodic System

1 Determine the inventory on hand

2 Determine the cost of goods sold for the period.

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Chapter

6-7

Involves counting, weighing, or measuring each

kind of inventory on hand.

Taken,

when the business is closed or when business

is slow.

at end of the accounting period.

Taking a Physical Inventory

LO 1 Describe the steps in determining inventory quantities.

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Goods in Transit

Purchased goods not yet received.

Sold goods not yet delivered.

Determining Ownership of Goods

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.

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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 Sale

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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

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Chapter

6-11

Consigned Goods

• In some lines of business, it is common to hold

the goods of other parties and try to sell the

goods for them for a fee, but without taking

ownership of goods.

• These are called consigned goods.

Determining Ownership of Goods

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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

Cost Flow Assumptions

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Chapter

6-13

Young & Crazy Company makes the following purchases:

1 One item on 2/2/08 for $10

3 One item on 2/25/08 for $20 Young & Crazy Company sells one item on 2/28/08 for

$90 What would be the balance of ending inventory, cost of goods sold, and net income for the month ended Feb 28, 2008, assuming the company used the Specific

Identification method to cost inventories and the item

purchased on 2/15/08 is sold? Assume a tax rate of

30%.

Example

LO 2 Explain the accounting for inventories and

apply the inventory cost flow methods.

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Purchase on 2/15/08 for $15

Young & Crazy Company Income Statement For the Month of Feb 2008

Sales $ 90

Cost of goods sold 15

Gross profit 75

Expenses: Administrative 14

Selling 12

Interest 7

Total expenses 33

Income before tax 42

Taxes 13

“Specific Identification”

Inventory

Balance = $ 30

Purchase on 2/2/08

for $10 Purchase on

2/25/08 for $20

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Chapter

6-15

An actual physical flow costing method in which

items still in inventory are specifically costed to

arrive at the total cost of the ending inventory.

Practice is relatively rare.

Most companies make assumptions ( Cost Flow Assumptions ) about which units were sold.

Specific Identification Method

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

Illustration 6-11

Use of cost flow methods in

major U.S companies

Cost Flow Assumption

does not need to equal

Physical Movement of

Goods

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Chapter

6-17

Young & Crazy Company makes the following purchases:

3 One item on 2/25/08 for $20 Young & Crazy Company sells one item on 2/28/08 for

$90 What would be the balance of ending inventory,

cost of goods sold, and net income for the month ended Feb 2008, assuming the company used the FIFO,

LIFO, and Average-cost flow assumptions? Assume a

tax rate of 30%.

Example

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Earliest goods purchased are first to be

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Chapter

6-19

Sales $ 90 Cost of goods sold 10 Gross profit 80 Expenses:

Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 47 47

Taxes 14 Net Income $ 33

“First-In-First-Out (FIFO)”

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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)”

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Chapter

6-21

Purchase on

2/2/08 for $10

Purchase on

2/15/08 for $15

Inventory

Balance = $ 25

Young & Crazy Company Income Statement For the Month of Feb 2008

Sales $ 90

Cost of goods sold 20

Gross profit 70

Expenses: Administrative 14

Selling 12

Interest 7

Total expenses 33

Income before tax 37 37

Taxes 11

Net Income $ 26

“Last-In-First-Out (LIFO)”

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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”

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Sales $ 90 Cost of goods sold 15 Gross profit 75 Expenses:

Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 42 42

Taxes 13 Net Income $ 29

“Average Cost”

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Chapter

6-24

FIFO

LO 3 Explain the financial effects of the inventory cost flow assumptions.

Comparative Financial Statement Summary

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Chapter

6-25

In Period of Rising Prices,

In Period of Rising Prices, FIFO Reports: FIFO Reports:

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Chapter

6-26

In Period of Rising Prices,

In Period of Rising Prices, LIFO Reports: LIFO Reports:

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Chapter

6-27

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.

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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

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Chapter

6-29

Q6-12 Casey Company has been using the FIFO

cost flow method during a prolonged period of rising prices During the same time period,

Casey has been paying out all of its net income as dividends What adverse effects may result from this policy?

Discussion Question

See notes page for discussion

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Using Cost Flow Methods Consistently

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LO 4 Explain the lower-of-cost-or-market

basis of accounting for 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

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BE6-7 Alou Appliance Center accumulates the

following cost and market data at December 31.

Compute the lower-of-cost-or-market valuation for the company’s total inventory.

$ 12,000

9,000 12,800

$ 33,800

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Failure to count or price inventory correctly

Not properly recognizing the transfer of legal title to goods in transit.

Errors affect both the income statement and balance sheet.

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Inventory errors affect the computation of cost of

goods sold and net income.

Income Statement Effects

Illustration 6-17 Illustration 6-16

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Chapter

6-35

LO 5 Indicate the effects of inventory errors on the financial statements.

Inventory errors affect the computation of cost of

goods sold and net income in two periods.

An error in ending inventory of the current period

will have a reverse effect on net income of the

next accounting period.

Over the two years, the total net income is correct

because the errors offset each other.

The ending inventory depends entirely on the accuracy of taking and costing the inventory.

Income Statement Effects

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Cost of goods purchased 40,000 40,000 68,000 68,000

Cost of goods available 60,000 60,000 80,000 83,000

Net Income Net Income $3,000

Combined income for

2-year period is correct.

Illustration 6-18

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Effect of inventory errors on the balance sheet is

determined by using the basic accounting equation:.

Balance Sheet Effects

Illustration 6-16

Illustration 6-19

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Chapter

6-39

Balance Sheet - Inventory classified as current

asset

Income Statement - Cost of goods sold subtracted

from sales.

There also should be disclosure of

1) major inventory classifications,

2) basis of accounting (cost or LCM), and

3) costing method (FIFO, LIFO, or average).

Presentation

LO 5 Indicate the effects of inventory errors on the financial statements.

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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

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Chapter

6-41

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 =

LO 6 Compute and interpret the inventory turnover ratio.

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BE6-9 At December 31, 2008, the following

information was available for J Graff Company: ending

inventory $40,000, beginning inventory $60,000, cost

of goods sold $270,000, and sales revenue $380,000

Calculate inventory turnover and days in inventory for

J Graff Company.

$270,000 ($60,000 + 40,000) / 2 = 5.4

Inventory

Turnover

365 5.4

67.59 days

=

Days in Inventory

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The following data from Houston Electronics will be used to

illustrate inventory costing under a perpetual system.

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

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Inventory Cost Flow Methods in Perpetual Inventory

Systems

Cost of goods sold

Computation of cost of goods sold and ending inventory under FIFO

for Houston Electronics.

Illustration 6A-2

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Computation of cost of goods sold and ending inventory under LIFO

for Houston Electronics.

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

Illustration 6A-3

Cost of goods sold

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Inventory Cost Flow Methods in Perpetual Inventory

Systems

Computation of cost of goods sold and ending inventory under moving

Illustration 6A-4

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Chapter

6-47

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