INVENTORY PLANNING AND VALUATION Lesson 6-1, page 166 For most merchandising businesses, merchandise inventory is the largest asset A successful business must maintain an adequate amount of merchandise that customers are willing to buy too much or too little = possible failure Managers frequently analyze sales and inventory transactions to assist in planning future inventory purchases selling well? NOT selling well? seasonal trends? – bathing suits in the winter???? Knowing the answers allows managers to order the right kinds of merchandise at the right time

FLOW OF INVENTORY COSTS Lesson 6-1, page 168 Beginning Merchandise Inventory (GAAP) Adequate Disclosure – statements contain all info necessary to understand a business’ financial state Beginning of fiscal period End of fiscal period Left over from last year Net Purchases Cost of Merchandise Available for Sale Bought this year What it COST you to have all of this merchandise Ending Merchandise Inventory a current asset that will be charged as costs in future fiscal periods What you STILL have Cost of Merchandise Sold COST of what you must have SOLD – a current fiscal period COST

EFFECTS OF ERRORS IN COSTING AN INVENTORY Lesson 6-1, page 168 The cost of both beginning and ending inventory affects items on an income statement, a statement of stockholders’ equity, and a balance sheet Reports and Items Affected If Ending inventory is UnderstatedOverstated Income Statement: Cost of Merchandise Sold OverstatedUnderstated Gross ProfitUnderstatedOverstated Net IncomeUnderstatedOverstated Statement of Stockholders’ Equity: Net IncomeUnderstatedOverstated Retained EarningsUnderstatedOverstated Stockholders’ EquityUnderstatedOverstated Balance Sheet: Merchandise InventoryUnderstatedOverstated Total AssetsUnderstatedOverstated Stockholders’ EquityUnderstatedOverstated Inaccurate Financial Statements

GOODS IN TRANSIT Lesson 6-1, page 169 For goods in transit at the time of a physical count of inventory, the business must determine who holds title to the goods (shipping point terms) Vendor’s terms of sale may indicate: FOB (Free on Board) FOB Shipping Point FOB Destination Who pays for shipping? BuyerVendor Who owns goods while in transit? Buyer (as soon as delivered to transportation company) Vendor (until the buyer receives the goods) Who includes goods in their inventory? BuyerVendor

GOODS ON CONSIGNMENT Lesson 6-1, page 169 Consignment – when goods are given to a business to sell but for which title remains with the vendor Consignee – the person or business that receives goods on consignment ( Play It Again Sports ) Consignor – the person or business that gives goods on consignment ( Mrs. S – giving softball gloves that are too small ) If the goods are sold, the consignee ( Play It Again Sports ) deducts a commission from the sale amount and sends the remainder to the consignor ( Mrs. S ) Goods are part of the consignor’s inventory ( Still belong to Mrs. S ) …Title does not pass to the consignee ( Play It Again Sports ) Consignees ( Play It Again Sports ) often report the cost of consigned goods as an attachment to its balance sheet Consignees ( Play It Again Sports ) agree to care for the goods on consignment …a consignee has implied liabilities if anything should happen to the goods before they are sold

PERPETUAL INVENTORY – Office Mart Lesson 6-1, page A continuous record of merchandise inventory increases, decreases, and balance on hand Provides day-to-day records about the quantity of goods on hand vs. Periodic Inventory Stock Ledger – a file of stock records for all merchandise on hand Stock Record – form used to show the type of merchandise, quantity received, quantity sold, and balance on hand (current stock)

STOCK RECORD FOR A PERPETUAL INVENTORY SYSTEM Lesson 6-1, page Record the description information Enter all purchase transactions. 2.Write the beginning quantity. 2 3.Record all sales transactions. 3 OfficeMart determines that 2 weeks are required to order and receive a shipment of diskettes In that 2 week period, OfficeMart will sell an average of 300 boxes – so we order 1000 boxes when we get down to our minimum quantity of 300 boxes When we reorder, we order 1,000 at a time

PERIODIC INVENTORY Lesson 6-1, page 171 Periodic Inventory - A merchandise inventory determined by counting, weighing, or measuring items of merchandise on hand -Very time consuming – usually only happens once a fiscal period Inventory Record – a form used during a periodic inventory to record information about each item of merchandise on hand One record is used for each item or category of items When only a periodic inventory is used, the low quantity of a merchandise item might be overlooked When this happens, the business may not have the merchandise when customers want it (why we use perpetual) To be safe, Office Mart takes a periodic inventory once a year -to check the accuracy of the perpetual inventory -to determine the amount of inventory lost or stolen Stock records are adjusted for any differences

INVENTORY RECORD USED FOR THE PERIODIC INVENTORY (physical, once-a-year count) Lesson 6-1, page Enter inventory date and item description Record stock numbers and descriptions. 3 3.Write the number of units on hand. 4 4.Record the unit price. 5 5.Calculate and record the total item cost. 6 6.Total the column.

Work Together 6-1 (p172, wb221) & On Your Own 6-1 (p172, wb221) Work Together 6-1 (p172, wb221) & On Your Own 6-1 (p172, wb221)

WT OYO SAME?

INVENTORY COSTING METHOD Lesson 6-2, page 173 -Therefore, we need to know the worth of our current inventory so we can figure out the cost of what we sold (GAAP) – Matching Expenses with Revenue – revenue and expenses associated with earning that revenue are recorded in the same accounting period -business selects the method of costing that best matches the revenue and costs for that business

INVENTORY COSTING Lesson 6-2, page 174 We have purchased 1500 binders up to this point. We have 700 left. Soooo…we sold 800 of those It depends on the costing method that our company uses… LIFO, FIFO, or Weighted-Average What is the worth of the 700 we have left? Do we still have the ones we bought last year $1.00 per unit)? Do we still have the ones we bought in June $1.20 per unit)?

FIRST-IN, FIRST-OUT INVENTORY COSTING METHOD How many did we buy? 700 binders remaining (800 sold) FIRST-IN, FIRST-OUT INVENTORY COSTING METHOD How many did we buy? 700 binders remaining (800 sold) The First-in, First-out (FIFO) method assumes that the earliest goods purchased are the first to be sold. Under FIFO, the cost of the ending inventory is obtained by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed. Lesson 6-2, page 173

The Last-in, First-out (LIFO) method assumes that the last goods purchased are the first to be sold. LIFO seldom coincides with the actual physical flow of inventory. Under LIFO, the cost of the ending inventory is obtained by taking the unit cost of the earliest goods available for sale and working forward until all units of inventory have been costed. LAST-IN, FIRST-OUT INVENTORY COSTING METHOD 700 binders remaining (800 sold) LAST-IN, FIRST-OUT INVENTORY COSTING METHOD 700 binders remaining (800 sold) Lesson 6-2, page 174

WEIGHTED-AVERAGE INVENTORY COSTING METHOD Lesson 6-2, page 174 Weighted-Average inventory costing method - based on the assumption that the cost is an average of the price paid for similar items purchased during the fiscal period Quantity on Hand = 700 Units Purchase Total Cost DateUnitsUnit Price January, beginning Inventory 500$1.00$ June November Totals1,500$1, Total of Beginning Inventory and Purchases $1, ÷ Total Units 1,500 = Weighted-Average Price per Unit $1.15 Units in Ending Inventory 700 x Weighted-Average Price per Unit $1.15 = $ Cost of Ending Inventory

During a period of increasing prices, the FIFO method usually results in the highest ending inventory valuation, the lowest cost of merchandise sold & the highest reported net income (=more taxes) PERIODS OF INCREASING PRICES - PAGE 175 PERIODS OF DECREASING PRICES - PAGE 176 During a period of decreasing prices, the LIFO method usually results in the lowest ending inventory valuation, the highest cost of merchandise sold & the lowest reported net income (=less taxes) Comparison of 3 Methods of Costing Inventory during Periods of Increasing or Decreasing Prices Prices Are Total Inventory Cost Using FIFO Method LIFO Method Weighted-Average Method (always between) Increasing$865.00$740.00$ Decreasing$740.00$865.00$805.00

LOWER OF COST OR MARKET INVENTORY COSTING METHOD Lesson 6-2, page Calculate the cost. 2 2.Calculate the market price. 3 3.Determine the smaller number to use as the lower of cost or market amount. the current replacement cost of the item

(GAAP) – Consistent Reporting – the same accounting procedures are followed in the same way each fiscal period -pick a method and stick with it for at least a few years so that statements can be compared -must use the same method for statements as you use on your tax return -if you decide you want to change your methods, you will need to defend your choice to the IRS (GAAP) – Historical Cost – the actual amount paid for merchandise or other items bought is recorded GAAPSGAAPS (GAAP) – Unit of Measurement – business transactions are reported in numbers that have common values

Work Together 6-2 (p178, wb223) & On Your Own 6-2 (p178, wb223) Work Together 6-2 (p178, wb223) & On Your Own 6-2 (p178, wb223)

UnitsUnit Price January (Beginning inventory) 120 $20.00 March, Purchase 100 $ left November, Purchase 100 $27.60 WT 40 of these left 100 of these left 1 st to go 20 of these left 120 of these left 1 st to go 120 x $20.00 = x $22.00 = x $27.60 = / 320 = 23

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GROSS PROFIT METHOD OF ESTIMATING INVENTORY Lesson 6-3, page 179 A business that keeps periodic (once-a-year) inventory records and prepares monthly interim financial statements needs a cost to use for monthly ending merchandise inventory -so we use estimates (same as chapter 4)

GROSS PROFIT METHOD OF ESTIMATING INVENTORY Lesson 6-3, page Enter beginning inventory amount (Cost not Retail) Determine net purchases. 7 7.Determine estimated ending inventory. 6 6.Calculate estimated cost of merchandise sold. 5 5.Estimate gross profit. 4 4.Enter net sales. 3 3.Calculate merchandise available for sale.

COST of merchandise available for sale = RETAIL VALUE of merchandise available for sale ÷ % increase of retail over cost $508, =$873, % ÷ Business must keep separate records of both cost and retail prices for: net purchases net sales beginning merchandise inventory …more work but will be more accurate (both cost & retail are considered) We need to find the % increase of retail over cost RETAIL METHOD OF ESTIMATING INVENTORY Lesson 6-3, page 180 Retail method of estimating inventory – uses a percentage based on both cost and retail prices (used instead of gross profit method)

Lesson 6-3, page Add net purchases at cost and retail. 2 5.Calculate estimated ending inventory at retail. 5 4.Write net sales (always retail). 4 3.Calculate merchandise available for sale at cost and retail. 3 1.Enter beginning inventory at cost and retail. 1 RETAIL METHOD OF ESTIMATING INVENTORY 6.Determine estimated ending inventory cost. 6

Cost, not retail

MERCHANDISE INVENTORY TURNOVER – method 1 Lesson 6-3, page 181 The more rapidly a business sells merchandise, the more chance it has to make a satisfactory net income 1)Merchandise inventory turnover ratio-the number of times the average amount of merchandise inventory is sold during a specific period of time - expresses a relationship between an average inventory and the cost of merchandise sold - use gross profit method rather than retail method (Retail doesn’t have Cost of Merchandise Sold) Jan 1 – Merch Inv. =+Dec 31 – Merch Inv.÷2Average Merch Inv. $168, =+$173,325.00÷2$170, =Cost of Merch Sold ⌯ Average Merch Inv. Merch Inv. Turnover Ratio $170,845.00$925, Times The higher the better – industry standard is 7 – get better control of merch.

MERCHANDISE INVENTORY TURNOVER – method 2 Lesson 6-3, page 181 2)Average number of days’ sales in Merchandise Inventory -the period of time needed to sell an average amount of merchandise inventory Days in Year 365 ÷ Merchandise Inventory Turnover Ratio 5.4 = Average number of Days’ Sales in merchandise Inventory 68 Days (rounded to the nearest day) An average of 68 days means that on average, each item in merchandise inventory is sold 68 days after it is purchased Industry Standard is 53 days

Work Together 6-3 (p183, wb225) & On Your Own 6-3 (p183, wb227) Work Together 6-3 (p183, wb225) & On Your Own 6-3 (p183, wb227)

WT 198, ÷ 303, = % * 165, = Cost Only Cost & Retail

OYO

First line of 6-2: Cost or Market – (410) (420) Which is lower? Cost Cost or Market – (330) (420) Which is lower? Cost Cost or Market – (382.90) (420) Which is lower? Cost –

Application 6-2, page 186 = 90 = 108 = Total of Beginning Inventory and Purchases $ ⌯ Total Units 56 = Weighted-Average Price per Unit $8.57 Units in Ending Inventory 30 x Weighted-Average Price per Unit $8.57 = $ Cost of Ending Inventory Stock # B18 - page 186

Application 6-3, page 186

Application 6-4, page 187

Application 6-5 page 187

Application 6-5 page 187