1 Inventories: Cost Measurement and Flow Assumptions Chapter 8 Intermediate Accounting 11th edition

2 2 Flow of Inventory Costs Merchandising Company Manufacturing Company

3 3 Alternative Inventory Systems A company using a perpetual system maintains a continuous record of the physical quantities in its inventory.

4 4 Alternative Inventory Systems A company using a periodic system does not maintain a continuous record of the physical quantities of inventory on hand.

5 5 Computation of Net Purchases Purchases +Freight-in –Purchases Returns and Allowances –Purchases Discounts Taken =Net Purchases

6 6 Beginning Inventory +Purchases (net) –Goods Sold =Ending Inventory Perpetual Inventory System Beginning Inventory +Purchases (net) –Ending Inventory =Goods Sold Periodic Inventory System Comparison of Systems

7 7 Under the gross price method, a company records the purchase at the gross price and records the amount of the discount in the accounting system only if the discount is taken. Under the net price method, a company records the purchase at its net price and records the amount of the discount in the accounting system only if the discount is not taken. Purchases Discounts

8 8 Purchases Discounts: Gross Price Method To record the purchase: Inventory (or Purchases)1,000 Accounts Payable1,000 A company purchases $1,000 of goods under terms of 1/10, n/30. To record payment within the discount period: Accounts Payable1,000 Purchases Discounts Taken10 Cash990 To record payment outside the discount period: Accounts Payable1,000 Cash1,000

9 9 To record the purchase: Inventory (or Purchases)990 Accounts Payable990 A company purchases $1,000 of goods under terms of 1/10, n/30. Purchases Discounts: Net Price Method To record payment within the discount period: Accounts Payable990 Cash990 To record payment outside the discount period: Accounts Payable990 Purchases Discounts Lost10 Cash1,000 Purchases Discounts Lost are treated as a financing expense in the Other Items section of the income statement.

10 Net Price Method Adjusting entry at end of period if discount has expired and invoice is unpaid: Purchases Discounts Lost10 Accounts Payable10 A company purchases $1,000 of goods under terms of 1/10, n/30. Purchases Discounts: Net Price Method

11 If the company does not pay promptly, it is forfeiting 2% in order to keep the money for an additional 20 days. A company purchases $1,000 of goods under terms of 2/10, n/30. What is the annual discount rate? The company can forfeit this discount 18 times during a year. (360 days/20 additional each time = 18) Annual Rate on Discounts 2% forfeited 18 times equals an annual interest rate of 36%

12 Specific Identification $10 per unit Apr. 1 Apr. 10 Apr. 20 $11 per unit $12 per unit On April 27, 90 units were sold from the beginning inventory and 50 units from the April 10 purchase.

13 Specific Identification $10 per unit Apr. 1 Apr. 10 Apr. 20 $11 per unit Apr. 20 $12 per unit $10 per unit Apr. 1 $11 per unit Apr. 10 $12 per unit $10 per unit $11 per unit $12 per unit Ending Inventory………… = $ 100 =330 = 840 $1,270 Cost of Goods Sold………. $1,450 =$ 900 =550 = 0

14 Specific Identification $10 per unit Apr. 1 Apr. 10 Apr. 20 $11 per unit Apr. 20 Apr. 1 Apr. 10 $12 per unit $10 per unit $11 per unit $12 per unit Ending Inventory………… Goods Available for Sale… = $ 1,000 =880 = 840 $2,720 = $ 100 =330 = 840 $1,270 $1,450 Cost of Goods Sold………..

15 Remember—Goods Available For Sale $10 per unit Apr. 1 Apr. 10 Apr. 20 $12 per unit $11 per unit Goods Available for Sale… = $ 1,000 =880 = 840 $2,720 Sold 140 Units

16 $10 per unit Apr. 1 Apr. 10 Apr. 20 $11 per unit Sold 140 units during April $11 per unit Sold all $10 per unit Sold 40 Sold 0 $12 per unit First-In, First-Out (FIFO)

17 Ending Inventory………… $10 per unit Apr. 1 Apr. 10 Apr. 20 $11 per $11 per unit $10 per unit $12 per unit Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold = $ 0 =440 = 840 $1,280 $1,000 + $1,720 – $1,280 = $1,440 First-In, First-Out (FIFO)

18 First-In, First-Out (FIFO) The ending inventory and the cost of goods sold under perpetual and periodic FIFO are identical.

19 = $1,000 =880 = 840 $2,720 Average Cost (Periodic) $10 per unit Apr. 1 Apr. 10 Apr. 20 $11 per unit $12 per unit Sold 140 units during April 250 units Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold $2,720  250 units = $10.88 $10.88 × 110 units = Ending Inventory of $1,197 $1,000 + $1,720 – $1,197 = $1,523

20 $1,780  160 Apr. 18Sales $10.44 (940) Apr. $10.44$ 940 Apr. 20Purchases $ $11.125$1,780 Moving Average (Perpetual) Apr. 1Beginning $10$1,000 Apr.10Purchases $ $10.44$1,880 Apr. 27Sales $ (556) Apr. $11.125$1,224 Cost of Goods Sold (140 units) $940 + $556$1,496 Ending Inventory (110 $11.125)$1,224 $1,880  180

21 Remember—Goods Available For Sale $10 per unit Apr. 1 Apr. 10 Apr. 20 $12 per unit $11 per unit Goods Available for Sale… = $ 1,000 =880 = 840 $2,720 Sold 140 Units

22 Last-In, First-Out (LIFO) $10 per unit Apr. 1 Apr. 10 Apr. 20 $11 per unit Sold 140 units during April $11 per unit Sold 0 Sold 70 Sold all $12 per unit Periodic Inventory System $12 per unit

23 Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold $10 per unit Apr. 1 Apr. 10 Apr. 20 $11 per $11 per unit $12 per unit Periodic Inventory System $12 per unit Ending Inventory………… = $1,000 =110 = 0 $1,110 Last-In, First-Out (LIFO) $1,000 + $1,720 – $1,110 = $1,610

24 $10 per unit $10 per unit Apr. 1 Apr. 10 Apr. 20 $11 per unit Purchased 80 $12 per unit Perpetual Inventory System Sold 80 $11 per unit $11 per unit Sold 10 Purchased 70 Sold 50 Last-In, First Out (LIFO) Sold 140 units during April (90 on 4/18 and 50 on 4/27)

25 Apr. 1 Apr. 10 Apr. 20 Perpetual Inventory System Ending Inventory………… Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold = $ 900 =0 = 240 $1,140 $1,000 + $1,720 – $1,140 = $1,580 $10 per unit $11 per unit $12 per unit Last-In, First Out (LIFO)

26 Cost of Goods Cost of Available Goods Ending for Sale Sold Inventory Cost Flow Assumption and Method FIFO, periodic$2,720$1,440$1,280 FIFO, perpetual2,7201,4401,280 Weighted average2,7201,5231,197 Moving average2,7201,4961,224 LIFO, periodic2,7201,6101,110 LIFO, perpetual2,7201,5801,140 Comparison of Inventory Assumptions

27 1.The LIFO method requires a company to keep numerous detailed records. 2.Fluctuations in the physical quantities of similar inventory items may occur. 3.As technological changes take place, inventory made up with one material is replaced by inventory made with substitute materials, or an outdated design is replaced by a newer design. Difficulties in Applying Simple LIFO

28 Step 1: Value the total ending inventory at current-year costs. 01/01/09$10,000 12/31/09$12,100 12/31/10$13,125 12/31/11$16,800 12/31/12$12,360 Dollar-Value LIFO

29 Step 2: Convert the ending inventory cost to base-year costs. 12/31/09$12,100 12/31/10$13,125 12/31/11$16,800 12/31/12$12,360 Ending Inventory at Current Costs × Base-Year Cost Index Current Cost Index ×100/110 = $11,000 12/31/09 Dollar-Value LIFO

30 Step 3: Compute the change in the inventory level for the year at base-year costs. $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 $11,000 – $10,000 $1,000 1/1/09 12/31/09 Dollar-Value LIFO

31 Step 4a:If there is an increase in the inventory levels at base-year costs, convert this increase to current-year costs. Base year, $10,000 $1,000$1,000 12/31/09 × 110/100 =$ 1,100 × 100/100 = 10,000 $11,100 Ending inventory, 12/31/09 Dollar-Value LIFO

32 Step 2: Convert the ending inventory cost to base-year costs. 12/31/09$12,100 12/31/10$13,125 12/31/11$16,800 12/31/12$12,360 Ending Inventory at Current Costs × Base-Year Cost Index Current Cost Index ×100/110 = $11,000 × 100/125 = $10,500 12/31/10 Dollar-Value LIFO

33 Step 3: Compute the change in the inventory level for the year at base-year costs. $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/10 $500 $11,000 – $10,500 Dollar-Value LIFO

34 Step 4b: If there is a decrease in the inventory levels at base-year costs, this decrease reduces the inventory. Base year, $10,000 $500 12/31/10 × 110/100 =$ 550 × 100/100 = 10,000 $10,550 Ending inventory, 12/31/10 Dollar-Value LIFO

35 Step 2: Convert the ending inventory cost to base-year costs. 12/31/09$12,100 12/31/10$13,125 12/31/11$16,800 12/31/12$12,360 ×110/100 = $11,000 × 100/125 = $10,500 ×100/140 = $12,000 12/31/11 Dollar-Value LIFO Ending Inventory at Current Costs × Base-Year Cost Index Current Cost Index

36 $500 $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/11 $1,500 Step 3: Compute the change in the inventory level for the year at base-year costs. Dollar-Value LIFO

37 Step 4a:If there is an increase in inventory levels at base-year costs, convert this increase to current-year costs. Base year, $10,000 12/31/11 × 140/100 =$ 2,100 × 110/100 = 550 × 100/100 = 10,000 $12,650 Ending inventory, 12/31/11 $500 $1,500 Dollar-Value LIFO

38 Step 2: Convert the ending inventory cost to base-year costs. 12/31/09$12,100 12/31/10$13,125 12/31/11$16,800 12/31/12$12,360 ×110/100 = $11,000 × 100/125 = $10,500 ×100/140 = $12,000 ×100/120 = $10,300 12/31/12 Dollar-Value LIFO Ending Inventory at Current Costs × Base-Year Cost Index Current Cost Index

39 $500 $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/12 $1,500 Dollar-Value LIFO Step 3: Compute the change in the inventory level for the year at base-year costs.

40 $500 $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/12 Dollar-Value LIFO

41 $300 $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/12 Dollar-Value LIFO

42 Step 4a:If there is an increase in the inventory levels at base-year costs, convert this increase to current-year costs. Base year, $10,000 12/31/12 × 110/100 = $ 330 × 100/100 = 10,000 $10,330 Ending inventory, 12/31/12 $300 Dollar-Value LIFO

43 P8-7 Alternative Inventory Methods The Habicht Company was formed in 2009 to produce a single product. The production and sales for the next four years were as follows: Problems 413 Production Sales Units Total Costs Units Sales Revenue Units in Ending Inventory ,000 $200,000 80,000 $400,000 20, , , , ,000 30, , , , ,000 10, , , , ,000 20,000 Required 1. Determine the gross profit for each year under each of the following periodic inventory methods: a. FIFO b. LIFO c. Average cost (round unit costs to 3 decimal places) 2. Explain whether the company ’ s return on assets (net income divided by average total assets, as we discussed in Chapter 6) would be higher under FIFO or LIFO.

44 E8-7 1.FIFO:Ending Inventory (500 units): 200 $5 =$1, $4 = 1,200 $2,200 Cost of Goods Sold (500 units): Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold $1,750 + [(300 x $4) + (200 x $5)] - $2,200 = Cost of Goods Sold $1,750 +$2,200 - $2,200 = $1,750 or 500 $3.50 = $1,750 2.LIFO:Ending Inventory (500 units): 500 $3.50 = $1,750 Cost of Goods Sold (500 units): Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold $1,750 + $2,200 - $1,750 = $2,200 or 200 $5 =$1, $4 = 1,200 $2,200 3.Weighted Average: Goods Available for Sale: 500 $3.50 =$1, $4.00 = 1, $5.00 = 1,000 1,000 $3,950 Cost of Goods Available for Sale$3,950 Units Available for Sale 1,000 Average Cost (Cost ¸ Number of Units)$ 3.95 Ending Inventory 500 $3.95$1,975 Cost of Goods Sold: Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold $1,750 + $2,200 - $1,975 = $1,975 or500 $3.95 = $1,975