HFT 2401 Chapter 10 - Inventory

Inventory  Goods that a firm holds for resale to its guests  As a percentage of total assets, it should be low for a hospitality operation  Inventory has a large impact on profit, therefore it should be monitored carefully

Internal Control of Inventory  Maintain separation of duties- Custodian of the inventory records and custodian of the inventory  Complete periodic physical inventories  Investigate any significance variances in inventory  Complete a daily inventory of high-priced items  Inventory storeroom should be secured and access limited to authorized personnel

Perpetual Inventory System  Continuously updates the merchandise inventory account  Uses record cards to monitor purchases and requisitions from the storeroom  Occasional physical inventories are completed to verify the status of the inventory to the record cards.

Periodic Inventory System  Does not keep a continuous record of the inventory items.  Between physical inventory counts, only estimates of inventory is available.  Uses a Purchases account when inventory items are purchased.  Uses a calculated cost of good sold statement

Effects on Profit from Inventory Errors  Error in Inventory Beginning Inventory Understated Beginning Inventory Overstated Ending Inventory Understated Ending Inventory Overstated  Effect on Profit Overstated Understated Overstated

Completion of the Physical Inventory  Should be a minimum of two people  Final inventory should be “footed” by another person to insure accuracy  Ensure a proper cut-off period Items physically in the storeroom but already sold should not be counted Items that are received but not invoiced should be included in the inventory

Transportation Costs  Should be included in the total purchase price  FOB Destination or FOB Shipping Point  FOB Destination – Shipper pays the freight – Shipper at risk for loss  FOB Shipping Point – Indicates the point of origin. The buyer pays shipping costs – Buyer at risk for loss

Inventory Valuation Methods  Specific Identification  FIFO  LIFO  Weighted Average These are valuation methods only and may not parallel the physical flow of goods through the storeroom

Specific Identification  Used to value big ticket items  Exact costs are used to value the inventory items  Usually have very few of these items in inventory

Weighted Average  Total number of inventory units available for sale is divided into the total cost of the units purchased.  This gives an “average” cost, which is used as the per unit cost in the inventory

FIFO  First In – First Out  Assumes that the first units purchased into inventory are the first units out of inventory.  The inventory consists of the latest purchases, while the cost of goods sold consists of the earliest purchases.

LIFO  Last In – First Out  Assumes the first units in are the last units out  Inventory pricing consist of the earliest purchases

LIFO Versus FIFO  In an inflationary climate, FIFO results in a higher inventory value and a lower cost of good sold. Will increase profit.  In an inflationary period, LIFO results in a lower inventory value and a higher coast of goods sold. Will reduce profit. Can be used for tax purposes.  In a deflationary period, FIFO results in a lower inventory value and higher cost of goods sold  In a deflationary period, LIFO results in a higher inventory value and a lower cost of goods sold.

Lower of Cost or Market (LCM) and Gross Profit Methods  Inventory cost is based using the lowest of either the market value or the original cost.  Can be done on either an item by item basis or in total  This method is based on the conservatism principle  Gross Profit Method assumes consistent cost percentages over a period of time.

Homework  Problem 7  Problem 8  Problem 9 – Using the instructions for problem 11. Ignore the instructions given in the problem  Problem 11  Problem 13 - do the calculation for both problems 11 & 13. Use $100 sales price per unit for problem 13.