Unit 2 Chapter 6: INVENTORY COSTING Unit 2 Test (covering chapter 5 and 6) will occur on Oct 24 (Friday)Unit 2 Test (covering chapter 5 and 6) will occur on Oct 24 (Friday) I will hand out the group quiz today after my lesson.

Classifying and Reporting Inventory How a company classifies its inventory depends on whether the company is a merchandise company or manufacturing company. Merchandise business has only one category for inventory such as “merchandise inventory” or “inventory”, which is ready to sell. For manufacturing business, inventory is usually classified as three categories: – Raw materials – Work in progress – Finished goods

Classifying and Reporting Inventory If it was a auto maker such as Ford or GM, they would have three categories: – Raw materials – Steels, tires, glasses, leather materials for seats etc… – Work in progress – units, which are being assembled in the factory. – Finished goods –cars, which are assembled. These units are finished goods.

Classifying and Reporting Inventory In the disclosure notes to a company’s financial statements, the following information should be included: 1. The major inventory classification 2. The cost flow assumption (FIFO, LIFO, Average cost or specific identification) 3. The amount of any write-down to net realizable value (LCM)

Analysis of Inventory A delicate balance must be kept between having too little inventory and too much inventory. On one hand, management wants to have a variety and enough quantity on hand so that customers will find a wide selection of items in stock. But having too much inventory on hand can cost the company money in storage costs and interest costs (money tied up in inventory)

Analysis of Inventory But having too little inventory can result in unhappy customers and lost sales. How quickly a company sells its inventory (or turns it over) is one way to determine whether the company has too much or too little inventory. We can also use this information to evaluate a company’s liquidity or its ability to pay its obligation (such as debt) that are expected to come due in the next year.

Inventory Turnover Inventory Turnover ratio measures the number of times, on average, inventory is sold during the period. It is calculated by dividing the cost of goods sold by average inventory. Inventory Turnover = COGS / AI AI = Average Inventory = (BB + EB)/2 Generally speaking, the more times (the higher it is) that inventory turns over each year, the more efficiently sales are being made.

Days Sales in Inventory The inventory turnover ratio is complemented by the days sales in inventory ratio. It converts the inventory turnover ratio into a measure of the average age of the inventory on hand. The lower number the better. (Most time) DSI = 365 days / Inventory Turnover DSI = Days Sales in Inventory

Days Sales in Inventory Let’s say Inventory Turnover = 2.7 then what is the days sales in inventory? DSI = 365 days / 2.7 = 135 days What does this 135 days mean? It means that it takes 135 days to sell their product since purchase date. This ratio should be compared to the company’s ratio in previous years and the industry average. However, this average number will be different for each type of inventory item.

Classwork / Homework P322 E6.10 P326 P6.7 I took up P6.4 (p325) before the bell. This is probably the best question in Chapter 6.