Inventories Chapter 7

CH1 Types of businesses: Manufacturing Business e.g. Ford. Merchandising Business e.g. Debenhams Servicing Business e.g. Saudi Airlines Manufacturing Businesses use Raw material to make product and the ending inventory from this kind of business is the unsold goods or items. Merchandising Businesses: buy & Hold inventory for resale - Do not make goods

CH6 Inventory: The raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for sale

Why is Inventory Control Important? Inventory is a significant asset and for many companies the largest asset. Inventory is central to the main activity of merchandising and manufacturing companies. Mistakes in determining inventory cost can cause critical errors in financial statements.

Learning Objective 1 Describe the importance of control over inventory.

Control of Inventory Two primary objectives of control over inventory are: Safeguarding the inventory from damage or theft. Reporting inventory in the financial statements. Inventory must be protected from external risks ( such as fire or damage and theft) and internal fraud by employees. Controls for safeguarding inventory should include security measures to prevent damage and theft such as: storing inventory in areas that are restricted to only authorized employees Locking high-priced inventory in cabinets using cameras and security tags.

Safeguarding Inventory Controls for safeguarding inventory begin as soon as the inventory is ordered, the following documents are often used for inventory control: The purchase order authorizes the purchase of the inventory from an approved vendor. The receiving report establishes an initial record of the receipt of the inventory. Vendor’s Invoice Recording inventory using a perpetual inventory system is also an effective means of control. The amount of inventory is always available in the subsidiary inventory ledger.

Safeguarding Inventory Controls for safeguarding inventory should include security measures to prevent damage and customer or employee theft. examples : Storing inventory in areas that are restricted to only authorized employees. Locking high-priced inventory in cabinets. Using two-way mirrors, cameras, security tags, and guards.

Reporting Inventory A physical inventory or count of inventory should be taken near year-end to make sure that the quantity of inventory reported in the financial statements is accurate.

Learning Objective 2 Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet.

INVENTORY COST FLOW ASSUMPTIONS An accounting issue arises when identical units of goods are acquired at different unit costs during a period. In such cases, when an item is sold, it’s necessary to determine its cost using a cost flow Assumptions and method.

Inventory Cost Flow Assumptions Purchased goods 4 3 2 1 Under FIFO, the first goods purchased are assumed to be the first goods sold FIFO Therefore, the ending inventory is made of the most recent purchases. 3 2 Sold goods 1

Inventory Cost Flow Assumptions Purchased goods 3 Under LIFO, the last goods purchased are assumed to be the first goods sold 2 1 LIFO The ending inventory is made up of the first/old purchases. 1 2 Sold goods 3

Inventory Cost Flow Assumptions Purchased goods 3 2 1 Sold goods Average Cost The cost of the units sold and the ending inventory is an average of the purchase costs. Small exercise

Inventory Cost Flow Assumptions To illustrate, assume that three identical units of merchandise are purchased during May, as follows: Assume that one unit is sold on may 30 for $20. Depending upon which unit was sold, the gross profit varies from $11 to $6.

Inventory Cost Flow Assumptions Assume that one unit is sold on May 30 for $20. Depending upon which unit was sold, the gross profit varies from $11 to $6 as shown below:

Inventory Cost Flow Assumptions Under the specific identification inventory cost flow method, the unit sold is identified with a specific purchase.

INVENTORY COST FLOW ASSUMPTIONS (continued)

Inventory Cost Flow Assumptions Under the first-in, first out (FIFO) inventory cost flow method, the first units purchased are assumed to be sold first and the ending inventory is made up of the most recent purchases. FIFO — Milk (or any perishable item). When shelves are restocked, the “older” milk is moved to the front, and the “newer” milk is placed in back to encourage customers to buy the older milk first.

INVENTORY COST FLOW ASSUMPTIONS (continued)

Inventory Cost Flow Assumptions Under the last-in, first out (LIFO) inventory cost flow method, the last units purchased are assumed to be sold first and the ending inventory is made up of the first units purchased. LIFO — Packages of nails or screws at a hardware store. When shelves are restocked, the older packages are slid to the back of the shelf or rack and the newer packages placed in front. Customers buy the newest hardware first.

Items in Ending Inventory Summary: Method Items Sold Items in Ending Inventory First-in, first-out First items purchased Last items purchased Last-in, first-out

INVENTORY COST FLOW ASSUMPTIONS (concluded)

Inventory Cost Flow Assumptions Under the weighted average inventory cost flow method, the cost of the units sold and in ending inventory is a weighted average of the purchase costs. Average — Gasoline. When new gasoline is delivered to a gas station, it is dumped into the tank with any old gas that has not been sold. Therefore, the customer is buying a mixture of old and new gas.

Learning Objective 3 Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and weighted average cost methods.

Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Item 127B Units Cost Price Jan. 1 Inventory 10 $20 4 Sale 7 $30 10 Purchase 8 21 22 Sale 4 31 28 Sale 2 32 30 Purchase 10 22 Cost of Mdse. Sold Two inventory systems is used : 1. Perpetual 2. Periodic Under all methods: ending inventory (15 units) units sold (13 units) *** the quantities are the same but the costs are different.

Fifo Perpetual

FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

FIFO Perpetual Inventory Account Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Item 127B Units Cost Price Jan. 1 Inventory 10 $20 4 Sale 7 $30 10 Purchase 8 21 22 Sale 4 31 28 Sale 2 32 30 Purchase 10 22 Cost of Mdse. Sold On January 4, 7 units of Item 127B are sold at $30 each.

FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 Jan. 1 10 20 200 4 7 20 140 3 20 60 The sale of 7 units leaves a balance of 3 units. On January 4, 7 units of Item 127B are sold at $30 each.

FIFO Perpetual Inventory Account Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Item 127B Units Cost Price Jan. 1 Inventory 10 $20 4 Sale 7 $30 10 Purchase 8 21 22 Sale 4 31 28 Sale 2 32 30 Purchase 10 22 Cost of Mdse. Sold On January 10, the firm purchased eight units at $21 each.

FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 Because the purchase price of $21 is different than the cost of the previous 3 units on hand, the inventory balance of 11 units is accounted for separately. On January 10, the firm purchased eight units at $21 each.

FIFO Perpetual Inventory Account Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Item 127B Units Cost Price Jan. 1 Inventory 10 $20 4 Sale 7 $30 10 Purchase 8 21 22 Sale 4 31 28 Sale 2 32 30 Purchase 10 22 On January 22, the firm sold four units for $31 each.

FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance On January 22, the firm sold four units for $31 each. Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 3 20 60 1 21 21 7 21 147 Of the four units sold, three are from the first units in (fifo) at a cost of $20.

FIFO Perpetual Inventory Account Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Item 127B Units Cost Price Jan. 1 Inventory 10 $20 4 Sale 7 $30 10 Purchase 8 21 22 Sale 4 31 28 Sale 2 32 30 Purchase 10 22 On January 28, the firm sold two units at $32.

On January 28, the firm sold two units at $32. FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 3 20 60 1 21 21 7 21 147 28 2 21 42 5 21 105 On January 28, the firm sold two units at $32.

FIFO Perpetual Inventory Account Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Item 127B Units Cost Price Jan. 1 Inventory 10 $20 4 Sale 7 $30 10 Purchase 8 21 22 Sale 4 31 28 Sale 2 32 30 Purchase 10 22 On January 30, purchased ten additional units of Item 127B at $22 each.

FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 On January 30, purchased ten additional units of Item 127B at $22 each. 10 8 21 168 3 20 60 8 21 168 22 3 20 60 1 21 21 7 21 147 28 2 21 42 5 21 105 30 10 22 220 5 21 105 10 22 220 Totals 18 $388 13 $263 15 $325

FIFO CMS: Income Statement LG 4 FIFO CMS: Income Statement JAN SOLD UNITS COST TOTAL 4 7 20 $140 22 3 1 21 60 28 2 42 31 CMS $263 I/S

FIFO INVENTORY: Balance Sheet LG 4 FIFO INVENTORY: Balance Sheet Ending Inventory COST TOTAL 5 21 $105 10 22 220 15 $325 B/S

= $360 EXERCISE LG 3 Ending inventory is 11 units. 1/1 Inventory 2/4 Purchase 7/20 Purchase 12/30 Purchase Calculate the cost of ending inventory using FIFO. 6 units @ $28 12 units @ $30 14 units @ $32 8 units @ $33 = $360

Lifo Perpetual

LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

On January 4, the firm sold 7 units at $30 each. LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 On January 4, the firm sold 7 units at $30 each.

On January 10, the firm purchased eight units at $21 each. LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 Note that a new layer is formed. On January 10, the firm purchased eight units at $21 each.

On January 22, the firm sells four units at $31 each. LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 4 21 84 3 20 60 4 21 84 Of the 4 units sold, all come from the most recent purchase at a cost of $21 each. On January 22, the firm sells four units at $31 each.

On January 28, sold two units at $32 each. LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 4 21 84 3 20 60 4 21 84 28 2 21 42 3 20 60 2 21 42 On January 28, sold two units at $32 each.

On January 30, purchase 10 units at $22 each. LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 4 21 84 3 20 60 4 21 84 28 2 21 42 3 20 60 2 21 42 30 10 22 220 3 20 60 2 21 42 10 22 220 On January 30, purchase 10 units at $22 each.

LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 4 21 84 3 20 60 4 21 84 Three layers 28 2 21 42 3 20 60 2 21 42 30 10 22 220 3 20 60 2 21 42 10 22 220 Totals 18 $388 13 $266 15 $322

LIFO CMS: Income Statement LG 4 LIFO CMS: Income Statement JAN SOLD UNITS COST TOTAL 4 7 20 $140 2 21 84 28 42 31 CMS $266 I/S

LIFO INVENTORY: Balance Sheet LG 4 LIFO INVENTORY: Balance Sheet Ending Inventory COST TOTAL 3 20 $60 2 21 42 10 22 220 15 $322 B/S

= $318 EXERCISE LG 3 Ending inventory is 11 units. 1/1 Inventory 2/4 Purchase 7/20 Purchase 12/30 Purchase Calculate the cost of ending inventory using LIFO. 6 units @ $28 12 units @ $30 14 units @ $32 8 units @ $33 = $318

Cost of Merchandise Available for Sale Units Available for Sale Average Cost method Cost of Merchandise Available for Sale = Average Unit Cost Units Available for Sale With Average cost, an average unit cost for each item is computed each time a purchase is made. Inventory data using the perpetual inventory system can be used in evaluating advertising campaigns and sales promotions.

Average cost-Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 11 20.7 228 22 4 20.7 83 7 20.7 145 Three layers 28 2 20.7 41.4 5 5 20.7 103.5 30 10 22 220 15 21.6 323.6 Totals 18 $388 13 $265 15 $323

Inventory Costing Methods For purposes of illustration, the data for Item 127B are used, as shown below. We will examine the perpetual inventory system first.

FIRST-IN, FIRST-OUT METHOD (continued)

FIRST-IN, FIRST-OUT METHOD (continued)

FIRST-IN, FIRST-OUT METHOD (continued)

FIRST-IN, FIRST-OUT METHOD (continued)

FIRST-IN, FIRST-OUT METHOD (continued)

FIRST-IN, FIRST-OUT METHOD (continued)

FIRST-IN, FIRST-OUT METHOD (continued)

LAST-IN, FIRST-OUT METHOD (continued)

LAST-IN, FIRST-OUT METHOD (continued)

LAST-IN, FIRST-OUT METHOD (continued)

LAST-IN, FIRST-OUT METHOD (continued)

LAST-IN, FIRST-OUT METHOD (continued)

LAST-IN, FIRST-OUT METHOD

LAST-IN, FIRST-OUT METHOD (continued)

 

Weighted Average Cost Method When the weighted average cost method is used in a perpetual system, an average unit cost for each item is computed each time a purchase is made. This unit cost is then used to determine the cost of each sale until another purchase is made and a new average is computed. This averaging technique is called a moving average.

WEIGHTED AVERAGE COST METHOD

 

ONLY 5 Learning Objective Compare and contrast the use of the three inventory costing methods. ONLY

COMPARING INVENTORY COST METHODS Inflation Deflation

Comparing Inventory Cost Methods When the FIFO method is used during a period of inflation or rising prices, FIFO will show a larger profit than the other two inventory costing methods.

Comparing Inventory Cost Methods When the LIFO method is used during a period of inflation or rising prices, LIFO will show a lower profit than the other two inventory costing methods. During a period of rising prices, using LIFO offers an income tax savings compared to the other two inventory costing methods.

Comparing Inventory Cost Methods The weighted average cost method of inventory costing is a compromise between FIFO and LIFO. Net income for the weighted average cost method is somewhere between the net incomes of LIFO and FIFO.

Learning Objective 6 Describe and illustrate the reporting of merchandise inventory in the financial statements.

Reporting Merchandise Inventory Cost is the primary basis for valuing and reporting inventories in the financial statements. However, inventory may be valued at other than cost in the following cases: The cost of replacing items in inventory is below the recorded cost. The inventory cannot be sold at normal prices due to imperfections, style changes, or other causes.

Valuation at Lower of Cost or Market Market, as used in lower-of-cost-or-market method, is the cost to replace the merchandise on the inventory date.

Valuation at Lower of Cost or Market Cost and replacement cost can be determined for the following: Each item in the inventory. Each major class or category of inventory. Total inventory as a whole.

VALUATION AT LOWER OF COST OR MARKET > < > < The market decline based on individual items ($15,520 – $15,070) = $450

Valuation at Net Realizable Value Merchandise that is out of date, spoiled, or damaged should be written down to its net realizable value. This is the estimated selling price less any direct costs of disposal, such as sales commissions or special advertising.

Valuation at Net Realizable Value Assume the following data about an item of damaged merchandise: The merchandise should be valued at its net realizable value of $650 ($800 – $150). Original cost $1,000 Estimated selling price 800 Selling expenses 150

Merchandise Inventory on the Balance Sheet Merchandise inventory is usually presented in the Current Assets section of the balance sheet, following receivables. The method of determining the cost of the inventory (FIFO, LIFO, or weighted average) and the method of valuing the inventory (cost or the lower of cost or market) should be shown.

MERCHANDISE INVENTORY ON THE BALANCE SHEET

+ more WAC exercises from E25 H.W: PE 7-1 A PE 7-1 B PE 7-2 A PE 7-2 B PE 7-3 A PE 7-3 B PE 7-5 A PE 7-5 B EX 7-3 EX 7-4 + more WAC exercises from E25

Inventories The End