CPA, MBA BY RACHELLE AGATHA, CPA, MBA Inventory Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac

1. Describe the importance of control over inventory. 2. Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet. Objectives 3. Determine the cost of inventory under the perpetual system, using the FIFO, LIFO, and average cost methods.

4. Determine the cost of inventory under the periodic system, using the FIFO, LIFO, and average cost methods. 5. Compare and contrast the use of the three inventory costing methods. 6. Describe and illustrate the reporting of merchandise inventory in the financial statement. Objectives

Describe the importance of control over inventory. Objective 1

Two primary objectives of control over inventory are: 1)Safeguarding the inventory, and 2)Properly reporting it in the financial statements.

Controls over inventory include developing and using security measures to prevent inventory damage or customer or employee theft.

To ensure the accuracy of the amount of inventory reported in the financial statements, a merchandising business should take a physical inventory.

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

Inventory Costing Methods

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

In FIFO, the cost in ending inventory are the newer costs and the cost of merchandise sold has the older cost (First In – First out). FIFO - cost inventory from the bottom up. Newest in is sitting in inventory.

FIFO Perpetual Inventory

In LIFO, the cost in ending inventory are the older cost and the cost of merchandise sold has the newer cost (Last In – First out). LIFO - cost inventory from the top down. Oldest is sitting in inventory.

LIFO Perpetual Inventory

When the Average Cost Method is used with in a perpetual system, the average cost for each type of item is computed each time a purchase is made The Average Cost Method is rarely used in a perpetual system so it is not illustrated.

1. Most companies will use a computerized system if they chose to do perpetual inventory as is it very time intensive manually. 2. Computerized systems track all relevant information about each inventory item, such as description, quantity, cost, size, location. 3. For every inventory transaction, there is an entry into the system. Companies will use bar codes, scanners, and other technology. Computerized Perpetual Accounting Systems 4. A physical inventory is taken at the end of the year and compared to the system records.

Determine the cost of inventory under the periodic inventory system, using FIFO, LIFO, and average cost methods. Objective 4

Using FIFO, the earliest batch purchased is considered the first batch of merchandise sold. The physical flow does not have to match the accounting method chosen. FIFO Periodic

Using LIFO, the most recent batch purchased is considered the first batch of merchandise sold. The actual flow of goods does not have to be LIFO. For example, a store selling fresh fish would want to sell the oldest fish first (which is FIFO) even though LIFO is used for accounting purposes. LIFO Periodic

The weighted average unit cost method is based on the average cost of identical units. The total cost of merchandise available for sale is divided by the related number of units of that item. Average Cost

Average Cost - Periodic

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

Comparison of Methods

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

7-6 If the cost of replacing an item in inventory is lower than the original purchase cost, the lower-of-cost- or-market (LCM) method is used to value the inventory. Lower-of-Cost-or-Market Method

Market, as used in lower of cost or market, is the cost to replace the merchandise on the inventory date.

Cost and replacement cost can be determined for— 1)each item in the inventory, 2)major classes or categories of inventory, or 3)the inventory as a whole.

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 cost of disposal, such as sales commissions.

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 inventory (FIFO, LIFO, or weighted average) should be shown.

Summary  Inventory and Controls  Inventory Costing Methods  Perpetual vs. Periodic systems  Reporting of Inventory