Copyright 2003 Prentice Hall Publishing1 Acquisitions/Payment: Inventory and Liabilities Chapter 6

Copyright 2003 Prentice Hall Publishing2 Inventory l Inventory is tangible property that is held for resale or will be part of goods held for resale. l Inventory is reported on the balance sheet as a current asset. l Types of inventory: merchandise inventory Raw materials inventory These 3 will Work in process inventory be studied Finished goods inventory in managerial accounting.

Copyright 2003 Prentice Hall Publishing3 l The amount recorded for inventory should include: n Invoice price, freight charges, inspection costs, and preparation costs. Inventory Cost

Copyright 2003 Prentice Hall Publishing4 l 2/10, n/30 (for example) n 2% discount if invoice paid in ten days n tells when and how much must be paid n high interest cost of not taking purchase discounts Terms of Sale and Purchases

Copyright 2003 Prentice Hall Publishing5 Shipping Terms (Sales & Purchases) l F.O.B. shipping point or destination n tells who pays shipping n and who includes the inventory on the Balance Sheet when in-transit. l F.O.B shipping indicates that the title to the goods changes hands at shipping. l F.O.B. destination indicates that the title to the goods changes hands at destination.

Copyright 2003 Prentice Hall Publishing6 l Whoever owns the goods while they are in-transit pays for the shipping. l Shipping costs to get the inventory IN are included as part of the cost of the inventory. l Shipping costs for a sale are part of operating expenses. Shipping Costs

Copyright 2003 Prentice Hall Publishing7 Alternative Inventory Cost Flow Methods FIFO LIFO WeightedAverage SpecificIdentification

Copyright 2003 Prentice Hall Publishing8 Inventory Cost Flow Methods These four inventory costing methods are used to assign the total dollar amount of goods available for sale between ending inventory and cost of goods sold. Ending inventory or CGS??

Copyright 2003 Prentice Hall Publishing9 l The cost of the oldest inventory items are charged to cost of goods sold when goods are sold. l The cost of the newest inventory items remain in ending inventory. l The actual physical flow of inventory items may differ from the FIFO cost flow assumptions. First-In, First-Out

Copyright 2003 Prentice Hall Publishing10 l The cost of the newest inventory items are charged to cost of goods sold when goods are sold. l The cost of the oldest inventory items remain in ending inventory. l The actual physical flow of inventory items may differ from the LIFO cost flow assumptions. Last-In, First-Out

Copyright 2003 Prentice Hall Publishing11 Weighted-Average l Take the average cost of all goods available for sale to value both COGS and Ending Inventory. l BE SURE IT’S WEIGHTED!

Copyright 2003 Prentice Hall Publishing12 Specific Identification l Specific cost of each inventory item is known. l Used with small volume, high dollar inventory.

l The inventory account is continuously updated for the following items: n Purchases n Returns & Allowances n Sales l Detailed record-keeping has become much easier with current technology. l A physical count of the inventory is still required at the end of the accounting period to assure accurate inventory records in case of errors or theft. Perpetual Inventory Systems

l The ending inventory is determined at the end of the period by taking a physical count of the goods remaining on hand. l Cost of goods sold is calculated at the end of the accounting period using the ending inventory count. Periodic Inventory Systems

Copyright 2003 Prentice Hall Publishing15 Beginning inventory Add: Purchases (net) Goods available for sale Deduct: Ending inventory Cost of goods sold Cost of Goods Sold

l Because entries are not made to the inventory account during the accounting period, the amount of inventory is not known until the end of the period, when the inventory count is done. l This system is being used less and less due to advancements in technology. Periodic Inventory Systems

Copyright 2003 Prentice Hall Publishing17 Income Statement : FIFOLIFOWt. Avg. Sales$236$236$ 236 CGS GM Balance Sheet : Inventory$122$ 92$ 107 Financial Statements:

Copyright 2003 Prentice Hall Publishing18 Comparison of Methods l Each of the four methods is acceptable, and an argument can be made for using each. l The choice of an inventory method will depend on management’s incentives, the tax laws, and the reporting company’s particular economic circumstances.

Copyright 2003 Prentice Hall Publishing19 Consistency Principle Because the choice of an inventory method can significantly affect the financial statements, a company might be inclined to select a new method each year that would result in the most favorable financial statements. However...

l Misstatements in inventory may cause errors in the following areas: n Income Statement »Cost of Goods Sold, Gross Profit, Net Income n Balance Sheet »Inventory, Payables, Retained Earnings two l Because the ending inventory of one period becomes the beginning inventory of the next period, ending inventory errors affect two accounting periods. Errors in Measuring Ending Inventory

l Provides an estimate l Not acceptable for GAAP l When to use n for interim reporting purposes n when physical inventory not possible Gross Profit Method of Estimating Inventory

l Ending inventory is reported at the lower of cost or market (LCM). l Market refers to the replacement cost of the merchandise. l An example of conservatism in accounting Lower of Cost or Market