1 © Copyright 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South-Western are trademarks used herein under license. FINANCIAL ACCOUNTING 2 ND EDITION BY DUCHAC, REEVE, & WARREN 6 Inventories

2 LEARNING GOALS When you finish this chapter, you should be able to

3 1.Identify types of inventory used. 2.Summarize control procedures for inventory. 3.Describe 3 inventory cost flow assumptions; financial statement impact. LEARNING GOALS Continued

4 LEARNING GOALS 4. Determine cost of perpetual inventory using FIFO, LIFO, average. 5.Determine cost of periodic inventory using FIFO, LIFO, average. 6.Compare 3 inventory methods. Continued

5 LEARNING GOALS 7.Determine lower-of-cost-or-market for inventory. 8.Describe quick response for inventory. 9.Interpret inventory turnover ratio, days sales in inventory.

6 BEST BUY Best Buy  Target inventory to its customers  Manages inventory for customer needs  Balances costs to hold inventory such as obsolescence, financing & storage costs

7 LEARNING GOALS 1 Identify types of inventory used.

8 TYPES OF INVENTORY Inventories differ between merchandisers and manufacturers Merchandisers Hold inventory for resale Do not make goods Inventories differ between merchandisers and manufacturers Merchandisers Hold inventory for resale Do not make goods LG 1

9 MANUFACTURING INVENTORIES Materials inventory Raw material used to make product Work-in-process inventory Cost of partially completed products Finished goods inventory Total costs of completed goods Materials Labor Factory overhead Materials inventory Raw material used to make product Work-in-process inventory Cost of partially completed products Finished goods inventory Total costs of completed goods Materials Labor Factory overhead LG 2

10 LEARNING GOALS 2 Summarize control procedures for inventory.

11 INVENTORY CONTROL 2 Objectives Safeguarding Reporting LG 2

12 SAFEGUARDING Safeguarding measures to prevent damage, theft Restrict access Alarm tags Safeguarding measures to prevent damage, theft Restrict access Alarm tags LG 2

13 REPORTING LG 2 Aids to reporting accuracy Perpetual inventory Subsidiary ledgers Physical inventory counts Aids to reporting accuracy Perpetual inventory Subsidiary ledgers Physical inventory counts

14 LEARNING GOALS 3 Describe 3 inventory cost flow assumptions; financial statement impact.

15 COST? How is cost of inventory determined? LG 3

16 COST FLOW ASSUMPTIONS 3 methods to calculate cost –First-in-first-out (FIFO) –Last-in-first-out (LIFO) –Average 3 methods to calculate cost –First-in-first-out (FIFO) –Last-in-first-out (LIFO) –Average LG 3

17 FIFO Under FIFO, the first goods purchased are assumed to be the first goods sold LG 3

18 FIFO CALCULATION During May, 3 units purchased, 1 unit sold. MAYUNITSCOST 101$9Income Statement 18113Balance 24114Sheet Total3$36 LG 3

19 FIFO STATEMENTS Income Statement Sales…………$20 CMS………….. 9 Gross Profit….$11 Balance Sheet Inventory…$27 LG 3 Click button to skip exercise

20 EXERCISE 6-10a Press “Enter” or click left mouse button for answer. 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 $28 12 $30 14 $32 8 $33 LG 3 a = $360

21 LIFO Under LIFO, the last goods purchased are assumed to be the first goods sold LG 3

22 LIFO CALCULATION During May, 3 units purchased, 1 unit sold. MAYUNITSCOST 101$9Balance 18113Sheet 24114Income Statement Total3$36 LG 3

23 LIFO STATEMENTS Income Statement Sales…………$20 CMS…………. 14 Gross Profit….$ 6 Balance Sheet Inventory…$22 LG 3 Click button to skip exercise

24 EXERCISE 6-10b Press “Enter” or click left mouse button for answer. 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 $28 12 $30 14 $32 8 $33 LG 3 a = $318

25 AVERAGE With Average cost, the average purchase cost is cost of merchandise sold. LG 3

26 AVERAGE CALCULATION During May, 3 units purchased, 1 unit sold. MAYUNITSCOST 101$ Total3$36 Average$12Income Statement LG 3

27 AVERAGE STATEMENTS Income Statement Sales…………$20 CMS…………. 12 Gross Profit….$ 8 Balance Sheet Inventory…$24 LG 3 Click button to skip exercise

28 EXERCISE 6-10b Press “Enter” or click left mouse button for answer. Ending inventory is 11 units. 1/1 Inventory 2/4 Purchase 7/20 Purchase 12/30 Purchase Calculate the cost of ending inventory using AVERAGE. 6 $28 12 $30 14 $32 8 $33 LG 3 a = $341

29 LEARNING GOALS 4 Determine cost of perpetual inventory using FIFO, LIFO, average.

30 PERPETUAL INVENTORY Increases, decreases in merchandise recorded in manner similar to cash Journal entry Inventory Cash / Accounts Payable Increases, decreases in merchandise recorded in manner similar to cash Journal entry Inventory Cash / Accounts Payable LG 4

31 PERPETUAL INVENTORY JANITEM 127BUNITSCOST 1Inventory10$20 4Sale7 10Purchase821 22Sale4 28Sale2 30Purchase1022 LG 4 1/31 Ending Inventory: 28 – 13 = 15

32 FIFO REVIEWED Under FIFO, the first goods purchased are assumed to be the first goods sold LG 4

33 FIFO CMS: Income Statement JAN SOLD UNITS COSTTOTAL 4720$ CMS$263 LG 4 I/S

34 FIFO INVENTORY: Balance Sheet Ending Inventory COSTTOTAL 521$ $325 LG 4 B/S

35 LIFO REVIEWED Under LIFO, the last goods purchased are assumed to be the first goods sold LG 3

36 LIFO CMS: Income Statement JAN SOLD UNITS COSTTOTAL 4720$ CMS$266 LG 4 I/S

37 LIFO INVENTORY: Balance Sheet Ending Inventory COSTTOTAL 320$ $322 LG 4 B/S

38 AVERAGE REVIEWED With Average cost, the average purchase cost is calculated among inventory units available for each sale. LG 4

39 LEARNING GOALS 5 Determine cost of periodic inventory using FIFO, LIFO, average

40 PERIODIC INVENTORY SYSTEM Only revenue is recorded at point of sale Cost of merchandise sold (CMS) is calculated at the end of the period using –FIFO –LIFO –Average Only revenue is recorded at point of sale Cost of merchandise sold (CMS) is calculated at the end of the period using –FIFO –LIFO –Average LG 5

41 LEARNING GOALS 6 Compare 3 inventory methods.

42 INVENTORY RECORDS UnitsCostTotal 1/1Inventory200$9$1,800 3/10Purchase300103,000 9/21Purchase400114,400 11/18Purchase100121,200 Available for sale 1,000$10,400 LG 6

43 COMPARING METHODS Sales = $15,000 Merchandise available for sale = $10,400 3 cost methods –FIFO –LIFO –Average Sales = $15,000 Merchandise available for sale = $10,400 3 cost methods –FIFO –LIFO –Average LG 6

44 FIFO Sales$15,000 - Cost of Merchandise sold7,000 LG 6 Gross Profit $8,000

45 LIFO Sales$15,000 - Cost of Merchandise sold7,600 LG 6 Gross Profit $7,400

46 AVERAGE Sales$15,000 -Cost of Merchandise sold7,280 LG 6 Gross Profit $7,720

47 LEARNING GOALS 7 Determine lower-of- cost-or-market for inventory.

48 INVENTORY VALUATION: Other Than Cost Used to ensure inventory not reported at a cost higher than its replacement cost LG 7

49 LOWER-OF-COST-OR MARKET (Slide 1 of 3) ItemQuantity Unit Cost Unit Market A400$10.25$ 9.50 B C D LG 7 Basic Information

50 LOWER-OF-COST-OR MARKET (Slide 2 of 3) ItemCostMarketLCM A$4,100$3,800 B2,7002,8922,700 C4,8004,650 D3,9204,1303,920 LG 7

51 Calculation: $3,800 + $2,700 + $4,650 + $3,920 Ending Inventory = $15,070 Calculation: $3,800 + $2,700 + $4,650 + $3,920 Ending Inventory = $15,070 LOWER-OF-COST-OR MARKET (Slide 3 of 3)

52 LEARNING GOALS 8 Describe quick response for inventory.

53 QUICK RESPONSE To optimize inventory levels using –Least amount of inventory on hand –Internet ordering LG 8

54 LEARNING GOALS 9 Interpret inventory turnover ratio, days sales in inventory.

55 INVENTORY RATIOS Measures efficiency, effectiveness of inventory level –Inventory turnover –Days sales in inventory

56 INVENTORY RATIOS: Formulas –Inventory turnover Cost Merchandise Sold/ Average Inventory –Days sales in inventory Ave Inventory/ Ave. Daily CMS

57 INVENTORY TURNOVER Best BuyCircuit City CMS$18,350$7,904 Ave Inventory$2,342$1,488 Inventory turnover Measures number of times inventory turns over during year.

58 ANALYSIS: Inventory Turnover Best Buy turns its inventory almost 8 times in a year Circuit City turns its inventory slightly more than 5 times in a year Best Buy turns its inventory almost 8 times in a year Circuit City turns its inventory slightly more than 5 times in a year

59 DAYS IN SALES Best Buy Circuit City Ave. Daily CMS$50.27$21.65 Ave. Inventory$2,342$1,488 Days in Sales47 days69 days Measures number of days inventory stays on shelves

60 ANALYSIS: Days in Sales Best Buy sells through its inventory every 47 days on average Circuit City sells through its inventory every 69 days on average Best Buy sells through its inventory every 47 days on average Circuit City sells through its inventory every 69 days on average

61 THE END CHAPTER 6