Chapter 6 Inventories Lecture 26

Practice Question

Following data refer to Company ABC for the year Sales revenue Work-in-process inventory, December Work-in-process inventory, December Selling and administrative expenses Income tax expense40% Purchase of raw material Raw-material inventory, December Raw-material inventory, December Direct labor Utilities, plant25000 Depreciation: plant and equipment Finished goods inventory, December Finished goods inventory, December Indirect material10000 Indirect labor25000 Other manufacturing overhead30000

Requirements Prepare Cost of Goods Sold Statement Prepare Income Statement Prepare Journal Entries Prepare Closing Entries

1.Summarize and provide examples of internal control procedures that apply to inventories. 2.Describe the effect of inventory errors on the financial statement. 3.Describe the three inventory cost flow assumptions and how they impact the income statement and balance sheet. 4.Compute the cost of inventory under the perpetual inventory system, using the following cost methods: first-in, first-out; last- in, first-out; average cost.

5.Compute the cost of inventory under the periodic inventory system, using the following costing methods: first-in, first-out; last-in, first-out; average cost. 6.Compare and contrast the use of the three inventory costing methods. 7.Compute the proper valuation of inventory at other than cost, using the lower-of-cost-or- market and net realization value concepts. 8.Prepare a balance sheet presentation of merchandise inventory.

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. Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.

Receiving report Purchase order Invoice AGREE AGREE AGREE JOURNAL Description Nov. 9 Post. Ref. Date Inventory Accounts Payable--XYZ Co Purchased merchandise on account.

LIABILITIES OWNER’S EQUITY REVENUES ASSETS COSTS & EXPENSES MerchandiseInventory Cost of Merchandise Sold If merchandise inventory is Cost of merchandise sold is Gross profit and net income are... Ending owner’s equity is If merchandise inventory is Cost of merchandise sold is Gross profit and net income are... Ending owner’s equity is overstated understated overstated Net Income

understated overstated understated

Defining Inventory 1. Assets held for resale purpose in a normal course of business. 2. Assets used to produce products for resale purpose. Merchandising Firms:merchandise Manufacturing Firms:raw materials Work-in-process Finished Goods

How to Account for Inventory Purchases, Sales and Reporting? nApplying either the periodic inventory system or the perpetual inventory system and select a cost flow assumption to determine the value of inventories. nBoth inventory systems require a physical count of inventory at the end of a period to determine the units which can be included in the inventory count. 12

Inventory Systems A. Perpetual Inventory System. B. Periodic Inventory System.

Perpetual Inventory System nInventory account is used for the purchase and sale. n The balance of inventory is available at all time. n A physical count is needed at the end of a period. n Any discrepancy of book balance with physical count should be adjusted to a loss or gain account.

Perpetual Inventory System (contd.) nCGS account is used to record the CGS of a sale. nTherefore, the CGS is also known at all time. nCGS is determined by selecting a cost flow assumption.

Cost Flow Assumptions n In order to apply these assumptions, companies must keep a record of the cost of each inventory unit purchased.

Cost Flow Assumptions (contd.) 1.First-In, First Out (FIFO) method. 2.Last-in, First-Out (LIFO) method. 3.Weighted-Average Cost method. 4.Specific Identification method.

Perpetual vs. Periodic Inventory System Perpetual system Periodic System At purchase Inventory xxx Purchases xxx A/P xxx A/P xxx At sale: CGS xxx None Inventory xxx A/R xxx Sales xxx Sales xxx 18

Purchased goods Sold goods

Purchased goods Sold goods

Purchased goods Sold goods

PurchasesCost of Mdse. SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCost

Lecture Overview

End of Lecture 26