Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 7 Reporting and Interpreting Inventories and Cost of Goods Sold

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 1 Describe inventory management goals.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Inventory Management Decisions The primary goals of inventory managers are to: 1.ensure sufficient quantities of inventory are available to meet customer’s needs, 2.ensure inventory quality meets customers’ expectations and company standards, and 3.minimize the costs of acquiring and carrying inventory The primary goals of inventory managers are to: 1.ensure sufficient quantities of inventory are available to meet customer’s needs, 2.ensure inventory quality meets customers’ expectations and company standards, and 3.minimize the costs of acquiring and carrying inventory

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 2 Describe the different types of inventory.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Items Included in Inventory Inventory includes goods that are: 1.held for sale in the normal course of business, or 2.used to produce goods for sale. Inventory includes goods that are: 1.held for sale in the normal course of business, or 2.used to produce goods for sale. Inventory is reported on the balance sheet as a current asset because it normally is used or converted into cash within one year. Balance Sheet Current Assets Inventory

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Items Included in Inventory Merchandiser Manufacturer Inventory Inventory is acquired in a finished condition and is ready for sale without further processing. Raw materials inventory Raw materials inventory includes materials that are processed further into finished goods. Work in process inventory Work in process inventory includes goods that are in the process of being manufactured. Finished goods inventory Finished goods inventory includes goods that are complete and ready to sell. Raw materials inventory Raw materials inventory includes materials that are processed further into finished goods. Work in process inventory Work in process inventory includes goods that are in the process of being manufactured. Finished goods inventory Finished goods inventory includes goods that are complete and ready to sell.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Cost of Goods Sold $40,000 Beginning Inventory $40,000 $55,000 Purchases $55,000 $95,000 Goods Available for Sale $95, $35,000 Ending Inventory $35,000 Still Here $60,000 Cost of Goods Sold $60,000 Sold

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Cost of Goods Sold

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 3 Compute costs using four inventory costing methods.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Inventory Costing Methods First-in, first-out (FIFO) Last-in, first-out (LIFO) Weighted average Specific identification

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Inventory Costing Illustration

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Specific Identification When this method is used, the cost of each item sold is individually identified and recorded as cost of goods sold.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Specific Identification The above purchases were made by Oakley during the year. Of the five units sold, one had a cost of $70, three cost $80, and one cost $100.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Specific Identification The Cost of Goods Sold would be: [(1 × $70) + (3 × $80)+ (1 × $100)] = $410. Ending Inventory would be: [(1 × $70) + (2 × $80] = $230. The Cost of Goods Sold would be: [(1 × $70) + (3 × $80)+ (1 × $100)] = $410. Ending Inventory would be: [(1 × $70) + (2 × $80] = $230.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin First-In, First-Out (FIFO) Cost of Goods Sold Ending Inventory Oldest Costs Recent Costs

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin First-In, First-Out (FIFO) Using FIFO, the unit sold would be: 2 units from beginning inventory and 3 units from the purchase of March 12 th.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin First-In, First-Out (FIFO) The Cost of Goods Sold would be: [(2 × $70) + (3 × $80)] = $380. Ending Inventory would be: [(2 × $80) + $100] = $260. The Cost of Goods Sold would be: [(2 × $70) + (3 × $80)] = $380. Ending Inventory would be: [(2 × $80) + $100] = $260.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Last-In, First-Out (LIFO) Cost of Goods Sold Ending Inventory Recent Costs Oldest Costs

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Last-In, First-Out (LIFO) Using LIFO, the unit sold would be: 1 unit from June 9 th purchase and 4 units from the purchase of March 12 th.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Last-In, First-Out (LIFO) The Cost of Goods Sold would be: [$100 + (4 × $80)] = $420. Ending Inventory would be: [$80 + (2 × $70)] = $220. The Cost of Goods Sold would be: [$100 + (4 × $80)] = $420. Ending Inventory would be: [$80 + (2 × $70)] = $220.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Weighted Average Cost When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. Cost of Goods Available for Sale Units on units Available for Sale ÷

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Weighted Average Cost WAC = $640 ÷ 8 = $80 per unit

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Weighted Average Cost The Cost of Goods Sold would be: (5 × $80) $400. Ending Inventory would be: (3 × $80) = $240. The Cost of Goods Sold would be: (5 × $80) $400. Ending Inventory would be: (3 × $80) = $240.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Financial Statement Effects of Costing Methods Because prices change, inventory methods nearly always assign different cost amounts.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Financial Statement Effects of Costing Methods Advantages of Methods Smoothes out price changes. Better matches current costs in cost of goods sold with revenues. Ending inventory approximates current replacement cost. First-In, First-Out Weighted Average Last-In, First-Out

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 4 Explain why inventory is reported at the lower of cost or market.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Reporting Inventory at the Lower of Cost or Market The value of inventory can fall below its recorded cost for two reasons: 1. it’s easily replaced by identical goods at a lower cost, or 2. it’s become outdated or damaged. The value of inventory can fall below its recorded cost for two reasons: 1. it’s easily replaced by identical goods at a lower cost, or 2. it’s become outdated or damaged.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Reporting Inventory at the Lower of Cost or Market When the value of inventory falls below its recorded cost, the amount recorded for inventory is written down to its lower market value. This is known as the lower of cost or market (LCM) rule.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 5 Compute and interpret the inventory turnover ratio.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Inventory Turnover Analysis Inventory Turnover Ratio = Cost of Goods Sold Average Inventory Beginning Inventory Ending Inventory + 2

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Inventory Turnover Analysis Days to Sell 365 Inventory Turnover Ratio =

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 6 Explain how accounting methods affect evaluations of inventory management.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The Impact of Inventory Cost Methods

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin End of Chapter 7