Chapter 6: INVENTORY COSTING Unit 2 Test (covering chapter 5 and 6) will occur on Oct 24 (Friday)

1. Describe the steps in determining inventory quantities. 2. Calculate ending inventory and cost of goods sold in a periodic inventory system using inventory cost flow assumptions. 3. Determine the effects of inventory cost flow assumptions and inventory errors on the financial statements. 4. Demonstrate the presentation and analysis of inventory. Objectives (Chapter 6)

In the balance sheet of merchandising and manufacturing companies, inventory is frequently the most significant current asset. In the income statement, inventory is vital in determining the results of operations (net income) for a particular period. Gross profit (net sales - cost of goods sold) is closely watched by management, owners, and other interested parties. INVENTORY BASICS

Perpetual vs. Periodic Inventory Accounting Perpetual – Updates inventory and cost of goods sold after every purchase and sales transaction Periodic – Delays updating of inventory and cost of goods sold until end of the period – Misstates inventory during the period This chapter covers the periodic inventory method.

In order to prepare financial statements, it is necessary to determine the number of units of inventory owned by the company at the statement date, and to value them. The determination of inventory quantities involves 1. taking a physical inventory of goods on hand, and 2. determining the ownership of goods. Taking a physical inventory involves counting, weighing, or measuring each kind of inventory on hand. DETERMINING INVENTORY QUANTITIES

TAKING A PHYSICAL INVENTORY A company, in order to minimize errors in taking the inventory, should adhere to internal control principles by adopting the following procedures: 1. Employees who are not responsible for custody of the inventory (for keeping inventory records) should do the counting (segregation of duties). 2. Each counter (counting machine) should establish the authenticity of each inventory item. (i.e. how many units are in each box etc. ).

TAKING A PHYSICAL INVENTORY 3. Another employee should make a second count (independent party’s verification might be necessary). 4. All inventory tags should be pre-numbered and accounted for (documentation procedures). 5. At the end of the count, a designated supervisor should ascertain that all inventory items are tagged and that no items have more than one tag.

Seller Buyer Public Carrier Co. Ownership passes to buyer here Ownership passes to buyer here FOB Shipping Point FOB Destination Point TERMS OF SALE Public Carrier Co. Buyer Seller

Goods in Transit Goods are considered in transit when they are on board of a public carrier such as a railway, airline, truck or shipping company at the end of the accounting period. The problem is determining who should include the goods in its inventory. (the buyer? or seller?) If the terms are FOB shipping point, and on December , the goods are on board of a truck. In whose book, should these goods be recorded as inventory?

Goods in Transit FOB shipping point: The goods should be in the buyer’s book. If the term was FOB destination, and the goods are on board of a truck on December 31, 2013 then whose goods are these? The seller must record this as their inventory in their book.

Goods in Transit Park Distribution has units of inventory in its warehouse on December 31, FOB destination. It also has the following goods in transit. – Sales of 1500 units shipped December 31, FOB destination and – Purchases of 2500 units shipped FOB shipping point by the seller on December 31 – What is the ending inventory for Park Distribution?

Goods in Transit Park Distribution has = units Why is recording accurate inventory quantities important? Inaccurate inventory affects not only the ending inventory amount on the balance sheet; they also affect the cost of goods sold, which is reported in income statement.

Under a consignment arrangement, the holder of the goods (called the consignee, used textbook store) does not own the goods. Ownership remains with the shipper (Mr. Park) of the goods (consignor) until the goods are actually sold to a customer. Consigned goods should be included in the consignor’s inventory, not the consignee’s inventory. Consignee Company DETERMINING OWNERSHIP OF CONSIGNED GOODS Owned by a consignor; do not count in our (consignee) inventory

Sometimes goods are not physically present at a company because the goods have been taken home on approval by a customer. = “Goods on approval” (example is electronics rental store) Goods on approval should be added to the physical inventory count because they still belong to the seller. In other cases, goods are sold but the seller is holding them for alteration (for example, man’s suit needs to be altered) or to be picked up, then these units should not be recorded as inventory for the seller. Other Situations

P319 E6.1, E6.2 P324 P6.1 Classwork / Homework