1. Inventories
Chapter 7

2. CH1 Types of businesses:
Manufacturing Business e.g. Ford.
Merchandising Business e.g. Debenhams
Servicing Business e.g. Saudi Airlines
Manufacturing Businesses use Raw material to make product and the ending inventory from this kind of business is the unsold goods or items.
Merchandising Businesses: buy & Hold inventory for resale - Do not make goods

3. CH6 Inventory:
The raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for sale

4. Why is Inventory Control Important?
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.

5. Learning Objective 1
Describe the importance of control over inventory.

6. Control of Inventory
Two primary objectives of control over inventory are:
Safeguarding the inventory from damage or theft.
Reporting inventory in the financial statements.

7. Safeguarding Inventory
Controls for safeguarding inventory begin as soon as the inventory is ordered, the following documents are often used for inventory control:
The purchase order authorizes the purchase of the inventory from an approved vendor.
The receiving report establishes an initial record of the receipt of the inventory.
Vendor’s Invoice
Recording inventory using a perpetual inventory system is also an effective means of control. The amount of inventory is always available in the subsidiary inventory ledger.

8. Safeguarding Inventory
Controls for safeguarding inventory should include security measures to prevent damage and customer or employee theft.
examples :
Storing inventory in areas that are restricted to only authorized employees.
Locking high-priced inventory in cabinets.
Using two-way mirrors, cameras, security tags, and guards.

9. Reporting Inventory
A physical inventory or count of inventory should be taken near year-end to make sure that the quantity of inventory reported in the financial statements is accurate.

10. Learning Objective 2
Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet.

11. INVENTORY COST FLOW ASSUMPTIONS
An accounting issue arises when identical units of goods are acquired at different unit costs during a period. In such cases, when an item is sold, it’s necessary to determine its cost using a cost flow Assumptions and method.

12. Inventory Cost Flow Assumptions
Under the first-in, first out (FIFO) inventory cost flow method, the first units purchased are assumed to be sold first and the ending inventory is made up of the most recent purchases.
FIFO — Milk (or any perishable item). When shelves are restocked, the “older” milk is moved to the front, and the “newer” milk is placed in back to encourage customers to buy the older milk first.

13. Inventory Cost Flow Assumptions
Under the last-in, first out (LIFO) inventory cost flow method, the last units purchased are assumed to be sold first and the ending inventory is made up of the first units purchased. 2
LIFO — Packages of nails or screws at a hardware store. When shelves are restocked, the older packages are slid to the back of the shelf or rack and the newer packages placed in front. Customers buy the newest hardware first. 1
LIFO 1 2

14. Items in Ending Inventory
Summary:
Method
Items Sold
Items in Ending Inventory
First-in, first-out
First items purchased
Last items purchased
Last-in, first-out

15. Inventory Cost Flow Assumptions
Under the weighted average inventory cost flow method, the cost of the units sold and in ending inventory is a weighted average of the purchase costs. 3
Average — Gasoline. When new gasoline is delivered to a gas station, it is dumped into the tank with any old gas that has not been sold. Therefore, the customer is buying a mixture of old and new gas. 2 1
Average
Cost

16. Inventory Cost Flow Assumptions
To illustrate, assume that three identical units of merchandise are purchased during May, as follows:
Assume that one unit is sold on may 30 for $20. Depending upon which unit was sold, the gross profit varies from $11 to $6.

17. Inventory Cost Flow Assumptions
Assume that one unit is sold on May 30 for $20. Depending upon which unit was sold, the gross profit varies from $11 to $6 as shown below:

18. Inventory Cost Flow Assumptions
Under the specific identification inventory cost flow method, the unit sold is identified with a specific purchase.

19. INVENTORY COST FLOW ASSUMPTIONS
(continued)

20. INVENTORY COST FLOW ASSUMPTIONS
(continued)

21. INVENTORY COST FLOW ASSUMPTIONS
(concluded)

22. Learning Objective 3
Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and weighted average cost methods.

23. Perpetual Inventory Costs
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Two inventory systems is used : 1. Perpetual 2. Periodic
Under all methods: ending inventory (150 units) units sold (130 units) *** the quantities are the same but the costs are different.

24. Fifo
Perpetual

25. FIFO Perpetual Inventory Account
B/S
I/S

26. Lifo
Perpetual

27. LIFO Perpetual Inventory Account
B/S
I/S

28. Cost of Merchandise Available for Sale Units Available for Sale
Average Cost method
Cost of Merchandise Available for Sale
= Average Unit Cost
Units Available for Sale
With Average cost, an average unit cost for each item is computed each time a purchase is made.
Inventory data using the perpetual inventory system can be used in evaluating advertising campaigns and sales promotions.

30. Inventory Costing Methods
For purposes of illustration, the data for Item 127B are used, as shown below. We will examine the perpetual inventory system first.

31. FIRST-IN, FIRST-OUT METHOD
(continued)

32. FIRST-IN, FIRST-OUT METHOD
(continued)

33. FIRST-IN, FIRST-OUT METHOD
(continued)

34. FIRST-IN, FIRST-OUT METHOD
(continued)

35. FIRST-IN, FIRST-OUT METHOD
(continued)

36. FIRST-IN, FIRST-OUT METHOD
(continued)

37. FIRST-IN, FIRST-OUT METHOD
(continued)

39. LAST-IN, FIRST-OUT METHOD
(continued)

40. LAST-IN, FIRST-OUT METHOD
(continued)

41. LAST-IN, FIRST-OUT METHOD
(continued)

42. LAST-IN, FIRST-OUT METHOD
(continued)

43. LAST-IN, FIRST-OUT METHOD
(continued)

44. LAST-IN, FIRST-OUT METHOD

45. LAST-IN, FIRST-OUT METHOD
(continued)

47. Weighted Average Cost Method
When the weighted average cost method is used in a perpetual system, an average unit cost for each item is computed each time a purchase is made.
This unit cost is then used to determine the cost of each sale until another purchase is made and a new average is computed. This averaging technique is called a moving average.

48. WEIGHTED AVERAGE COST METHOD

50. Learning Objective 4
Determine the cost of inventory under the periodic inventory system, using the FIFO, LIFO, and weighted average cost methods.

51. ONLY 5 Learning Objective
Compare and contrast the use of the three inventory costing methods.
ONLY

52. COMPARING INVENTORY COST METHODS
Inflation Deflation

53. Comparing Inventory Cost Methods
When the FIFO method is used during a period of inflation or rising prices, FIFO will show a larger profit than the other two inventory costing methods.

54. Comparing Inventory Cost Methods
When the LIFO method is used during a period of inflation or rising prices, LIFO will show a lower profit than the other two inventory costing methods.
During a period of rising prices, using LIFO offers an income tax savings compared to the other two inventory costing methods.

55. Comparing Inventory Cost Methods
The weighted average cost method of inventory costing is a compromise between FIFO and LIFO. Net income for the weighted average cost method is somewhere between the net incomes of LIFO and FIFO.

56. Learning Objective 6
Describe and illustrate the reporting of merchandise inventory in the financial statements.

57. Reporting Merchandise Inventory
Cost is the primary basis for valuing and reporting inventories in the financial statements. However, inventory may be valued at other than cost in the following cases:
The cost of replacing items in inventory is below the recorded cost.
The inventory cannot be sold at normal prices due to imperfections, style changes, or other causes.

58. Valuation at Lower of Cost or Market
Market, as used in lower-of-cost-or-market method, is the cost to replace the merchandise on the inventory date.
In other words, If the cost of replacing inventory is lower than its recorded purchase cost, the lower-of-cost-or-market (LCM) method is used to value the inventory.

59. Valuation at Lower of Cost or Market
Cost and replacement cost can be determined for the following:
Each item in the inventory.
Each major class or category of inventory.
Total inventory as a whole.

60. LOWER-OF-COST-OR MARKET
LG 7
LOWER-OF-COST-OR MARKET
Item
Quantity
Unit
Cost
Unit Market A
400
$10.25
$ 9.50 B
120
22.50
24.10 C
600
8.00
7.75 D
280
14.00
14.75
p.325

61. VALUATION AT LOWER OF COST OR MARKET
>
< >
<
The market decline based on individual items
($15,520 – $15,070) = $450

62. Valuation at Net Realizable Value
Merchandise that is out of date, spoiled, or damaged should be written down to its net realizable value. This is the estimated selling price less any direct costs of disposal, such as sales commissions or special advertising.

63. Valuation at Net Realizable Value
Assume the following data about an item of damaged merchandise:
The merchandise should be valued at its net realizable value of $650 ($800 – $150).
Original cost $1,000
Estimated selling price 800
Selling expenses 150

64. Merchandise Inventory on the Balance Sheet
Merchandise inventory is usually presented in the Current Assets section of the balance sheet, following receivables.
The method of determining the cost of the inventory (FIFO, LIFO, or weighted average) and the method of valuing the inventory (cost or the lower of cost or market) should be shown.

65. MERCHANDISE INVENTORY ON THE BALANCE SHEET

66. Effect of Inventory Errors on the Financial Statements page 327-334

67. Learning Objective 7
Describe and illustrate the inventory turnover and the number of days’ sales in inventory in analyzing the efficiency and effectiveness of inventory management.

68. + more WAC exercises from E25
H.W:
PE 7-1 A
PE 7-1 B
PE 7-2 A
PE 7-2 B
PE 7-3 A
PE 7-3 B
PE 7-5 A
PE 7-5 B
EX 7-3
EX 7-4
+ more WAC exercises from E25

69. Inventories
The End