1. Chapter 6 Inventories ( ) Instructor: Chih-Liang Julian Liu Department of Industrial and Business Management Chang Gung University

2. Chapter 6 Inventories Learning Objectives 1.Describe the steps in determining inventory quantities ( ). 2.Explain the accounting for inventories and apply the inventory cost flow methods ( ). 3.Explain the financial effects of the inventory cost flow assumptions.

3. Chapter 6 Inventories Learning Objectives 4.Explain the lower-of-cost-or-net realizable value ( ) basis of accounting for inventories. 5.Indicate the effects of inventory errors on the financial statements. 6.Compute and interpret the inventory turnover ratio ( ).

4. Preview of Chapter 6

5. One Classification: Inventory ( ) Three Classifications: Raw Materials ( ) Work in Process ( ) Finished Goods ( ) Merchandising Company Manufacturing Company Regardless of the classification, companies report all inventories under Current Assets ( ) on the Statement of Financial Position. Classifying Inventory

6. Physical Inventory ( ) taken for two reasons: Perpetual System 1.Check accuracy of inventory records ( ). 2.Determine amount of inventory lost (wasted raw materials, shoplifting, or employee theft). Periodic System 1.Determine the inventory on hand ( ). 2.Determine the cost of goods sold for the period. Determining Inventory Quantities

7. Involves counting, weighing, or measuring each kind of inventory on hand. Taken, when the business is closed or business is slow. at end of the accounting period. Taking a Physical Inventory Determining Inventory Quantities

8. Goods in Transit ( ) Purchased goods not yet received. Sold goods not yet delivered. Determining Ownership of Goods ( ) Goods in transit should be included in the inventory of the company that has legal title ( ) to the goods. Legal title is determined by the terms of sale ( ). Determining Inventory Quantities

9. Illustration 6-1 Terms of sale Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. Ownership of the goods remains with the seller until the goods reach the buyer. Goods in Transit Determining Inventory Quantities

10. Goods in transit should be included in the inventory of the buyer when the: a.public carrier accepts the goods from the seller. b.goods reach the buyer. c.terms of sale are FOB destination. d.terms of sale are FOB shipping point. Question Determining Inventory Quantities

11. Hargrove Company 20,000 units of inventory on hand. Goods in transit: (1) sales of 1,500 units shipped FOB destination. (2) purchases of 2,500 units shipped FOB shipping point by the seller. Whats the inventory quantities?

12. Consigned Goods ( ) Goods held for sale by one party. Ownership of the goods is retained by another party. Determining Inventory Quantities Determining Ownership of Goods

13. Inventory Cost Inventory Quantities Unit costs ? Determining Inventory Cost?

14. Unit costs ( ) can be applied to quantities on hand using the following costing methods: Specific Identification ( ) First-in, first-out (FIFO) ( ) Average-cost ( ) Cost Flow Assumptions Inventory Costing

15. Illustration: Crivitz TV Company purchases three identical 50-inch TVs on different dates at costs of £700, £750, and £800. During the year Crivitz sold two sets at £1,200 each. These facts are summarized below. Illustration 6-2 Inventory Costing

16. Specific Identification If Crivitz sold the TVs it purchased on February 3 and May 22, then its cost of goods sold is £1,500 (£700 + £800), and its ending inventory is £750. Illustration 6-3 Inventory Costing

17. Actual physical flow costing method in which items still in inventory are specifically costed to arrive at the total cost of the ending inventory. Practice is relatively rare. Most companies make assumptions (Cost Flow Assumptions) about which units were sold. Inventory Costing Specific Identification

18. Inventory Costing There are two assumed cost flow methods: 1.First-in, first-out (FIFO) 2.Average-cost Cost flow does not need be consistent with the physical movement of the goods.

19. Illustration: Data for Lin Electronics Astro condensers (Periodic System). Illustration 6-4 (Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold Inventory Costing

20. Earliest goods purchased are first to be sold. ( ). Often parallels actual physical flow of merchandise ( ). Generally good business practice to sell oldest units first ( ). First-In-First-Out (FIFO) Inventory Costing

21. Illustration 6-5 First-In-First-Out (FIFO) Inventory Costing

22. Illustration 6-5 Inventory Costing First-In-First-Out (FIFO) Illustration 6-6 Proof of COGS

23. Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO. Illustration 6A-1 APPENDIX 6A PERPETUAL INVENTORY SYSTEMS

24. First-In-First-Out (FIFO) Cost of Goods Sold Ending Inventory Illustration 6A-2 APPENDIX 6A PERPETUAL INVENTORY SYSTEMS

25. Allocates cost of goods available for sale on the basis of weighted-average unit cost incurred ( ). Assumes goods are similar in nature. Applies weighted-average unit cost to the units on hand to determine cost of the ending inventory. Inventory Costing Average Cost

26. Illustration 6-8 Inventory Costing Average Cost

27. Inventory Costing Average Cost Illustration 6-8

28. Illustration 6A-3 Cost of Goods Sold Ending Inventory APPENDIX 6A PERPETUAL INVENTORY SYSTEMS Average Cost (Moving-Average System)

29. Financial Statement and Tax Effects Illustration 6-9 Inventory Costing

30. A major advantage of the FIFO method is that in a period of inflation, the costs allocated to ending inventory will approximate their current cost. A shortcoming of the average-cost method is that in a period of inflation, the costs allocated to ending inventory may be understated in terms of current cost. Financial Statement Effects

31. In a period of inflation: FIFO - inventory and net income higher. Average-Cost - lower income taxes. Tax Effects

32. In Summary Prices are rising (inflation) FIFO: (1) Higher ending inventory cost (Statement of financial position) (2) Lower cost of good sold, higher net income, and higher income tax (Income statement).

33. The cost flow method that often parallels the actual physical flow of merchandise is the: a.FIFO method. b.average cost method. c.gross profit method. d.none of the above Question Inventory Costing

34. In a period of rising prices, average cost will produce: a.higher net income than FIFO. b.the same net income as FIFO. c.lower net income than FIFO. d.net income is equal to the specific identification method. Question Inventory Costing

35. Using Cost Flow Methods Consistently Method should be used consistently, enhances comparability. Although consistency is preferred, a company may change its inventory costing method. When a company adopts a different method, it should disclose in the financial statements the change and its effect on net income. Inventory Costing

36. Lower-of-Cost-or-Net Realizable Value When the value of inventory is lower than its cost Companies must write down ( ) the inventory to its net realizable value in the period in which the price decline occurs. Net realizable value ( ) refers to the net amount ( ) that a company expects to realize (receive) from the sale of inventory (estimated selling price in the normal course of business, less estimated costs to complete and sell). Inventory Costing

37. Illustration: Assume that Gao TV has the following lines of merchandise with costs and net realizable values as indicated. Illustration 6-10 Inventory Costing Lower-of-Cost-or-Net Realizable Value

38. Common Cause: Failure to count or price inventory correctly. Not properly recognizing the transfer of legal title to goods in transit. Errors affect both the income statement and statement of financial position. Inventory Errors

39. Inventory errors affect the computation of cost of goods sold and net income. Illustration 6-12 Illustration 6-11 Inventory Costing Income Statement Effects Sales revenue - Cost of Goods Sold = Gross Profit

40. Inventory errors affect the computation of cost of goods sold and net income in two periods. An error in ending inventory of the current period will have a reverse effect on net income of the next accounting period. Over the two years, the total net income is correct because the errors offset ( ) each other. Ending inventory depends entirely on the accuracy of taking and costing the inventory. Inventory Costing Income Statement Effects

41. Beginning inventory Ending inventory 2013 2014 Cost of goods sold Net income Cost of goods sold Net income Inventory Errors

42. (3,000) Net Income understated 3,000 Net Income overstated Combined income for 2- year period is correct. Illustration 6-13 Inventory Costing

43. Effect of inventory errors on the statement of financial position is determined by using the basic accounting equation: Illustration 6-11 Illustration 6-14 Inventory Costing Statement of Financial Position Effects

44. Understating ending inventory will overstate: a.assets. b.cost of goods sold. c.net income. d.equity. Question Inventory Costing

45. Net realizable value - Inventory classified as current asset. Income Statement - Cost of goods sold subtracted from sales. There also should be disclosure of 1) major inventory classifications, 2) basis of accounting (cost or lower-of-cost-or-net realizable value), and 3) costing method (specific identification, FIFO, or average). Statement Presentation and Analysis Presentation

46. Inventory management is a double-edged sword 1. High Inventory Levels - may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage). 2. Low Inventory Levels – may lead to stockouts and lost sales. Statement Presentation and Analysis Analysis

47. Inventory turnover ( ) measures the number of times on average the inventory is sold during the period. Cost of Goods Sold Average Inventory Inventory Turnover = Days in inventory measures the average number of days inventory is held. Days in Year (365) Inventory Turnover Days in Inventory = Statement Presentation and Analysis

48. Days in Inventory: Inventory turnover of 5.4 times divided into 365 is approximately 68 days. This is the approximate time that it takes a company to sell the inventory. Illustration: Esprit Holdings (HKG) reported in a recent annual report a beginning inventory of HK$3,170 million, an ending inventory of HK$2,997 million, and cost of goods sold for the year ended of HK$16,523 million. The inventory turnover formula and computation for Esprit Holdings are shown below. Illustration 6-16 Statement Presentation and Analysis