1. Inventory May 2010©Kimberly Lyons 1

2. Goods purchased or produced for resale Merchandiser (retailer) purchases for resale Manufacturer produces for resale Raw materials inventory Work-in-process inventory Finished goods inventory Costs included in inventory Raw materials Labor Manufacturing overhead All costs are carried as an asset until the time of sale, when they are expensed as Cost of goods sold May 2010©Kimberly Lyons 2

3. Additional costs included in inventory: Delivery costs or Transportation-in Taxes Insurances Final delivered cost Who owns inventory in transit? FOB (Free on Board) destination Title transfers when the goods reach their destination FOB shipping point Title transfers when goods are shipped Who owns goods on consignment? Consignor is the owner Consignee is the seller May 2010©Kimberly Lyons 3

4. Cost of goods available for sale is the cost of beginning inventory plus the cost of net purchases Net purchases + Purchases - Purchase returns & allowances - Purchase discounts Cost of goods available must be assigned to either cost of goods sold or ending inventory at the end of the accounting period May 2010©Kimberly Lyons 4

5. Perpetual is defined as something that is continuous Whenever there is a change in the cost of inventory on hand, that change is recorded in the inventory account immediately For example: On 1/3/08 Brewer Co. purchases inventory on credit for $1,000, terms 2/10, Net 30 On 1/5/08 Brewer returns $300 worth as defective On 1/7/08 Brewer pays for the remaining inventory On 1/15/08 Brewer sells one half of the remaining inventory for $600, to customers on credit May 2010©Kimberly Lyons 5

6. Recording these transactions for Brewer Co. using the perpetual method of accounting for inventory: 1/3Inventory1,000 Accounts payable 1,000 1/5Accounts payable 300 Inventory 300 1/7Accounts payable 700 Inventory 14 Cash 686 1/15Accounts receivable 600 Revenue 600 Cost of goods sold 343 Inventory 343 May 2010©Kimberly Lyons 6

7. Periodic is defined as something that occurs occasionally, or at the end of the period Whenever there is a change in the cost of inventory on hand, that change is NOT recorded in the inventory account immediately Instead, we use a variety of temporary accounts to track purchases, purchase returns, and purchase discounts May 2010©Kimberly Lyons 7

8. Purchases: a temporary holding account (debit balance) Purchase returns & allowances and purchase discounts are contra purchases accounts (credit balance) These accounts are closed at the end of the period to update inventory and record cost of goods sold under the periodic method These accounts are not used under the perpetual method, where all changes to the inventory account are recorded immediately in inventory May 2010©Kimberly Lyons 8

9. Inventory costs flow from the balance sheet to the income statement There are a variety of choices as to which costs flow first These cost flow alternatives are independent of actual goods flow First-in, First-out (FIFO) Last-in, First-out (LIFO) Weighted average cost (WA) Specific identification May 2010©Kimberly Lyons 9

10. Example: Dynold Inc. had the following inventory transactions for January of the current year:UnitsCost/u Total Cost Beginning inventory 40$2$80 1/15 purchase 10$3$30 1/20 purchase 10$4$40 1/25 purchase 10$5$50 Total available Total available70$200 ©Kimberly Lyons 10 May 2010

11. During the period Dynold sells 30 units Use the data for Dynold to calculate cost of goods sold and ending inventory FIFO FIFO CGS: 30u x $2/u = $60 The first cost incurred is the first to expense FIFO End: $200 - $60 = $140 Of the total cost of goods available, those costs not assigned to cost of goods sold remain in ending inventory May 2010©Kimberly Lyons 11

12. Dynold sells 30 units Use the data for Dynold to calculate cost of goods sold and ending inventory LIFO LIFO CGS: 30u 10u x $5 = $50 10u x $4 = $40 10u x $3 = $30 $120 Last cost incurred is the first to cost of goods sold LIFO End: $200 – 120 = $80 Beginning inventory costs remain in ending inventory May 2010©Kimberly Lyons 12

13. Dynold sells 30 units Use the data for Dynold to calculate cost of goods sold and ending inventory WA Calculate a weighted average cost per unit Total cost of goods available/Total units available=Avg. cost/u $200/70u = $2.8571/u Assign the average cost per unit to the number of units sold and the number of units in ending inventory WA CGS: 30u x $2.8571 = $85.71 (rounded) WA End: 40u x $2.8571 = $114.29 (rounded) Or $200 – 85.71 = 114.29 May 2010©Kimberly Lyons 13

14. In the preceding examples, we assigned cost to 30 units sold without identifying which units were sold The only time the specific units sold is relevant is when we use the specific identification method Under this method, the actual cost would be traced to the actual unit that was sold Otherwise, cost flows are independent of goods flows May 2010©Kimberly Lyons 14

15. FIFOWALIFO Sales revenue $1,000$1,000$1,000 Less: Cost of goods sold (60)(85.71)(120) Gross Profit $940$914.29$880 Less: Operating expenses (200)(200)(200) Income before tax $740$714.29$680 Less: Income tax exp. @ 30% (222)(214.29)(204) Net Income $518$500$476 ©Kimberly Lyons 15 May 2010

16. In a period of rising prices (inflation) LIFO results in Higher cost of goods sold Lower net income Lower taxes Lower ending inventory FIFO results in Lower cost of goods sold Higher net income Higher taxes Higher ending inventory Weighted average numbers are in between In a period of declining prices, the opposite is true If prices are stable or unchanging, there is no difference May 2010©Kimberly Lyons 16

17. The effect on net income of inventory alternatives is arbitrary All actual costs incurred were the same either way Sales and sales revenue were the same either way The real cash consequence is the income tax effect May 2010©Kimberly Lyons 17

18. Inventory should be reported at no more than its net realizable value Net realizable value (NRV) = selling price – cost to sell When NRV drops below recorded cost (FIFO, LIFO, etc.), the inventory is written down and the loss recorded immediately Assets are not reported at amounts that exceed their future economic benefits Inventory should not be written down below NRV less normal profit margin May 2010©Kimberly Lyons 18

19. With a perpetual inventory accounting system the value of ending inventory can be determined at any time When this value does not match the physical count, a loss may exist due to lost, damaged, or stolen goods The inventory account must be adjusted by Inventory ShrinkageXXX InventoryXXX If the amount of loss is relatively small, it may be reported as part of cost of goods sold May 2010©Kimberly Lyons 19

20. What types of costs, other than purchase price, are included in inventory? Who is a consignor? Consignee? Who owns goods in transit FOB destination? Who owns goods in transit FOB shipping point? Record inventory transactions using the perpetual method Calculate net purchases Calculate cost of goods available for sale Calculate cost of goods sold: FIFO, LIFO, & WA Calculate ending inventory: FIFO, LIFO, & WA May 2010©Kimberly Lyons 20

21. Understand the effect of rising (falling) prices on FIFO, LIFO, & Weighted average: Cost of goods sold Ending inventory Net Income Income taxes Prepare a basic income statement illustrating these differences What is the lower of cost or market rule (LCM)? Estimate the value of ending inventory using the gross profit percentage Account for inventory shrinkage May 2010©Kimberly Lyons 21