1. Chapter 6 - Inventory Valuation1 INVENTORY – Chapt 6. p.277-284 BALANCE SHEET Biggest Asset Inventory  see example How can an inventory item be both raw materials and finished goods at the same time? INCOME STATEMENT Biggest Expense COGS Manufacturer inventory  Raw Materials  Work in Progress (WIP)  Finished Goods

2. Chapter 6 - Inventory Valuation2 The Audiophile sells high end stereo equipment. Windsor Acoustics recently introduced the Carnegie 440, a state of the art speaker system. During the current year the Audiophile purchase 9 of these speaker systems at the following dates and acquisition costs:

3. Chapter 6 - Inventory Valuation3 The problem is that acquisition costs change so how is inventory evaluated? Date Units Purchased Unit CostTotal Cost Oct 1230006000 Nov 17332009600 Dec 14325013000 Total9 Average cost = $3177.78 28600

4. Chapter 6 - Inventory Valuation4 AVERAGE COST The average cost method assumes that the goods available for sale are homogeneous. The allocation of the cost of goods available for sale is made on the basis of the weighted average unit cost incurred. The weighted average unit cost is then applied to the units sold to determine the cost of goods sold and to the units on hand to determine the ending inventory.

5. Chapter 6 - Inventory Valuation5 Allocation of the cost of goods available for sale in average cost method is made on the basis of the weighted average unit cost

6. Chapter 6 - Inventory Valuation6 Average cost method assumes that goods available for sale are homogeneous

7. Chapter 6 - Inventory Valuation7 On November 21, The Audiophile sold 4 of these speaker systems to the Hamilton Symphony for $5000 per unit. At December 31, the other 5 sets remained in inventory. Compute the COGS and the ending inventory value based on the average inventory costs: Cash20,000 Revenue20,000 COGS12480 Inventory12480 Sale 4 Carnegie speaker systems to Hamilton Symphony Inventory value (ave. cost @ Nov 21) = 15600/5 = $3120 Value of remaining inventory is: 28600 – 12480 = 16120

8. Chapter 6 - Inventory Valuation8 The problem is that acquisition costs change so how is inventory evaluated? Date Units Purchased Unit CostTotal Cost Oct 1230006000 Nov 17332009600 Dec 14325013000 Total928600

9. Chapter 6 - Inventory Valuation9 FIFO = first in first out The FIFO method assumes that the earliest goods purchased are the first to be sold. Often reflects the actual physical flow of merchandise. Under FIFO, the costs of the earliest goods purchased are the first to be recognized as cost of goods sold. The costs of the most recent goods purchased are recognized as the ending inventory.

10. Chapter 6 - Inventory Valuation10 FIFO method assumes earliest goods purchased are the first to be sold

11. Chapter 6 - Inventory Valuation11 On November 21, The Audiophile sold 4 of these speaker systems to the Hamilton Symphony for $5000 per unit. At December 31, the other 5 sets remained in inventory. Compute the COGS and the ending inventory value based on the “First In –First Out” (FIFO) inventory cost: Cash20,000 Revenue20,000 COGS12400 Inventory12400 Sale 4 Carnegie speaker systems to Hamilton Symphony Inventory value (FIFO @ Nov 21) = 2@ $3000 + 2 @3200 = $12400 Value of remaining inventory is: 28600 – 12400 = 16200

12. Chapter 6 - Inventory Valuation12 Average vs. FIFO AverageFIFO Income Statement Slightly higher COGS exp.  lower profit  lower taxes Lower COGS exp.  Higher profit Balance SheetLower ending inventory values Higher remaining inventory value AverageFIFO Income Statement Balance Sheet

13. Chapter 6 - Inventory Valuation13 LIFO The LIFO method assumes that the latest goods purchased are the first to be sold and that the earliest goods purchased remain in ending inventory. Seldom coincides with the actual physical flow of inventory. Under the periodic method, all goods purchased during the year are assumed to be available for the first sale, regardless of date of purchase. Rarely used in Canada.

14. Chapter 6 - Inventory Valuation14 LIFO method assumes latest goods purchased are the first to be sold

15. Chapter 6 - Inventory Valuation15 On November 21, The Audiophile sold 4 of these speaker systems to the Hamilton Symphony for $5000 per unit. At December 31, the other 5 sets remained in inventory. Compute the COGS and the ending inventory value based on the “Last In – First Out” (LIFO) inventory costs: Cash20,000 Revenue20,000 COGS12600 Inventory12600 Sale 4 Carnegie speaker systems to Hamilton Symphony Inventory value (LIFO @ Nov 21) = 3@ $3200 + 1@3000 = $12600 Value of remaining inventory is: 28600 – 12600 = 16,000

16. Chapter 6 - Inventory Valuation16 USING INVENTORY COST FLOW METHODS CONSISTENTLY A company needs to use its chosen cost flow method consistently from one accounting period to another. Such consistent application enhances the comparability of financial statements over successive time periods. When a company adopts a different cost flow method, the change and its effects on net income should be disclosed in the financial statements.