1. Chapter 6-1 CHAPTER 6 INVENTORIES Accounting Principles, Eighth Edition

2. Chapter 6-2 Classifying Inventory One Classification: Merchandise 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 balance sheet.

3. Chapter 6-3 Manufacturing inventories may not yet be ready for sale Classified into three categories: 1. Raw materials components on hand waiting to be used 2. Work in process various stages of production (not completed) 3. Finished goods ready for sale CLASSIFYING INVENTORY IN A MANUFACTURING ENVIRONMENT

4. Chapter 6-4 Unit costs can be applied to quantities on hand using the following costing methods: Specific Identification First-in, first-out (FIFO) Last-in, first-out (LIFO) Average-cost Inventory Cost flow methods Cost Flow Assumptions

5. Chapter 6-5 Inventory Costing – Cost Flow Assumptions Illustration 6-11 Use of cost flow methods in major U.S. companies Cost Flow Assumption does not need to equal Physical Movement of Goods

6. Chapter 6-6 Young & Crazy Company makes the following purchases: 1. One item on 2/2/08 for $10 2. One item on 2/15/08 for $15 3. One item on 2/25/08 for $20 Young & Crazy Company sells one item on 2/28/08 for $90. What would be the balance of ending inventory, cost of goods sold, and net income for the month ended Feb. 28, 2008, assuming the company used the Specific Identification method to cost inventories and the item purchased on 2/15/08 is sold? Assume a tax rate of 30%. Example Inventory Costing

7. Chapter 6-7 Purchase on 2/15/08 for $15 Young & Crazy Company Income Statement For the Month of Feb. 2008 Sales $ 90 Cost of goods sold 15 Gross profit 75 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 42 Taxes 13 Net Income $ 29 “Specific Identification” Inventory Costing Inventory Balance = $ 30 Purchase on 2/2/08 for $10 Purchase on 2/25/08 for $20

8. Chapter 6-8 An actual physical flow costing method in which items still in inventory are specifically used 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. Specific Identification Method Inventory Costing

9. Chapter 6-9 Young & Crazy Company makes the following purchases: 1. One item on 2/2/08 for $10 2. One item on 2/15/08 for $15 3. One item on 2/25/08 for $20 Young & Crazy Company sells one item on 2/28/08 for $90. What would be the balance of ending inventory, cost of goods sold, and net income for the month ended Feb. 2008, assuming the company used the FIFO, LIFO, and Average-cost flow assumptions? Assume a tax rate of 30%. Example Inventory Costing – Cost Flow Assumptions

10. Chapter 6-10 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 – Cost Flow Assumptions

11. Chapter 6-11 Purchase on 2/2/08 for $10 Purchase on 2/15/08 for $15 Purchase on 2/25/08 for $20 Inventory Balance = $ 35 Young & Crazy Company Income Statement For the Month of Feb. 2008 Sales $ 90 10 Cost of goods sold 10 Gross profit 80 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 47 Income before tax 47 14 Taxes 14 $ 33 Net Income $ 33 “First-In-First-Out (FIFO)” Inventory Costing – Cost Flow Assumptions

12. Chapter 6-12 Latest goods purchased are first to be sold. Seldom coincides with actual physical flow of merchandise. Exceptions include goods stored in piles, such as coal or hay. “Last-In-First-Out (LIFO)” Inventory Costing – Cost Flow Assumptions

13. Chapter 6-13 Purchase on 2/2/08 for $10 Purchase on 2/15/08 for $15 Inventory Balance = $ 25 Purchase on 2/25/08 for $20 Young & Crazy Company Income Statement For the Month of Feb. 2008 Sales $ 90 20 Cost of goods sold 20 Gross profit 70 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 37 Income before tax 37 11 Taxes 11 $ 26 Net Income $ 26 “Last-In-First-Out (LIFO)” Inventory Costing – Cost Flow Assumptions

14. Chapter 6-14 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. “Average-Cost” Inventory Costing – Cost Flow Assumptions

15. Chapter 6-15 Purchase on 2/2/08 for $10 Purchase on 2/15/08 for $15 Purchase on 2/25/08 for $20 Inventory Balance = $ 30 Young & Crazy Company Income Statement For the Month of Feb. 2008 Sales $ 90 15 Cost of goods sold 15 Gross profit 75 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 42 Income before tax 42 13 Taxes 13 $ 29 Net Income $ 29 “Average Cost” Inventory Costing – Cost Flow Assumptions

16. Chapter 6-16 FIFO Inventory Costing – Cost Flow Assumptions Sales$90$90$90 Cost of goods sold101520 Gross profit807570 Admin. & selling expense333333 Income before taxes474237 Income tax expense141311 Net income$33$29$26 Inventory balance$35$30$25 LIFOAverage Comparative Financial Statement Summary

17. Chapter 6-17 In Period of Rising Prices, FIFO Reports: FIFO Inventory Costing – Cost Flow Assumptions Highest Lowest Sales$90$90$90 Cost of goods sold101520 Gross profit807570 Admin. & selling expense333333 Income before taxes474237 Income tax expense141311 Net income$33$29$26 Inventory balance$35$30$25 LIFOAverage

18. Chapter 6-18 In Period of Rising Prices, LIFO Reports: FIFO Inventory Costing – Cost Flow Assumptions Highest Lowest Sales$90$90$90 Cost of goods sold101520 Gross profit807570 Admin. & selling expense333333 Income before taxes474237 Income tax expense141311 Net income$33$29$26 Inventory balance$35$30$25 LIFOAverage

19. Chapter 6-19 Lower-of-Cost-or-Market Lower-of-cost-or-market basis of accounting for inventories When the value of inventory is lower than its cost Companies can “write down” the inventory to its market value in the period in which the price decline occurs. Market value = Replacement Cost

20. Chapter 6-20 COMPUTATION OF LOWER OF COST OR MARKET $ 159,000

21. Chapter 6-21 Statement Presentation and Analysis Balance Sheet - 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 LCM), and 3) costing method (FIFO, LIFO, or average). Presentation

22. Chapter 6-22 Statement Presentation and Analysis 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. Analysis

23. Chapter 6-23 End of the Chapter!