1. Copyright © 2007 Prentice-Hall. All rights reserved 1 InventoryInventory Chapter 8

2. Copyright © 2007 Prentice-Hall. All rights reserved 2 Objective 1 Describe inventory and discuss the related internal controls

3. Copyright © 2007 Prentice-Hall. All rights reserved 3 InventoryInventory Goods that a business owns and has available to sell to customers as part of normal operations Current asset – usually listed after accounts receivable

4. Copyright © 2007 Prentice-Hall. All rights reserved 4 Internal Controls Separation of access to assets from access to record Secure inventory items Physical count at least once a year Maintain perpetual records of inventory transactions Document purchases and sales

5. Copyright © 2007 Prentice-Hall. All rights reserved 5 Objective 2 Compute inventory costs using first-in, first-out (FIFO), last-in, first-out (LIFO), and average cost methods and journalize inventory transactions

6. Copyright © 2007 Prentice-Hall. All rights reserved 6 Inventory Costing Methods Specific Unit Cost FIFO LIFO Average Cost

7. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

8. Copyright © 2007 Prentice-Hall. All rights reserved July 1140$40 Item DVD’s FIFO Perpetual Inventory Account PurchasesCost of Mdse. SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCost

9. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

10. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit FIFO Perpetual Inventory Accounting Inventory.270 Accounts Payable270 July 5

11. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $270 Item DVD’s FIFO Perpetual Inventory Account PurchasesCost of Mdse. SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost Because the purchase price of $45 is different than the cost of the previous unit on hand, the inventory balance of 7 units is accounted for separately.

12. Copyright © 2007 Prentice-Hall. All rights reserved 12 First-In, First-Out (FIFO) Cost of Goods Sold Ending Inventory Valued based on the earlier cost of purchases. Valued based on the most recent costs of purchases

13. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

14. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $470 Item DVD’s FIFO Perpetual Inventory Account PurchasesCost of Mdse. SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost Because the purchase price of $45 is different than the cost of the previous unit on hand, the inventory balance of 7 units is accounted for separately.

15. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $470 151$40$40 3$45$1353$45 $135 Item DVD’s FIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

16. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit FIFO Perpetual Inventory Accounting Accounts Receivable320 Sales320 Cost of Goods Sold 175 Inventory175 July 15

17. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

18. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit FIFO Perpetual Inventory Accounting Inventory.350 Accounts Payable350 July 26

19. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $270 15 1$40 $40 3$45$1353$45 $135 267$50$3503$45$135 7$50$350 Item DVD’s FIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

20. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

21. Copyright © 2007 Prentice-Hall. All rights reserved 21 First-In, First-Out (FIFO) Cost of Goods Sold Ending Inventory Valued based on the earlier cost of purchases. Valued based on the most recent costs of purchases

22. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $470 15 1$40 $40 3$45$1353$45 $135 267$50$3503$45$135 7$50$350 Item DVD’s FIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

23. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $470 151$40$40 3$45$1353$45 $135 267$50$3503$45$135 7$50$350 31 3$45$135 5 $50$2502$50$100 Item DVD’s FIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

24. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit FIFO Perpetual Inventory Accounting Accounts Receivable640 Sales640 Cost of Goods Sold 385 Inventory385 July 31

25. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

26. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit FIFO Perpetual Inventory Accounting Inventory.275 Accounts Payable275 July 31

27. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $470 151$40$40 3$45$1353$45 $135 267$50$3503$45$135 7$50$350 31 3$45$135 315 $50 $2502$50$100 315$55$2752$50 $100 5 $55 $275 Item DVD’s FIFO Perpetual Inventory Account PurchasesCost Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

28. Copyright © 2007 Prentice-Hall. All rights reserved 28 Inventory Shrinkage Loss of inventory Compare physical count with balance in books Sources –Breakage –Theft –Obsolescence

29. Copyright © 2007 Prentice-Hall. All rights reserved 29 Inventory Shrinkage Took a physical count of DVD’s and determined that two were damaged during shipment. Record the adjusting entry for inventory shrinkage.

30. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $470 151$40$40 3$45$1353$45 $135 267$50$3503$45$135 7$50$350 31 3$45$135 315 $50 $2502$50$100 315$55$2752$50 $100 5 $55 $275 Item Suede Jacket FIFO Perpetual Inventory Account PurchasesCost Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

31. Copyright © 2007 Prentice-Hall. All rights reserved 31 First-In, First-Out (FIFO) Cost of Goods Sold and shrinkage Ending Inventory Valued based on the earlier cost of purchases. Valued based on the most recent costs of purchases

32. Copyright © 2007 Prentice-Hall. All rights reserved Inventory Shrinkage 5 at $55 = $275 ($375-$275 = $100) Inventory value of 5 units Remaining

33. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit FIFO Inventory Shrinkage Cost of Goods Sold 100 Inventory100 July 31

34. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

35. Copyright © 2007 Prentice-Hall. All rights reserved July 1140$40 Item DVD’s LIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCost

36. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

37. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit LIFO Perpetual Inventory Accounting Inventory270 Accounts Payable270 July 5

38. Copyright © 2007 Prentice-Hall. All rights reserved Nov. 11 $40$40 56$45$270 1 $40 $40 6 $45 $270 Item DVD’s LIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost Because the purchase price of $45 is different than the cost of the previous unit on hand, the inventory balance of 7 units is accounted for separately.

39. Copyright © 2007 Prentice-Hall. All rights reserved 39 Last-In, First-Out (LIFO) Valued based on the most recent costs of purchases Cost of Goods Sold Valued based on the earlier costs of purchases Ending Inventory

40. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $270 Item DVD’s LIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost Because the purchase price of $45 is different than the cost of the previous unit on hand, the inventory balance of 7 units is accounted for separately.

41. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1 Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1 Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

42. Copyright © 2007 Prentice-Hall. All rights reserved 42 Last-In, First-Out (LIFO) Valued based on the most recent costs of purchases Cost of Goods Sold Valued based on the earlier costs of purchases Ending Inventory

43. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $270 Item DVD’s LIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost Because the purchase price of $45 is different than the cost of the previous unit on hand, the inventory balance of 7 units is accounted for separately.

44. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $270 15 1 $40$40 4$45$1802 $45 $90 Item DVD’s LIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

45. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit LIFO Perpetual Inventory Accounting Accounts Receivable320 Sales320 Cost of Goods Sold 180 Inventory180 July 15

46. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

47. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit LIFO Perpetual Inventory Accounting Inventory.350 Accounts Payable350 July 26

48. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $270 15 1 $40$40 4$45$1802 $45 $90 267$50$3501$40 $50 2$45$90 7$50$350 Item DVD’s LIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

49. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

50. Copyright © 2007 Prentice-Hall. All rights reserved 50 Last-In, First-Out (LIFO) Valued based on the most recent costs of purchases Cost of Goods Sold Valued based on the earlier costs of purchases Ending Inventory

51. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $270 15 1 $40$40 4$45$1802 $45 $90 267$50$3501$40 $50 2$45$90 7$50$350 Item DVD’s LIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

52. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $270 15 1 $40$40 4$45$1802 $45 $90 267$50$3501$40 $50 2$45 $90 7$50$350 31 7$50$3501$40 $40 1$45$451$45 $45 LIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

53. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit LIFO Perpetual Inventory Accounting Accounts Receivable640 Sales640 Cost of Goods Sold 395 Inventory395 July 31

54. Copyright © 2007 Prentice-Hall. All rights reserved Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Smart Touch Learning Units Cost Price July 1Inventory1 $40 5Purchase6$45 15Sale4 $80 26Purchase7 $50 31Sale8$80 31Purchase5$55 Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

55. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit LIFO Perpetual Inventory Accounting Inventory.275 Accounts Payable275 July 31

56. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $270 15 1 $40 $40 4$45$180 2 $45 $90 267$50$3501$40 $50 2$45 $90 7$50$350 31 7$50$3501$40 $40 1$45$451$45 $45 315$55$2751$40 $40 1 $45 $45 5 $55 $275 LIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

57. Copyright © 2007 Prentice-Hall. All rights reserved 57 Inventory Shrinkage Loss of inventory Compare physical count with balance in books Sources –Breakage –Theft –Obsolescence

58. Copyright © 2007 Prentice-Hall. All rights reserved 58 Inventory Shrinkage Took a physical count of DVD’s and determined that two were damaged during shipment. Record the adjusting entry for inventory shrinkage.

59. Copyright © 2007 Prentice-Hall. All rights reserved July 11 $40$40 56$45$270 1 $40 $40 6 $45 $270 15 1 $40 $40 4$45$180 2 $45 $90 267$50$3501$40 $50 2$45 $90 7$50$350 31 7$50$3501$40 $40 1$45$451$45 $45 315$55$2751$40 $40 1 $45 $45 5 $55 $275 LIFO Perpetual Inventory Account PurchasesCost of Goods SoldInventory Balance UnitTotalUnitTotalUnitTotal Date Qty. CostCost Qty.CostCost Qty.CostCost

60. Copyright © 2007 Prentice-Hall. All rights reserved 60 Last-In, First-Out (LIFO) Valued based on the most recent costs of purchases Cost of Goods Sold and shrinkage Valued based on the earlier costs of purchases Ending Inventory

61. Copyright © 2007 Prentice-Hall. All rights reserved Inventory Shrinkage 1 at $40 = $40 1 at $45 = $45 3 at $55= $165 $250 ($360-$250 = $110) Inventory value of 5 units Remaining

62. Copyright © 2007 Prentice-Hall. All rights reserved DateDescriptionDebitCredit DateDescriptionDebitCredit LIFO Inventory Shrinkage Cost of Goods Sold110 Inventory110 July 31

63. Copyright © 2007 Prentice-Hall. All rights reserved 63 Objective 3 Compare the effects of the different costing methods on the financial statements

64. Copyright © 2007 Prentice-Hall. All rights reserved 64 ComparisonComparison FIFOLIFO Sales$960 COGS Gross Profit $660 $300 $685 $275

65. Copyright © 2007 Prentice-Hall. All rights reserved 65 ComparisonComparison FIFOLIFO Inventory$275 $250

66. Copyright © 2007 Prentice-Hall. All rights reserved 66 Advantage of Each Method Smoothes out price changes During inflation minimizes net income and income taxes. Better matching of current costs in cost of goods sold with revenues Matches actual flow of goods. Inventory valued closest to replacement value First-In, First-Out Weighted Average Last-In, First-Out

67. Copyright © 2007 Prentice-Hall. All rights reserved 67 Use of Inventory Methods in Practice

68. Copyright © 2007 Prentice-Hall. All rights reserved 68 Objective 4 Apply the lower-of-cost-or- market (LCM) rule to value inventory

69. Copyright © 2007 Prentice-Hall. All rights reserved 69 Conservatism Principle Exercise caution in reporting items in the financial statements Report realistic figures

70. Copyright © 2007 Prentice-Hall. All rights reserved 70 Lower-of-Cost-or-MarketLower-of-Cost-or-Market Inventory is reported at whichever is lower – historical cost or market value (current replacement cost) If market is lower than cost – write inventory down –Debit Cost of Goods Sold –Credit Inventory

71. Copyright © 2007 Prentice-Hall. All rights reserved 71 Lower-of-Cost-or-MarketLower-of-Cost-or-Market Must disclose method of valuation in financial statements –As parenthetical in statements or –In notes to financial statements

72. Copyright © 2007 Prentice-Hall. All rights reserved 72 Objective 5 Report inventory on the balance sheet and measure the effect of inventory errors

73. Copyright © 2007 Prentice-Hall. All rights reserved 73 Materiality Concept A company must perform strictly proper accounting only for significant items

74. Copyright © 2007 Prentice-Hall. All rights reserved 74 Full Disclosure Principle Report enough information for outsiders to make wise decisions about the company

75. Copyright © 2007 Prentice-Hall. All rights reserved 75 Consistency in Reporting A company should use the same accounting methods from period to period so that financial statements are comparable across periods

76. Copyright © 2007 Prentice-Hall. All rights reserved 76 Effects of Inventory Errors Ending inventory becomes next year’s beginning inventory Results in misstatement of income statement over two years Misstatement of balance sheet in first year and then error counterbalances itself

77. Copyright © 2007 Prentice-Hall. All rights reserved 77 Effects of Inventory Errors If ending inventory is overstated, so is net income and gross profit. Cost of Goods sold is understated. If ending inventory is understated, so is net income and gross profit. Cost of Goods sold is overstated. In year two, the effects of year one are reversed.

78. Copyright © 2007 Prentice-Hall. All rights reserved 78 End of Chapter 6