1. Inventories: Cost Measurement and Flow Assumptions C hapter 8 COPYRIGHT © 2010 South-Western/Cengage Learning Intermediate Accounting 11th edition Nikolai Bazley Jones An electronic presentation By Norman Sunderman and Kenneth Buchanan Angelo State University

2. 2 Flow of Inventory Costs Merchandising Company Cost of Goods Sold Accounts Payable (or Cash) Merchandise Inventory Goods Purchased Goods Sold

3. 3 Manufacturing Company Accounts Payable (or Cash) Raw Materials Inventory Materials Purchased Materials Used in Production To Work in Process InventoryContinuedContinued Flow of Inventory Costs

4. 4 Direct Labor Actual Direct Labor Manufacturing (Factory) Overhead Actual Mfg. Over- head Overhead Applied to Production To Work in Process Inventory Labor Charged to Production To Work in Process InventoryContinuedContinued Flow of Inventory Costs Manufacturing Company

5. 5 Work in Process Inventory Materials Used Direct Labor Overhead Applied Finished Goods Inventory Goods Finished (Manufactured) Goods Sold to Cost of Goods Sold Flow of Inventory Costs Manufacturing Company

6. 6 Alternative Inventory Systems A company using a perpetual system maintains a continuous record of the physical quantities in its inventory.

7. 7 A company using a periodic system does not maintain a continuous record of the physical quantities of inventory on hand. Alternative Inventory Systems

8. 8 Computation of Net Purchases Purchases +Freight-in –Purchases Returns and Allowances –Purchases Discounts Taken =Net Purchases Purchases +Freight-in –Purchases Returns and Allowances –Purchases Discounts Taken =Net Purchases

9. 9 Beginning Inventory +Purchases (net) –Goods Sold =Ending Inventory Beginning Inventory +Purchases (net) –Goods Sold =Ending Inventory Perpetual Inventory System Beginning Inventory +Purchases (net) –Ending Inventory =Goods Sold Beginning Inventory +Purchases (net) –Ending Inventory =Goods Sold Periodic Inventory System Comparison of Systems

10. 10 Determination of Inventory Costs  Price paid or consideration given  Freight-in  Receiving  Unpacking  Inspecting  Storage  Insurance  Applicable taxes  Price paid or consideration given  Freight-in  Receiving  Unpacking  Inspecting  Storage  Insurance  Applicable taxes

11. 11 Under the gross price method, a company records the purchase at the gross price and records the amount of the discount in the accounting system only if the discount is taken. Under the net price method, a company records the purchase at its net price and records the amount of the discount in the accounting system only if the discount is not taken. Purchases Discounts

12. 12 If the company does not pay promptly, it is forfeiting 2% in order to keep the money for an additional 20 days. A company purchases $1,000 of goods under terms of 2/10, n/30. What is the annual discount rate? The company can forfeit this discount 18 times during a year. (360 days/20 additional each time = 18) Annual Rate on Discounts 2% forfeited 18 times equals an annual interest rate of 36%

13. 13 Specific Identification 100units @ $10 per unit Apr. 1 Apr. 10 Apr. 20 80units @ $11 per unit 70units @ $12 per unit On April 27, 90 units were sold from the beginning inventory and 50 units from the April 10 purchase.

14. 14 Specific Identification 100units @ $10 per unit Apr. 1 Apr. 10 Apr. 20 80units @ $11 per unit Apr. 20 0units @ $12 per unit 90units @ $10 per unit Apr. 1 50units @ $11 per unit Apr. 10 70units @ $12 per unit 10units @ $10 per unit 30units @ $11 per unit 70units @ $12 per unit Sold 90 Sold 50 Ending Inventory………… = $ 100 =330 = 840 $1,270 Cost of Goods Sold………. $1,450 =$ 900 =550 = 0 Sold 0

15. 15 Specific Identification 100units @ $10 per unit Apr. 1 Apr. 10 Apr. 20 30units @ $11 per unit Apr. 20 Apr. 1 Apr. 10 70units @ $12 per unit 10units @ $10 per unit 80units @ $11 per unit 70units @ $12 per unit Ending Inventory………… Goods Available for Sale… = $ 1,000 =880 = 840 $2,720 = $ 100 =330 = 840 $1,270 Cost of Goods Sold…………. $1,480 Cost of Goods Sold………..

16. 16 100units @ $10 per unit Apr. 1 Apr. 10 Apr. 20 80units @ $11 per unit Sold 140 units during April 40units @ $11 per unit Sold all 0units @ $10 per unit Sold 40 Sold 0 70units @ $12 per unit First-In, First-Out (FIFO)

17. 17 Ending Inventory………… 100units @ $10 per unit Apr. 1 Apr. 10 Apr. 20 80units @ $11 per unit40units @ $11 per unit 0units @ $10 per unit 70units @ $12 per unit Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold = $ 0 =440 = 840 $1,280 $1,000 + $1,720 – $1,280 = $1,440 First-In, First-Out (FIFO)

18. 18 The ending inventory and the cost of goods sold under perpetual and periodic FIFO are identical. First-In, First-Out (FIFO)

19. 19 = $1,000 =880 = 840 $2,720 Average Cost 100units @ $10 per unit Apr. 1 Apr. 10 Apr. 20 80units @ $11 per unit 70units @ $12 per unit Sold 140 units during April 250 units Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold $2,720  250 units = $10.88 $10.88 × 110 units = Ending Inventory of $1,197 $1,000 + $1,720 – $1,197 = $1,523

20. 20 $1,780  160 Apr. 18Sales (90)units @ $10.44 (940) Apr. 18Balance90units @ $10.44$ 940 Apr. 20Purchases 70units @ $12 840 Apr.20Balance160units @ $11.125$1,780 Moving Average Apr. 1Beginning Inventory100units @ $10$1,000 Apr.10Purchases 80units @ $11 880 Apr.10Balance180units @ $10.44$1,880 Apr. 27Sales (50)units @ $11.125 (556) Apr. 30Balance110units @ $11.125$1,224 Cost of Goods Sold (140 units) $940 + $556$1,496 Ending Inventory (110 units @ $11.125)$1,224 $1,880  180

21. 21 Last-In, First-Out (LIFO) 100units @ $10 per unit Apr. 1 Apr. 10 Apr. 20 80units @ $11 per unit Sold 140 units during April 10units @ $11 per unit Sold 0 Sold 70 Sold all 70units @ $12 per unit Periodic Inventory System 0units @ $12 per unit

22. 22 Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold 100units @ $10 per unit Apr. 1 Apr. 10 Apr. 20 80units @ $11 per unit10units @ $11 per unit 70units @ $12 per unit Periodic Inventory System 0units @ $12 per unit Ending Inventory………… = $1,000 =110 = 0 $1,110 Last-In, First-Out (LIFO) $1,000 + $1,720 – $1,110 = $1,610

23. 23 100units @ $10 per unit 90units @ $10 per unit Apr. 1 Apr. 10 Apr. 20 80units @ $11 per unit Purchased 80 70units @ $12 per unit Perpetual Inventory System Sold 80 80units @ $11 per unit 0units @ $11 per unit Sold 10 Purchased 70 Sold 50 Last-In, First Out (LIFO) Sold 90 units during April

24. 24 Apr. 1 Apr. 10 Apr. 20 Perpetual Inventory System Ending Inventory………… Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold = $ 900 =0 = 240 $1,140 $1,000 + $1,720 – $1,140 = $1,580 90units @ $10 per unit 0units @ $11 per unit 20units @ $12 per unit Last-In, First Out (LIFO)

25. 25 Cost of Goods Cost of Available Goods Ending for Sale Sold Inventory Cost Flow Assumption and Method FIFO, periodic$2,720$1,440$1,280 FIFO, perpetual2,7201,4401,280 Weighted average2,7201,5231,197 Moving average2,7201,4961,224 LIFO, periodic2,7201,6101,110 LIFO, perpetual2,7201,5801,140 Comparison of Inventory Assumptions

26. Holding Gains Comparisons FIFO matches the oldest cost with revenue. LIFO matches the most recent cost with revenue. 26

27. 27 10,000units @ $20 per unit 6,000units @ $22 per unit 8,000units @ $24 per unit 4,000units @ $30 per unit =$200,000 =132,000 =192,000 = 120,000 $644,000 Inventory, Jan. 1, 2010….. In 2010 the company purchases 50,000 units at $35 per unit but sells 60,000 units. 2006: 2007: 2008: 2009: Liquidation of LIFO Layers

28. 28 10,000units @ $20 per unit 6,000units @ $22 per unit 8,000units at $24 per unit 4,000units at $30 per unit 2006: 2007: 2008: 2009: 2010: =$ 200,000 =132,000 =192,000 = 120,000 =$1,750,000 50,000units at $35 per unit 0units @ $35 per unit Sold 4,000 Sold 6,000 0units @ $30 per unit 2,000units @ $24 per unit Liquidation of LIFO Layers In 2010 the company purchases 50,000 units at $35 per unit and sells 60,000 units. Sold 50,000

29. 29 10,000units @ $20 per unit 6,000units @ $22 per unit 6,000units @ $24 per unit 4,000units @ $30 per unit 2006: 2007: 2008: =$ 144,000 =120,000 = 1,750,000 $2,014,000 50,000units @ $35 per unit 2,000units @ $24 per unit 2008: 2009: 2010: Cost of Goods Sold……….. Liquidation of LIFO Layers

30. 30 1.The LIFO method requires a company to keep numerous detailed records. 2.Fluctuations in the physical quantities of similar inventory items may occur. 3.As technological changes take place, inventory made up with one material is replaced by inventory made with substitute materials, or an outdated design is replaced by a newer design. Difficulties in Applying Simple LIFO

31. 31 Step 1: Value the total ending inventory at current-year costs. 01/01/09$10,000 12/31/09$12,100 12/31/10$13,125 12/31/11$16,800 12/31/12$12,360 Dollar-Value LIFO

32. 32 Step 2: Convert the ending inventory cost to base-year costs. 12/31/09$12,100 12/31/10$13,125 12/31/11$16,800 12/31/12$12,360 Ending Inventory at Current Costs × Base-Year Cost Index Current Cost Index ×100/110 = $11,000 12/31/09 Dollar-Value LIFO

33. 33 Step 3: Compute the change in the inventory level for the year at base-year costs. $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 $11,000 – $10,000 $1,000 1/1/09 12/31/09 Dollar-Value LIFO

34. 34 Step 4a:If there is an increase in the inventory levels at base-year costs, convert this increase to current-year costs. Base year, $10,000 $1,000$1,000 12/31/09 × 110/100 =$ 1,100 × 100/100 = 10,000 $11,100 Ending inventory, 12/31/09 Dollar-Value LIFO

35. 35 Step 2: Convert the ending inventory cost to base-year costs. 12/31/09$12,100 12/31/10$13,125 12/31/11$16,800 12/31/12$12,360 Ending Inventory at Current Costs × Base-Year Cost Index Current Cost Index ×100/110 = $11,000 × 100/125 = $10,500 12/31/10 Dollar-Value LIFO

36. 36 Step 3: Compute the change in the inventory level for the year at base-year costs. $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/10 $1,000 $11,000 – $10,500 Dollar-Value LIFO

37. 37 Step 3: Compute the change in the inventory level for the year at base-year costs. $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/10 $500 Dollar-Value LIFO

38. 38 Step 4b: If there is a decrease in the inventory levels at base-year costs, this decrease reduces the inventory. Base year, $10,000 $500 12/31/10 × 110/100 =$ 550 × 100/100 = 10,000 $10,550 Ending inventory, 12/31/10 Dollar-Value LIFO

39. 39 Step 2: Convert the ending inventory cost to base-year costs. 12/31/09$12,100 12/31/10$13,125 12/31/11$16,800 12/31/12$12,360 ×110/100 = $11,000 × 100/125 = $10,500 ×100/140 = $12,000 12/31/11 Dollar-Value LIFO Ending Inventory at Current Costs × Base-Year Cost Index Current Cost Index

40. 40 Step 3: Compute the change in the inventory level for the year at base-year costs. $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/11 $500 $12,000 – $10,500 = $1,500 Dollar-Value LIFO

41. 41$500 $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/11 $1,500 Step 3: Compute the change in the inventory level for the year at base-year costs. Dollar-Value LIFO

42. 42 Step 4a:If there is an increase in inventory levels at base-year costs, convert this increase to current-year costs. Base year, $10,000 12/31/11 × 140/100 =$ 2,100 × 110/100 = 550 × 100/100 = 10,000 $12,650 Ending inventory, 12/31/11 $500 $1,500 Dollar-Value LIFO

43. 43 Step 2: Convert the ending inventory cost to base-year costs. 12/31/09$12,100 12/31/10$13,125 12/31/11$16,800 12/31/12$12,360 ×110/100 = $11,000 × 100/125 = $10,500 ×100/140 = $12,000 ×100/120 = $10,300 12/31/12 Dollar-Value LIFO Ending Inventory at Current Costs × Base-Year Cost Index Current Cost Index

44. 44$500 $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/12 $1,500 Dollar-Value LIFO

45. 45$500 $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/12 Dollar-Value LIFO

46. 46$300 $11,000 $10,500 $12,000 $10,300 12/31/09 12/31/10 12/31/11 12/31/12 Base year, $10,000 12/31/12 Dollar-Value LIFO

47. 47 Step 4a:If there is an increase in the inventory levels at base-year costs, convert this increase to current-year costs. Base year, $10,000 12/31/12 × 110/100 = $ 330 × 100/100 = 10,000 $10,330 Ending inventory, 12/31/12 $300 Dollar-Value LIFO

48. 48 Cost Index = Sample of Ending Inventory at Current-Year Costs Sample of Ending Inventory at Base-Year Costs × 100 Double-Extension Method Determination of Cost Index

49. 49 Cost Index = Sample of Ending Inventory at Current -Year Costs Sample of Ending Inventory at Previous-Year Costs × Link-Chain Method Previous- Year Cost Index Determination of Cost Index

50. 50 A company may use inventory pools in conjunction with dollar-value LIFO. The purpose of the pools is to maintain the benefits from using LIFO when fluctuations in the physical quantities or similar inventory items occur and when technological change takes place. Inventory Pools

51. 51  Life Valuation Adjustment - Frequently, a company uses LIFO for external financial reporting and income tax purposes but uses another method for internal management. Additional LIFO Considerations

52. 52  Interim Statements Using LIFO – If a company uses LIFO for annual reporting purposes, it must use LIFO for interim reporting purposes. GAAP states that if a company using LIFO has an inventory liquidation at an interim date that it expects to replace by the end of the annual period, it does not include the LIFO liquidation in its inventory, and its cost of sales includes the expected cost of replacement of the liquidated LIFO inventory. Additional LIFO Considerations

53. 53  Change to or from LIFO - A company may occasionally change its inventory cost flow assumption.  To – Usually, the effect on the results of prior periods is not determinable. Then GAAP requires that the company apply the change prospectively, as of the earliest date practicable.  From – Retroactively restate the results of prior periods and treat the change as a retrospective adjustment. Additional LIFO Considerations

54. 54 IFRS vs. U.S. GAAP  IFRS do not allow the use of LIFO for both financial and tax purposes.  While both U.S. GAAP and IFRS allow the use of multiple acceptable cost flow assumptions, IFRS require that the same assumption be used for all inventories that have a similar nature and use. No such requirement exists under U.S. GAAP.

55. 55 1.An exchange gain occurs when the exchange rate declines between the date a payable is recorded as a result of a purchase of inventory and the date of the cash payment. 2.An exchange gain occurs when the exchange rate increases between the date a receivable is recorded as a result of a sale of inventory and the date of the cash receipt. When exchange rates are stated in terms of $ per unit of foreign currency, exchange gains and losses occur for purchases or sales on account as follows: ContinuedContinued Appendix: Foreign Currency Transactions Involving Inventory

56. 56 Appendix: Foreign Currency Transactions Involving Inventory 3.An exchange loss occurs when the exchange rate increases between the date a payable is recorded as a result of a purchase of inventory and the date of the cash payment. 4.An exchange loss occurs when the exchange rate declines between the date a receivable is recorded as a result of a sale of inventory and the date of the cash receipt. RMB

57. 57 C hapter 8 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.