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Chapter 6
Reporting and Analyzing Inventory
6
Manufacturing Inventory
• Finished goods inventory
• Work in process
• Raw materials
7
Finished Goods Inventory
Manufactured items that are complete and ready for sale.
8
Work in Process
Manufactured inventory that has been placed into production but is not yet complete.
9
Raw Materials
The basic goods that will be used in production, but have not been placed in production.
Key difference between
periodic and perpetual inventory…
is the point at which the costs of goods sold is
computed.
7
Determine Inventory Quantities
• Determine inventory quantities by counting, weighting or measuring each type of inventory.
• Determine ownership of goods, including goods in transit, consigned goods.
8
Questions Concerning Ownership
• Do all the goods included in the count belong to the company?
• Does the company own any goods not included in the count?
9
Goods in Transit
Goods are on board a truck, train, ship, or plane at the end of the period.
36
Who includes them in inventory?
Seller?Buyer? The
Company with Legal Title
Terms of Sale- FOB (free-on-board)
Consigned Goods
• Goods of others you hold. You do not pay for the goods until they sell.
• The company does not take ownership.
What Is a Cost Flow Assumption?
To presume the order in which goods are sold even if flow of costs is unrelated to the physical flow of goods.
Inventory Cost Flows
• Specific Identification--The tracking of actual costs for specifically identified units.
• FIFO (first-in, first-out)--Assumption that the first goods bought are the first goods sold.
• LIFO (last-in, first-out)--Assumption that the last goods purchased are the first goods sold.
• Weighted Average Cost –Assumption that when similar units are combined in inventory the costs are merged and averaged between all parts.
Specific Identification
• Used by companies that sell limited products at a high price.
• Requires that each unit has a specific cost associated with it.
Data for Examples
Beginning Inventory 10 hats @ $10 each = $100
Purchases (February) 15 hats @ $15 each = $225
Sales (June) 20 hats
Purchases (July) 10 hats @ $18 each = $180
Ending Inventory 15 hats
Use the following data to show the journal entry for the sales in June and the value of ending inventory using the FIFO Perpetual method.
FIFO 2007 Inventory
Purchase Sale Balance `Date Units Total Units Total Units Cost Total
Jan 1 10 $10 $100
Feb 15 $225 10 $10 $100 15 $15 $225
June 10 $100 10 $150 5 $15 $ 75
July 10 $180 5 $15 $ 75 10 $18 $180
FIFO Perpetual
Cost of Goods Sold:
Beginning Inventory 10 @ $10 = $ 100
February Purchases 10 @ $15 = $ 150
Total $ 250
Ending Inventory:
February Purchases 5 @ $15 = $ 75
December Purchases 10 @ $18 = $ 180
Total $ 255
FIFO Perpetual Journal Entry
In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:
Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.
In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:
Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.
Cost of Goods Sold............... .. 250 Inventory........................... 250To recognize expenses from selling hats.
FIFO Perpetual Journal Entry
Using FIFO - - - both perpetual and periodic inventory systems result in the same results.
FIFO Periodic Inventory
Beg. 10
Jan
Purch. 15
Feb
Purch. 10
July
Sale 20
June
LIFO Perpetual Inventory
Purchase Sale Balance `Date Units Total Units Total Units Cost Total
Jan 1 10 $10 $100
Feb 15 $225 10 $10 $100 15 $15 $225
June 15 $225 5 $ 50 5 $10 $ 50
Dec 10 $180 5 $10 $ 50 10 $18 $180
Using LIFO - - - perpetual removes the latest items received at the time of each sale.
LIFO Perpetual Inventory
Beg. 10
Jan
Purch. 15
Feb
Purch. 10
July
Sale 20
June
LIFO Perpetual Journal Entry
In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:
Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.
LIFO Perpetual Journal Entry
In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:
Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.
Cost of Goods Sold............... .. 275 Inventory........................... 275To recognize expenses from selling hats.
Inventory Costing - Periodic
1. Determine quantity of units of inventory
2. Apply unit costs to the quantities
3. Determine total cost of inventory
4. Determine cost of goods sold
Process can be complicated if units are purchased at different times and at different prices!
LIFO Periodic
Cost of Goods Sold:
July Purchases 10 @ $18 = $ 180
February Purch 10 @ $15 = $ 150
Total $ 330
Ending Inventory:
Beginning Inventory 10 @ $10 = $ 100
February Purchases 5 @ $15 = $ 75
Total $ 175
Using LIFO - - - periodic removes the latest items received as of the end of the period.
LIFO Periodic Inventory
Beg. 10
Jan
Purch. 15
Feb
Purch. 10
July Sale 20
June
Weighted-Average Perpetual
In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:
Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.
Weighted-Average Perpetual
In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:
Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.
Cost of Goods Sold................. 260 Inventory........................... 260To recognize expenses from selling hats.
Weighted-Average 2007 Inventory
Purchase Sale Balance `Date Units Total Units Total Units Cost Total
Jan 1 10 $10.00 $100
Feb 15 $225 25 $13.00 $325
June 20 $260 5 $13.00 $ 65
July 10 $180 15 $16.33 $245
Weighted Average
Cost of Goods Sold:
Units Sold 20 @ $13.00 = $ 260
Total $ 260
Ending Inventory:
Units Remaining 15 @ $16.33 = $ 245
Total $ 245
Using Weighted Average - - - perpetual removes units at the average cost of all goods on hand.
Weighted Average Inventory
Beg. 10
Jan
Purch. 15
Feb
Purch. 10
July
Sale 20
June
Question 1Question 1
Which inventory cost flow method produces Which inventory cost flow method produces the the highesthighest net income in a period of rising net income in a period of rising prices?prices?
a.a. Weighted average costWeighted average costb.b.LifoLifoc.c. FifoFifod.d.Specific Identification.Specific Identification.
Question 1Question 1
Which inventory cost flow method produces Which inventory cost flow method produces the the highesthighest net income in a period of rising net income in a period of rising prices?prices?
a.a. Weighted average costWeighted average costb.b.LifoLifoc.c. FifoFifod.d.Specific Identification.Specific Identification.
Which inventory cost flow method produces Which inventory cost flow method produces the the lowestlowest income taxes in a period of rising income taxes in a period of rising prices?prices?
Question 2Question 2
a.a. Weighted average costWeighted average costb.b. LifoLifoc.c. FifoFifod.d. Specific Identification.Specific Identification.
Which inventory cost flow method produces Which inventory cost flow method produces the the lowestlowest income taxes in a period of rising income taxes in a period of rising prices?prices?
Question 2Question 2
a.a. Weighted average costWeighted average costb.b. LifoLifoc.c. FifoFifod.d. Specific Identification.Specific Identification.
Comparison of Inventory Costing Methods -- Perpetual
Weighted FIFO LIFO Average
EndingInventory $255 $230 $245
Comparison of Inventory Costing Methods -- Perpetual
Weighted FIFO LIFO Average
EndingInventory $255 $230 $245
Cost ofGoods Sold $250 $275 $260
Income Statement Effects
The Lower of Cost or Market Basis of Accounting for Inventories
When the value of inventory is lower than
its cost, the inventory is written down to
its market value by valuing the inventory
at the lower of cost or market (LCM) in
the period in which the price decline
occurs.
Lower of Cost or Market (LCM)
• departure from cost principle
• follows conservatism concept
• can be used only after one of the cost flow methods ( Specific Identification FIFO, LIFO, or Average Cost)
57
Market Is...
CURRENT REPLACEMENT COST
How Much Inventory Should a Company Have?
– Only enough for sales needs
– Excess inventory costs:
• storage costs
• interest costs
• obsolescence - technology, fashion
Inventory Turnover Ratio =
An indication of how quickly a company sells its goods.
Higher is better.
Inventory Turnover Ratio =
Cost of Goods Sold
Average Inventory
Days in Inventory =
An indication of how quickly a company sells its goods.
Lower is better.
Days in Inventory =
365 days
Inventory Turnover Ratio
Lifo Reserve And Its Importance For Comparing Results Of Different Companies
• Accounting standards require firms using LIFO to
report the amount by which inventory would be
increased (or on occasion decreased) if the firm had
instead been using FIFO.
• This amount is referred to as the LIFO reserve.
Reporting the LIFO reserve enables analysts to
make adjustments to compare companies that use
different cost flow methods.