Inventories: Cost Measurement and Flow Assumptions C hapter 8 An electronic presentation by Norman Sunderman Angelo State University An electronic presentation

Inventories: Cost Measurement and Flow

Assumptions

Chapter8

An electronic presentation by Norman Sunderman Angelo State University

COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Intermediate AccountingIntermediate Accounting 10th edition 10th edition

Nikolai Bazley JonesNikolai Bazley Jones

2

Flow of Inventory Costs

Merchandising Company

Cost of Goods Sold

Accounts Payable (or Cash)

Merchandise Inventory

Goods Purchased

Goods Sold

3

Alternative Inventory Systems

A company using a perpetual system

maintains a continuous record of the physical

quantities in its inventory.

4

A company using a periodic system does not

maintain a continuous record of the physical

quantities on hand.

Alternative Inventory Systems

5

Computation of Net Purchases

Purchases+ Freight-in- Purchases Returns and

Allowances- Purchases Discounts Taken= Net Purchases

6

Determination of Inventory Costs

Price paid or consideration given

Freight-inReceivingUnpacking Inspecting Storage InsuranceApplicable taxes

7

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

8

Purchases Discounts-Gross Price Method

To record the purchaseInventory (or Purchases) 1,000

Accounts Payable 1,000

A company purchases $1,000 of goods under terms of 1/10, n/30.

To record payment within the discount period:Accounts Payable 1,000

Purchases Discounts Taken 10Cash 990

To record payment after the discount period:Accounts Payable 1,000

Cash 1,000

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To record the purchase:Inventory (or Purchases) 990

Accounts Payable990


Purchases Discounts-Net Price Method

To record payment within the discount period:Accounts Payable 990

Cash990To record payment after the discount period:

Accounts Payable 990Purchases Discounts Lost 10

Cash1,000

Purchases Discounts Lost are treated as a financing expense in the Other section of the income statement.

10

Net Price Method

Adjusting entry at the end of period if discount has expired and invoice is unpaid:Purchases Discounts Lost 10

Accounts Payable10


Purchases Discounts

11

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%

12

Specific Identification

100 units @ $10 per unitApr. 1Apr. 10Apr. 20

80 units @ $11 per unit70 units @ $12 per unit

On April 27, sold 90 units from the beginning inventory, 50 units from the April 10

purchase.

13



80 units @ $11 per unit

Apr. 20 0 units @ $12 per unit

90 units @ $10 per unitApr. 150 units @ $11 per unitApr. 10


10 units @ $10 per unit30 units @ $11 per unit70 units @ $12 per unit

Sold 90Sold 50

Ending inventory . . . . . . . . .

= $ 100= 330= 840

$1,270

Cost of Goods Sold . . . . . . . . $1,450

= $900= 550= 0

Sold 0

14



30 units @ $11 per unitApr. 20

Apr. 1Apr. 10




70 units @ $12 per unitEnding inventory . . . . . . . . . . . . .

Goods available for sale . . . . . . .

= $ 1,000= 880= 840

$2,720

= $ 100= 330= 840

$1,270Cost of Goods Sold…………. $ 1,480Cost of Goods Sold . . . . . . . . . . .

15



Sold 140 units during April.

40 units @ $11 per unitSold all0 units @ $10 per unitSold 40Sold 070 units @ $12 per unit

First-In, First-Out (FIFO)

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Ending inventory…………….……




Beg. Inv. + Purchases - End. Inv. = Cost of Goods Sold

= $ 0= 440= 840

$1,280

$1,000 + $1,720 - $1,280 = $1,440

First-In, First-Out (FIFO)

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= $1,000= 880= 840

$2,720

Average Cost




250 units

Beg. Inv. + Purchases - End. Inv. = Cost of Goods Sold $1,000 + $1,720 - $1,197 = $1,523

$2,720 250 units = $10.88$10.88 x 110 units = ending inventory of $1,197

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$1,780 $1,780 160 160

Apr. 18 Sales -90 units @ $10.44 -940Apr. 18 Balance 90 units @ $10.44 $ 940Apr. 20 Purchases 70 units @ $12 840Apr. 20 Balance 160 units @ $11.125 $1,780

Moving AverageApr. 1 Beginning Inventory100 units @ $10 $1,000Apr. 10 Purchases 80 units @ $11 880Apr. 10 Balance 180 units @ $10.44 $1,880

Apr. 27 Sales -50 units @ $11.125 -556Apr. 30 Balance 110 units @ $11.125 $1,224

Cost of Goods Sold (140 units) $940 + $556 $1,496Ending Inventory (110 units @ $11.125) $1,224

$1,880 $1,880 180 180

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Last-In, First-Out (LIFO)





Sold 0Sold 70Sold all70 units @ $12 per unit

Periodic Inventory SystemPeriodic Inventory System


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Periodic Inventory SystemPeriodic Inventory System

0 units @ $12 per unitEnding inventory…………

= $1,000= 110= 0

$1,110

$1,000 + $1,720 - $1,110 = $1,610

Last-In, First-Out (LIFO)

21

100 units @ $10 per unit90 units @ $10 per unitApr. 1Apr. 10Apr. 20

80 units @ $11 per unitPurchased 80


Perpetual Inventory SystemPerpetual Inventory System

Sold 8080 units @ $11 per unit0 units @ $11 per unitSold 10

Purchased 70Sold 50

Sold 90

Last-in, First Out

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Apr. 1Apr. 10Apr. 20

Perpetual Inventory SystemPerpetual Inventory System

Ending inventory………………


= $ 900= 0= 240

$1,140

$1,000 + $1,720 - $1,140 = $1,580



Last-in, First Out

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Per Unit

FIFO LIFO ($12) LIFO ($11)

Revenue $30 $30 $30 Cost of goods sold -10 -12 -11Gross profit $20 $18 $19 Holding gains (ex-cluded from income) 2 1

$20 $20

Holding Gains Comparisons

24

When a company initially changes to the LIFO method, the base year cost for the beginning of the year of change is the ending inventory for the prior year based on whatever method was used previously.

Initial Adoption of LIFO

25

10,000 units at $20 per unit6,000 units at $22 per unit8,000 units at $24 per unit4,000 units at $30 per unit

= $200,000= 132,000= 192,000= 120,000

$644,000Inventory, January 1, 2007…………

In 2007 the company purchases 50,000 units at $35 per unit and sells 60,000 units.

2003:2004:2005:2006:

Liquidation of Layers

26

10,000 units at $20 per unit6,000 units at $22 per unit8,000 units at $24 per unit4,000 units at $30 per unit

2003:2004:2005:2006:2007:

= $200,00= 132,000= 192,000= 120,000=1,750,00050,000 units at $35 per unit0 units at $35 per unit Sold 50,000Sold 50,000Sold 4,000Sold 4,000Sold 6,000Sold 6,000

0 units at $30 per unit2,000 units at $24 per unit

Liquidation of Layers

In 2007 the company purchases 50,000 units at $35 per unit and sells 60,000 units.

27

10,000 units at $20 per unit6,000 units at $22 per unit

6,000 units at $24 per unit4,000 units at $30 per unit

2003:2004:2005:

= $ 144,000= 120,000= 1,750,000

$2,014,00050,000 units at $35 per unit

2,000 units at $24 per unit

2005:2006:2007:

Cost of goods sold………

Liquidation of LayersInventory Layers

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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

29

Step 1: Value the total ending inventory at current-year costs.

01/1/06 $10,000

12/31/06 $12,100

12/31/07 $13,125

12/31/08 $16,800

12/31/09 $12,360

Dollar-Value LIFO

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Step 2: Convert the ending inventory cost to base-year cost:

12/31/06 $12,10012/31/07 $13,12512/31/08 $16,800

12/31/09 $12,360

Ending Inventory at Current Cost

x

Base Year Cost Index

Current Cost Index

x 100/110 = $11,000

12/31/06

Dollar-Value LIFO

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Step 3: Compute the change in the inventory level for the year at base-year costs.

$11,000$10,500$12,000

$10,300

12/31/0612/31/0712/31/08

12/31/08

Base year, $10,000Base year, $10,000

$11,000 - $10,000$11,000 - $10,000

$1,000$1,000

1/1/0612/31/06

Dollar Value LIFO

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Step 4a: If there has been an increase, convert this increase to current-year costs.


$1,000$1,000

12/31/06

x 110/100 = $ 1,100

x 100/100 = 10,000$11,100

Ending inventory, 12/31/06

Dollar-Value LIFO

33


12/31/06 $12,10012/31/07 $13,12512/31/08 $16,800

12/31/09 $12,360


x


Current Cost Index

x 100/110 = $11,000x 100/125 = $10,500

12/31/07

Dollar-Value LIFO

34


$11,000$10,500$12,000

$10,300

12/31/0612/31/0712/31/08

12/31/09

Base year, $10,000Base year, $10,00012/31/07

$1,000$1,000

$11,000 - $10,500

Dollar-Value LIFO

35


$11,000$10,500$12,000

$10,300

12/31/0612/31/0712/31/08

12/31/09


$500$500

Dollar-Value LIFO

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Step 4b: If there is a decrease, this decrease reduces the inventory.


$500$500

12/31/07

x 110/100 = $ 550

x 100/100 = 10,000$10,550


Dollar-Value LIFO

37


12/31/06 $12,10012/31/07 $13,12512/31/08 $16,800

12/31/09 $12,360

x 110/100 = $11,000x 100/125 = $10,500

x 100/140 = $12,000

12/31/08

Dollar-Value LIFO


x


Current Cost Index

38


$11,000$10,500$12,000

$10,300

12/31/0612/31/0712/31/08

12/31/09


$500$500$12,000 - $10,500 = $1,500

Dollar-Value LIFO

39

$500$500

$11,000$10,500$12,000

$10,300

12/31/0612/31/0712/31/08

12/31/09


$1,500$1,500


Dollar-Value LIFO

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Step 4a: Convert increase to current-year costs.


12/31/08

x 140/100 = $ 2,100

x 110/100 = 550

x 100/100 = 10,000$12,650


$500$500

$1,500$1,500

Dollar-Value LIFO

41


12/31/06 $12,10012/31/07 $13,12512/31/08 $16,800

12/31/09 $12,360

x 110/100 = $11,000x 100/125 = $10,500x 100/140 = $12,000

x 100/120 = $10,300

12/31/09

Dollar-Value LIFO


x


Current Cost Index

42

$500$500

$11,000$10,500$12,000

$10,300

12/31/0612/31/0712/31/08

12/31/09


$1,500$1,500

Dollar-Value LIFO

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$500$500

$11,000$10,500$12,000

$10,300

12/31/0612/31/0712/31/08

12/31/09


Dollar-Value LIFO

44

$300$300

$11,000$10,500$12,000

$10,300

12/31/0612/31/0712/31/08

12/31/09


Dollar-Value LIFO

45

Step 4a: Convert increase to current-year costs.


12/31/09

x 110/100 = $ 330

x 100/100 = 10,000$10,330


$300$300

Dollar-Value LIFO

46

ContinueContinue

Example 8-12

Current Current cost at Historical Costs base year prices Cost

12/31/06 $12,100 X 100 110

= 11,000

$10,000 X 100 100

=$10,000

1,000 X 110 100

= 1,100

$11,100

12/31/07 $13,125 X 100125

= 10,500

$10,550

$10,000 X 100 100

= $10,000

500 X 110 100

= 550

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12/31/08 $16,800 X 100140

= 12,000500 X 110

100= 550

$12,650

$10,000 X 100 100

=$10,000

1,500 X 140100

= 2,100

12/31/09 $12,360 X 100120

= $10,300

$10,330

$10,000 X 100 100

= $10,000

300 X 110

100

= 330

Example 8-12

Current Current cost at Historical Costs base year prices Cost

48

Cost Index =

Sample of Ending Inventory at Current -Year Costs

Sample of Ending Inventory at Base-Year Costs

x 100

Double-Extension Method

Determination of Cost Index

49

Cost Index =

Sample of Ending Inventory at Current -Year Costs

Sample of Ending Inventory at Previous-Year Costs

x

Link-Chain Method

Previous-Year Cost

Index

Determination of Cost Index

50

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

Foreign Currency Transactions Involving Inventory

51


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

52

A U.S. company purchases inventory of electronic components from a Japanese company for 50 million yen (¥) when the exchange rate is

$0.008.

¥50,000,000 x $0.008 = $400,000

Inventory (or Purchases) 400,000 Cash 400,000


53

Assume that the exchange rate on the date of payment is $0.0078. The U.S. company has to pay only $390,000.

¥50,000,000 x $0.0078 = $390,000

Accounts Payable 400,000 Cash 390,000 Exchange Gain 10,000


54

A U.S. company sells computer equipment (cost, $200,000) to a German Company on account and the

agreed price is 300,000 euros. On the date of the sale, the exchange rate is $1.20 (1 euro = $1.20).

€300,000 x $1.20 = $360,000

Accounts Receivable 360,000 Sales Revenue 360,000Cost of Goods Sold 200,000 Inventory 200,000


55

If the exchange rate is $1.18 when German Company pays the amount owed, the U.S. company can convert those euros into only

$354,000.

€300,000 x $1.18 = $354,000

Cash 354,000Exchange Loss 6,000 Accounts Receivable 360,000


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Chapter8

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Inventories: Cost Measurement and Flow Assumptions C hapter 8 An electronic presentation by Norman Sunderman Angelo State University An electronic presentation