INVENTORIES: MEASUREMENT

1. Chapter 8 INVENTORIES:MEASUREMENT

2. Merchandise Inventory Manufacturing Inventory Goods acquired for resale • Raw Materials • Work-in-Process • Finished Goods Recording and Measuring Inventory Types of Inventory

3. Manufacturing Inventories RawMaterials FinishedGoods Work inProcess $XX (7) $XX (4) $XX (1) $XX $XX $XX (8) DirectLabor Cost of GoodsSold $XX (5) (2) $XX ManufacturingOverhead $XX $XX (6) (3) $XX • Raw materials purchased • Direct labor incurred • Manufacturing overhead incurred • Raw materials used • Direct labor applied • Manufacturing overhead applied • Work in process transferred to finished goods • Finished goods sold

4. Perpetual Inventory System Periodic Inventory System The inventory account is continuously updated as purchases and sales are made. The inventory account is adjusted at the end of a reporting cycle. Inventory Systems Two accounting systems are used to record transactions involving inventory:

5. GENERAL JOURNAL Date Description Debit Credit 2009 600,000 Inventory Accounts Payable 600,000 Perpetual Inventory System Lothridge Wholesale Beverage Company (LWBC) purchases on account $600,000 of merchandise for resale to customers. Returnsof inventory are credited to the inventory account. Discountson inventory purchases can be recorded using the gross or net method.

6. GENERAL JOURNAL Date Description Debit Credit 2009 Accounts Receivable 820,000 820,000 Sales Cost of Goods Sold 540,000 540,000 Inventory Perpetual Inventory System LWBC sold, on account, inventory with a retail price of $820,000 and a cost basisof $540,000, to a customer.

7. Periodic Inventory System

8. GENERAL JOURNAL Date Description Debit Credit 2009 600,000 Purchases Accounts Payable 600,000 Periodic Inventory System LWBC purchases on account $600,000 of merchandise for resale to customers. Returnsof inventory are credited to the Purchase Returns and Allowances account. Discountson inventory purchases can be recorded using the gross or net method.

9. GENERAL JOURNAL Date Description Debit Credit 2009 Accounts Receivable 820,000 820,000 Sales Periodic Inventory System LWBC sold on account, inventory with a retail price of $820,000 and a cost basisof $540,000, to a customer. No entry is made to record Cost of Goods Sold. Assuming BeginningInventory of $120,000, a physical count of Ending Inventory showsa balance of $180,000. Let’s calculate Cost of Goods Sold atthe end of the accounting period.

10. Adjusting entry to determine Cost of Goods Sold Periodic Inventory System

11. Comparison of Inventory Systems

12. General Rule All goods owned by the company on the inventory date, regardless of their location. What is Included in Inventory? Goods in Transit Goods on Consignment Depends on FOB shipping terms.

13. Invoice Price Purchase Returns + Freight-in on Purchases Purchase Discounts Expenditures Included in Inventory

14. Purchase Discounts Discount terms are 2/10, n/30. $14,000x 0.02$ 280 Partial payment not made within the discount period

15. Specific identification Average cost First-in, first-out (FIFO) Last-in, first-out (LIFO) Inventory Cost Flow Assumptions

16. Perpetual Average Cost The following schedule shows the Frame inventory for Yore Frame, Inc. for September. The physical inventory count at September 30 shows 600frames in ending inventory. Use theperpetualaverage cost method to determine: (1) Ending inventory cost (2) Cost of goods sold

17. Perpetual Average Cost

18. Perpetual Average Cost

19. Perpetual Average Cost $11,600.00 ÷ (800-600+300) = $23.200

20. Perpetual Average Cost $27,490.00 ÷ (800-600+300-300+250+200+400) = $26.181

21. Sum Perpetual Average Cost

22. Ending Inventory (600 units) Beginning Inventory (800 units) Purchases (1,150 units) Available for Sale (1,950 units) Goods Sold (1,350) Weighted-Average Periodic System Let’s use the same information to assign costs to ending inventory and cost of goods sold using the periodic system. $47,650 ÷ 1,950 = $24.4359 weighted-average per unit cost

23. Weighted-Average Periodic System

24. The cost of the oldest inventory items are charged to COGS when goods are sold. The cost of the newest inventory items remain in ending inventory. First-In, First-Out (FIFO) The FIFO method assumes that items are sold in the chronological order of their acquisition.

25. First-In, First-Out (FIFO) Even though the periodic and the perpetual approaches differ in the timing of adjustments to inventory . . . . . . COGS and Ending Inventory Cost are the same under both approaches.

26. First-In, First-Out (FIFO) These are the 600 most recently acquired units.

27. First-In, First-Out (FIFO)

28. First-In, First-Out (FIFO) These are the first 1,350 units acquired.

29. First-In, First-Out (FIFO)

30. The cost of the newest inventory items are charged to COGS when goods are sold. The cost of the oldest inventory items remain in inventory. Last-In, First-Out The LIFO method assumes that the newest items are sold first, leaving the older units in inventory.

31. Unlike FIFO, using the LIFO method may result in COGS and Ending Inventory Cost that differ under the periodic and perpetual approaches. Last-In, First-Out

32. LIFO Matches high (newer) costs with current (higher) sales. Inventory is valued based on low (older) cost basis. Results in lower taxable income. Not permitted by international accounting standards. FIFO Matches low (older) costs with current (higher) sales. Inventory is valued at approximate replacement cost. Results in higher taxable income. When Prices Are Rising . . .

33. Supplemental LIFO Disclosures Many companies use LIFO for external reporting and income tax purposes but maintain internal records using FIFO or average cost. The conversion from FIFO or average cost to LIFO takes place at the end of the period. The conversion may look like this:

34. How closely do reported costs reflect actual flow of inventory? How well are costs matched against related revenues? Decision Makers’ Perspective Factors Influencing Method Choice How are income taxes affected by inventory method choice?

35. LIFO Liquidation When prices rise . . . • LIFO inventory costs in the balance • sheet are “out of date” because they reflect • old purchase transactions. If inventory declines, these “out of date” costs may be charged to current earnings. This LIFO liquidation results in “paper profits.”

36. Gross profitratio Gross profit Net sales = Inventory Management This measure indicates how much of each sales dollar is left after deducting the cost of goods sold to cover expenses and provide a profit.

37. This ratio measures how many times a company’s inventory has been sold and replaced during the year. Inventory Management Inventory turnover ratio Cost of goods sold Average inventory = If a company’s inventory turnover is less than its industry average, it may experience difficulties in generating sales because of obsolete or slow-moving inventory items.

38. Earnings Quality Many believe that manipulating income reduces earnings quality because it can mask permanent earnings. Inventory write-downs and changes in inventory method are two additional inventory-related techniques a company could use to manipulate earnings.

39. Methods of Simplifying LIFO LIFO Inventory Poolsconsist of inventory units grouped according to similarities. Using Inventory Pools with LIFO simplifies record keeping. For example, all similar units purchased at the same time can be “pooled” and assigned an average unit cost.

40. Methods of Simplifying LIFO Dollar-Value LIFO (DVL) DVL inventory pools are viewed as layers of value, rather than layers of similar units. DVL simplifies LIFO record-keeping. At the end of the period, we determine if a new inventory layer was added by comparing ending inventory to beginning inventory. Example The replacement inventory differs from the old inventory on hand. We just create a new layer. DVL minimizes the probability of layer liquidation.

41. End of Chapter 8