Chapter 7: Inventory. Acquisition of inventory: What costs to capitalize? Recording inventory activity: Which method? Selling inventory: Which cost flow assumption? Ending inventory: Lower-of-cost-or market valuation. Chapter 7: Inventory. What items or units to include?
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Recording inventory activity: Which method?
Selling inventory: Which cost flow assumption?
Ending inventory: Lower-of-cost-or market valuation.Chapter 7: Inventory
General rule: (1) held for sale and (2) complete and unrestricted ownership.
Consignments: belong to consignor, ownership not based on physical possession.
Goods in transit
FOB Shipping Point: belongs to the purchaser while in transit (once inventory leaves seller’s facilities).
FOB Destination: belongs to seller while in transit (until inventory reaches purchaser’s facilities).1. Acquiring Inventory
1. FOB Shipping Point (purchase):
2. FOB Shipping Point (sale):
Yes - inventory overstated.
3. FOB Destination (sale):
4. FOB Destination (purchase):
5. FOB Destination (purchase):
Yes - inventory overstatedClass Exercise E7-1
Because of the carryover nature of inventory, some inventory errors reverse out by the end of the second year involved.
To analyze, use basic inventory formula.Inventory Errors
BI + P - EI = COGS NI A = L + SE
Note that the asset account in inventory error analysis is ending inventory, and the equity effect is retained earnings, specifically the effect on net income.Class Problem
Freight-in (transportation-in) adds to the cost of inventory.
Purchase returns reduce the cost of purchases (contra) for returned inventory.
Purchase allowances reduce the cost of purchases (contra) for reduced prices due to damage or errors.
Purchase discounts from early cash payments (contra) reduce the cost of purchases.Acquiring inventory - contd.
Up-to-date record in inventory account.
Cost of goods sold computed for each sale.
Inventory purchases are recorded as incurred.
Inventory and cost of goods sold determined at the end of each period through physical count.
Costs and benefits
Perpetual requires more bookkeeping but provides more useful information.
General application: Periodic used for external reporting; perpetual used for internal tracking of units.2. Perpetual or Periodic Method
Accts. Pay. 2,000
December 20 Sale of 50 units @ $30:
(no COGS entry until the end of the period)
December 31 AJE/CJE to recognize EI and COGS:
(Note: BI given at $2,500 and EI of 175 units (125 BI + 100 Purchase -50 Sold) valued at $20 per unit, or $3,500)
Inventory (end) 3,500
Inventory (begin) 2,500Figure 7.3, Periodic System
2,500 + 2,000 - 3,500 = 1,000
Note that Purchases (net) =
- Purchase Discounts (see next slide)
- Purchase Returns
- Purchase AllowancesThis AJE under periodic system follows the formula for COGS:
(Alternative: BI + P(net) = EI + COGS)
GJE to record purchase on 6/1/05:
Accounts Payable 100
GJE to record payment, if on or before 6/16/05:
Accounts Payable 100
Purchase Discounts 2
GJE to record payment, if after 6/16/05:
Accounts Payable 100
(Purch Disc. is contra to Purchases; part of COGS calc.)Purchase Discounts - Gross Method
How to assign costs of inflows [BI + P(net)] to EI and COGS?
Averagefor both COGS and EI
FIFO- (first-in, first-out) for COGS
and LISH (last-in, still here) for EI
LIFO - (last-in, first-out) for COGS
and FISH (first-in, still here) for EI3. Cost Flow Assumptions
The perpetual system give similar results, but is more cumbersome to illustrate.
In fact, using the FIFO method, the perpetual and periodic systems yield exactly the same results.Class Problem - Cost Flows
Why use LIFO for taxes?
Why use LIFO for financial statements?
LIFO and market valuation
Should market value a company higher or lower if they use LIFO?
What happens to net income with liquidation of an old LIFO layer?
what information is contained in this disclosure?Additional LIFO issues:
Problem: can create hidden reserves
Recognizes price decreases immediately
Defers price increase recognition until sold4. Ending Inventory:Applying the Lower-of-Cost-or-Market Rule
Loss on Inventory 12
b. Sale next year (new basis = 40):
Cash (or A/R) 48
c. Loss of $12 in first year; gain of $8 in second year:
- or creating hidden reserve?Class Issues for Discussion: ID7-4