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Chapter 3

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Chapter 3

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  1. inventory Chapter 3

  2. Learning Objectives • Describe how inventory accounts are classified. • Explain the uses of perpetual and periodic inventory systems. • Identify how inventory quantities are determined. • Determine the cost of inventory. • Compute ending inventory and cost of goods sold under specific identification, FIFO, average cost, and LIFO. • Explain the conceptual issues regarding alternative inventory cost flow assumptions. • Understand dollar-value LIFO. • Explain additional LIFO issues. • Understand inventory disclosures.

  3. Learning Objectives • Understand the lower of cost or market method. • Explain the conceptual issues regarding the lower of cost or market method. • Understand purchase obligations and product financing arrangements. • Explain the valuation of inventory above cost. • Use the gross profit method. • Understand the retail inventory method. • Explain the conceptual issues regarding the retail inventory method. • Understand the dollar-value retail method. • Understand the effects of inventory errors on the financial statements.

  4. Importance of Inventories Typicallyrepresent the largest current asset of manufacturing and retail firms. For many companies inventories are a significant portion of total assets as well. Inventory methods and management practices can become profit-enhancing tools.

  5. Inventory Categories • Merchandise inventory Goods acquired for resale • Manufacturing inventory Raw materials Work-in-process Finished goods Manufacturing supplies • Miscellaneous inventory

  6. Flow of Inventory Costs Merchandising Company Manufacturing Company

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

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

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

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

  11. Items Included in Inventory General Rule All goods owned by the company on the inventory date, regardless of their location. Goods in transit depend on the FOB terms. Goods on consignment.

  12. Who Owns the Inventory?

  13. Components of Inventory Cost • Invoice price • Freight-in • Purchase discounts • Other costs to get the inventory ready for sale

  14. Purchases Discounts 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.

  15. Purchases Discounts-Gross Price Method A company purchases $1,000 of goods under terms of 1/10, n/30. To record the purchase Inventory (or Purchases) 1,000 Accounts Payable 1,000 To record payment within the discount period: Accounts Payable 1,000 Purchases Discounts Taken 10 Cash 990 To record payment after the discount period: Accounts Payable 1,000 Cash 1,000

  16. Purchases Discounts-Net Price Method A company purchases $1,000 of goods under terms of 1/10, n/30. Purchases Discounts Lost are treated as a financing expense in the Other section of the income statement. To record the purchase: Inventory (or Purchases) 990 Accounts Payable 990 To record payment within the discount period: Accounts Payable 990 Cash 990 To record payment after the discount period: Accounts Payable 990 Purchases Discounts Lost 10 Cash 1,000

  17. Purchases Discounts A company purchases $1,000 of goods under terms of 1/10, n/30. Net Price Method Adjusting entry at the end of period if discount has expired and invoice is unpaid: Purchases Discounts Lost 10 Accounts Payable 10

  18. Inventory Recording Methods PERIODIC METHOD vs. PERPETUAL METHOD

  19. Alternative Inventory Systems A company using a periodic systemdoes not maintain a continuous record of the physical quantities on hand.

  20. Calculating Cost of Goods Sold (COGS) Beginning Inventory + Purchases (net) = Cost of Goods Available for Sale - Ending Inventory = Cost of Goods Sold

  21. Comparison of Systems Perpetual Inventory System Periodic Inventory System Beginning inventory + Purchases (net) - Goods Sold = Ending Inventory Beginning inventory + Purchases (net) - Ending Inventory = Goods Sold

  22. Periodic versus Perpetual

  23. Periodic System • At the end of the accounting period, calculate COGS by closing: Purchases, Purchases Discount, Purchase Returns and Allowances, Beginning Inventory, and Record Ending Inventory. • COGS is closed to Income Summary.

  24. Periodic System

  25. Periodic System

  26. Periodic System

  27. Periodic System

  28. Periodic System

  29. Periodic System • Purchases discount and purchase returns and allowances are contra-purchases accounts, i.e., they have a credit balance. • Purchases can be recorded using the gross or net method.

  30. Perpetual System The inventory account is continuously updated for:

  31. Perpetual System Returns of inventory are credited to the inventory account. Discounts on inventory purchases can be recorded using the gross or net method.

  32. Perpetual System Cable TV, Inc. used the gross method to record a purchase on March 23 for $50,000 with terms of 2/10,n/30. Payment was made on April 1. Which of the following is included on the April 1 entry? a. Credit Purchases Discount $1,000 b. Debit Purchases Discount $1,000 c. Credit Inventory $1,000 d. Debit Inventory $1,000

  33. Perpetual System Cable TV, Inc. used the gross methodto record a purchase on March 23 for $50,000 with terms of 2/10,n/30. Payment was made on April 1. Which of the following is included on the April 1 entry? a. Credit Purchases Discount $1,000 b. Debit Purchases Discount $1,000 c.Credit Inventory $1,000 d. Debit Inventory $1,000

  34. Perpetual System

  35. Periodic System Cable TV, Inc. used the net methodto record a purchase on March 23 for $50,000 with terms of 2/10,n/30. Payment was made on April 5. Which of the following is included on the April 5 entry? a. Credit Purchases Discount $1,000 b. Debit Purchases Discount $1,000 c. Credit Purchases Discounts Forfeited $1,000 d. Debit Purchases Discounts Forfeited $1,000

  36. Periodic System Cable TV, Inc. used the net method to record a purchase on March 23 for $50,000 with terms of 2/10,n/30. Payment was made on April 5. Which of the following is included on the April 5 entry? a. Credit Purchases Discount $1,000 b. Debit Purchases Discount $1,000 c. Credit Purchases Discounts Forfeited $1,000 d. Debit Purchases Discounts Forfeited $1,000

  37. Periodic System Represents a finance charge and is included with misc. expenses

  38. Perpetual System Cost of Goods Sold is closed to Income Summary during the usual closing entries at the end of the period.

  39. Inventory Values - Unit Cost • Cost basis • Departures from cost Lower of cost or market (LCM) Net realizable value Replacement cost Current cost Selling price

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

  41. Specific Cost Identification • Specific cost of each inventory item must be known. • Opportunity to manipulate income by selection of items at time of sale.

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

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

  44. = $ 1,000 = 880 = 840 $2,720 = $ 100 = 330 = 840 $1,270 Cost of Goods Sold . . . . . . . . . . . $ 1,480 Specific Identification 100 units @ $10 per unit Apr. 1 Apr. 10 Apr. 20 80 units @ $11 per unit 70 units @ $12 per unit Goods available for sale . . . . . . . 10 units @ $10 per unit Apr. 1 30 units @ $11 per unit Apr. 10 Apr. 20 70 units @ $12 per unit Ending inventory . . . . . . . . . . . . .

  45. Average Cost Method • The periodic inventory system uses the weighted-average unit cost method. • The perpetual inventory system uses the moving-average unit cost method.

  46. Weighted-AveragePeriodic Method Weighted-average cost (WAC) per unit Beginning inventory cost + Current purchase cost Beginning inventory units + Current purchase units Ending Inventory Ending Inv. = Units in Ending Inv. x WAC per Unit Cost of Goods Sold COGS = Units Sold x WAC per Unit

  47. Weighted-AveragePeriodic Method The following schedule shows the mouse pad inventory for Computers, Inc. for September. The physical inventory count shows 800 mouse pads in ending inventory. Use the weighted-average periodic method to determine: (1) Ending inventory cost. (2) Cost of goods sold.

  48. Weighted-AveragePeriodic Method

  49. Weighted-AveragePeriodic Method GAS 1,550 -EI (800) COGS 750

  50. Weighted-AveragePeriodic Method $8,370 ÷1,550 = $5.40 weighted-average