ch 6 inventory
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Chapter 6; Inventory
Prepared by Aj.Ratchadaporn Putjorn
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Preview ofCHAPTER6
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One Classification:
Inventory
Three Classifications:
Raw Materials
Work in Process
Finished Goods
MerchandisingCompany
ManufacturingCompany
Regardless of the classification, companies report all inventories underCurrent Assets on the balance sheet.
Classifying Inventory
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Physical Inventory taken for two reasons:
Perpetual System
1. Check accuracy of inventory records.
2. Determine amount of inventory lost (wasted raw
materials, shoplifting, or employee theft).
Periodic System
1. Determine the inventory on hand.
2. Determine the cost of goods sold for the period.
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
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Involves counting, weighing, or measuring each kind of
inventory on hand.
Taken,
when the business is closed or business is slow.
at end of the accounting period.
Taking a Physical Inventory
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
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Goods in Transit
Purchased goods not yet received.
Sold goods not yet delivered.
Determining Ownership of Goods
SO 1 Describe the steps in determining inventory quantities.
Goods in transit should be included in the inventory of the
company that has legal title to the goods. Legal title is
determined by the terms of sale.
Determining Inventory Quantities
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Illustration 6-1Terms of sale
Ownership of the goods
passes to the buyer when the
public carrier accepts thegoods from the seller.
Ownership of the goodsremains with the seller until
the goods reach the buyer.
Goods in Transit
Determining Inventory Quantities
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Goods in transit should be included in the inventory of the
buyer when the:
a. public carrier accepts the goods from the seller.
b. goods reach the buyer.
c. terms of sale are FOB destination.
d. terms of sale are FOB shipping point.
Question
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
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Consigned Goods
Goods held for sale by one party.
Ownership of the goods is retained by another
party.
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Determining Ownership of Goods
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Unit costs can be applied to quantities on hand using thefollowing costing methods:
Specific Identification
First-in, first-out (FIFO)
Average-cost
SO 2 Explain the basis of accounting for inventories andapply the inventory cost flow methods.
Cost FlowAssumptions
Inventory Costing
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Illustration: Assume that Crivitz TV Company purchases threeidentical 50-inch TVs on different dates at costs of $700, $750,
and $800. During the year Crivitz sold two sets at $1,200 each.
These facts are summarized below.
Illustration 6-2
Inventory Costing
SO 2 Explain the basis of accounting for inventories andapply the inventory cost flow methods.
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Specific Identification
If Crivitz sold the TVs it purchased on February 3 and May 22,
then its cost of goods sold is $1,500 ($700 + $800), and its
ending inventory is $750.
Illustration 6-3
Inventory Costing
SO 2 Explain the basis of accounting for inventories andapply the inventory cost flow methods.
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Actual physical flow costing method in which items still in
inventory are specifically costed to arrive at the total cost of
the ending inventory.
Practice is relatively rare.
Most companies make assumptions (Cost Flow
Assumptions) about which units were sold.
Inventory Costing
Specific Identification
SO 2 Explain the basis of accounting for inventories andapply the inventory cost flow methods.
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Illustration 6-11Use of cost flow methods in
major U.S. companies
Cost Flow Assumptions
do not need to match the
physical movement of
goods
Inventory Costing
SO 2 Explain the basis of accounting for inventories andapply the inventory cost flow methods.
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Illustration: Data for Houston Electronics Astro condensers.
Illustration 6-4
(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold
Inventory Costing
SO 2 Explain the basis of accounting for inventories andapply the inventory cost flow methods.
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Earliest goods purchased are first to be sold.
Often parallels actual physical flow of merchandise.
Generally good business practice to sell oldest units
first.
First-In-First-Out (FIFO)
Inventory Costing
SO 2 Explain the basis of accounting for inventories andapply the inventory cost flow methods.
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Illustration 6-5
SO 2
First-In-First-Out (FIFO)
Inventory Costing
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Illustration 6-5
Inventory Costing
First-In-First-Out (FIFO)
SO 2 Explain the basis of accounting for inventories andapply the inventory cost flow methods.
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Allocates cost of goods available for sale on the basis
of weighted-average unit cost incurred.
Assumes goods are similar in nature.
Applies weighted-average unit cost to the units on
hand to determine cost of the ending inventory.
Inventory Costing
Average Cost
SO 2 Explain the basis of accounting for inventories andapply the inventory cost flow methods.
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Illustration 6-10
Inventory Costing
Average Cost
SO 2 Explain the basis of accounting for inventories andapply the inventory cost flow methods.
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Illustration 6-10
Inventory Costing
Average Cost
SO 2 Explain the basis of accounting for inventories andapply the inventory cost flow methods.
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Powerpoint Templates Page 22SO 3 Explain the financial effects of the inventory cost flow assumptions.
Financial Statement and Tax EffectsIllustration 6-12
Inventory Costing
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The cost flow method that often parallels the actual
physical flow of merchandise is the:
a. FIFO method.b. LIFO method.
c. average cost method.
d. gross profit method.
Question
Inventory Costing
SO 3 Explain the financial effects of the inventory cost flow assumptions.
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Using Cost Flow Methods Consistently
Method should be used consistently, enhances
comparability.
Although consistency is preferred, a company maychange its inventory costing method.
Illustration 6-14Disclosure of change incost flow method
Inventory Costing
SO 3 Explain the financial effects of the inventory cost flow assumptions.
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Lower-of-Cost-or-Market
SO 4 Explain the lower-of-cost-or-market basis of accounting for inventories.
When the value of inventory is lower than its cost
Companies can write down the inventory to its market
value in the period in which the price decline occurs.
Market value = Replacement Cost
Example ofconservatism.
Inventory Costing
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Illustration: Assume that Ken Tuckie TV has the following
lines of merchandise with costs and market values as
indicated.
Illustration 6-15
Inventory Costing
Lower-of-Cost-or-Market
SO 4 Explain the lower-of-cost-or-market basis of accounting for inventories.
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Powerpoint Templates Page 27SO 5 Indicate the effects of inventory errors on the financial statements.
Common Cause:
Failure to count or price inventory correctly.
Not properly recognizing the transfer of legal title to
goods in transit.
Errors affect both the income statement and balance
sheet.
Inventory Errors
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Inventory errors affect the computation of cost of goods sold
and net income.
Illustration 6-17
Illustration 6-16
SO 5 Indicate the effects of inventory errors on the financial statements.
Inventory Costing
Income Statement Effects
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Powerpoint Templates Page 29SO 5 Indicate the effects of inventory errors on the financial statements.
Effect of inventory errors on the balance sheet is determined
by using the basic accounting equation:.
Illustration 6-16
Illustration 6-19
Inventory Costing
Balance Sheet Effects
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Balance Sheet - Inventory classified as current asset.
Income Statement - Cost of goods sold subtracted from
sales.
There also should be disclosure of
1) major inventory classifications,
2) basis of accounting (cost or LCM), and
3) costing method (FIFO, LIFO, or average).
Statement Presentation and Analysis
Presentation
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Inventory turnovermeasures the number of times onaverage the inventory is sold during the period.
Cost of Goods Sold
Average Inventory
Inventory
Turnover
=
Days in inventory measures the average number of days
inventory is held.
Days in Year (365)
Inventory Turnover
Days in Inventory=
SO 6 Compute and interpret the inventory turnover ratio.
Statement Presentation and Analysis
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Illustration: Wal-Mart reported in its 2010 annual report a beginning
inventory of $34,511 million, an ending inventory of $33,160 million, and
cost of goods sold for the year ended January 31, 2010, of $304,657
million. The inventory turnover formula and computation for Wal-Mart are
shown below.
SO 6 Compute and interpret the inventory turnover ratio.
Illustration 6-21
Days in Inventory: Inventory turnover of 9 times divided into 365 is
approximately 40.6 days. This is the approximate time that it takes a
company to sell the inventory.
Statement Presentation and Analysis
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Powerpoint Templates Page 33SO 7 Apply the inventory cost flow methods to perpetual inventory records.
Assuming the Perpetual Inventory System, compute Cost of Goods Sold
and Ending Inventory under FIFO and Average cost.
Illustration 6A-1
APPENDIX6APerpetual Inventory Systems
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Powerpoint Templates Page 34SO 7 Apply the inventory cost flow methods to perpetual inventory records.
First-In-First-Out (FIFO)
Cost of Goods SoldEnding Inventory
Illustration 6A-2
Perpetual Inventory System
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Powerpoint Templates Page 35SO 7 Apply the inventory cost flow methods to perpetual inventory records.
Average-Cost
Illustration 6A-4
Cost of Goods Sold Ending Inventory
Perpetual Inventory System
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Estimates the cost of ending inventory by applying a gross profit rate
to net sales.
Gross Profit Method
SO 8 Describe the two methods of estimating inventories.
Illustration 6B-1
APPENDIX6BEstimating Inventories
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Illustration: Kishwaukee Companys records for January show net
sales of $200,000, beginning inventory $40,000, and cost of goods
purchased $120,000. The company expects to earn a 30% gross
profit rate. Compute the estimated cost of the ending inventory at
January 31 under the gross profit method.
SO 8 Describe the two methods of estimating inventories.
Illustration 6B-2
Estimating Inventories
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Company applies the cost-to-retail percentage to ending
inventory at retail prices to determine inventory at cost.
SO 8 Describe the two methods of estimating inventories.
Illustration 6B-3
Estimating Inventories
Retail Inventory Method
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Powerpoint Templates Page 39SO 8 Describe the two methods of estimating inventories.
Note that it is not necessary to take a physical inventory to
determine the estimated cost of goods on hand at any given time.
Illustration 6B-4Illustration:
Estimating Inventories
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Exercise
In its first month of operations, Danielle Company madethree purchases of merchandise in the following sequence:(1) 300 units at $6, (2) 400 units at $7, and (3) 200 units at$8. Assuming there are 360 units on hand, compute thecost of ending inventory under the (a) FIFO method.
Danielle uses a periodic inventory system.
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