chapter 9 inventory and cost of goods sold - · pdf file01.02.2013 · 9-1 1....

9-1

1. Inventory for merchandising & manufacturing

business

2. Periodic vs. perpetual inventory systems

3. Recognition of inventory on the books

4. Compute total inventory acquisition cost

5. Inventory valuation methods: specific identification,

average cost, FIFO, and LIFO

6. LIFO inventory layers and the LIFO reserve

7. Choose an inventory valuation method

8. The lower-of-cost-or-market (LCM) valuation

9. The gross profit method valuing inventory

Chapter 9 Inventory and Cost of Goods Sold

9-2

10. Financial statement impact of inventory recording

errors

11. Analyze inventory using financial ratios

12. FIFO, LIFO, average cost, and lower-of-cost-or-

market inventory using the retail inventory method

13. Use LIFO pools, dollar-value LIFO, and dollar-

value LIFO retail to compute ending inventory

14. The impact of changing prices on purchase

commitments

15. Record inventory purchase transactions

denominated in foreign currencies

Chapter 9 Inventory and Cost of Goods Sold

(Continued)

9-3 9-3

9-4 9-4

9-5

What Is Inventory?

• Inventory designates goods held for sale in

the normal course of business or, for a

manufacturer, also includes goods in

production or to be placed into production.

• For some businesses, inventory represents the

most active element in business operations.

• The terms raw materials, work in process,

and finished goods refer to the inventories of

a manufacturing enterprise.

1. Define inventory for a merchandising

business, and identify the different types of

inventory for a manufacturing business

9-6 9-6

9-7

Raw Materials

• Raw Materials are goods acquired to use in

the production process.

• The term direct materials is frequently used

to refer to materials that will be physically

incorporated in the products being

manufactured.

• The term indirect materials is then used to

refer to auxiliary materials, that is, materials

that are necessary in the production process

but not directly incorporated into the product.

9-8

Work in Process

• Work in Process (WIP) consists of

materials partly processed and requiring

further work before they can be sold.

• Work in Process includes three cost

elements.

1. Direct materials

2. Direct labor

3. Manufacturing overhead

(continued)

9-9

1. Direct materials refers to the cost of

materials directly identified with goods in

production.

3. Manufacturing overhead refers to the

portion of factory overhead assignable to

goods in production.

2. Direct labor refers to the cost of labor

directly identified with goods in production.

Work in Process

9-10

Finished Goods

• Finished goods are the manufactured

products awaiting sale.

• As products are completed, the costs

accumulated in the production process are

transferred from Work in Process to the

Finished Goods Inventory account.

9-11 9-11

9-12

Inventory Systems

Two types of inventory systems that keep track of

how much inventory has been sold and at what

price are:

• Periodic inventory system—requires a physical

count of the inventory periodically, and at the

point of sale only records the sale price.

• Perpetual inventory system—at point of sale

records selling price and type of item sold are

recorded. Example: a bar code scanning system.

2. Explain the advantages and disadvantages of

both periodic and perpetual inventory systems

9-13

The following transactions occurred during the

period for CyBorg, Inc.

Beginning inventory 50 units @ $10 $ 500

Purchases during the period 300 units @ $10 3,000

Sales during the period 275 units @ $15 4,125

Ending inventory (physical) 70 units @ $10 700

Beginning inventory 50 units @ $10 $ 500

Purchases during the period 300 units @ $10 3,000

Sales during the period 275 units @ $15 4,125

Ending inventory (physical) 70 units @ $10 700

(continued)

Inventory Systems

9-14

Purchases during the period:

Purchases 3,000

Accounts Payable 3,000

Sales during the period:

Accounts Receivable 4,125

Sales 4,125

Periodic Inventory System Periodic Inventory System

(continued)

Inventory Systems

9-15

Inventory 3,000


Purchases during the period:

Accounts Receivable 4,125

Sales 4,125

Cost of Goods Sold 2,750

Inventory 2,750

Sales during the period:

Perpetual Inventory System Perpetual Inventory System

(continued) 275 units @ $10

Inventory Systems

9-16

Comparison of Methods

The cost of goods sold in the CyBorg example is

computed as follows:

9-17

Whose Inventory Is It?

• As a general rule, goods should be included in the inventory of the business holding legal title.

• The passing of title is a legal term designating the point at which ownership changes.

• Issues that develop:

• Goods in transit

• Goods on consignment

3. Determine when ownership of goods in

transit changes hands and what

circumstances require shipped inventory to

be kept on the books

9-18

Goods in Transit

Whose inventory is it? Whose inventory is it?

When terms of sale are FOB (free on board)

shipping point, title passes to the buyer with

the loading of goods at the point of shipment.

When terms of sale are FOB (free on board)

destination, legal title does not pass until the

goods are received by the buyer.

9-19 9-19

9-20

Goods on Consignment

• Shipper retains title and includes the goods in

inventory until their sale or use by the dealer or

customer.

• Consigned goods are properly reported by

the shipper at the sum of their costs, and the

shipping and handling costs incurred transfer

to the dealer or customer.

9-21

Conditional Sales, Installment Sales, and

Repurchase Agreements

• Conditional sales and installment sales

contracts may provide a retention of title by

the seller until the sales price is fully

recovered.

• As a creative way to obtain cash on a short-

term basis, firms sometimes sell inventory to

another company but at the same time agree

to repurchase the inventory at a future date.

9-22

Inventory costs consist of all expenditures, both

direct and indirect, relating to acquisition,

preparation, and placement for sale.

• Expenditures that are relatively small and

difficult to allocate are period costs.

These are recognized as expenses in the

current period.

Items Included in Inventory Cost

4. Compute total inventory acquisition cost

9-23

• Costs that can be identified with the

product being manufactured are called

product or inventoriable costs.

• Costs arising from idle capacity, excessive

spoilage, and reprocessing are usually

considered abnormal and are expensed in

the current period.


9-24

• Traditionally, manufacturing overhead costs

have been allocated to products based on the

amount of direct labor required in production.

• Activity-based cost (ABC) systems strive

to allocate overhead based on clearly

identified cost drivers—characteristics of the

production process that are known to create

overhead costs.


9-25 9-25

9-26

Discounts as Reductions in Cost

• Discounts associated with the purchase of

inventory should be treated as a reduction in

the cost assigned to the inventory.

• Trade discounts refer to the difference

between a catalog price and the price actually

charged to a buyer.

• Cost is defined as the list price less the trade

discount.

9-27


• Cash discounts are discounts granted for

payment of invoices within a limited time

period.

• Example: A purchase of $10,000 provides for

payment on a 2/10, n/30 basis. If the buyer

pays by the 10th day, $9,800 settles the

invoice. After that, the full $10,000 is required.

9-28


• The net method records inventory at this

discounted amount (i.e., the gross invoice

prices less the allowable discount).

• The net method reflects that discounts not

taken are in effect a finance charge incurred

for failure to pay within the discount period.

9-29 9-29

(continued)

9-30


• Under the gross method, cash discounts are

booked only when they are taken.

• While the net method tracks discounts not

taken, the gross method provides no such

information, and inventory records are

maintained at the gross unit price.

• The net method of accounting for purchases

is strongly preferred.

9-31

Purchases Reported Using

the Net Method

To record the purchase of merchandise priced at

$10,000 with a cash discount of 2%:

Inventory 9,800


To record the payment of the invoice within

discount period:


Cash 9,800

9-32

To record payment of the invoice after the

discount period:

Accounts Payable 9,800 Discounts Lost 200 Cash 10,000

To record adjustment at the end of the period if

invoice has not been paid and the discount

period has lapsed:

Discounts Lost 200

Accounts Payable 200


the Net Method

9-33


Inventory 200

Cash 9,800

To record the purchase of merchandise priced at

$10,000 with a cash discount of 2%:

Inventory 10,000


To record the payment of the invoice within

discount period:


the Gross Method

9-34

No entry required

To record payment of the invoice after the

discount period:

Accounts Payable 10,000 Cash 10,000

To record adjustment at the end of the period if

invoice has not been paid and the discount

period has lapsed:


the Gross Method

9-35

Purchase Returns and Allowances

• Adjustments are

also made when

goods are

damaged or are

lesser in quality

than ordered.

• Sometimes the

customer

returns the

goods.


Purchase Returns

and Allowances 400

Periodic Inventory System

Perpetual Inventory System


Inventory 400

9-36

Inventory Valuation

Methods Specific

Identification

Last-in, first-

out (LIFO)

Cost

Allocation

Methods

Cost

Allocation

Methods

Average

Cost

First-in, first-

out (FIFO)

5. Use the four basic inventory valuation

methods: specific identification, average

cost, FIFO, and LIFO

9-37 9-37

9-38

Inventory Valuation Methods

The four methods will be illustrated using the

following simple example for Dalton Company.

Note: No beginning inventory

9-39

Specific Identification Method

• This specific identification method requires a

way to identify the historical cost of each

individual unit of inventory.

• From a theoretical standpoint, the specific

identification method is very attractive,

especially when each inventory item is unique

and has a high cost.

• This method opens the door to possible profit

manipulation.

9-40

200 units @ $10 per unit



Sold 200 units from the

January 1 and 500 from

the July 15 purchase.


1,100 units

Jan. 1

Mar. 23

July 15

Nov. 6

Purchases:


9-41



Jan. 1

July 15

= $2,000

= 5,500

Total cost of goods sold $7,500


not sold

not sold

9-42

sold



Mar. 23

Nov. 6

= $3,600

= 1,300

Ending inventory $4,900

sold


9-43

Average Cost Method

• The average cost method assigns the same

average cost to each unit.

• This method is based on the assumption that

goods sold should be charged at an average

cost.

• For periodic inventory, the unit cost is the

weighted average for the entire period.

9-44





1,100 units

Jan. 1

Mar. 23

July 15

Nov. 6

= $ 2,000

= 3,600

= 5,500

= 1,300

$12,400

$12,400 1,100 units = $11.27 per unit (rounded)

Cost of goods sold = $11.27 700 = $7,890

Ending inventory = $11.27 400 = $4,510

Average Cost Method

9-45

• The First-in, first out (FIFO) method is based

on the assumption that the units sold are the

oldest units on hand.

• FIFO assumes a cost flow closely paralleling the

usual physical flow of goods sold.

• With FIFO, the units remaining in ending

inventory are the most recently purchased units,

so their reported cost would most closely match

end-of-year replacement costs.

First-In, First-Out (FIFO) Method

9-46





Jan. 1

Mar. 23

July 15

Nov. 6


Sold 200

= $2,000

Sold 300 = 3,600

Sold 200 = 2,200


200

9-47


Jan. 1

Mar. 23

July 15

Nov. 6

= 2,200

= 1,300






200

9-48

Last-In, First-Out (LIFO) Method

• The last-in, first-out (LIFO) method is based

on the assumption that the newest units are

sold first.

• There is no required connection between the

actual physical flow of goods and the

inventory valuation method used.

• LIFO is the best method of matching current

inventory costs with current revenues.

9-49





Jan. 1

Mar. 23

July 15

Nov. 6


= $1,300

= $5,500

= $1,200



9-50






Jan. 1

Mar. 23

July 15

Nov. 6


= $2,400

= $2,000


9-52

• The complications of a perpetual system are

Illustrated in Exhibit 9-11 (Slides 9-53 and 9-

54), in which Dalton Company’s cost of goods

sold and ending inventory for 2013 are

computed assuming that 300 units were sold

on June 30 and 400 units were sold on

December 31.

• For FIFO, cost of goods sold and ending

inventory are the same whether a periodic

system or perpetual system is used.

Complications with a


9-53

Complications with a


• Because the newest units (last in) as of June

30 are not the same as the newest units on

December 31, applying LIFO on a perpetual

basis gives a different cost of goods sold and

ending inventory than if a periodic system is

used.

• Applying average cost on a perpetual and a

periodic basis yields different results.

9-54

Inv

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Valu

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Me

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Perp

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Inv

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Syste

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9-55 9-55

Inve

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Meth

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Perp

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Inve

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9-56

The following data are for Ryanes Company for the first three

years of its existence:

6. Explain how LIFO inventory layers are

created, and describe the significance of

the LIFO reserve

9-57

• Each year in which the number of units purchased

exceeds the number of units sold, a new LIFO layer

is created in ending inventory.

• Many companies that use LIFO report the amount of

their LIFO reserve, either as a parenthetical note in

the balance or the notes to the financial statements.

LIFO Layers

• The difference between the LIFO ending inventory

amount and the amount obtained using another

inventory valuation method (like FIFO or average

cost) is called the LIFO reserve. For example, in this

case, the LIFO reserve is $350 ($1,350 FIFO ending

inventory – $1,000 LIFO ending inventory).

9-58

The following data can be used to calculate

FIFO cost of goods sold for Ryanes for 2012.

2011 2012

LIFO ending inventory $ 400 $1,000

LIFO reserve 100 350

LIFO cost of goods sold 1,200 1,800

The FIFO calculations can be done as shown

in the next slide.

LIFO Layers

9-59

LIFO FIFO

$ 400 Beginning inventory $ 500 ($400 + $100 LIFO reserve)

2,400 + Purchases 2,400 (160 units x $15; same for

LIFO and FIFO)

$2,800 = Cost of goods available $2,900

1,000 – Ending inventory 1,350 ($1,000 + $350 LIFO

reserve)

$1,800 = Cost of goods sold $1,550

LIFO Layers (2012)

9-60 9-60

9-61 9-61

9-62

LIFO Liquidation

Ryanes Company’s purchases and sales for

2013 are as follows:

Purchases 60 units @ $20

Sales 150 units @ $25

Because the number of units purchased does

not exceed the number sold, no new LIFO layer

is added in 2013.

9-63

LIFO liquidation causes old LIFO layer costs to flow

through cost of goods sold, sometimes with bizarre

results.

LIFO Liquidation

In this example, if Ryanes had not reduced inventory during

2013, LIFO cost of goods sold would have been $3,000

(150 units × $20 per unit). In this example, Thus, the impact

of reducing inventory levels and dragging old LIFO layers

into cost of goods sold is to reduce reported cost of goods

sold by $800, which should be disclosed in notes.

9-65

LIFO and Income Taxes

• The LIFO inventory method was developed in

the United States during the late 1930s as a

method of reducing income taxes during

periods of rising prices.

• The LIFO conformity rule specifies that only

those taxpayers who use LIFO for financial

reporting purposes may use it for tax purposes.

The rule has been relaxed.

9-66

LIFO and Income Taxes

• As a means of simplifying the valuation process

and extending the applicability to more items,

the IRS developed the technique of establishing

LIFO inventory pools of substantially identical

goods.

• To further simplify the recordkeeping associated

with LIFO and to eliminate the issues

associated with new products replacing old

products, the dollar-value LIFO inventory

method was developed.

9-67

Income Tax Effects

• If a company has large inventory levels, is

experiencing significant inventory cost

increases, and does not anticipate reducing

inventory levels in the future, LIFO gives

substantial cash flow benefits in terms of tax

deferrals.

• This is the primary reason for LIFO adoption by

most firms.

7. Choose an inventory valuation method

based on the trade-offs among income

tax effects, bookkeeping costs, and the

impact on the financial statements

9-69

Bookkeeping Costs

• The bookkeeping associated with LIFO is a

bit more complicated than with FIFO or

average cost.

• In dollars and cents, a LIFO system costs

more to operate.

• With information technology and with the

simplification of LIFO pools and dollar-value

LIFO, the incremental bookkeeping costs can

be minimized.

9-70

Impact on Financial Statements

• While LIFO gives tax benefits, it also gives

reduced reported income and reduced

reported inventory.

• These negative financial statement effects

can harm a company by scaring off

stockholders, potential investors, and banks.

• Supplement disclosure using FIFO or

average cost might offset this problem.

9-71

International Accounting and

Inventory Valuation

• In 1992, the IASB decided to officially

endorse FIFO and average cost, to kill the

base stock method, and to let LIFO live on as

a second-class “allowed alternative

treatment.”

• In 2003, the IASB adopted a revised version

of IAS 2 and did away with LIFO once and

for all.

9-72

Inventory Accounting Change

When a company changes its method of valuing

inventory, the change is accounted for as a

change in accounting principle.

Report the effect of changing methods

on the financial statements.

LIFO LIFO Average Cost

or FIFO change to

(continued)

9-73

Any Method Any Method change to LIFO LIFO

No adjustment to financial statements for change to

LIFO, but special disclosure required.

Inventory Accounting Change

(continued)

If the change is to LIFO from another method, a

company’s records are generally not complete

enough to reconstruct the prior years’ inventory

layer.

9-74 9-74

9-75

Applying the Lower of Cost or Market Method

1. Define pertinent values: historical cost, floor

(NRV ‒ normal profit), replacement cost,

ceiling (NRV).

2. Determine “market” (replacement cost as

constrained by ceiling and floor limits).

3. Compare cost with market (as defined in

step 2 above), and select the lower amount.

8. Apply the lower-of-cost-or-market

(LCM) rule to reflect declines in the

market value of inventory

9-76 9-76

9-77

The term market in lower of cost or market

means replacement cost (entry cost).

Replacement

Cost

Ceiling: Also known as the net

realizable value (NRV)

Floor: Net realizable value

less a normal profit margin

Market

Historical Cost

compare to

Range

9-78

Lower of Cost or Market

Fezzig Company sells six products identified with the

letters A through F. For each product, the selling price

per unit is $1.00, selling expenses are $0.20 per unit,

and the normal profit is 25% of sales, or $0.25 per unit.

9-79

$0.70 $0.70

Ceiling: $0.80

Floor: $0.55

$0.65

LCM = $0.65 LCM = $0.65

Market

Historical Cost

Range

CASE A


9-80

$0.60 $0.60

Ceiling: $0.80

$0.65

LCM = $0.60 LCM = $0.60

Market

Historical Cost

Range

Floor: $0.55

CASE B


9-81

$0.55 $0.50 $0.50

Ceiling: $0.80

$0.65

LCM = $0.55 LCM = $0.55

Market

Historical Cost

Range

Floor: $0.55

CASE C


9-82

$0.55 $0.45 $0.45

Ceiling: $0.80

$0.50

LCM = $0.50 LCM = $0.50

Market

Historical Cost

Range

Floor: $0.55

CASE D


9-83

$0.80 $0.85

Ceiling: $0.80

$0.75

LCM = $0.75 LCM = $0.75

Market

Historical Cost

Range

Floor: $0.55


CASE E

9-84

$1.00 $0.80 $1.00

Ceiling: $0.80

$0.90

LCM = $0.80 LCM = $0.80

CASE F

Market

Historical Cost

Range

Floor: $0.55


9-85

Lower of Cost or Market Applied Individually

versus as a Whole

(continued)

9-86

Lower of Cost or Market Applied Individually

versus as a Whole

The journal entry to record the write-down of the

inventory on an individual item basis is usually

made as follows:

Loss from Decline in Value

of Inventory 250

Inventory 250

($4,100 ‒ $3,850)

Once an individual item is reduce to a

lower market price, the new market price

is considered to be the item’s cost for

future inventory valuations.

9-87

Allowance Method

Rather than reducing the inventory directly, the

inventory account can be maintained at cost,

and an allowance account can be used to

record the decline in value.

Loss from Decline in Value

of Inventory 100

Allowance for Decline in Value

of Inventory 100

($4,100 ‒ $4,000)

9-88

Gross Profit Method

• The gross profit method is based on the

observation that the relationship between

sales and cost of goods sold is usually fairly

stable.

• The gross profit percentage [(Sales – Cost

of goods sold)/Sales] is applied to sales to

estimate cost of goods sold.

• To be useful, the gross profit percentage must

be a reliable measure of current experience.

9. Use the gross profit method to estimate

ending inventory

9-89

Gross Profit Method—Rugen Company

Beginning inventory, January 1 $25,000

Sales, January 1–January 31 50,000

Purchases, January 1–January 31 40,000

Historical gross profit percentages:

Last year 40%

Two years ago 37%

Three years ago 42%

Last year’s gross profit

percentage 40% is considered a

good estimate.

9-90

Sales (actual) $50,000 100 %

Cost of goods sold (estimate) 30,000 60 %

Gross profit (estimate) $20,000 40 %

Beginning inventory (actual) $25,000

+ Purchases (actual) 40,000

= Cost of goods available for

sale (actual) $65,000

– Ending inventory (estimate) 35,000

= Cost of goods sold (estimate) $30,000


9-91 9-91

9-92

(continued)


• Rugen does a physical inventory count

indicating that January 31 inventory is

$32,000, compared to $35,000 estimate

computed in Slide 9-90.

• One way to determine if the estimated count

is reasonable is to see what range of ending

inventory estimates is possible given the

differences observed in historical gross profit

percentages.

9-93

Gross Profit Method

Sales (actual) $50,000 100 %









9-94

Gross Profit Method

Sales (actual) $50,000 100 %









9-95

Retail Inventory Method

• Like the gross profit method, the retail

inventory method can be used to generate a

reliable estimate of inventory position

whenever desired.

• The retail inventory method is more flexible

than the gross profit method in that it allows

estimates to be based on FIFO, LIFO, or

average cost assumptions.

9-96

Effects of Errors in Recording Inventory

Failure to correctly report inventory results in

misstatements on both the balance sheet and the

income statement. There are three typical inventory

errors:

1. Overstatement of ending inventory through an

improper physical count

2. Understatement of ending inventory through an

improper physical count

3. Understatement of ending inventory through

delay in recording a purchase until the following

year

10. Determine the financial statement

impact of inventory recording errors

9-98

Consider the financial information relating to inventories

for Deere & Co. provided below.

11. Analyze inventory using financial ratios,

and properly compare ratios of different

firms after adjusting for differences in

inventory valuation methods

9-99

Inventory Turnover

Appropriateness of inventory size and

position can be measured by calculating

the inventory turnover ratio.

Cost of Goods Sold $16,255

Average Inventory $2,719.5 =

= 5.98 times ($2,397 + $3042)/2 = $2,719.5

9-100

Inventory Turnover

If Deere & Co. had used FIFO instead of LIFO,

inventory turnover for 2009 would have been

4.03 (instead of 5.98 under LIFO), computed as

follows:

= 4.03 times

FIFO Cost of Goods Sold $16,212

FIFO Average Inventory $4,020 =

$16,255 +($1,324 – $1,367) =

$16,212

(continued)

9-101

Inventory Turnover

If Deere & Co. had used FIFO instead of LIFO,

inventory turnover for 2009 would have been

4.03 (instead of 5.98 under LIFO), computed as

follows:

= 4.03 times

FIFO Cost of Goods Sold $16,212

FIFO Average Inventory $4,020 =

($3,674 + $4,366)/2 = $4,020

9-102

Number of Days’ Sales in Inventory

Number of days’ sales in inventory = 61.0

Average Inventory

Average Daily Cost of Goods Sold

= $2,719.5

$44.534

($3,042 + $2,397)/2

$16,255/365

Deere’s number of days’ sales in inventory

results mean that, on average, Deere & Co.

has enough inventory to continue operations

for 61.0 days using just its existing inventory.

9-103 9-103

9-104


• The retail inventory method is widely employed by

retail firms to arrive at reliable estimates of inventory

position whenever desired.

• This method permits the estimation of an inventory

amount without the time and expense of taking a

physical inventory or maintaining detailed perpetual

inventory records.

12. Compute estimates of FIFO,LIFO,

average cost, and lower-of-cost-or-

market inventory using the retail

inventory method

9-105 9-105

9-106


Inventory, Jan. 1 $30,000 $50,000

Purchases in January 30,000 40,000

Goods available for sale $60,000 $90,000

Cost Retail

Cost percentage ($60,000 ÷

$90,000) = 66.7%

Deduct sales for January 65,000

Inventory, January 31, at retail $25,000

Inventory, January 31, at estimated

cost ($25,000 66.7%) $16,675

One Cost Percentage One Cost Percentage

9-107

Inventory, Jan. 1 $30,000 $50,000

Purchases in January 30,000 40,000

Goods available for sale $60,000 $90,000

Cost Retail

Cost percentage:

Beg. inventory ($30,000 + $50,000) = 60.0%

Purchases ($30,000 + $40,000) = 75.0%

Deduct sales for January 65,000

Multiple Cost Percentages Multiple Cost Percentages

LIFO ($25,000 60.0%) $15,000

Inventory, January 31, at estimated cost:

FIFO ($25,000 75.0%) $18,750

Inventory, January 31, at retail $25,000


9-108

Retail Inventory Method: Lower of Cost

or Market

Frequently, retail prices change after they are

originally set. The following terms are used to

describe these changes.

• Original retail—the initial sales price,

including the original increase over cost

referred to as the initial markup.

• Markups—increases that raise sales prices

above original retail.

• Markdowns—decreases that reduce sales

prices below original retail.

9-109

Retail Inventory Method: Lower of Cost or Market

9-110

LIF

O P

oo

ls

To illustrate the formation of LIFO pools, the following

data are provided for Elohar Co., a seller of fine neckties:

13. Use LIFO pools, dollar-value LIFO, and dollar-

value LIFO retail to compute ending inventory

9-111

If two types of neckties are accounted for separately,

computations of LIFO ending inventory are as follows:

LIFO Pools

LIFO cost of goods sold:

9-112

Dollar-Value LIFO

• Under dollar-value LIFO, LIFO layers are

determined based on total dollar changes

rather than quantity changes.

• With dollar-value LIFO, the unit of

measurement is the dollar.

• All goods in the inventory pool to which dollar-

value LIFO is to be applied are viewed as

though they are identical items.

9-113

First, the replacement cost of ending inventory is

computed using prices prevailing at the end of the

period.

The beginning inventory was $22,000, so there

was an increase in inventory during the period.

Dollar-Value LIFO

9-114

To determine if a new LIFO layer was added, we need

to find out what the value of the beginning inventory

would be at ending prices.

Dollar-Value LIFO

After adjusting for price increases during the year, we

can see that the dollar value of inventory increased.

Finally, dollar-value LIFO ending inventory is computed

as follows:

9-115 9-115

9-116

Dollar-Value LIFO Retail Method

The following is the LIFO retail layer data for

Miracle Max Department Store as of December

31.

9-117

Assume that the 2013 year-end price index is

1.08. The incremental cost percentages and 2013

ending inventory at end-of-year retail prices are

computed as follows:


9-118


9-119

Purchase Commitments

• Extreme fluctuations in the price of inventory

purchases can expose a company to excessive

risk.

• Of the different ways to manage this risk, the

simplest is a purchase commitment that locks

in the inventory purchase price in advance.

• Accounting question: Should the company

committing to the future purchase record an

asset and a liability at the commitment date?

14. Account for the impact of changing

prices on purchase commitments

9-120

• Rollins Oat Company entered into a

purchase commitment on November 1,

2012, for 100,000 bushes of wheat at $3.40

per bushel to be delivered on March 2013.

At the end of 2012, the market price for

wheat had dropped to $3.20 per bushel.


• A purchase commitment is an exchange of

promises about future action and is known

as an executory contract.

9-121

2012

Dec. 31 Loss on Purchase Commitments 20,000

Estimated Loss on Purchase

Commitments 20,000

(100,000 bushels $0.20 per bushel)

2013

Mar. 31 Estimated Loss on Purchase

Commitments 20,000

Purchases 320,000



9-122

Foreign Currency Inventory Transactions

• Only transactions denominated in currencies

other than the U.S. dollar are foreign

currency transactions for U.S. companies.

• If the transaction contract is written in terms of

U.S. dollars, there is no foreign currency risk

whether the other company is based in

Azerbaijan or Zimbabwe.

15. Record inventory purchase transactions

denominated in foreign currencies

9-123

Foreign Currency Inventory

Transactions

On November 1, 2012, Washington Company

purchased inventory from Swiss Company and

the invoice was denominated in Swiss francs with

a purchase price of 50,000 francs. At the time,

the spot rate, the rate at which the two

currencies can be exchanged right now, was 5

francs per U.S. dollar.

(continued)

9-124

Washington Company would make the following

journal entry to record the purchase.

2012

Nov.1 Inventory 10,000

Accounts Payable (fc) 10,000 (50,000 francs/5 = $10,000)


Transactions

Assume the spot rate is 4.7 francs per U.S. dollar

on February 1, 2013. 2013

Feb. 1 Accounts Payable (fc) 10,000

Exchange Loss 638

Cash 10,638

$50,000/4.7

(continued)

9-125

Assume the spot rate is 5.1 francs per U.S.

dollar on February 1, 2013. 2013


Exchange Gain 196

Cash 9,804

$50,000/5.1


Transactions

(continued)

9-126

Suppose that Washington Company’s fiscal

year ends on December 31 and the exchange

rate on December 31, 2012 is 4.8 francs per

U.S. dollar, the following adjusting entry is

needed: 2012

Dec. 31 Exchange Loss 417

Accounts Payable (fc) 417

($50,000/4.8) $10,000


Transactions

(continued)

9-127

When the liability is subsequently paid on

February 1, 2013, the spot rate is 4.7 francs

per dollar, the journal entry would be as

follows: 2013


Exchange Loss 221

Cash 10,638

$50,000/4.7


Transactions

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