Chapter
6-1
Reporting and
Analyzing Inventory
Chapter
6-2
Financial Accounting, Fifth Edition
Study Objectives
1.
Describe the steps in determining inventory quantities.
2.
Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
3.
Explain the financial statement and tax effects of each of the
inventory cost flow assumptions.
4.
Explain the lower-of-cost-or-market basis of accounting for
inventories.
5.
Compute and interpret the inventory turnover ratio.
6.
Describe the LIFO reserve and explain its importance for comparing
results of different companies.
7.
Apply the inventory cost flow methods to perpetual inventory
records.
8.
Indicate the effects of inventory errors on the financial statements.
Chapter
6-3
The Classified Balance Sheet
Illustration 2-2
Chapter
6-4
Classifying Inventory
Merchandising
Company
One Classification:
Merchandise
Inventory
Manufacturing
Company
Three Classifications:
Raw Materials
Work in Process
Finished Goods
Regardless of the classification, companies report all
inventories under Current Assets on the balance sheet.
Chapter
6-5
Determining Inventory Quantities
Physical Inventory taken for two reasons:
Perpetual System
1.
Check accuracy of inventory records.
2. Determine amount of inventory lost.
Periodic System
1.
Determine the inventory on hand.
2. Determine the cost of goods sold for the period.
Chapter
6-6
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Taking a Physical Inventory
when the business is closed or when business is
slow.
at end of the accounting period.
Chapter
6-7
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Determining Ownership of Goods
Goods in Transit
Purchased goods not yet received.
Sold goods not yet delivered.
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.
Chapter
6-8
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Terms of Sale
Illustration 6-1
Ownership of the goods
passes to the buyer when
the public carrier accepts
the goods from the seller.
Ownership of the goods
remains with the seller
until the goods reach the
buyer.
Chapter
6-9
SO 1 Describe the steps in determining inventory quantities.
Determining Inventory Quantities
Determining Ownership of Goods
Consigned Goods
Goods held for sale by one party although
ownership of the goods is retained by another
party.
Chapter
6-10
SO 1 Describe the steps in determining inventory quantities.
Inventory Costing
Unit costs can be applied to quantities on hand
using the following costing methods:
Specific Identification
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
Cost Flow
Assumptions
Average-cost
Chapter
6-11
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing
Specific Identification Method
An actual physical flow costing method.
Practice is relatively rare.
Most companies make assumptions (Cost Flow
Assumptions) about which units were sold.
Chapter
6-12
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
Cost Flow Assumption
does not need to equal
Physical Movement of
Goods
Illustration 6-11
Use of cost flow methods in
major U.S. companies
Chapter
6-13
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
Illustration: Data for Houston Electronics’ Astro
condensers.
Illustration 6-4
(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold
Chapter
6-14
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Earliest goods purchased are first to be sold.
Often parallels actual physical flow of
merchandise.
Generally good business practice to sell oldest
units first.
Chapter
6-15
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
“First-In-First-Out (FIFO)”
Illustration 6-5
Solution
on notes
page
Chapter
6-16
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Latest goods purchased are first to be sold.
Seldom coincides with actual physical flow of
merchandise.
Exceptions include goods stored in piles, such as
coal or hay.
Chapter
6-17
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
“Last-In-First-Out (LIFO)”
Illustration 6-7
Solution
on notes
page
Chapter
6-18
SO 2 Explain the basis of accounting for inventories and apply the
cost flow methods under a periodic inventory system.
inventory
Inventory Costing – Cost Flow Assumptions
“Average Cost”
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.
Chapter
6-19
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
“Average Cost”
Illustration 6-10
Solution
on notes
page
Chapter
6-20
SO 2 Explain the basis of accounting for inventories and apply the
inventory cost flow methods under a periodic inventory system.
Inventory Costing – Cost Flow Assumptions
Comparative Financial Statement Summary
FIFO
Sales
$9,000 $9,000
LIFO
$9,000
Cost of goods sold
6,200
6,600
7,000
Gross profit
2,800
2,400
2,000
330
330
330
2,470
2,070
1,670
140
120
110
Net income
$2,330
$1,950
$1,560
Inventory balance
$5,800 $5,400
$5,000
Admin. & selling expense
Income before taxes
Income tax expense
Chapter
6-21
Average
LO 3 Explain the financial statement and tax effects of
each of the inventory cost flow assumptions.
Inventory Costing – Cost Flow Assumptions
In Period of Rising Prices, FIFO Reports:
FIFO
Lowest
Sales
$9,000
6,200
6,600
7,000
Gross profit
2,800
2,400
2,000
330
330
330
2,470
2,070
1,670
140
120
110
Net income
$2,330
$1,950
$1,560
Inventory balance
$5,800 $5,400
$5,000
Income before taxes
Income tax expense
Chapter
6-22
$9,000 $9,000
LIFO
Cost of goods sold
Admin. & selling expense
Highest
Average
LO 3 Explain the financial statement and tax effects of
each of the inventory cost flow assumptions.
Inventory Costing – Cost Flow Assumptions
In Period of Rising Prices, LIFO Reports:
FIFO
Highest
Sales
$9,000
6,200
6,600
7,000
Gross profit
2,800
2,400
2,000
330
330
330
2,470
2,070
1,670
140
120
110
Net income
$2,330
$1,950
$1,560
Inventory balance
$5,800 $5,400
$5,000
Income before taxes
Income tax expense
Chapter
6-23
$9,000 $9,000
LIFO
Cost of goods sold
Admin. & selling expense
Lowest
Average
LO 3 Explain the financial statement and tax effects of
each of the inventory cost flow assumptions.
Inventory Costing – Cost Flow Assumptions
Review Question
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.
Chapter
6-24
LO 3 Explain the financial statement and tax effects of
each of the inventory cost flow assumptions.
Inventory Costing – Cost Flow Assumptions
Review Question
In a period of inflation, the cost flow method that
results in the lowest income taxes is the:
a. FIFO method.
b. LIFO method.
c. average cost method.
d. gross profit method.
Chapter
6-25
LO 3 Explain the financial statement and tax effects of
each of the inventory cost flow assumptions.
Inventory Costing
Lower-of-Cost-or-Market
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 of conservatism.
Chapter
6-26
SO 4 Explain the lower-of-cost-or-market
basis of accounting for inventories.
Inventory Costing
Lower-of-Cost-or-Market
Illustration: Assume that Ken Tuckie TV has the
following lines of merchandise with costs and market
values as indicated.
Inventory
Categories
Cost
Data
Market
Data
$ 60,000
$ 55,000
Radios
45,000
52,000
DVD recorders
48,000
45,000
DVDs
14,000
12,800
TVs
Lower of
Cost or Market
Total inventory
Chapter
6-27
SO 4 Explain the lower-of-cost-or-market
basis of accounting for inventories.
Analysis of Inventory
Analysis of Inventory
Inventory management is a double-edged sword
1. High Inventory Levels - may incur high carrying
costs (e.g., investment, storage, insurance,
obsolescence, and damage).
2. Low Inventory Levels – may lead to stockouts and
lost sales.
Chapter
6-28
SO 5 Compute and interpret the inventory turnover ratio.
Analysis of Inventory
Inventory turnover measures the number of times
on average the inventory is sold during the period.
Inventory
Turnover
=
Cost of Goods Sold
Average Inventory
Days in inventory measures the average number of
days inventory is held.
Days in Year (365)
Days in
=
Inventory
Inventory Turnover
Chapter
6-29
SO 5 Compute and interpret the inventory turnover ratio.
Analysis of Inventory
Illustration: The following data are available for
Wal-Mart.
Chapter
6-30
Inventory
Turnover
2007
=
=
Days in
inventory
2007
=
=
SO 5 Compute and interpret the inventory turnover ratio.
Analysis of Inventory
Illustration: The following data are available for
Wal-Mart.
Inventory
Turnover
2006
Days in
inventory
2006
Chapter
6-31
=
=
$237,649
(31,910 + 29,419) / 2
365 Days
7.7
= 7.7 times
= 47.4 Days
SO 5 Compute and interpret the inventory turnover ratio.
Cost Flow Methods in Perpetual Systems
Illustration:
Appendix 6A
Illustration 6A-1
Assuming the Perpetual Inventory System, compute Cost of Goods
Sold and Ending Inventory under FIFO, LIFO, and Average cost.
Chapter
6-32
SO 7 Apply the inventory cost flow methods to perpetual inventory records.
Cost Flow Methods in Perpetual Systems
“First-In-First-Out (FIFO)”
Solution on
notes page
Chapter
SO
6-33
Cost of Goods Sold
Illustration 6A-2
Ending Inventory
7 Apply the inventory cost flow methods to perpetual inventory records.
Cost Flow Methods in Perpetual Systems
“Last-In-First-Out (LIFO)”
Solution on
notes page
Chapter
SO
6-34
Cost of Goods Sold
Illustration 6A-3
Ending Inventory
7 Apply the inventory cost flow methods to perpetual inventory records.
Cost Flow Methods in Perpetual Systems
“Average Cost” (Moving-Average System)
Illustration 6A-4
Cost of Goods Sold
Solution on
notes page
Chapter
SO
6-35
Ending Inventory
7 Apply the inventory cost flow methods to perpetual inventory records.
Copyright
“Copyright © 2009 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United States Copyright Act without
the express written permission of the copyright owner is
unlawful. Request for further information should be addressed
to the Permissions Department, John Wiley & Sons, Inc. The
purchaser may make back-up copies for his/her own use only
and not for distribution or resale. The Publisher assumes no
responsibility for errors, omissions, or damages, caused by the
use of these programs or from the use of the information
contained herein.”
Chapter
6-36