Learning
Learning Objectives
Objectives
CHAPTER
1.
8
VALUATION OF INVENTORIES:
A COSTCOST-BASIS APPROACH
Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield
Identify major classifications of inventory.
2.
Distinguish between perpetual and periodic inventory systems.
3.
Identify the effects of inventory errors on the financial
statements.
4.
Understand the items to include as inventory cost.
5.
Describe and compare the cost flow assumptions used to account
for inventories.
6.
Explain the significance and use of a LIFO reserve.
7.
Understand the effect of LIFO liquidations.
8.
Explain the dollardollar-value LIFO method.
9.
Identify the major advantages and disadvantages of LIFO.
10. Understand why companies select given inventory methods.
Chapter
8-1
Chapter
8-2
Valuation
Valuation of
of Inventories:
Inventories:
Cost-Basis Approach
Cost
Cost-Basis
Approach
Inventory
Issues
Classification
Cost flow
Control
Basic inventory
valuation
Physical
Goods
Included in
Inventory
Costs
Included
in Inventory
Goods in transit
Consigned
goods
Special sales
agreements
Inventory errors
Product costs
Period costs
Purchase
discounts
Inventory
Inventory Issues
Issues
Inventory
Inventory Issues
Issues
Classification
Classification
Illustration 88-1
Inventories are:
Cost Flow
Assumptions
LIFO: Special
Issues
Specific
identification
Average cost
FIFO
LIFO
LIFO reserve
LIFO liquidation
DollarDollar-value LIFO
Comparison of
LIFO approaches
Advantages of
LIFO
Disadvantages of
LIFO
Basis for
Selection
items held for sale, or
One inventory
account
Purchase goods
ready for sale
goods to be used in the production of goods to be sold.
Summary of
inventory
valuation
methods
Businesses with Inventory:
or
Merchandiser
Chapter
8-4
Chapter
8-5
Inventory
Inventory Issues
Issues
Classification
Chapter
8-3
Manufacturer
LO 1 Identify major classifications of inventory.
Chapter
8-6
Inventory
Inventory Issues
Issues
Illustration 88-1
Inventory Cost Flow
LO 1 Identify major classifications of inventory.
Inventory
Inventory Issues
Issues
Illustration 88-2
Inventory Cost Flow
Illustration 88-3
Three accounts
Raw materials
Work in process
Finished goods
Companies use one of two types of systems for maintaining
inventory records — perpetual system or periodic system.
Chapter
8-7
LO 1 Identify major classifications of inventory.
Chapter
8-8
LO 1 Identify major classifications of inventory.
Chapter
8-9
LO 1 Identify major classifications of inventory.
Inventory
Inventory Cost
Cost Flow
Flow
Inventory
Inventory Cost
Cost Flow
Flow
Perpetual System
1.
Periodic System
Purchases of merchandise are debited to Inventory.
1. Purchases of merchandise are debited to Purchases.
2. Freight-in is debited to Inventory. Purchase returns and
allowances and purchase discounts are credited to
Inventory.
3. Calculation of Cost of Goods Sold:
Beginning inventory
Purchases, net
Goods available for sale
Ending inventory
Cost of goods sold
4. Subsidiary records show quantity and cost of each type of
inventory on hand.
The perpetual inventory system provides a continuous
record of Inventory and Cost of Goods Sold.
LO 2 Distinguish between perpetual and periodic inventory systems.
systems.
Chapter
8-11
Inventory
Inventory Cost
Cost Flow
Flow
Illustration:
Illustration: Fesmire Company had the following
transactions during the current year.
2. Ending Inventory determined by physical count.
3. Cost of goods sold is debited and Inventory is credited for
each sale.
Chapter
8-10
Inventory
Inventory Cost
Cost Flow
Flow
$ 100,000
800,000
900,000
125,000
$ 775,000
Record these transactions using the Perpetual and Periodic
systems.
LO 2 Distinguish between perpetual and periodic inventory systems.
systems.
Chapter
8-12
Inventory
Inventory Cost
Cost Flow
Flow
Illustration 88-4
Inventory
Inventory Issues
Issues
Illustration: Assume that at the end of the reporting
period, the perpetual inventory account reported an
inventory balance of $4,000. However, a physical count
indicates inventory of $3,800 is actually on hand. The entry
to record the necessary write-down is as follows.
Inventory Over and Short
Inventory
LO 2 Distinguish between perpetual and periodic inventory systems.
systems.
Inventory Control
All companies need periodic verification of the inventory
records by actual count, weight, or measurement, with
the counts compared with the detailed inventory
records.
200
Companies should take the physical inventory near the
end of their fiscal year, to properly report inventory
quantities in their annual accounting reports.
200
Note: Inventory Over and Short adjusts Cost of Goods Sold. In practice,
companies sometimes report Inventory Over and Short in the “Other revenues
and gains” or “Other expenses and losses” section of the income statement.
Chapter
8-13
Solution on
notes page
LO 2 Distinguish between perpetual and periodic inventory systems.
systems.
Chapter
8-14
Basic
Basic Issues
Issues in
in Inventory
Inventory Valuation
Valuation
Valuation
LO 2 Distinguish between perpetual and periodic inventory systems.
systems.
Chapter
8-15
Basic
Basic Issues
Issues in
in Inventory
Inventory Valuation
Valuation
Valuation requires determining
Companies must allocate the cost of all the goods
available for sale (or use) between the goods that were
sold or used and those that are still on hand.
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
LO 2 Distinguish between perpetual and periodic inventory systems.
systems.
Physical
Physical Goods
Goods Included
Included in
in Inventory
Inventory
A company should record purchases when it obtains
legal title to the goods.
Illustration 88-6
The costs to include (product vs. period costs).
Illustration 88-5
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).
Chapter
8-16
LO 2 Distinguish between perpetual and periodic inventory systems.
systems.
Chapter
8-17
LO 2 Distinguish between perpetual and periodic inventory systems.
systems.
Chapter
8-18
LO 2 Distinguish between perpetual and periodic inventory systems.
systems.
Effect
Effect of
of Inventory
Inventory Errors
Errors
Effect
Effect of
of Inventory
Inventory Errors
Errors
Ending Inventory Misstated
Illustration 88-7
Effect
Effect of
of Inventory
Inventory Errors
Errors
Illustration: Jay Weiseman Corp. understates its ending inventory
by $10,000 in 2009; all other items are correctly stated.
Purchases and Inventory Misstated
Illustration 88-9
Illustration 88-8
The understatement does not affect cost of goods sold and net
income because the errors offset one another.
The effect of an error on net income in one year (2009) will be
counterbalanced in the next (2010), however the income statement
will be misstated for both years.
Chapter
8-19
LO 3 Identify the effects of inventory errors on the financial statements.
Chapter
8-20
Costs
Costs Included
Included in
in Inventory
Inventory
Product Costs - costs directly connected with
bringing the goods to the buyer’s place of
business and converting such goods to a salable
condition.
LO 3
Costs
Costs Included
Included in
in Inventory
Inventory
FIFO
Illustration 88-11
Physical
Physical Movement
Movement of
of Goods
Goods
Average Cost
Chapter
8-23
Cost
Cost Flow
Flow Assumptions
Assumptions
LO 4 Understand the items to include as inventory cost.
Cost
Cost Flow
Flow Assumptions
Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = $ 45
Young & Crazy Company makes the following purchases:
One item on 2/2/11 for $10
2.
One item on 2/15/11 for $15
3.
One item on 2/25/11 for $20
Young & Crazy Company sells one item on 2/28/11 for
$90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2011,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-26
“First-In-First-Out (FIFO)”
Inventory
Balance = $ 35
Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Chapter
8-24
Cost
Cost Flow
Flow Assumptions
Assumptions
Example
Specific Identification
Answer: Method adopted should be one
that most clearly reflects periodic income.
Solution on
notes page
** $10,000 x 98% = $9,800
Chapter
8-25
does
does not
not need
need to
to equal
equal
*
* $4,000 x 2% = $80
1.
LIFO
Cost
Cost Flow
Flow Assumption
Assumption Adopted
Adopted
**
Purchase Discounts – Gross vs. Net Method
LO 4 Understand the items to include as inventory cost.
LO 3 Identify the effects of inventory errors on the financial statements.
Which
Which Cost
Cost Flow
Flow Assumption
Assumption to
to Adopt?
Adopt?
Treatment of Purchase Discounts
Period Costs – generally selling, general, and
administrative expenses.
Chapter
8-22
Chapter
8-21
$ 90
0
90
Purchase on
2/25/07 for $20
14
12
7
33
57
17
$ 40
Purchase on
2/15/07 for $15
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Purchase on
2/2/07 for $10
Chapter
8-27
Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income
$ 90
10
80
14
12
7
33
47
14
$ 33
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Cost
Cost Flow
Flow Assumptions
Assumptions
Cost
Cost Flow
Flow Assumptions
Assumptions
“Last-In-First-Out (LIFO)”
“Last-In-First-Out (LIFO)”
Inventory
Balance = $ 45
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
$ 90
0
90
14
12
7
33
57
17
$ 40
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Chapter
8-28
Inventory
Balance = $ 25
Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Purchase on
2/2/07 for $10
Inventory
Balance = $ 45
$ 90
15
75
Purchase on
2/25/07 for $20
14
12
7
33
42
12
$ 30
Purchase on
2/15/07 for $15
Financial Statement Summary
FIFO
$ 90
10
80
LIFO
$ 90
20
70
Average
$ 90
15
75
14
12
7
33
47
14
33
14
12
7
33
37
11
26
14
12
7
33
42
12
30
$
$
Chapter
8-34
35
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
$
25
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income
$ 90
0
90
14
12
7
33
57
17
$ 40
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Chapter
8-30
“Specific Identification”
Inventory
Balance = $ 45
$ 90
0
90
Purchase on
2/25/07 for $20
14
12
7
33
57
17
$ 40
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-33
Young & Crazy Company
Income Statement
For the Month
Feb. 2007
Depends
whichof one
is sold
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income
$ 90
0
90
14
12
7
33
57
17
$ 40
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Cost
Cost Flow
Flow Assumptions
Assumptions
Specific
Specific Identification
Identification
Illustration: Call-Mart Inc. had the following transactions
in its first month of operations.
Illustration: Assume that Call-Mart Inc.’s 6,000 units of inventory
consists of 1,000 units from the March 2 purchase, 3,000 from the
March 15 purchase, and 2,000 from the March 30 purchase.
Compute the amount of ending inventory and cost of goods sold.
Illustration 88-12
Calculate Goods Available for Sale
Beginning inventory (2,000 x $4)
$ 8,000
Purchases:
6,000 x $4.40
Goods available for sale
30
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income
Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Cost
Cost Flow
Flow Assumptions
Assumptions
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Chapter
8-32
2,000 x 4.75
Inventory Balance
14
12
7
33
37
11
$ 26
Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Purchase on
2/2/07 for $10
Cost
Cost Flow
Flow Assumptions
Assumptions
Sales
Cost of goods sold
Gross profit
Operating expenses:
Administrative
Selling
Interest
Total expenses
Income before taxes
Income tax expense
Net income
Purchase on
2/25/07 for $20
“Specific Identification”
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Chapter
8-31
$ 90
20
70
Cost
Cost Flow
Flow Assumptions
Assumptions
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income
Purchase on
2/2/07 for $10
Inventory
Balance = $ 45
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Chapter
8-29
Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Purchase on
2/15/07 for $15
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income
Purchase on
2/15/07 for $15
“Average Cost”
Purchase on
2/25/07 for $20
“Average Cost”
Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Purchase on
2/25/07 for $20
Cost
Cost Flow
Flow Assumptions
Assumptions
Inventory
Balance = $ 30
Cost
Cost Flow
Flow Assumptions
Assumptions
Chapter
8-35
26,400
9,500
$43,900
LO 5
Solution on
Chapter
notes page
8-36
Average
Average Cost
Cost
Weighted-Average
Average
Average Cost
Cost
Illustration 88-13
First-In, First-Out (FIFO)
First
First
First-In,
First-Out
(FIFO)
Moving-Average
Illustration 88-14
Periodic Method
Illustration 88-15
In this method, Call-Mart computes a new average unit
cost each time it makes a purchase.
Determine cost of ending inventory by taking the cost of the most recent
purchase and working back until it accounts for all units in the inventory.
Chapter
8-37
Solution on
notes page
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Chapter
8-38
Solution on
notes page
First-In, First-Out (FIFO)
First
First
First-In,
First-Out
(FIFO)
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Periodic Method
In all cases where FIFO is used, the inventory and cost of goods sold
would be the same at the end of the month whether a perpetual or
periodic system is used.
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
The cost of the total quantity sold or issued during the month comes
from the most recent purchases.
Chapter
8-41
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Perpetual Method
Illustration 88-18
The LIFO method results in different ending inventory and cost of goods
sold amounts than the amounts calculated under the periodic method.
Chapter
8-42
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
LIFO Reserve is the difference between the
inventory method used for internal reporting purposes
and LIFO.
FIFO value per books
$160,000
Example:
LIFO value
145,000
LIFO Reserve
$ 15,000
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
Cost of goods sold
1.
LO 6 Explain the significance and use of a LIFO reserve.
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration: Basler Co. has 30,000 pounds of steel in
its inventory on December 31, 2010, with cost
determined on a
specific goods
LIFO approach.
15,000
Allowance to reduce inventory to LIFO
Solution on
notes page
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Journal entry to reduce inventory to LIFO:
Reasons:
Chapter
8-43
Solution on
notes page
LO 5 Describe and compare the cost flow assumptions
used to account for inventories.
Last-In, First-Out (LIFO)
Last
First
Last-In,
First-Out
(LIFO)
Illustration 88-17
Illustration 88-16
Solution on
notes page
Solution on
notes page
Last-In, First-Out (LIFO)
Last
First
Last-In,
First-Out
(LIFO)
Perpetual Method
Chapter
8-40
Chapter
8-39
15,000
Companies should disclose either the LIFO reserve or the replacement
cost of the inventory.
Chapter
8-44
LO 6 Explain the significance and use of a LIFO reserve.
Chapter
8-45
LO 7 Understand the effect of LIFO liquidations.
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
LIFO Liquidation
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Dollar-Value LIFO
Illustration: At the end of 2011, only 6,000 pounds of
steel remained in inventory.
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Illustration 88-21
Exercise 8-26 (partial): The following information relates
to the Choctaw Company.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.
Use the dollar-value LIFO method to compute the ending
inventory for 2007 through 2009.
Chapter
8-46
LO 7 Understand the effect of LIFO liquidations.
Chapter
8-47
LO 8 Explain the dollardollar-value LIFO method.
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Exercise 8-26 Solution
Inventory at
Inventory at
End-of-Year
Base-Year
Base
Index
Prices
Layers
70,000
1.00
$ 70,000
88,200
1.05
84,000
Year
2007
2008
2009
Prices
$
95,120
1.16
Balance Sheet
Inventory
LIFO Reserve
Journal entry
Cost of goods sold
Lifo reserve
Chapter
8-49
Dec. 31
2007
70,000
$
70,000
$
Exercise 8-26 Solution
$ Value
LIFO
LIFO
Index
LIFO
TOTAL
Reserve
Year
$ 70,000
1.00
$ 70,000
$ 70,000
$
2007
70,000
1.00
70,000
14,000
1.05
14,700
70,000
1.00
70,000
12,000
1.05
12,600
Dec. 31
2008
88,200
(3,500)
$
84,700
$
-
2008
84,700
3,500
82,600
12,520
2009
Dec. 31
2009
95,120
(12,520)
$
82,600
$
3,500
(3,500)
9,020
(9,020)
LO 8 Explain the dollardollar-value LIFO method.
Inventory at
Inventory at
End-of-Year
Base-Year
Base
Index
Prices
Layers
70,000
1.00
$ 70,000
88,200
1.05
84,000
Prices
$
95,120
1.16
Balance Sheet
Inventory
LIFO Reserve
Dec. 31
2007
70,000
$
70,000
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Exercise 8-26 Solution
$ Value
$ Value
LIFO
LIFO
Index
LIFO
TOTAL
Reserve
$ 70,000
1.00
$ 70,000
$ 70,000
70,000
1.00
70,000
14,000
1.05
14,700
70,000
1.00
70,000
12,000
1.05
12,600
82,000
$
Journal entry
Cost of goods sold
Lifo reserve
Chapter
8-50
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Dec. 31
2008
88,200
(3,500)
$
84,700
$
3,500
(3,500)
$
-
Advantages
Specific-goods LIFO - costing goods on a unit basis
is expensive and time consuming.
Specific-goods Pooled LIFO approach
reduces record keeping and clerical costs.
more difficult to erode the layers.
using quantities as measurement basis can lead to
untimely LIFO liquidations.
84,700
3,500
82,600
12,520
Base-Year
Base
Index
Prices
Layers
70,000
1.00
$ 70,000
88,200
1.05
84,000
Year
Prices
2007
$
Dec. 31
2009
95,120
(12,520)
$
82,600
$
9,020
(9,020)
LO 8 Explain the dollardollar-value LIFO method.
Disadvantages
Reduced earnings
Tax Benefits/Improved
Cash Flow
Inventory understated
Physical flow
95,120
1.16
Balance Sheet
Inventory
LIFO Reserve
$ Value
$ Value
LIFO
LIFO
Index
LIFO
TOTAL
Reserve
$ 70,000
1.00
$ 70,000
$ 70,000
70,000
1.00
70,000
14,000
1.05
14,700
70,000
1.00
70,000
12,000
1.05
12,600
82,000
Dec. 31
2007
70,000
$
70,000
$
Journal entry
Cost of goods sold
Lifo reserve
Chapter
8-51
Dec. 31
2008
88,200
(3,500)
$
84,700
$
$
-
84,700
3,500
82,600
12,520
Dec. 31
2009
95,120
(12,520)
$
82,600
$
3,500
(3,500)
9,020
(9,020)
LO 8 Explain the dollardollar-value LIFO method.
Basis
Basis for
for Selection
Selection of
of Inventory
Inventory Method
Method
LIFO is generally preferred:
1.
if selling prices are increasing faster than costs and
2. if a company has a fairly constant “base stock.”
LIFO is not appropriate:
1.
Involuntary Liquidation /
Poor Buying Habits
if prices tend to lag behind costs,
2. if specific identification
traditionally used, and
3. when unit costs tend to
decrease as production
increases.
Dollar-value LIFO is used by most companies.
LO 8 Explain the dollardollar-value LIFO method.
Inventory at
2009
Matching
Future Earnings Hedge
Inventory at
End-of-Year
2008
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Comparison of LIFO Approaches
Chapter
8-52
LO 8 Explain the dollardollar-value LIFO method.
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
$ Value
82,000
Chapter
8-48
Chapter
8-53
LO 9 Identify the major advantages and disadvantages of LIFO.
Chapter
8-54
LO 10 Understand why companies select given inventory methods.
Copyright
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
8-55