INVENTORY
Accounting ASW
Summer 2005
Two Inventory Issues
• Manufacturing accounting
– what if you make inventory rather than buying?
• Inventory cost flow assumptions
– how do you know which units you sold?
Manufacturing Accounting
• How do we value inventory/CGS for a
manufacturing firm?
• Should include all costs of acquiring the
product and making it ready for sale
Overview of Manufacturing Firm
• Period costs
- Selling, general and administrative, etc.
• Production costs
Period Costs
• Examples
- corporate headquarters
- marketing, advertising
- finance, interest
- research and development
• Generate period costs charged to expense
- just as in a merchandising firm
Product Costs
• Identify all relevant costs of “acquiring”
– Direct labor
• labor costs which can be linked to specific product
• typically costs of employees working directly on
that product
• assigned based on actual labor used
• Direct materials
– materials costs which can be linked to products
– typically major components of the product
– assigned based on actual materials used
• Overhead--can’t be linked to products
– indirect labor
• e.g., janitorial, supervisor
– indirect materials
• e.g., supplies, small components
– overhead
• e.g., depr., rent, utilities on production facilities
– allocate based on “drivers”
• e.g., direct labor, direct materials
Are these product or period costs?
Cutting-machine operator
Factory janitor
Factory payroll clerks
Factory superintendent
General office secretary
Guards at the factory gate
Inspectors in a factory
Factory maintenance workers
Factory security guards
General office clerks
President of the firm
Sales manager
Raw materials receiving room workers
Sweepers who clean a retail store
Traveling salespersons
Physical flow
• Raw materials into warehouse
• Materials and labor on plant floor
• Finished product to warehouse
• Shipped out when sold
Cost allocation
• Cost of materials inputs into raw material
inventory when acquired
• Cost of materials, labor & overhead into
work in process inventory as produced
• Total cost incurred into finished goods
inventory when completed
• Total cost into cost of goods sold at sale
DIRECT COSTS
Wages Payable
(Dir. Labor)
Raw Mat. Inv.
(Dir. Materials)
Inc. Statement
Sales
WIP Inv.
FG Inv.
-
OVERHEAD
Wages Payable
(Indir. Labor)
Accum. Depr.
(Depreciation)
S, G & A Expense
Salaries Pay.
(SG&A Exp.)
CGS
GM
- SG&A
NI
Journal Entries—Problem 7.36
Raw Materials Inventory (B/S-A)
Cash (B/S-A)
Acquire raw materials
Work-in-Process Inventory (B/S-A)
Raw Materials Inventory (B/S-A)
Place raw materials in production
667.2
667.2
689.1
689.1
Work-in-Process Inventory (B/S-A)
432.8
Selling, Gen’l and Admin. Exp. (I/S-E)
112.0
Cash (B/S-A)
544.8
Pay salaries, part for production and part for S,G&A
Work-in-Process Inventory (B/S-A)
182.9
Selling, Gen’l and Admin. Exp. (I/S-E)
99.6
Accumulated Depreciation (B/S-CA)
282.5
Record depreciation, split between production and S,G&A
Work-in-Process Inventory (B/S-A)
218.5
Selling, Gen’l and Admin. Exp. (I/S-E)
89.8
Cash (B/S-A)
308.3
Pay other costs, part for production and part for S,G&A
Finished Goods Inventory (B/S-A)
1,564.5
Work-in-Process Inventory (B/S-A)
1,564.5
Complete production of a portion of the work in progress
Accounts Receivable (B/S-A)
Sales Revenue (I/S-R)
Sell a portion of the completed units
2,400.0
Cost of Goods Sold (I/S-E)
Finished Goods Inventory (B/S-A)
Record cost of units sold
1,536.6
2,400.0
1,536.6
Selected T-Accounts
INCOME STATEMENT
Sales
Raw Materials Inv.
BB:226.8
Purchases Transfers
667.2
to WIP
689.1
EB:204.9
Work-In-Process Inv.
BB:427.9
Transfers Transfers
from RM to FG
689.1
1,564.5
Salaries
432.8
Depr.
182.9
Other
218.5
EB:386.7
2,400.0
Finished Goods Inv.
BB:182.7
Transfers Cost of
from WIP Goods
1,564.5
Sold
1,536.6 Cost of Goods Sold 1,536.6
EB:210.6
S, G and A Exp.
Net Income
301.4
562.0
Inventory Accounting
Inventory
Cash
xx
Cost of Goods Sold
Inventory
xx
xx
xx
Issue: How do you know which inventory you
sold?
Inventory Cost Systems
• Perpetual inventory system
–
–
–
–
Implicitly assumed so far
Keep track of invent. cost and units continuously
Often impractical and unnecessarily expensive
Rare in practice (except with unique items)
• Periodic inventory system
– keeps track of beginning inventory & purchases
– uses ending balance in inventory to infer cost of
goods sold
– most common approach
Inventory Equations
• Problem 7.29
Beg. Inv. + Purchases = Cost of Goods Available for Sale
$0
+ $24,384
= $24,384
0 Units
+ 10,700 units
= 10,700 units available
CGAS - Ending Inventory = Cost of Goods Sold
$24,384 - Ending Inventory = Cost of Goods Sold
10,700 - 3,500
= 7,200 units sold
• How to infer what products were sold?
- only important if prices are changing
- typically make an assumption
Ways to measure cost flows
• Specific identification
- identify specific item being sold
- accurately measures cost
- cumbersome and expensive
• Cost flow assumption
- need not mirror actual flows
- all three are common in practice
Cost flow assumptions
• First In, First Out (FIFO)
– assumes first ones purchased were first sold
– generally matches costs and unit flows
– high net income and inventory balances if prices
are increasing
• Last In, First Out (LIFO)
– assumes last ones purchased were first sold
– poor matching of costs and unit flows
– low net income and inventory balances if prices are
increasing
– required in US for financial reporting if used for tax
– rare outside the US
– exception to general rule that financial reporting
does not need to match tax
• Weighted average
– assumes inventory sold was purchased at
average cost
– generally good matching of costs and unit flows
– net income and inventory balances between
LIFO and FIFO (most similar to FIFO)