© the mcgraw-hill companies, inc., 2007 mcgraw-hill/irwin chapter 6 inventories

© The McGraw-Hill Companies, Inc., 2007McGraw-Hill/Irwin

Chapter 6

Inventories


Conceptual Chapter Objectives

C1: Identify the items making up merchandise inventory

C2: Identify the costs of merchandise inventory


Analytical Chapter Objectives

A1: Analyze the effects of inventory methods for both financial and tax reporting

A2: Analyze the effects of inventory errors on current and future financial statements

A3: Assess inventory management using both inventory turnover and days’ sales in inventory


Procedural Chapter Objectives

P1: Compute inventory in a perpetual system using the methods of specific identification, FIFO, LIFO, and weighted average

P2: Compute the lower of cost or market amount of inventory

P3: Appendix 6A: Compute inventory in a periodic system using the methods of specific identification, FIFO, LIFO, and weighted average

P4: Appendix 6B: Apply both the retail inventory and gross profit methods to estimate inventory.


Determining Inventory Items

Merchandise inventory includes all goods that a company owns and holds for sale, regardless of where the goods are located when inventory is counted.

Items requiring special attention include:

Goods in Transit

Goods Damaged or

ObsoleteGoods on Consignment

C 1

© The McGraw-Hill Companies, Inc., 2007McGraw-Hill/IrwinFOB Destination Point

Public Carrier

Seller Buyer

Goods in Transit

Public Carrier

Seller Buyer

FOB Shipping Point

Ownership passes to the buyer here.

C 1


Goods on Consignment

Merchandise is included in the inventory of the consignor, the owner of the inventory.

Consignor

Consignee

Thanks for selling my inventory in

your store.

C 1


Goods Damaged or Obsolete

Damaged or obsolete goods are not counted in inventory if they cannot be sold.

Cost should be reduced to net realizable value if they can be sold.

C 1


Determining Inventory Costs

Invoice Cost

Include all expenditures necessary to bring an item to a salable condition and location.

Minus Discounts

and Allowances

Plus Import Duties Plus

Freight

Plus Storage

Plus Insurance

C 2


Internal Controls and Taking a Physical Count

Most companies take a physical count of inventory at least once each year.

When the physical count does not match the Merchandise Inventory account, an adjustment must be made.

InventoryCount TagCountedby _______

Quantity Counted ___

C 2


Inventory Costing Under a Perpetual System

Inventory Inventory affects . . . affects . . .

The matching The matching principle requires principle requires matching cost of matching cost of sales with sales.sales with sales.

Balance Balance SheetSheet

Income Income StatementStatement

P1


Inventory Costing Under a Perpetual System

Accounting for inventory

requires several decisions . . .

Costing Method Specific Identification, FIFO, LIFO,

or Weighted Average

Inventory System Perpetual or Periodic

P1


Frequency in Use of Inventory Methods

P1


Inventory Cost Flow Assumptions

First-In, First-Out(FIFO)

Assumes costs flow in the order incurred.

Last-In, First-Out(LIFO)

Assumes costs flow in the reverse order incurred.

Weighted Average

Assumes costs flow at an average of the costs available.

P1


Inventory Systems

+

+

Beginninginventory

Net cost ofpurchases

Merchandiseavailable for sale

Ending inventory Cost of goodssold

==

C 3


Inventory Costing IllustrationP1


Specific Identification

When units are sold, the specific cost of the unit sold is added to cost of

goods sold.

P1



The above purchases were made in August. On August 14, a company sold eight bikes originally costing $91 and 12 bikes originally costing $106.

P1


The Cost of Goods Sold for the August 14 sale is $2,000.

8 bikes @ 91 = $ 72812 bikes @ 106 = $1,272

COGS = $2,000

After this sale, there are five units in inventory at $500:

2 bikes @ $91 = $ 182 3 bikes @ $106 = $ 318

Inventory Balance = $ 500

Specific IdentificationP1


Additional purchases were made on August 17 and 28.

The cost of the 23 items sold on August 31 were as follows: 2 @ $91

3 @ $106 15 @ $115 = 1,408

3 @ $119

Specific IdentificationP1



Sold 23 bikes on Aug. 31Cost of Goods Sold for Aug. 31

= $2,582

P1



After the August 31 sale, there are

12 units in inventory at $1,408: 5 @ $1157 @ $119

P1



Balance Sheet Inventory = $1,408

Income Statement COGS

= $4,582

P1



Aug. 3 Merchandise inventory 1,590 Accounts payable 1,590

Aug. 14 Accounts receivable 2,600 Sales 2,600

Aug. 14 Cost of goods sold 2,000 Merchandise inventory 2,000





Here are the entries to record the purchases and sales. The numbers in red are determined by the cost flow assumption used.

All purchases and sales are

made on credit.

The selling price of

inventory was as follows:

8/14 $130 8/31 150

P1


First-In, First-Out (FIFO)

Cost of Goods Sold

Ending Inventory

Oldest Costs

Recent Costs

P1



The above purchases were made in August.

On August 14, the company sold 20 bikes.

P1




After this sale, there are five units in inventory at $530: 5 @ $106

P1




Twenty-three bikes were sold on August 31.

P1



Cost of Goods Sold for August 31 = $2,600

P1



After the August 31 sale, there are 12 units in inventory at $1,420:

2 @ $11510 @ $119

P1




Income Statement COGS = $4,570

P1










Here are the entries to record the purchases and sales entries. The numbers in red are determined by the cost flow assumption used.


made on credit.



8/14 $130 8/31 150

P1


Last-In, First-Out (LIFO)

Cost of Goods Sold

Ending Inventory

Recent Costs

Oldest Costs

P1




On August 14, the company sold 20 bikes.

P1





5 @ $91

P1





P1




5 @ $91 7 @ $115

P1





= $4,730

P1










Here are the entries to record the purchases and sales entries. The numbers in red are determined by the cost flow assumption used.


made on credit.



8/14 $130 8/31 150

P1


Weighted Average

When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold.

Cost of Goods Available for

Sale

Units on hand on the date of

sale÷

P1


Weighted Average


On August 14, 20 bikes were sold.

P1


Cost of goods available for sale 2,500$ Total units in inventory 25 Weighted average cost per unit 100$

÷

Weighted Average

First, we need to compute the weighted average cost per unit of items in inventory.

P1


Weighted Average



P1


Weighted Average



What is the weighted average cost per unit of items in inventory?

P1


Weighted Average

Cost of goods available for sale 3,990$ Total units in inventory 35 Weighted average cost per unit 114$

÷

UnitsInventory 8/14 5 Purchase 8/17 20 Purchase 8/28 10 Units available for sale 35

P1


Weighted Average


P1


Weighted Average


12 @ $114

P1


Weighted Average



= $4,622

P1


Weighted Average








Here are the entries to record the purchases and sales entries for Trekking. The numbers in red are determined by the cost flow assumption used.


made on credit.



8/14 $130 8/31 150

P1


Financial Statement Effects of Costing Methods

Because prices change, inventory methods nearly always assign different cost amounts.

A1


Financial Statement Effects of Costing Methods

Advantages of MethodsAdvantages of Methods

Smoothes out Smoothes out price changes.price changes.

Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with

revenues.revenues.

Ending inventory Ending inventory approximates approximates

current current replacement cost.replacement cost.

First-In, First-In, First-OutFirst-Out

Weighted Weighted AverageAverage

Last-In, Last-In, First-OutFirst-Out

A1


Consistency in Using Costing Methods

The The consistency principleconsistency principle requires a requires a company to use the same accounting company to use the same accounting methods period after period so that methods period after period so that financial statements are comparable financial statements are comparable across periods.across periods.

A1


Lower of Cost or Market (LCM)

Inventory must be reported at market Inventory must be reported at market value when value when marketmarket is is lowerlower than than

cost.cost.

Can be applied three ways:Can be applied three ways:(1)(1) separately to each separately to each

individual item.individual item.(2)(2) to major categories of to major categories of

assets.assets.(3)(3) to the whole inventory.to the whole inventory.

Defined as current Defined as current replacement costreplacement cost (not sales price).(not sales price).Consistent withConsistent withthe conservatismthe conservatismprinciple.principle.

P2


Lower of Cost or Market

A motorsports retailer has the following items in A motorsports retailer has the following items in inventory:inventory:

P2



Here is how to compute lower of cost or Here is how to compute lower of cost or market for market for individual inventory itemsindividual inventory items..

P2



Here is how to compute lower of cost or market Here is how to compute lower of cost or market for for the two groups of inventory itemsthe two groups of inventory items..

P2



Here is how to compute lower of cost or market Here is how to compute lower of cost or market for for the entire inventorythe entire inventory..

P2


Financial Statement Effects of Inventory Errors

Income Statement EffectsIncome Statement Effects

A2

BeginningInventory

NetPurchases

EndingInventory

Cost ofGoods Sold

COGS+ - =

NetSales

NetIncomeExpenses

Cost ofGoods Sold

COGS- - =


Financial Statement Effects of Inventory Errors

Balance Sheet EffectsBalance Sheet Effects

A2


End of Chapter 6

© the mcgraw-hill companies, inc., 2007 mcgraw-hill/irwin chapter 6 inventories

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