1. General Course Questions

2. Return Discussion Question #4 Revenue Recognition

3. Turn in Columbia Sportswear Annual Report Projects

4. Discuss Final Group Project

5. Chapter 8 Inventory (using assigned homework)

A. When is it Inventory (Ex 1, 3, 5)

B. Inventory Errors (BE 4 and exercise 5)

C. Inventory Costing Methods (Specific Identification, FIFO, LIFO, Weighted/Moving Average) ?12,13,16. BE 5,6,7, P 6

D. Other Inventory Topics (? 3 , 5, 10)

E. Dollar Value LIFO, LIFO effect, LIFO reserve (Ex 21)

Intermediate AccountingIntermediate AccountingNovember 22November 22ndnd, 2010, 2010

Intermediate AccountingIntermediate AccountingNovember 22November 22ndnd, 2010, 2010

1

A company should record purchases when it obtains legal title to the goods.

What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?

Ex 1, 3 and 52

3

Report inventory units at the lower of cost or market (conservatism). What is included in cost for:

- Retailer:- Manufacturing Company:

What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?

4

Report inventory units at the lower of cost or market (conservatism). What is included in cost for:

- Merchandiser: items held for sale (Finished Goods)

- Manufacturing Company:

items held for sale (Finished Goods)

goods to be used in production (Raw Materials)

goods in production (Work in Process)

What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?What is Included in Inventory?

Inventory – Cost FlowInventory – Cost FlowMerchandiser vs. Manufacturing Co.Merchandiser vs. Manufacturing Co.

Inventory – Cost FlowInventory – Cost FlowMerchandiser vs. Manufacturing Co.Merchandiser vs. Manufacturing Co.

5

Product Costs - costs directly connected with bringing the goods to the buyer’s place of business and converting such goods to a salable condition.

Period Costs – generally selling, general, and administrative expenses.

Purchase Discounts – Gross vs. Net Method (? 10)

Product Financing (Question 5)

Costs Included in Inventory?Costs Included in Inventory?Costs Included in Inventory?Costs Included in Inventory?

6

Purchase Discounts: Gross or Net

Illustration 8-Illustration 8-1111

* $4,000 x 2% = $80

*

** $10,000 x 98% = $9,800

**

Solution on notes page

Question 107

Purchase Discounts: Gross or Net

Illustration 8-Illustration 8-1111

* $4,000 x 2% = $80** $10,000 x 98% = $9,800

**

Solution on notes page

8

Inventory – Cost FlowInventory – Cost FlowPerpetual vs. Periodic SystemPerpetual vs. Periodic System

Inventory – Cost FlowInventory – Cost FlowPerpetual vs. Periodic SystemPerpetual vs. Periodic System

9

• Purchases are debited to Inventory account

• Freight-in, Purchases Returns & Allowances and Purchase Discounts are recorded in the Inventory account.

• Debit COGS and credit Inventory account for each sale.

• Purchases are debited to Purchases account.

• Freight-in, Purch. R & A and Purch. Disc. are recorded in their respective accounts.

• COGS is computed only periodically:

Cost of Goods Available – Ending Inventory = Cost of Goods Sold

Perpetual Method Periodic Method

The perpetual inventory system provides a continuous record of Inventory and Cost of Goods Sold.

Perpetual vs. Periodic SystemPerpetual vs. Periodic SystemPerpetual vs. Periodic SystemPerpetual vs. Periodic System

Ending Inventory is determined only by physical count at the end of the period. 10

11

Purchase of Inventory:Dr. Inventory 1,000

Cr. A/P, Cash, etc. 1,000Purchase Returns, Purchases DiscountsDr. A/P 100

Cr. Inventory 100Transportation InDr. Inventory 100

Cr. A/P, Cash, etc. 100Sale of Inventory:Dr. Cost of Goods Sold 1,000

Cr. Inventory 1,000Dr. Cash, A/R, etc. 1,500

Cr. Sales Revenue 1,500At Year-End: no j/e required, unless errors are found in inventory count(physical inventory = perpetual inventory, than adjust to physical

Inventory System - Perpetual

12

Purchase of Inventory:Dr. Purchases 1,000

Cr. A/P, Cash, etc. 1,000Purchase Returns, Purchases DiscountsDr. A/P 100

Cr. Purchases Returns or Purchases Discounts 100Transportation InDr. Transportation In 100

Cr. A/P, Cash, etc. 100Sale of Inventory:Dr. Cash, A/R, etc. 1,500

Cr. Sales Revenue 1,500At Year-End:Dr. Ending Inventory (determined by count) 38,000Dr. Cost of Sales (plug) 283,000Dr. Purchase Returns and Purchase Discounts (close balance)Cr. Purchases (also close Transportation In) 286,000Cr. Opening Inventory (carried forward from prior year) 35,000

Inventory System - Periodic

Inventory Control – Physical Count

All companies need periodic verification of the inventory records by actual count, weight, or measurement, with the counts compared with the detailed inventory records.

Companies should take the physical inventory near the end of their fiscal year, to properly report inventory quantities in their annual accounting reports.

Question 313

Error in Effect on Effect onEnding Income Balance sheetInventory Items Items

Under- COGS (over) Inventory (under)stated Net income (under) Retained Earn (under)

Over- COGS (under) Inventory (over)stated Net income (over) Retained Earn (over)

Effect of Inventory Errors

14

Effect of Inventory Errors (U/S Ending)

15

Cost flow assumptions DO NOT Need to be consistent with physical flow of goods. The objective is to most clearly reflect periodic income.

The cost flow assumptions are:1 Specific identification 2 Average cost3 First-in, first-out (FIFO) and 4 Last-in, first-out (LIFO) (prohibited under

IFRS)

Cost Flow Assumptions

16

Spaworld reports the following transactions for 2010 (assume no opening inventory):

Date Purchases Cost/Unit Purchase CostMay 12 100 units @ $10/unit = $1,000Aug 14 200 units @ $11/unit = 2,200Sep 18 120 units @ $15/unit = 1,800

420 units $5,000On December 31, the company had 20 units on hand and uses the periodic inventory system.

What is the cost of goods sold?What is the cost of ending inventory?

Cost Flow Assumptions: Example

17

Date Purchases CostMay 12 100 units $1,000

Aug 14 200 units $2,200

Sep 18 120 units $1,800420 units $5,000

Dec. 31 Ending inventory 20 unitsSteps:

1. Calculate per unit average cost: use four places to right of decimal

2. Apply this per unit average cost to units sold to get COGS: round to nearest dollar

3. Apply the per unit average cost to units remaining in inventory to determine Ending inventory: round to nearest dollar

Average Cost Method

18

Date Purchases CostMay 12 100 units $1,000

Aug 14 200 units $2,200

Sep 18 120 units $1,800420 units $5,000

Dec. 31 Ending inventory 20 units1. Calculate per unit average cost: use four places to right of decimal

Cost per unit: $5000/420 = 11.9047 per unit2. Apply this per unit average cost to units sold to get

COGS: round to nearest dollar

11.9047 x 400 = $4,762 COGS3. Apply the per unit average cost to units remaining in

inventory to determine Ending inventory: round to nearest dollar

11.9047 x 20 = $238 ending inventory

Average Cost Method

19

20

Journal Entry (Periodic Inventory):

Year End Entry – Average Cost

20

21

Journal Entry:

Dr. Ending Inventory 238Dr. Cost of Sales 4,762Cr. Purchases 5,000Cr. Opening Inventory 0

Year End Entry – Average Cost

21

Given data: Date Purchases CostMay 12 100 units @ $10$1,000Aug 14 200 units @ $11$2,200Sep 18 120 units @ $15$1,800 420 $5,000Ending Inventory 20 units

COGS

EI$5,000

GAFS

Ending Inventory (FIFO)

First-In, First-Out (FIFO) Method

“Count” from one direction and “plug” the other

Cost of goods sold (FIFO)

22

Given data: Date Purchases CostMay 12 100 units @ $10$1,000Aug 14 200 units @ $11$2,200Sep 18 120 units @ $15$1,800 420 $5,000Ending Inventory 20 units

COGS $4,700

$300EI$5,000

GAFS

Ending Inventory (FIFO)20 x $15 = $300

First-In, First-Out (FIFO) Method

“Count” from one direction and “plug” the other

Cost of goods sold (FIFO)100 units @ $10 $1,000200 units @ $11 $2,200100 units @ $15 $1,500

23

Given data: Date Purchases CostMay 12 100 units @ $10$1,000Aug 14 200 units @ $11$2,200Sep 18 120 units @ $15$1,800 420 $5,000Ending Inventory 20 units

COGS

EI$5,000

GAFS

Ending Inventory (FIFO)

Last-In, First-Out (LIFO) Method

“Count” from one direction and “plug” the other

Cost of goods sold (FIFO)

24

Given data: Date Purchases CostMay 12 100 units @ $10$1,000Aug 14 200 units @ $11$2,200Sep 18 120 units @ $15$1,800 420 $5,000Ending Inventory 20 units

COGS

EI$5,000

GAFS

Ending Inventory (FIFO)20 x $10 = $200

Last-In, First-Out (LIFO) Method

“Count” from one direction and “plug” the other

Cost of goods sold (FIFO) 80 units @ $10 $ 800200 units @ $11 $2,200120 units @ $15 $1,800

$4,800

$200

25

• The ending inventory in units is the same in all three methods: the cost is different

• The cost of goods available is the same for all methods

• The cost of goods sold and the cost of ending inventory are different

• In periods of rising prices, LIFO would result in the smallest reported net income.

Cost Flow Assumptions: Notes

26

27

Periodic vs. Perpetual

• FIFO: COGS and EI numbers are exactly the same under either periodic or perpetual systems

• BUT – LIFO, Weighted Average will give you different numbers– Under perpetual LIFO, with each sale, you cut into only

existing layers (so you must stop and calculate the cost of goods sold at each sale)

– Under perpetual Weighted Average (more accurately, Moving Average), you stop and calculate a new average cost for every sale

28

Same Example - Perpetual Basis

Unit Total UnitsUnits Cost Cost Sold

12-May 100 10 10001-Jun 85

14-Aug 200 11 22001-Sep 100

18-Sep 120 15 180020-Sep 215

420 5000 400

Unit Extended Unit ExtendedFIFO: Units Cost Value LIFO: Units Cost Value

1-Jun 85 10 850 1-Jun 85 10 8501-Sep 15 10 150 1-Sep 100 11 1100

85 11 935 20-Sep 120 15 180020-Sep 115 11 1265 95 11 1045

100 15 1500COGS 400 4700 COGS 400 4795

EI 20 15 300 EI 15 10 150Same as Periodic 5 11 55

205Different from Periodic

Purchased

29

Same Example - Perpetual BasisSold

Unit ExtendedUnits Cost Cost Units

12-May 100 10 10001-Jun 85

14-Aug 200 11 22001-Sep 100

18-Sep 120 15 180020-Sep 215

420 5000 400

Calculate the average cost at time of each sale

Unit ExtendedWt. Av. Units Cost Value 1-Sep

1-Jun 85 10 850 costs to date 32001-Sep 100 10.9 1093.02 costs expensed 850

20-Sep 215 13 2796.81 0 23500 2150 Av Cost 10.9

COGS 400 4739.83Sept. 20

EI 20 13 260.168 Costs to date 5000Costs expensed 1943Remaining costs 3057Remaining units 235

Different from Periodic Av cost 13

Purchased

• LIFO matches more recent costs with current revenues.

• With increasing prices:– LIFO yields the lowest taxable income

(assuming inventory does not decrease).

– Under LIFO, there is less need to write down inventory down to market

Advantages of LIFO Method

30

LIFO Reserve (Allowance) account is used, when:

LIFO is used for tax & external financial reporting purposes

FIFO, average cost, or standard cost system for internal reporting purposes.

Reasons:

Special Issues Related to LIFO: Special Issues Related to LIFO: Setting up a LIFO ReserveSetting up a LIFO Reserve

Special Issues Related to LIFO: Special Issues Related to LIFO: Setting up a LIFO ReserveSetting up a LIFO Reserve

1. Pricing decisions2. Record keeping easier3. Profit-sharing or bonus arrangements4. LIFO troublesome for interim periods

SEC reporting requirements – disclose the difference between LIFO and current cost of inventory reported on the Balance Sheet which is the LIFO RESERVE

31

Jeppo Inc reports the following balances: Inventory (FIFO basis) on Dec 31, 2004:$50,000 Inventory (LIFO basis) on Dec 31, 2004:$20,000

Adjust the cost of ending inventory to the LIFO basis

Dr. Cost of goods sold $30,000Cr. Allowance to Reduce Inventory

to LIFO $30,000

Balance Sheet (Assets):Inventory (FIFO) $50,000less: Allowance to Reduce Inventory ($30,000)Inventory (LIFO) basis $20,000

LIFO Reserve: Example

32

• Under the LIFO approach, a business may build up layers of inventory from prior periods. A layer liquidation occurs, when:– Earlier costs are matched against current sales

due to a reduction of quantities of inventory during a period (results in “costing” items at older prices)

– Such matching results in distorted income.

LIFO Layers

33

• LIFO yields the lowest net income and therefore reduced earnings (with increasing prices)

• Under LIFO, the ending inventory is understated relative to current costs

• LIFO liquidation (reduction of quantities of inventory during a period – results in “costing” items at older prices):– May result in income that is detrimental from a tax

view– May cause poor buying habits (because of the layer

liquidation problem)

• LIFO Conformity Rule: if you use LIFO for tax purposes, you must use it for financial reporting also.

Disadvantages of LIFO Method

34

35

• Dollar value LIFO applies LIFO procedures to pools of similar goods based on dollars rather than units

• Used for external purposes (i.e., financial statements and taxes)

• Advantages over regular LIFO: – Reduces record keeping (maximum of one layer per year).– Mitigates likelihood of eroding old layers (some decreases in goods in the

pool are offset by increases in other goods in the pool).

• Price index – a measure of the change in prices from a base year (the year dollar value LIFO is adopted in this case) to the current year

– Internal = Ending inventory quantities X current year costs Ending inventory quantities X base year costs

– External – calculated by the Bureau of Labor Statistics

Dollar Value LIFO

36

Compare ending inventory at base year prices to beginning of year inventory, also at base year prices – if there is an increase – we add a new LIFO layer at Current Year prices:

1. Calculate Ending Inventory at current year costs (FIFO)2. Calculate or locate the current year price index.3. Convert the ending inventory at current cost to inventory at base-year

cost by dividing the current year cost by the current price index (1 / 2 )4. Split the ending inventory at current cost into layers depending on the

year the items were acquired by comparing current inventory at base prices to prior inventory at base prices. If there is an increase add an additional layer. If there is a decrease deduct from the most recently purchased layer. Once a layer is eliminated (peeled off), it can not be rebuilt.

5. Multiply each layer by the appropriate price index (price index of the year of acquisition) to obtain the quantity in ending inventory at dollar-value LIFO cost.

Dollar Value LIFO Calculation Steps

37

Given: Base layer (Dec 31, 2009):$20,000 Inventory (current prices) Dec 31, 2010: $26,400 Prices increased 20% during 2010.

Determine dollar value LIFO at Dec 31, 2010

Dollar Value LIFO: Example

38

Dec 31, 2009 Dec 31, 2010

Price increase, 20%

At EOY prices:$26,400

$26,400 / 1.20At base $:$22,000

Net increaseat base $:

$22,000 less$20,000

Restate atcurrent $:

$2,400(layer added)

$2,000 * 1.20

$20,000 plus

$2,400 =$22,400

Dollar valueLIFO Inventory

Dollar Value LIFO: Example

39

When the ending inventory (at base year prices) is less than the beginning inventory (at base year prices) (i.e. in the example above if EI at base year prices was < $20,000):– the decrease must be subtracted from the

most recently added layer. – Once a layer is eliminated (peeled off), it

cannot be rebuilt.

Dollar Value LIFO: Notes