6 inventories - kau.edu.sakau.edu.sa/files/0006920/subjects/ch06 11th.pdf · 6-1 prepared by coby...

6-16-1

Prepared byCoby Harmon

University of California, Santa BarbaraWestmont College

6-26-2

6Learning Objectives

After studying this chapter, you should be able to:

[1] Determine how to classify inventory and inventory quantities.

[2] Explain the accounting for inventories and apply the inventory cost flow

methods.

[3] Explain the financial effects of the inventory cost flow assumptions.

[4] Explain the lower-of-cost-or-market basis of accounting for inventories.

[5] Indicate the effects of inventory errors on the financial statements.

[6] Compute and interpret the inventory turnover.

Inventories

6-36-3

Preview of Chapter 6

Accounting Principles

Eleventh Edition

Weygandt Kimmel Kieso

6-46-4

One Classification:

� Inventory

Three Classifications:

� Raw Materials

� Work in Process

� Finished Goods

Merchandising Company

Manufacturing Company

Classifying Inventory

Helpful Hint Regardless of theclassification, companies reportall inventories under CurrentAssets on the balance sheet.

6-56-5

(See page 324)

6-66-6

Physical Inventory taken for two reasons:

Perpetual System

1. Check accuracy of inventory records.

2. Determine amount of inventory lost due to wasted raw

materials, shoplifting, or employee theft.

Periodic System

1. Determine the inventory on hand.

2. Determine the cost of goods sold for the period.

LO 1 Determine how to classify inventory and inventory quantities.

Determining Inventory Quantities

6-76-7

Involves counting, weighing, or measuring each kind of inventory

on hand.

Taken,

� when the business is closed or business is slow.

� at the end of the accounting period.

Taking a Physical Inventory



6-86-8

6-96-9

Goods in Transit

� Purchased goods not yet received.

� Sold goods not yet delivered.

Determining Ownership of Goods

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.



6-106-10

Illustration 6-2 Terms of sale


Goods in Transit

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.


6-116-11

Goods in transit should be included in the inventory of the

buyer when the:

a. public carrier accepts the goods from the seller.

b. goods reach the buyer.

c. terms of sale are FOB destination.

d. terms of sale are FOB shipping point.


Review Question


6-126-12

Consigned Goods

To hold the goods of other parties and try to sell the goods

for them for a fee, but without taking ownership of the

goods.

Many car, boat, and antique dealers sell goods on

consignment, why?


Determining Ownership of Goods


6-136-13

1. Goods of $15,000 held on consignment should be deducted from the inventory

count.

2. The goods of $10,000 purchased FOB shipping point should be added to the

inventory count.

3. Item 3 was treated correctly.

Hasbeen Company completed its inventory count. It arrived at a total inventory value

of $200,000. You have been given the information listed below. Discuss how this

information affects the reported cost of inventory.

1. Hasbeen included in the inventory goods held on consignment for Falls Co.,

costing $15,000.

2. The company did not include in the count purchased goods of $10,000, which

were in transit (terms: FOB shipping point).

3. The company did not include in the count inventory that had been sold with a

cost of $12,000, which was in transit (terms: FOB shipping point).

Solution

Inventory should be $195,000

($200,000 - $15,000 + $10,000).

LO 1

DO IT!>

6-146-14LO 1 Determine how to classify

inventory and inventory quantities.

Advance slide in presentation mode to reveal answer.

6-156-15LO 2 Explain the accounting for inventories and

apply the inventory cost flow methods.

Inventory is accounted for at cost.

� Cost includes all expenditures necessary to acquire goods and

place them in a condition ready for sale.

� Unit costs are applied to quantities to determine the total cost

of the inventory and the cost of goods sold using the following

costing methods:

► Specific identification

► First-in, first-out (FIFO)

► Last-in, first-out (LIFO)

► Average-cost

Cost Flow Assumptions

Inventory Costing

6-166-16

Illustration: Crivitz TV Company purchases three identical 50-

inch TVs on different dates at costs of $700, $750, and $800.

During the year Crivitz sold two sets at $1,200 each. These facts

are summarized below.

Illustration 6-3

LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.

Inventory Costing

6-176-17

Specific Identification

If Crivitz sold the TVs it purchased on February 3 and May 22,

then its cost of goods sold is $1,500 ($700 + $800), and its ending

inventory is $750.

Illustration 6-4


Inventory Costing

6-186-18

Specific Identification

Actual physical flow costing method in which items still in

inventory are specifically costed to arrive at the total cost of the

ending inventory.

� Practice is relatively rare.

� Most companies make assumptions (cost flow assumptions)

about which units were sold.


Inventory Costing

6-196-19

Illustration 6-12Use of cost flow methods in

major U.S. companies

Cost Flow

Assumption

does not need to be

consistent with the

physical movement of

goods


Inventory Costing

6-206-20

Illustration: Data for Houston Electronics’ Astro condensers.

Illustration 6-5

(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold



6-216-21

� Costs of the earliest goods purchased are the first to

be recognized in determining cost of goods sold.

� Often parallels actual physical flow of merchandise.

� Companies determine the cost of the ending inventory

by taking the unit cost of the most recent purchase and

working backward until all units of inventory have been

costed.

First-In, First-Out (FIFO)



6-226-22

COST OF GOODS AVAILABLE FOR SALE

Illustration 6-6

LO 2


STEP 1: ENDING INVENTORY STEP 2: COST OF GOODS SOLD


6-236-23

Illustration 6-6

Helpful Hint Another way ofthinking about the calculationof FIFO ending inventory is theLISH assumption—last in still here.




6-246-24

� Costs of the latest goods purchased are the first to be

recognized in determining cost of goods sold.

� Seldom coincides with actual physical flow of

merchandise.

� Exceptions include goods stored in piles, such as coal or

hay.



Last-In, First-Out (LIFO)

6-256-25

Illustration 6-8

LO 2





6-266-26

Illustration 6-8

Helpful Hint Another way ofthinking about the calculationof LIFO ending inventory is theFISH assumption—first in still here.




6-276-27

� Allocates cost of goods available for sale on the basis of

weighted-average unit cost incurred.

� Applies weighted-average unit cost to the units on

hand to determine cost of the ending inventory.

Average-Cost



6-286-28

Illustration 6-11



Average-Cost



6-296-29

Illustration 6-11



Average-Cost

6-306-30

Comparative effects of cost flow methods

LO 3 Explain the financial effects of inventory cost flow assumptions.

Illustration 6-13

HOUSTON ELECTRONICSCondensed Income Statements

Financial Statement and Tax Effects

6-316-31

Using Cost Flow Methods Consistently

� Method should be used consistently, enhances

comparability.

� Although consistency is preferred, a company may change

its inventory costing method.

Inventory Costing

Illustration 6-15Disclosure of change in cost flow method

6-326-32

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.

Review Question



6-336-33

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.

Review Question

Helpful Hint A tax rule,often referred to as the LIFOconformity rule, requires thatif companies use LIFO for taxpurposes, they must also use itfor financial reporting purposes. This means that if a company chooses the LIFO method to reduce its tax bills, it will also have to report lower net income in its financial statements.



6-346-34

(See page 324)

6-356-35

Lower-of-Cost-or-Market

LO 4 Explain the lower-of-cost-or-market basis of accounting for inventories.

When the value of inventory is lower than its cost

� Companies “write down” the inventory to its market value in

the period in which the price decline occurs.

� Market value = Replacement Cost

� Example of conservatism. International Note UnderU.S. GAAP, companies cannotreverse inventory write-downsif inventory increases invalue in subsequent periods.IFRS permits companies toreverse write-downs in somecircumstances.

Inventory Costing

6-366-36LO 4 Explain the lower-of-cost-or-market

basis of accounting for inventories.

Illustration: Assume that Ken Tuckie TV has the following lines

of merchandise with costs and market values as indicated.

Lower-of-Cost-or-Market

Illustration 6-16

Inventory Costing

6-376-37 LO 5 Indicate the effects of inventory errors on the financial statements.

Common Cause:

� Failure to count or price inventory correctly.

� Not properly recognizing the transfer of legal title to goods

in transit.

� Errors affect both the income statement and balance sheet.

Inventory Errors

6-386-38

Inventory errors affect the computation of cost of goods sold

and net income.

Illustration 6-18

Illustration 6-17

LO 5 Indicate the effects of inventory errors on the financial statements.

Income Statement Effects

Inventory Errors

6-396-39

Inventory errors affect the computation of cost of goods

sold and net income in two periods.

� An error in ending inventory of the current period will have a

reverse effect on net income of the next accounting

period.

� Over the two years, the total net income is correct because

the errors offset each other.

� Ending inventory depends entirely on the accuracy of taking

and costing the inventory.


Income Statement Effects

Inventory Errors

6-406-40

($3,000)Net Income understated

$3,000Net Income overstated

Combined income for 2-year period is correct.

Illustration 6-19


Inventory Errors

6-416-41

Understating ending inventory will overstate:

a. assets.

b. cost of goods sold.

c. net income.

d. owner's equity.

Question


Inventory Errors

6-426-42 LO 5 Indicate the effects of inventory errors on the financial statements.

Effect of inventory errors on the balance sheet is determined

by using the basic accounting equation:.

Illustration 6-17

Illustration 6-20

Balance Sheet Effects

Inventory Errors

6-436-43

Balance Sheet - Inventory classified as current asset.

Income Statement - Cost of goods sold subtracted from

sales.

There also should be disclosure of

1) major inventory classifications,

2) basis of accounting (cost or LCM), and

3) costing method (FIFO, LIFO, or average).

Statement Presentation and Analysis

Presentation

6-446-44

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.

LO 6 Compute and interpret the inventory turnover.


Analysis

6-456-45

Inventory turnover measures the number of times on

average the inventory is sold during the period.

Cost of Goods Sold

Average Inventory

Inventory Turnover

=

Days in inventory measures the average number of days

inventory is held.

Days in Year (365)

Inventory Turnover

Days in Inventory

=



6-466-46

Illustration: Wal-Mart reported in its 2011 annual report a beginning

inventory of $32,713 million, an ending inventory of $36,318 million, and

cost of goods sold for the year ended January 31, 2011, of $315,287

million. The inventory turnover formula and computation for Wal-Mart are

shown below.


Illustration 6-22

Days in Inventory: Inventory turnover of 9.1 times divided into 365 is

approximately 40.1 days. This is the approximate time that it takes a

company to sell the inventory.


6-476-47

6-486-48

Illustration:

LO 7 Apply the inventory cost flow methods to perpetual inventory records.

Assuming the Perpetual Inventory System, compute Cost of Goods Sold

and Ending Inventory under FIFO, LIFO, and Average cost.

Illustration 6A-1

APPENDIX 6A Cost Flow Methods

Perpetual Inventory System

HOUSTON ELECTRONICSAstro Condensers

6-496-49 LO 7 Apply the inventory cost flow methods to perpetual inventory records.


Cost of Goods Sold

Ending Inventory

Illustration 6A-2





Cost of Goods Sold

Ending Inventory

Illustration 6A-3




Average-CostIllustration 6A-4

Cost of Goods Sold

Ending Inventory



6-526-52 LO 8 Describe the two methods of estimating inventories.

A method of estimating the cost of ending inventory by applying a

gross profit rate to net sales. A company needs to know

► its net sales, cost of goods available for sale, and gross profit

rate.Illustration 6B-1

APPENDIX 6B Estimating Inventories

Gross Profit Method

6-536-53

Illustration 6B-1


Illustration: Kishwaukee Company records show net sales of

$200,000, beginning inventory $40,000, and cost of goods purchased

$120,000. In the preceding year, the company realized a 30% gross

profit rate. It expects to earn the same rate this year. Compute the

estimated cost of the ending inventory at January 31 under the gross

profit method.

Illustration 6B-2

6-546-54 LO 8

► Retail companies establish a relationship between cost and sales

price.

► Company applies cost-to-retail percentage to ending inventory at

retail prices to determine inventory at cost.Illustration 6B-3


Retail Inventory Method

6-556-55

Illustration 6B-1


Illustration: Note that it is not necessary to take a physical inventory

to determine the estimated cost of goods on hand at any given time.

Illustration 6B-4

The major disadvantage of the retail method is that it is an averaging technique.

It may produce an incorrect inventory valuation if the mix of the ending inventory

is not representative of the mix in the goods available for sale.

LO 8

6-566-56

Key Points

A Look at IFRS

LO 9 Compare the accounting procedures for inventories under GAAP and IFRS.

� The requirements for accounting for and reporting inventories

are more principles-based under IFRS. That is, GAAP provides

more detailed guidelines in inventory accounting.

� The definitions for inventory are essentially similar under IFRS

and GAAP. Both define inventory as assets held-for-sale in the

ordinary course of business, in the process of production for

sale (work in process), or to be consumed in the production of

goods or services (e.g., raw materials).

6-576-57

� Who owns the goods—goods in transit or consigned goods—

as well as the costs to include in inventory, are accounted for

the same under IFRS and GAAP.

� Both GAAP and IFRS permit specific identification where

appropriate. IFRS actually requires that the specific

identification method be used where the inventory items are

not interchangeable (i.e., can be specifically identified). If the

inventory items are not specifically identifiable, a cost flow

assumption is used. GAAP does not specify situations in which

specific identification must be used.

Key Points

A Look at IFRS


6-586-58

Key Points

A Look at IFRS


� A major difference between IFRS and GAAP relates to the

LIFO cost flow assumption. GAAP permits the use of LIFO for

inventory valuation. IFRS prohibits its use. FIFO and average-

cost are the only two acceptable cost flow assumptions

permitted under IFRS.

� IFRS requires companies to use the same cost flow

assumption for all goods of a similar nature. GAAP has no

specific requirement in this area.

6-596-59

Key Points

A Look at IFRS


� In the lower-of-cost-or-market test for inventory valuation,

IFRS defines market as net realizable value. Net realizable

value is the estimated selling price in the ordinary course of

business, less the estimated costs of completion and

estimated selling expenses. GAAP, on the other hand, defines

market as essentially replacement cost.

6-606-60

Key Points

A Look at IFRS


� Under GAAP, if inventory is written down under the lower-of-

cost-or-market valuation, the new basis is now considered its

cost. As a result, the inventory may not be written back up to

its original cost in a subsequent period. Under IFRS, the write-

down may be reversed in a subsequent period up to the

amount of the previous write-down. Both the write-down and

any subsequent reversal should be reported on the income

statement as an expense. An item-by-item approach is

generally followed under IFRS.

6-616-61

� Unlike property, plant, and equipment, IFRS does not permit

the option of valuing inventories at fair value. As indicated

above, IFRS requires inventory to be written down, but

inventory cannot be written up above its original cost.

� Similar to GAAP, certain agricultural products and mineral

products can be reported at net realizable value using IFRS.

� IFRS allows companies to report inventory at standard cost if it

does not differ significantly from actual cost. Standard cost is

addressed in managerial accounting courses.

Key Points

A Look at IFRS


6-626-62

Looking to the Future

A Look at IFRS


One convergence issue that will be difficult to resolve relates to the use

of the LIFO cost flow assumption. As indicated, IFRS specifically

prohibits its use. Conversely, the LIFO cost flow assumption is widely

used in the United States because of its favorable tax advantages. In

addition, many argue that LIFO from a financial reporting point of view

provides a better matching of current costs against revenue and,

therefore, enables companies to compute a more realistic income.

6-636-63

Which of the following should not be included in the inventory of a

company using IFRS?

a) Goods held on consignment from another company.

b) Goods shipped on consignment to another company.

c) Goods in transit from another company shipped FOB shipping

point.

d) None of the above.

IFRS Self-Test Questions

A Look at IFRS


6-646-64


A Look at IFRS


Which method of inventory costing is prohibited under IFRS?

a) Specific identification.

b) FIFO.

c) LIFO.

d) Average-cost.

6-656-65


A Look at IFRS


Specific identification:

a) must be used under IFRS if the inventory items are not

interchangeable.

b) cannot be used under IFRS.

c) cannot be used under GAAP.

d) must be used under IFRS if it would result in the most

conservative net income.

6-666-66

“Copyright © 2013 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.”

Copyright

6 inventories - kau.edu.sakau.edu.sa/files/0006920/subjects/ch06 11th.pdf · 6-1 prepared by coby...

Documents