copyright © 2008 by the mcgraw-hill companies, inc. all rights reserved. mcgraw-hill/irwin chapter...

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 7

Reporting and Interpreting Inventories andCost of Goods Sold


Learning Objective 1

Describe inventory management goals.


Inventory Management Decisions

The primary goals of inventory managers are to:The primary goals of inventory managers are to:

1.1. ensure sufficient quantities of inventory are ensure sufficient quantities of inventory are available to meet customer’s needs,available to meet customer’s needs,

2.2. ensure inventory quality meets customers’ ensure inventory quality meets customers’ expectations and company standards, andexpectations and company standards, and

3.3. minimize the costs of acquiring and carrying minimize the costs of acquiring and carrying inventoryinventory



Describe the different types of inventory.


Items Included in Inventory

Inventory includes goods that are:Inventory includes goods that are:

1.1. held for sale in the normal course of business, orheld for sale in the normal course of business, or

2.2. used to produce goods for sale.used to produce goods for sale.

Inventory is reported on the balance Inventory is reported on the balance sheet as a current asset because it sheet as a current asset because it normally is used or converted into normally is used or converted into

cash within one year.cash within one year.

Balance SheetBalance Sheet Current AssetsCurrent Assets Inventory Inventory


Items Included in Inventory

Merchandiser

Manufacturer

InventoryInventory is acquired in a finished condition and is ready for sale without further processing.

Raw materials inventoryRaw materials inventory includes materials that are processed further into finished goods.

Work in process inventoryWork in process inventory includes goods that are in the process of being manufactured.

Finished goods inventoryFinished goods inventory includes goods that are complete and ready to sell.


Cost of Goods Sold

BeginningInventory$40,000$40,000

Purchases$55,000$55,000

Goods Availablefor Sale$95,000$95,000

+ +

EndingInventory$35,000$35,000

Still Here Cost ofGoods Sold

$60,000$60,000

Sold


Cost of Goods Sold

Beginning inventory 40,000$ + Purchases of merchandise during the period 55,000 = Cost of goods available for sale 95,000 – Ending inventory 35,000 = Cost of goods sold 60,000$

Schedule of Cost of Goods Sold



Compute costs using four inventory costing

methods.


Inventory Costing Methods

First-in, first-out(FIFO)

Last-in, first-out(LIFO)

Weighted average

Specificidentification


Inventory Costing Illustration


Specific Identification

When this method is used, the cost of each item sold

is individually identified and

recorded as cost of goods sold.



The above purchases were made by Oakley during The above purchases were made by Oakley during the year. Of the five units sold, one had a cost of the year. Of the five units sold, one had a cost of

$70, three cost $80, and one cost $100.$70, three cost $80, and one cost $100.



The Cost of Goods Sold would be:[(1 × $70) + (3 × $80)+ (1 × $100)] = $410.

Ending Inventory would be:

[(1 × $70) + (2 × $80] = $230.


First-In, First-Out (FIFO)

Cost of Goods Sold

Ending Inventory

Oldest Costs

Recent Costs



Using FIFO, the unit sold would be:2 units from beginning inventory and

3 units from the purchase of March 12th.



The Cost of Goods Sold would be:[(2 × $70) + (3 × $80)] = $380.


[(2 × $80) + $100] = $260.


Last-In, First-Out (LIFO)

Cost of Goods Sold

Ending Inventory

Recent Costs

Oldest Costs



Using LIFO, the unit sold would be:1 unit from June 9th purchase and

4 units from the purchase of March 12th.



The Cost of Goods Sold would be:[$100 + (4 × $80)] = $420.


[$80 + (2 × $70)] = $220.


Weighted Average Cost

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

cost of goods sold.

Cost of Goods Cost of Goods Available for Available for

SaleSale

Units on units Units on units Available forAvailable for

SaleSale÷



WAC = $640 ÷ 8 = $80 per unitWAC = $640 ÷ 8 = $80 per unit



The Cost of Goods Sold would be:(5 × $80) $400.

Ending Inventory would be:(3 × $80) = $240.


Financial Statement Effects of Costing Methods

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


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



Explain why inventory is reported at the lower of cost or

market.


Reporting Inventory at the Lower of Cost or Market

The value of inventory can fall below its The value of inventory can fall below its recorded cost for two reasons:recorded cost for two reasons:

1.1. it’s easily replaced by identical goods atit’s easily replaced by identical goods at a lower cost, or a lower cost, or

2.2. it’s become outdated or damaged.it’s become outdated or damaged.


Reporting Inventory at the Lower of Cost or Market

When the value of inventory falls When the value of inventory falls below its recorded cost, the amount below its recorded cost, the amount

recorded for inventory is written recorded for inventory is written down to its lower market value. This down to its lower market value. This

is known as the lower of cost or is known as the lower of cost or market (LCM) rule.market (LCM) rule.



Compute and interpret the

inventory turnover ratio.


Inventory Turnover Analysis

InventoryTurnover

Ratio= Cost of Goods Sold

Average Inventory

BeginningInventory

EndingInventory+

2


Inventory Turnover Analysis

Days toDays toSellSell

365365Inventory Turnover RatioInventory Turnover Ratio==



Explain how accounting methods affect evaluations of

inventory management.


The Impact of Inventory Cost Methods

Handheld, Inc.For Month Ended August 31 Specific

Identification FIFO LIFO Weighted Average

Sales 6,050$ 6,050$ 6,050$ 6,050$ Cost of goods sold 4,582 4,570 4,730 4,622 Gross profit 1,468$ 1,480$ 1,320$ 1,428$ Operating expenses 450 450 450 450 Income before taxes 1,018$ 1,030$ 870$ 978$ Income tax expense (30%) 305 309 261 293 Net income 713$ 721$ 609$ 685$

Balance sheet inventory 1,408$ 1,420$ 1,260$ 1,368$


End of Chapter 7

copyright © 2008 by the mcgraw-hill companies, inc. all rights reserved. mcgraw-hill/irwin chapter...

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