© 2004 the mcgraw-hill companies, inc. mcgraw-hill/irwin chapter 8 inventory: measurement

© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin

Chapter 8

Inventory:

Measurement


Slide8-2

Inventory

Those assets that a company:

2. Has in production for future sale.2. Has in production for future sale.

1. Intends to sell in the normalcourse of business.

1. Intends to sell in the normalcourse of business.

3. Uses currently in the productionof goods to be sold.

3. Uses currently in the productionof goods to be sold.


Slide8-3

Types of Inventories

Merchandise Inventory

Merchandise Inventory

Goods acquired for resale

Goods acquired for resale

Manufacturing Inventory

Manufacturing Inventory

•Raw Materials•Work-in-process•Finished Goods

•Raw Materials•Work-in-process•Finished Goods


Slide8-4

Inventory Methods

Perpetual Inventory System

Perpetual Inventory System

The inventory account is

continuously updated as

purchases and sales are made.

The inventory account is

continuously updated as

purchases and sales are made.

Periodic Inventory System

Periodic Inventory System

The inventory The inventory account is adjusted account is adjusted

at the end of a at the end of a reporting cycle.reporting cycle.

The inventory The inventory account is adjusted account is adjusted

at the end of a at the end of a reporting cycle.reporting cycle.


Slide8-5 Accounting Entries in a Perpetual

System

Returns of inventory are credited to the inventory account.

Discounts on inventory purchases can be recorded using the gross or net method.

Returns of inventory are credited to the inventory account.

Discounts on inventory purchases can be recorded using the gross or net method.


Slide8-6 Accounting Entries in a Perpetual

System


Slide8-7 Periodic Cost of Goods Sold

Equation

Beginning Inventory+ Net Purchases

Cost of Goods Available for Sale

- Ending Inventory= Cost of Goods Sold


Slide8-8 Accounting Entries in a Periodic

System



System



System

In addition to Purchases, the contra-purchase accounts are also closed to

COGS at the end of the period:Purchases Discounts

Purchase Returns and Allowances

In addition to Purchases, the contra-purchase accounts are also closed to

COGS at the end of the period:Purchases Discounts

Purchase Returns and Allowances


Slide8-11 Comparison of Inventory

Systems

Transaction or Event

Periodic Inventory

Perpetual Inventory

Routine purchases of various inventory items

Costs debited to purchases account

Costs debited to inventory account

Items removed from inventory for use in

production

No accounting entries made

Debit WIP inventory and credit Raw

Materials inventory account

End-of-period accounting entries and

related activities

Physical count of inventory to

determine cost of good sold

No separate determination of cost

of goods sold necessary


Slide8-12

What is Included in Inventory?

General RuleAll goods owned by the company on the inventory

date, regardless of their location.

General RuleAll goods owned by the company on the inventory

date, regardless of their location.

Goods in TransitGoods in Transit Goods on Consignment

Goods on Consignment

Depends on FOB shipping terms.

Depends on FOB shipping terms.


Slide8-13 Expenditures Included in

Inventory

Invoice Price

Invoice Price

Freight-in on

Purchases

Freight-in on

Purchases

+

Purchase Returns

Purchase Returns

Purchase Discounts

Purchase Discounts


Slide8-14

Inventory Cost Flow Methods

Specific cost identification

Average cost

First-in, first-out (FIFO)

Last-in, first-out (LIFO)

Specific cost identification

Average cost

First-in, first-out (FIFO)

Last-in, first-out (LIFO)


Slide8-15

The specific cost of each inventory item must be known.

By selecting specific items from inventory at the time of sale, income can be manipulated.

The specific cost of each inventory item must be known.

By selecting specific items from inventory at the time of sale, income can be manipulated.

Specific Cost Identification

Items are added to inventory at cost when they are purchased.

COGS for each sale is based on the specific cost of the item sold.

Items are added to inventory at cost when they are purchased.

COGS for each sale is based on the specific cost of the item sold.


Slide8-16

Average Cost Method


Slide8-17 Weighted-Average

Periodic Example

The following schedule shows the frame inventory for Yore Frame, Inc. for September.

The physical inventory count at September 30 shows 600 frames in ending inventory.

Use the periodic weighted-average method to determine:

(1) Ending inventory cost.

(2) Cost of goods sold.


The physical inventory count at September 30 shows 600 frames in ending inventory.

Use the periodic weighted-average method to determine:





Periodic Example

Yore Frame, Inc.Frame Inventory

Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$

9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00

Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 ?Cost of Goods Sold 1,350 ?



Periodic Example

Now, we have to assign costs to ending inventory and cost of goods sold.

Beginning Inventory (800 units)

Purchases (1,150 units)

Beginning Inventory (800 units)

Purchases (1,150 units)

Available for Sale

(1,950 units)

Available for Sale

(1,950 units)

Ending Inventory(600 units)

Ending Inventory(600 units)

Goods Sold(1,350)

Goods Sold(1,350)

$47,650 ÷ 1,950 = $24.4359 weighted-average per unit cost

$47,650 ÷ 1,950 = $24.4359 weighted-average per unit cost



Periodic Example



9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00

Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 24.4359 14,661.54 Cost of Goods Sold 1,350 24.4359 32,988.46$


Slide8-21 Moving-Average

Perpetual Example

The following schedule shows the Frame inventory for Yore Frame, Inc. for September.

The physical inventory count at September 30 shows 600 mouse pads in ending inventory.

Use the perpetual weighted-average method to determine:



The following schedule shows the Frame inventory for Yore Frame, Inc. for September.


Use the perpetual weighted-average method to determine:




Slide8-22



9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00

Goods Available for Sale 1,950 Ending Inventory 600 Cost of Goods Sold 1,350

Moving-AveragePerpetual Example



Perpetual Example



Perpetual Example

$11,600.00 ÷ (800-600+300) = $23.200



Perpetual Example

$27,490.00 ÷ (800-600+300-300+250+200+400) = $26.181



Perpetual Example

Su

m


Slide8-27

First-In, First-Out

The cost of the oldest inventory items are charged to COGS when goods are sold.

The cost of the newest inventory items remain in ending inventory.

The cost of the oldest inventory items are charged to COGS when goods are sold.

The cost of the newest inventory items remain in ending inventory.

The FIFO method

assumes that items are sold

in the chronological order of their acquisition.


Slide8-28

First-In, First-Out

Even though the periodic and the perpetual

approaches differ in the timing of adjustments to

inventory . . .

. . . COGS and Ending Inventory Cost are the

same under both approaches.

Even though the periodic and the perpetual

approaches differ in the timing of adjustments to

inventory . . .

. . . COGS and Ending Inventory Cost are the

same under both approaches.


Slide8-29

FIFO - Periodic Example



Use the periodic FIFO method to determine:





Use the periodic FIFO method to determine:




Slide8-30



9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00

Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 Cost of Goods Sold 1,350


These are the 600 most recently

acquired units.

These are the 600 most recently

acquired units.


Slide8-31



9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00




9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00

Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 16,600.00 Cost of Goods Sold 1,350



Slide8-32



9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00



These are the first 1,350 units acquired.

These are the first 1,350 units acquired.


Slide8-33



9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00




9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00

Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 16,600.00 Cost of Goods Sold 1,350 31,050.00$



Slide8-34

FIFO - Perpetual Example



Use the perpetual FIFO method to determine:





Use the perpetual FIFO method to determine:




Slide8-35




9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00



Slide8-36

FIFO - Perpetual Example200

The ending inventory on 9/1 consists of:The ending inventory on 9/1 consists of: 200 units from beginning inventory @ $22.00200 units from beginning inventory @ $22.00



Slide8-37

FIFO - Perpetual Example200


300 units from the 9/3 purchase @ $24.00300 units from the 9/3 purchase @ $24.00




Slide8-38


200

The ending inventory on 9/10 consists of:The ending inventory on 9/10 consists of:200 units from the 9/3 purchase @ $24.00200 units from the 9/3 purchase @ $24.00



Slide8-39






200


Slide8-40



250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00


250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00

200


Slide8-41



250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00400 units from the 9/29 purchase @ $28.00400 units from the 9/29 purchase @ $28.00


250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00400 units from the 9/29 purchase @ $28.00400 units from the 9/29 purchase @ $28.00

200


Slide8-42


The ending inventory on 9/30 consists of:The ending inventory on 9/30 consists of: 200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00

400 units from the 9/29 purchase @ $28.00.400 units from the 9/29 purchase @ $28.00.

The ending inventory on 9/30 consists of:The ending inventory on 9/30 consists of: 200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00



Slide8-43


Note that this is the same COGS computed using the Periodic

approach.


Slide8-44

Last-In, First-Out

Any questions before we run into

LIFO?


Slide8-45

Last-In, First-Out

The cost of the newest inventory items are charged to COGS when goods are sold.

The cost of the oldest inventory items remain in inventory.

The cost of the newest inventory items are charged to COGS when goods are sold.

The cost of the oldest inventory items remain in inventory.

The LIFO method

assumes that the newest

items are sold first, leaving the

older units in inventory.


Slide8-46

Last-In, First-Out

Unlike FIFO, using the LIFO method may

result in COGS and Ending Inventory Cost

that differ under the periodic and perpetual

approaches.

Unlike FIFO, using the LIFO method may

result in COGS and Ending Inventory Cost

that differ under the periodic and perpetual

approaches.


Slide8-47



Use the periodic LIFO method to determine:





Use the periodic LIFO method to determine:



LIFO - Periodic Example


Slide8-48



9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00



These are the 600 oldest units in

inventory.

These are the 600 oldest units in

inventory.


Slide8-49



9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00



200

600 x $22.00


Slide8-50



9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00



600 x $22.00

These are the most recently acquired 1,350

units.

These are the most recently acquired 1,350

units.

200


Slide8-51



9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00

Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 13,200.00 Cost of Goods Sold 1,350 34,450.00$


$4,400 + $30,050

200 x $22.00

200


Slide8-52

LIFO - Perpetual Example



Use the perpetual LIFO method to determine:





Use the perpetual LIFO method to determine:




Slide8-53




9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00



Slide8-54


In LIFO, we assume that we sell the newest units in inventory first.

In this case, the 600 “newest” units come from beginning inventory,

leaving 200 units in the beginning inventory layer.

In LIFO, we assume that we sell the newest units in inventory first.

In this case, the 600 “newest” units come from beginning inventory,

leaving 200 units in the beginning inventory layer.

200


Slide8-55


The ending inventory on 9/3 consists of: 200 units from beginning inventory @ $22.00

300 units from the 9/3 purchase @ $24.00

The ending inventory on 9/3 consists of: 200 units from beginning inventory @ $22.00

300 units from the 9/3 purchase @ $24.00

200


Slide8-56


For the 9/30 sale, we must identify the 300 newest units. They all come from the September 3

purchase.

Note that all of the 9/3 units have been “sold” and only 200 of the beginning inventory units remain.

For the 9/30 sale, we must identify the 300 newest units. They all come from the September 3

purchase.

Note that all of the 9/3 units have been “sold” and only 200 of the beginning inventory units remain.

200


Slide8-57


The ending inventory on 9/15 consists of: 200 units from beginning inventory @ $22.00250 units from the 9/15 purchase @ $25.00

The ending inventory on 9/15 consists of: 200 units from beginning inventory @ $22.00250 units from the 9/15 purchase @ $25.00

200


Slide8-58


The ending inventory on 9/21 consists of: 200 units from beginning inventory @ $22.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00


200


Slide8-59



400 units from the 9/29 purchase @ $28.00.


400 units from the 9/29 purchase @ $28.00.

200


Slide8-60


150

For the 9/30 sale, we must identify the 450 newest For the 9/30 sale, we must identify the 450 newest units. 400 of them come from the 9/29 purchase. units. 400 of them come from the 9/29 purchase.

The other 50 come from the 9/21 purchase. The other 50 come from the 9/21 purchase.

For the 9/30 sale, we must identify the 450 newest For the 9/30 sale, we must identify the 450 newest units. 400 of them come from the 9/29 purchase. units. 400 of them come from the 9/29 purchase.

The other 50 come from the 9/21 purchase. The other 50 come from the 9/21 purchase.

200


Slide8-61


150

200








Slide8-62

When Prices Are Rising . . .

LIFOMatches high (newer) costs with current (higher) sales.Inventory is valued based on low (older) cost basis.Results in lower taxable income.Is not officially endorsed by the IASC.

LIFOMatches high (newer) costs with current (higher) sales.Inventory is valued based on low (older) cost basis.Results in lower taxable income.Is not officially endorsed by the IASC.

FIFOMatches low (older) costs with current (higher) sales.Inventory is valued approximates replacement cost.Results in higher taxable income.

FIFOMatches low (older) costs with current (higher) sales.Inventory is valued approximates replacement cost.Results in higher taxable income.


Slide8-63

Decision Makers’ PerspectiveWhat factors motivate companies to

select one inventory method over another?

How accurate are the timing of

reported incomeand income taxes?

How accurate are the timing of

reported incomeand income taxes?

How closely do reported

costs reflect actualflow of inventory?

How closely do reported

costs reflect actualflow of inventory?

How well are costs matched against

related revenues?

How well are costs matched against

related revenues?


Slide8-64

LIFO Liquidation

LIFO inventory costs on the balance sheet are “out of date” because they reflect

old purchase transactions.

LIFO inventory costs on the balance sheet are “out of date” because they reflect

old purchase transactions.

When prices rise . . .

If inventory declines, these “out of date” costs

may be charged to current earnings.

If inventory declines, these “out of date” costs

may be charged to current earnings.

This LIFOliquidation results in

“paper profits.”

This LIFOliquidation results in

“paper profits.”


Slide8-65

LIFO Inventory Pools

Inventory Pools consist of inventory units grouped according to similarities.

Inventory Pools consist of inventory units grouped according to similarities.

For example, all similar units

purchased at the same time can be “pooled”

and assigned an average unit cost.

For example, all similar units

purchased at the same time can be “pooled”

and assigned an average unit cost.

Using Inventory Pools with LIFO simplifies

record keeping.

Using Inventory Pools with LIFO simplifies

record keeping.


Slide8-66

Example

The replacement inventory differs from the old inventory on

hand. We just create a new layer.

Example

The replacement inventory differs from the old inventory on

hand. We just create a new layer.

Dollar-Value LIFO (DVL)

DVL inventory pools are viewed as layers of value, rather than layers of similar units.DVL inventory pools are viewed as layers

of value, rather than layers of similar units.

DVL simplifies LIFO record-keeping.

DVL simplifies LIFO record-keeping.

DVL minimizes the probability of layer

liquidation.

DVL minimizes the probability of layer

liquidation.

At the end of the period, we determine if a new inventory layer

was added by comparing ending

inventory to beginning inventory.

At the end of the period, we determine if a new inventory layer

was added by comparing ending

inventory to beginning inventory.


Slide8-67


We need to determine if the increase in ending inventory over beginning inventory was due to a price increase or an increase

in inventory.

We need to determine if the increase in ending inventory over beginning inventory was due to a price increase or an increase

in inventory.

1a. Compute a Cost Index for the

year.

1a. Compute a Cost Index for the

year.


Slide8-68


1b. Deflate the ending

inventory value using

the cost index.

1b. Deflate the ending

inventory value using

the cost index.

1c. Compare ending

inventory (at base year cost) to

beginning inventory.

1c. Compare ending

inventory (at base year cost) to

beginning inventory.


Slide8-69


Next, identify the layers in ending inventory and the years they were created.

Next, identify the layers in ending inventory and the years they were created.

Sum all the layers to arrive at Ending Inventory at DVL

cost.

Sum all the layers to arrive at Ending Inventory at DVL

cost.

Convert each layer’s base year cost to layer

year cost by multiplying times the

cost index.

Convert each layer’s base year cost to layer

year cost by multiplying times the

cost index.


Slide8-70

End of Chapter 8

It’s Over

© 2004 the mcgraw-hill companies, inc. mcgraw-hill/irwin chapter 8 inventory: measurement

Documents

mcgrawhillirwin slide

inventory purchases

mcgrawhill companies

measurement slide

equation slide

periodic system slide

inventory account

perpetual system slide