accounting principles-10th edition-ch06
TRANSCRIPT
Chapter 6-2
CHAPTER CHAPTER 66
IINVENTORIESNVENTORIESThe raw materials, work-in-process goods and completely The raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a finished goods that are considered to be the portion of a business’s assets that are ready or will be ready for sale.business’s assets that are ready or will be ready for sale.
Accounting Principles, Eighth Edition
Chapter 6-3
1. Describe the steps in determining 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 ratio.
Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives
Chapter 6-4
Reporting and Analyzing InventoryReporting and Analyzing InventoryReporting and Analyzing InventoryReporting and Analyzing Inventory
Taking a Taking a physical physical inventoryinventory
Determining Determining ownership of ownership of goodsgoods
Classifying Classifying
InventoryInventory
Classifying Classifying
InventoryInventory
Determining Determining
Inventory Inventory
QuantitiesQuantities
Determining Determining
Inventory Inventory
QuantitiesQuantities
Inventory Inventory
CostingCosting
Inventory Inventory
CostingCostingInventory Inventory
ErrorsErrors
Inventory Inventory
ErrorsErrors
Statement Statement
PresentatioPresentatio
n and n and
AnalysisAnalysis
Statement Statement
PresentatioPresentatio
n and n and
AnalysisAnalysis
Finished Finished goodsgoods
Work in Work in processprocess
Raw materialsRaw materials
Specific Specific identificationidentification
Cost flow Cost flow assumptionsassumptions
Financial Financial statement statement and tax and tax effectseffects
Consistent Consistent useuse
Lower-of-Lower-of-cost-or-cost-or-marketmarket
Income Income statement statement effectseffects
Balance Balance sheet sheet effectseffects
PresentatioPresentationn
AnalysisAnalysis
Other Method
s of valuing Invento
ry
•Lower of cost and market•Estimating inventories
•Lower of cost and market•Estimating inventories
Chapter 6-5
Inventories affect both the balance sheet and the income Inventories affect both the balance sheet and the income statement. In the balance sheet of merchandising statement. In the balance sheet of merchandising companies, inventory is frequently the most significant companies, inventory is frequently the most significant current asset. Of course, its amount and relative current asset. Of course, its amount and relative importance can vary, even for enterprises in the same importance can vary, even for enterprises in the same industry. industry.
In the income statement, inventory is vital in determining In the income statement, inventory is vital in determining the results of operations for a particular period. the results of operations for a particular period.
Chapter 6-6
Classifying InventoryClassifying InventoryClassifying InventoryClassifying Inventory
One Classification:
Merchandise Inventory (is needed to describe the many different items that make up the total inventory.)
Three Classifications:Raw Materials (that are on hand waiting to be used in production)
Work in Process (that are on the assembly line in various stage of production)
Finished Goods (that are completed and ready for sale)
Merchandising Company
Manufacturing Company
Regardless of the classification, companies report all inventories under Current Assets on the balance sheet.
Chapter 6-7
Classification Inventory Classification Inventory Merchandising enterprise, inventory consists of many different items. Canned goods, dairy products, meats, and produce, for example, are just a few of the inventory items on hand in grocery store. These items have two common characteristics. (1) they are owned by the company, and (2) they are in a form ready for sale to customers in the ordinary in the ordinary course of business. course of business.
In a manufacturing enterprise, inventories are also owned by In a manufacturing enterprise, inventories are also owned by the company, but some goods may not yet be ready for sale. the company, but some goods may not yet be ready for sale.
Chapter 6-8
Physical Inventory taken for two reasons:Perpetual System1. Check accuracy of inventory records.2. Determine amount of inventory lost (wasted raw
materials, shoplifting, or employee theft).
Periodic System1. Determine the inventory on hand2. Determine the cost of goods sold for the period.
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
LO 1 Describe the steps in determining inventory quantities.LO 1 Describe the steps in determining inventory quantities.
Chapter 6-9
Involves counting, weighing, or measuring each kind of inventory on hand.
Taken,
when the business is closed or when business is slow.
at end of the accounting period.
Taking a Physical InventoryTaking a Physical Inventory
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
LO 1 Describe the steps in determining inventory quantities.LO 1 Describe the steps in determining inventory quantities.
Chapter 6-10
Goods in Transit
Purchased goods not yet received.
Sold goods not yet delivered.
Determining Ownership of Goods (Determining Ownership of Goods (Goods are Goods are considered to be in transit when they are in the hands of a considered to be in transit when they are in the hands of a public carrier such as railway, airline, or trucking or shipping public carrier such as railway, airline, or trucking or shipping company at the statement date. company at the statement date.
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
LO 1 Describe the steps in determining inventory quantities.LO 1 Describe the steps in determining inventory quantities.
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.
Chapter 6-11
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
LO 1 Describe the steps in determining inventory quantities.LO 1 Describe the steps in determining inventory quantities.
Illustration 6-1
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.
Terms of SaleTerms of Sale
Chapter 6-12
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 QuestionReview Question
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
LO 1 Describe the steps in determining inventory quantities.LO 1 Describe the steps in determining inventory quantities.
Chapter 6-13
Consigned Goods
Goods held for sale by one party (the consignee) does not own the goods. although ownership of the goods is retained by another party (the consignor) until the goods are actually sold to a customer.
It is common 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 is called CG
Determining Ownership of GoodsDetermining Ownership of Goods
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
LO 1 Describe the steps in determining inventory quantities.LO 1 Describe the steps in determining inventory quantities.
Chapter 6-14
Inventory CostInventory Cost
Inventory cost is the purchase price of the goods, not the selling price of the goods.
All expenditures related to acquiring the goods and making them ready for sale are included in the cost of goods available for sale. This expenditures are commonly known as inventoriable cost.
In accordance with the cost principle, the primary basis of accounting for inventories is cost.
under the matching principle, the primary objective in accounting for inventories is the matching of appropriate costs with sales revenue.
Chapter 6-15
Unit costs can be applied to quantities on hand using the following costing methods:
Specific Identification
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
Average cost
Inventory CostingInventory CostingInventory CostingInventory Costing
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Cost Flow Assumptions
Chapter 6-16
Young & Crazy Company makes the following purchases:1. One item on 2/2/07 for $102. One item on 2/15/07 for $153. One item on 2/25/07 for $20
Young & Crazy Company sells one item on 2/28/07 for $90. What would be the balance of ending inventory and cost of goods sold for the month ended Feb. 2007, assuming the company used the Specific Identification method to cost inventories? Assume a tax rate of 30%.
Example
Inventory CostingInventory CostingInventory CostingInventory Costing
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Chapter 6-17
Purchase on 2/2/07 for $10
Purchase on 2/15/07 for $15
Purchase on 2/25/07 for $20
Inventory Balance = $ 45
Young & Crazy CompanyIncome Statement
For the Month of Feb. 2007 Sales $ 90 Cost of goods sold 0 Gross profit 90 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 57 Taxes 17 Net Income $ 40
“Specific Identification”
Depends which one is soldDepends which one is sold
Inventory CostingInventory CostingInventory CostingInventory Costing
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Chapter 6-18
An actual physical flow costing method in which items still in inventory are specifically costed to arrive at the total cost of the ending inventory.•This method tracks the actual physical flow of the cost. Each item of inventory is marked, tagged, or coded with its specific unit cost. Specific identification is possible when a company sell a limited number of high unit cost that can be clearly identified from the time of purchase through the time of sale.
Practice is relatively rare.Most companies make assumptions (Cost Flow Assumptions) about which units were sold.
Specific Identification MethodSpecific Identification Method
Inventory CostingInventory CostingInventory CostingInventory Costing
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Chapter 6-19
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Illustration 6-11Use of cost flow methods in major U.S. companies
Cost Flow Assumption does not need to equal Physical Movement of Goods.
Because specific identification is often impractical, other cost flow methods are allowed. These differ from specific identification by assuming flows of costs that may be unrelated to the physical flow of goods.
Chapter 6-20
Young & Crazy Company makes the following purchases:1. One item on 2/2/07 for $102. One item on 2/15/07 for $153. One item on 2/25/07 for $20
Young & Crazy Company sells one item on 2/28/07 for $90. What would be the balance of ending inventory and cost of goods sold for the month ended Feb. 2007, assuming the company used the FIFO, LIFO, and Average cost flow assumptions? Assume a tax rate of 30%.
Example
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Chapter 6-21
Earliest goods purchased are first to be sold.
Often parallels actual physical flow of merchandise.
Generally good business practice to sell oldest units first.
““First-In-First-Out (FIFO)”First-In-First-Out (FIFO)”
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Chapter 6-22
Perpetual Inventory SystemPerpetual Inventory System
Under perpetual FIFI, the cost of the oldest goods on hand prior to Under perpetual FIFI, the cost of the oldest goods on hand prior to each sale is charged to cost of goods sold. Therefore, the cost of each sale is charged to cost of goods sold. Therefore, the cost of goods sold on May 1 is assumed to consist of all the January 1 goods sold on May 1 is assumed to consist of all the January 1 beginning inventory and 50 units of the items purchased on April 15. beginning inventory and 50 units of the items purchased on April 15. similarly, the cost of goods sold on September 1 is assumed to similarly, the cost of goods sold on September 1 is assumed to consist of the remaining 150 units purchased on April 15, plus 250 consist of the remaining 150 units purchased on April 15, plus 250 of the items purchased on August 24. the ending inventory in this of the items purchased on August 24. the ending inventory in this situation is 5800, and the cost of goods sold is 6200.situation is 5800, and the cost of goods sold is 6200.
Cost of goods available for sale (1000+11000)Cost of goods available for sale (1000+11000) 1200012000
Less ending inventoryLess ending inventory 5800 5800
Cost of goods soldCost of goods sold 6200 6200
Chapter 6-23
Purchased Sold Balance
Date Units Cost Total Units cost Total Units Cost total
1/1 100 10 1000
4/15 200 11 2200 100200
1011
3200
5/1 10050
1011
1550 150 11 1650
8/24 300 12 3600 150300
1112
5250
9/1 150250
1112
4650 50 12 600
11/27
400 13 5200 50400
1213
5800
900 11000 550 6200 450 5800
Chapter 6-24
Periodic Inventory SystemPeriodic Inventory SystemIn the periodic inventory system, we ignore the timing of the dates of each of the sales. Instead, we make the allocation at the end of period and assume that the entire pool of costs is available for allocation at that time.
Pool of CostsCost of goods available for sale
Date Explanation Units Units Cost Total cost
1/1 Beginning Inventory 100 10 1000
4/5 Purchase 200 11 2200
8/24 Purchase 300 12 3600
11/27 Purchase 400 12 5200
Total 1000 12000
Chapter 6-25
Periodic Inventory SystemPeriodic Inventory SystemStep 1
Cost of Goods SoldStep 2
Ending Inventory
Date Units Unit cost Total cost Date Units Unit cost Total cost
1/1 100 10 1000 11/27 400 13 5200
4/15 200 11 2200 8/24 50 12 600
8/24 250 12 3000
550 6200 450 5800
Chapter 6-26
Purchase on 2/2/07 for $10
Purchase on 2/15/07 for $15
Purchase on 2/25/07 for $20
Inventory Balance = $ 45
Young & Crazy CompanyIncome Statement
For the Month of Feb. 2007 Sales $ 90 Cost of goods sold 0 Gross profit 90 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 57 Taxes 17 Net Income $ 40
“First-In-First-Out (FIFO)”
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Chapter 6-27
Purchase on 2/2/07 for $10
Purchase on 2/15/07 for $15
Purchase on 2/25/07 for $20
Inventory Balance = $ 35
Young & Crazy CompanyIncome Statement
For the Month of Feb. 2007 Sales $ 90 Cost of goods sold 10 10 Gross profit 80 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 4747 Taxes 14 14 Net Income $ 33 $ 33
“First-In-First-Out (FIFO)”
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Chapter 6-28
Latest goods purchased are first to be 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)”Last-In-First-Out (LIFO)”
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Chapter 6-29
Purchase on 2/2/07 for $10
Purchase on 2/15/07 for $15
Purchase on 2/25/07 for $20
Inventory Balance = $ 45
Young & Crazy CompanyIncome Statement
For the Month of Feb. 2007 Sales $ 90 Cost of goods sold 0 Gross profit 90 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 57 Taxes 17 Net Income $ 40
“Last-In-First-Out (LIFO)”
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Chapter 6-30
Purchase on 2/2/07 for $10
Purchase on 2/15/07 for $15
Inventory Balance = $ 25
Purchase on 2/25/07 for $20
Young & Crazy CompanyIncome Statement
For the Month of Feb. 2007 Sales $ 90 Cost of goods sold 20 20 Gross profit 70 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 37 37 Taxes 11 11 Net Income $ 26$ 26
“Last-In-First-Out (LIFO)”
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Chapter 6-31
Allocates cost of goods available for sale on the basis of weighted average unit cost incurred.
Assumes goods are similar in nature.
Applies weighted average unit cost to the units on hand to determine cost of the ending inventory.
““Average Cost”Average Cost”
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Chapter 6-32
Purchase on 2/2/07 for $10
Purchase on 2/15/07 for $15
Purchase on 2/25/07 for $20
Inventory Balance = $ 45
Young & Crazy CompanyIncome Statement
For the Month of Feb. 2007 Sales $ 90 Cost of goods sold 0 Gross profit 90 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 57 Taxes 17 Net Income $ 40
“Average Cost”
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Chapter 6-33
Purchase on 2/2/07 for $10
Purchase on 2/15/07 for $15
Purchase on 2/25/07 for $20
Inventory Balance = $ 30
Young & Crazy CompanyIncome Statement
For the Month of Feb. 2007 Sales $ 90 Cost of goods sold 15 15 Gross profit 75 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 42 42 Taxes 12 12 Net Income $ 30$ 30
“Average Cost”
LO 2 Explain the accounting for inventories and LO 2 Explain the accounting for inventories and apply the inventory cost flow methods.apply the inventory cost flow methods.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Chapter 6-34
FIFO
LO 3 Explain the financial effects of the inventory cost flow assumptions.LO 3 Explain the financial effects of the inventory cost flow assumptions.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Sales $90 $90 $90Cost of goods sold 10 15 20 Gross profit 80 75 70Admin. & selling expense 33 33 33Income before taxes 47 42 37Income tax expense 14 12 11Net income $33 $30 $26
Inventory balance $35 $30 $25
LIFOAverage
Comparative Financial Statement SummaryComparative Financial Statement Summary
Chapter 6-35
In Period of Rising Prices,In Period of Rising Prices, FIFO Reports: FIFO Reports:FIFO
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Highest
LowestSales $90 $90 $90Cost of goods sold 10 15 20 Gross profit 80 75 70Admin. & selling expense 33 33 33Income before taxes 47 42 37Income tax expense 14 12 11Net income $33 $30 $26
Inventory balance $35 $30 $25
LIFOAverage
LO 3 Explain the financial effects of the inventory cost flow assumptions.LO 3 Explain the financial effects of the inventory cost flow assumptions.
Chapter 6-36
In Period of Rising Prices,In Period of Rising Prices, LIFO Reports: LIFO Reports:FIFO
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Highest
Lowest
Sales $90 $90 $90Cost of goods sold 10 15 20 Gross profit 80 75 70Admin. & selling expense 33 33 33Income before taxes 47 42 37Income tax expense 14 12 11Net income $33 $30 $26
Inventory balance $35 $30 $25
LIFOAverage
LO 3 Explain the financial effects of the inventory cost flow assumptions.LO 3 Explain the financial effects of the inventory cost flow assumptions.
Chapter 6-37
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 QuestionReview Question
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
LO 3 Explain the financial effects of the inventory cost flow assumptions.LO 3 Explain the financial effects of the inventory cost flow assumptions.
Chapter 6-38
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 QuestionReview Question
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
LO 3 Explain the financial effects of the inventory cost flow assumptions.LO 3 Explain the financial effects of the inventory cost flow assumptions.
Chapter 6-39
Q6-12 Casey Company has been using the FIFO cost flow method during a prolonged period of rising prices. During the same time period, Casey has been paying out all of its net income as dividends. What adverse effects may result from this policy?
Discussion QuestionDiscussion Question
See notes page for discussion
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
LO 3 Explain the financial effects of the inventory cost flow assumptions.LO 3 Explain the financial effects of the inventory cost flow assumptions.
Chapter 6-40
Using Cost Flow Methods ConsistentlyUsing Cost Flow Methods Consistently
Inventory CostingInventory CostingInventory CostingInventory Costing
Method should be used consistently, enhances comparability.
Although consistency is preferred, a company may change its inventory costing method.
Illustration 6-14Disclosure of change in cost flow method
LO 3 Explain the financial effects of the inventory cost flow assumptions.LO 3 Explain the financial effects of the inventory cost flow assumptions.
Chapter 6-41
Lower-of-Cost-or-MarketLower-of-Cost-or-Market
Inventory CostingInventory CostingInventory CostingInventory Costing
LO 4 Explain the lower-of-cost-or-market LO 4 Explain the lower-of-cost-or-market basis of accounting for inventories.basis of accounting for inventories.
When the value of inventory is lower than its cost
Companies can “write down” the inventory to its market value in the period in which the price decline occurs.
Market value = Replacement Cost
Example of conservatism.
Chapter 6-42
Lower-of-Cost-or-MarketLower-of-Cost-or-Market
Inventory CostingInventory CostingInventory CostingInventory Costing
LO 4 Explain the lower-of-cost-or-market LO 4 Explain the lower-of-cost-or-market basis of accounting for inventories.basis of accounting for inventories.
BE6-7 Alou Appliance Center accumulates the following cost and market data at December 31.
Inventory Cost Market Lower ofCategories Data Data Cost or MarketCameras 12,000$ 12,100$ Camcorders 9,000 9,700 VCRs 14,000 12,800
Compute the lower-of-cost-or-market valuation for the company’s total inventory.
$ 12,0009,000
12,800$ 33,800
Chapter 6-43
Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors
LO 5 Indicate the effects of inventory errors on the financial statements.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.
Chapter 6-44
Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors
LO 5 Indicate the effects of inventory errors on the financial statements.LO 5 Indicate the effects of inventory errors on the financial statements.
Inventory errors affect the computation of cost of goods sold and net income.
Income Statement EffectsIncome Statement Effects
Illustration 6-17
Illustration 6-16
Chapter 6-45
Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors
LO 5 Indicate the effects of inventory errors on the financial statements.LO 5 Indicate the effects of inventory errors on the financial statements.
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.
The ending inventory depends entirely on the accuracy of taking and costing the inventory.
Income Statement EffectsIncome Statement Effects
Chapter 6-46
Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors
LO 5 Indicate the effects of inventory errors on the financial statements.LO 5 Indicate the effects of inventory errors on the financial statements.
Incorrect Correct Incorrect CorrectSales 80,000$ 80,000$ 90,000$ 90,000$ Beginning inventory 20,000 20,000 12,000 15,000 Cost of goods purchased 40,000 40,000 68,000 68,000 Cost of goods available 60,000 60,000 80,000 83,000 Ending inventory 12,000 15,000 23,000 23,000 Cost of good sold 48,000 45,000 57,000 60,000 Gross profit 32,000 35,000 33,000 30,000 Operating expenses 10,000 10,000 20,000 20,000 Net income 22,000$ 25,000$ 13,000$ 10,000$
2008 2009
($3,000)Net Income understated
$3,000Net Income overstated
Combined income for 2-year period is correct.
Illustration 6-18
Chapter 6-47
Understating ending inventory will overstate: a. assets. b. cost of goods sold. c. net income. d. owner's equity.
Review QuestionReview Question
Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors
LO 5 Indicate the effects of inventory errors on the financial statements.LO 5 Indicate the effects of inventory errors on the financial statements.
Chapter 6-48
Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors
LO 5 Indicate the effects of inventory errors on the financial statements.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:.
Balance Sheet EffectsBalance Sheet Effects
Illustration 6-16
Illustration 6-19
Chapter 6-49
Statement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and Analysis
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).
PresentationPresentation
Chapter 6-50
Statement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and Analysis
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.
AnalysisAnalysis
LO 6 Compute and interpret the inventory turnover ratio.LO 6 Compute and interpret the inventory turnover ratio.
Chapter 6-51
Inventory turnover measures the number of times on average the inventory is sold during the period.
Cost of Goods Sold
Average Inventory Inventory Turnover
=
Statement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and Analysis
Days in inventory measures the average number of days inventory is held.
Days in Year (365)
Inventory Turnover Days in
Inventory =
LO 6 Compute and interpret the inventory turnover ratio.LO 6 Compute and interpret the inventory turnover ratio.
Chapter 6-52
BE6-9 At December 31, 2008, the following information was available for J. Graff Company: ending inventory $40,000, beginning inventory $60,000, cost of goods sold $270,000, and sales revenue $380,000. Calculate inventory turnover and days in inventory for J. Graff Company.
Statement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and AnalysisStatement Presentation and Analysis
LO 6 Compute and interpret the inventory turnover ratio.LO 6 Compute and interpret the inventory turnover ratio.
$270,000
($60,000 + 40,000) / 2
5.4 =Inventory Turnover
365
5.4 67.59 days
=Days in Inventory
Chapter 6-53
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