marley chap8 inventory

7/31/2019 Marley Chap8 Inventory

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1. General Course Questions2. 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 Accounting

November 22nd, 2010

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

What is Included in Inventory?

Ex 1, 3 and 5 2


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3

Report inventory units at the lower of cost or market(conservatism).

What is included in cost for:- Retailer:

- Manufacturing Company:



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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)



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InventoryCost FlowMerchandiser vs. Manufacturing Co.

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Product Costs - costs directly connected withbringing the goods to the buyers place of business

and converting such goods to a salable condition.

Period Costs generally selling, general, andadministrative expenses.

Purchase Discounts Gross vs. Net Method (? 10)

Product Financing (Question 5)

Costs Included in Inventory?

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Purchase Discounts: Gross or Net

Illustration 8-11

* $4,000 x 2% = $80

*

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

**

Solution onnotes page

Question 107


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Purchase Discounts: Gross or Net

Illustration 8-11

* $4,000 x 2% = $80

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

**

Solution onnotes page

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InventoryCost Flow

Perpetual vs. Periodic System

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Purchases are debitedto Inventory account

Freight-in, Purchases

Returns & Allowancesand Purchase Discountsare recorded in theInventory account.

Debit COGS and creditInventory account foreach sale.

Purchases are debited toPurchases account.

Freight-in, Purch. R & Aand Purch. Disc. arerecorded in theirrespective accounts.

COGS is computed onlyperiodically:

Cost of Goods Available Ending Inventory =Cost of Goods Sold

Perpetual Method Periodic Method

The perpetual inventory system

provides a continuous record ofInventory and Cost of Goods Sold.

Perpetual vs. Periodic System

Ending Inventory is determined

only by physical count at the endof the period. 10


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Purchase of Inventory:

Dr. Inventory 1,000Cr. A/P, Cash, etc. 1,000

Purchase Returns, Purchases Discounts

Dr. A/P 100

Cr. Inventory 100

Transportation InDr. Inventory 100

Cr. A/P, Cash, etc. 100

Sale of Inventory:

Dr. Cost of Goods Sold 1,000

Cr. Inventory 1,000

Dr. Cash, A/R, etc. 1,500

Cr. Sales Revenue 1,500

At Year-End: no j/e required, unless errors are found in inventory count

(physical inventory = perpetual inventory, than adjust to physical

Inventory System - Perpetual


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Purchase of Inventory:

Dr. Purchases 1,000

Cr. A/P, Cash, etc. 1,000

Purchase Returns, Purchases Discounts

Dr. A/P 100

Cr. Purchases Returns or Purchases Discounts 100

Transportation In

Dr. Transportation In 100Cr. A/P, Cash, etc. 100

Sale of Inventory:

Dr. Cash, A/R, etc. 1,500

Cr. Sales Revenue 1,500

At Year-End:Dr. Ending Inventory (determined by count) 38,000

Dr. Cost of Sales (plug) 283,000

Dr. Purchase Returns and Purchase Discounts (close balance)

Cr. Purchases (also close Transportation In) 286,000

Cr. Opening Inventory (carried forward from prior year) 35,000

Inventory System - Periodic


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Inventory Control Physical Count

All companiesneed periodic verification of the inventoryrecords by actual count, weight, or measurement, withthe counts compared with the detailed inventoryrecords.

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

Question 313


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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

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Effect of Inventory Errors (U/S Ending)

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Cost flow assumptions DO NOT Need to beconsistent with physical flow of goods. Theobjective is to most clearly reflect periodic income.

The cost flow assumptions are:

1 Specific identification

2 Average cost

3 First-in, first-out (FIFO) and4 Last-in, first-out (LIFO) (prohibited under IFRS)

Cost Flow Assumptions

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

Date Purchases Cost/Unit Purchase Cost

May 12 100 units @ $10/unit = $1,000Aug 14 200 units @ $11/unit = 2,200

Sep 18 120 units @ $15/unit = 1,800

420 units $5,000

On December 31, the company had 20 units on handand uses the periodic inventory system.

What is the cost of goods sold?

What is the cost of ending inventory?

Cost Flow Assumptions: Example

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Date Purchases CostMay 12 100 units $1,000Aug 14 200 units $2,200Sep 18 120 units $1,800

420 units $5,000Dec. 31 Ending inventory 20 units

Steps:

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 ininventory to determine Ending inventory: round to nearest dollar

Average Cost Method

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Date Purchases CostMay 12 100 units $1,000Aug 14 200 units $2,200Sep 18 120 units $1,800

420 units $5,000Dec. 31 Ending inventory 20 units

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

Cost per unit: $5000/420 = 11.9047 per unit

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

11.9047 x 400 = $4,762 COGS

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

11.9047 x 20 = $238 ending inventory

Average Cost Method

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Journal Entry (Periodic Inventory):

Year End EntryAverage Cost

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21

Journal Entry:

Dr. Ending Inventory 238Dr. Cost of Sales 4,762

Cr. Purchases 5,000

Cr. Opening Inventory 0

Year End EntryAverage Cost

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Given data:

Date Purchases CostMay 12 100 units @ $10 $1,000Aug 14 200 units @ $11 $2,200Sep 18 120 units @ $15 $1,800

420 $5,000

Ending 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)

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Given data:


420 $5,000


COGS $4,700

$300EI$5,000

GAFS


20 x $15 = $300

First-In, First-Out (FIFO) Method



100 units @ $10 $1,000200 units @ $11 $2,200100 units @ $15 $1,500

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Given data:


420 $5,000


COGS

EI$5,000

GAFS


Last-In, First-Out (LIFO) Method



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Given data:


420 $5,000


COGS

EI$5,000

GAFS

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

Last-In, First-Out (LIFO) Method



80 units @ $10 $ 800200 units @ $11 $2,200120 units @ $15 $1,800

$4,800

$200

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

The cost of goods available is the same forall methods

The cost of goods sold and the cost ofending inventory are different

In periods of rising prices, LIFO would resultin the smallest reported net income.

Cost Flow Assumptions: Notes

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Periodic vs. Perpetual

FIFO: COGS and EI numbers are exactly thesame under either periodic or perpetual systems

BUTLIFO, Weighted Average will give youdifferent numbers Under perpetual LIFO, with each sale, you cut into only

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

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


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Same Example - Perpetual Basis

Unit Total Units

Units Cost Cost Sold

12-May 100 10 10001-Jun 85

14-Aug 200 11 2200

1-Sep 100

18-Sep 120 15 1800

20-Sep 215

420 5000 400

Unit Extended Unit Extended

FIFO: Units Cost Value LIFO: Units Cost Value

1-Jun 85 10 850 1-Jun 85 10 850

1-Sep 15 10 150 1-Sep 100 11 1100

85 11 935 20-Sep 120 15 1800

20-Sep 115 11 1265 95 11 1045

100 15 1500

COGS 400 4700 COGS 400 4795

EI 20 15 300 EI 15 10 150

Same as Periodic 5 11 55

205

Different from Periodic

Purchased


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Same Example - Perpetual BasisSold

Unit Extended

Units Cost Cost Units

12-May 100 10 10001-Jun 85

14-Aug 200 11 2200

1-Sep 100

18-Sep 120 15 1800

20-Sep 215

420 5000 400

Calculate the average cost at time of each sale

Unit Extended

Wt. Av. Units Cost Value 1-Sep

1-Jun 85 10 850 costs to date 3200

1-Sep 100 10.9 1093.02 costs expensed 850

20-Sep 215 13 2796.81 0 2350

0 215

0 Av Cost 10.9

COGS 400 4739.83

Sept. 20

EI 20 13 260.168 Costs to date 5000

Costs expensed 1943

Remaining costs 3057

Remaining units 235Different from Periodic Av cost 13

Purchased


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LIFO matches more recent costs withcurrent revenues.

With increasing prices: LIFO yields the lowest taxable income

(assuming inventory does not decrease).

Under LIFO, there is less need to writedown inventory down to market

Advantages of LIFO Method

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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:

Setting up a LIFO Reserve

1. Pricing decisions

2. Record keeping easier

3. Profit-sharing or bonus arrangements

4. LIFO troublesome for interim periods

SEC reporting requirements disclose the differencebetween LIFO and current cost of inventory reportedon the Balance Sheet which is the LIFO RESERVE 31


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

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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

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LIFO yields the lowest net income and thereforereduced earnings (with increasing prices)

Under LIFO, the ending inventory is understatedrelative to current costs

LIFO liquidation (reduction of quantities ofinventory during a period results in costingitems at older prices): May result in income that is detrimental from a tax view

May cause poor buying habits (because of the layerliquidation problem)

LIFO Conformity Rule: if you use LIFO for taxpurposes, you must use it for financial reportingalso.

Disadvantages of LIFO Method

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Dollar value LIFO applies LIFO procedures to pools of similar goodsbased 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 thepool are offset by increases in other goods in the pool).

Price indexa measure of the change in prices from a base year(the year dollar value LIFO is adopted in this case) to the currentyear

Internal = Ending inventory quantities X current year costs

Ending inventory quantities X base year costs

Externalcalculated by the Bureau of Labor Statistics

Dollar Value LIFO


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Compare ending inventory at base year prices to beginning of yearinventory, also at base year pricesif there is an increasewe 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 theyear the items were acquired by comparing current inventory at baseprices to prior inventory at base prices. If there is an increase add anadditional layer. If there is a decrease deduct from the most recentlypurchased layer. Once a layer is eliminated (peeled off), it can not berebuilt.

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

value LIFO cost.

Dollar Value LIFO Calculation Steps


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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


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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

$20,000plus

$2,400 =

$22,400

Dollar value

LIFO Inventory

Dollar Value LIFO: Example


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When the ending inventory (at base yearprices) is less than the beginning inventory

(at base year prices) (i.e. in the exampleabove if EI at base year prices was

marley chap8 inventory

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