FIN Chapter 8 - Recording and Measuring Inventory Inventory...

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Unformatted text preview: Recording and Measuring Inventory Inventory Inventories consist of assets that a retail Inventories or wholesale company acquires for resale or goods that manufacturers produce for sale sale Most important objective – matching the Most expense (cost of goods sold) with the revenue generated from the sale of inventory inventory Types of Inventory Merchandising Inventory – Cost of merchandise inventory includes the purchase price plus Cost any other costs necessary to get the goods in condition and location for sale. location Manufacturing Inventories – Raw materials Cost of components purchased from other manufacturers that will Cost become part of the of the finished product become – Work in process Cost of raw materials introduced into production, direct labor, and Cost an allocated portion of manufacturing overhead an Overhead includes utilities, depreciation of factory buildings and Overhead equipment, supervision, and other indirect manufacturing costs equipment, – Finished goods – completed goods held for sale to customers Perpetual Inventory System Continuously records changes in inventory quantity and inventory Continuously cost cost Records each purchase, sale, return, etc. To record purchase of inventory: Dr. Inventory Cr. Accounts Payable Cr. To record sale of inventory: Dr. A/R or Cash (at sales price) Cr. Sales Revenue (at sales price) Dr. Cost of Goods Sold (at cost) Cr. Inventory (at cost) Actual quantity of inventory is verified through periodic inventory Actual counts (physical inventories) counts – Differences could be due to theft, spoilage, breakage, recording errors E8­1, p. 406 Work in class Periodic Inventory System Adjusts inventory quantities and records Cost of Goods Adjusts Sold only at end of each reporting period. Sold To record purchase of inventory: Dr. Purchases Cr. Accounts Payable Cr. To record sale of inventory: Dr. A/R or Cash (at sales price) Cr. Sales Revenue (at sales price) Notice that there is no entry to COGS at time of sale. – Need to perform physical inventory count to compute COGS for Need the period. the E8­2, p. 406 Work in class Inventory Cost Flows to Financial Statements Compute COGS Beginning Inventory $XXXX + Purchases XXXX Cost of Goods Available for Sale $XXXX − Ending Inventory XXXX Ending = Cost of Goods Sold $XXXX Assumes that any good NOT in ending Assumes inventory was sold inventory – No way to determine theft, spoilage, etc. COGS Journal Entry Adjusting journal entry needed to record COGS: Dr. COGS (from formula above) Dr. Inventory (Ending inventory balance from physical Dr. count) count) Cr. Inventory (Beginning inventory balance) Cr. Purchases (total amount of purchases for the Cr. period) period) Notice that the Purchases account is now Notice “closed” for the period. “closed” A Comparison of the Perpetual and Periodic Inventory Systems A perpetual system provides more timely perpetual information but is more costly in terms of recordkeeping. recordkeeping. What is Included in Inventory? Goods in Transit – Inventory shipped f.o.b. shipping point is included in purchaser’s Inventory inventory as soon as the merchandise is shipped. inventory – Inventory shipped f.o.b. destination is included in the purchaser’s Inventory inventory only after it reaches the purchaser’s destination. inventory Goods on Consignment – Goods held on consignment are included in the inventory of the Goods consignor until sold by the consignee. consignor Sales Returns – Recall that inventory is increased by the amount of estimated Recall inventory to be returned when estimating the Allowance for Sales Returns Sales E8­10, p. 408 Work in class Expenditures Included in Inventory Inventory costs include all expenditures Inventory necessary to bring inventory to its condition and location for sale or use (in manufacturing) location Shipping charges paid on outgoing goods (sold Shipping to customers) are NOT included in inventory to – Those shipping costs are a selling expense (Selling, Those General & Administrative Expense) General Freight-In on Purchases – Also called Transportation-In – Included in inventory cost E8­11, p. 408 Work in class Costs paid by the purchaser to ship goods to purchaser’s location Perpetual System: Dr. Inventory Cr. Cash Periodic System: Dr. Freight-In Cr. Cash Purchase Returns Purchase returns (and allowances) reduce Purchase net purchases (inventory cost) net Perpetual System: Dr. A/P Cr. Inventory Periodic System: Dr. A/P Cr. Purchase Returns (a contra Cr. purchases account) purchases Purchase Discounts Opposite of Sales Discounts Represent reductions in inventory cost if A/P is paid Represent within a certain time period within Can use either Gross or Net Methods – Gross Method – views discounts not taken as part of inventory Gross cost cost – Net Method – considers discounts not taken as interest expense – Gross Method: – Net Method: Dr. Purchases** (Full amount less Purchase Discount) Cr. A/P (Full amount less Purchase Discount) When Goods are Purchased: Dr. Purchases** (full amount) Cr. A/P (full amount) Purchase Discounts If paid within Discount Period: – Gross Method: Dr. A/P (full amount) Cr. Purchase Discounts ** (for amount Cr. of discount) (a contra purchases account) account) Cr. Cash (Full amount less Purchase Cr. Discount) Discount) – Net Method: Dr. A/P (Full amount less Purchase Dr. Purchase Discounts If Paid after Discount period expires: – Gross Method: Dr. A/P (full amount) Cr. Cash (full amount) – Net Method: Dr. A/P (Full amount less Purchase Dr. Discount) Discount) Dr. Interest Expense** (Amount of Dr. Discount) Discount) Cr. Cash (full amount) E8­8, p. 408 Work in class Now COGS Computation is more complicated: Still need to perform physical inventory count to Still compute COGS for the period: compute Beginning Inventory + Purchases Less Purchase Returns Less Purchase Discounts Plus Freight-In Net Purchases Cost of Goods Available for Sale − Ending Inventory Ending = Cost of Goods Sold $XXXX $XXXX $XXXX (XXXX) (XXXX) XXXX XXXX XXXX $XXXX XXXX XXXX $XXXX Adjusting journal entry needed to record COGS is now: Dr. COGS (from formula above) Dr. Inventory (Ending inventory balance from physical Dr. count) count) Dr. Purchase Returns Dr. Purchase Discounts Cr. Inventory (Beginning inventory balance) Cr. Freight-In Cr. Purchases (total amount of purchases for the Cr. period) period) Notice that the Purchases Returns, Purchase Notice Discounts, Freight-In, and Purchases accounts are now “closed” for the period. are E8­3, p. 407 Work in class Inventory Cost Flow Assumptions Allocates units and inventory cost between Allocates Ending Inventory and Cost of Goods Sold Ending Purchases and Cost of Goods Available for Sale Purchases are the same no matter which inventory cost flow assumption is used flow Cost Flow Alternatives: – – – – Specific Identification Average Cost First-In, First Out (FIFO) Last-In, First-Out (LIFO) Specific Identification Physical Flow of Goods = Cost Flows Appropriate for expensive, unique items Appropriate with low sales volume with Average Cost Assumes that items sold and items in Assumes ending inventory come from a mixture of all goods available for sale. all Computed by using an average cost Computed weighted by the number of units acquired at various unit costs. at Periodic Average Cost Calculated at the end of the period as: – Weighted-Average Unit Cost = Cost of Goods Weighted-Average Available for Sale / Quantity Available for Sale Available – This weighted average unit cost is then This multiplied by the units in ending inventory to arrive at the dollar value of ending inventory. arrive COGS = Cost of Goods Available for Sale minus COGS Dollar Value of Ending Inventory Dollar Dollar Value of Ending Inventory = Cost of Goods Dollar Available for Sale minus COGS Available Perpetual Average Cost More complex than periodic average cost – Computes a moving-average unit cost each Computes time additional inventory is purchased time Perpetual Wtd Average Cost = (Cost of Previous Perpetual Inventory Balance + Cost of New Purchase) / Number of Units on Hand Number This moving average weighted average unit cost is This then multiplied by the units in ending inventory to arrive at the dollar value of ending inventory. arrive E8­15, p. 410 Work in class First­In, First Out (FIFO) Assumes that items sold were those that Assumes were acquired first. were Ending inventory will consist of most Ending recently acquired items (most up-to-date EI values) EI Periodic versus Perpetual FIFO will Periodic always result in same Ending Inventory and COGS values and Apple’s Footnotes Last­In, First­Out (LIFO) Assumes that items sold are those that were Assumes most recently acquired (most up-to-date COGS) most Better matching of revenues and expenses Ending inventory will consist of the items first Ending acquired. acquired. Periodic versus Perpetual LIFO will result in Periodic different amounts for Ending Inventory and COGS COGS IFRS does not allow use of LIFO E8­14, p. 409 Work in class Comparison of Cost Flow Methods If unit costs are increasing, LIFO will result in If higher COGS and lower EI than FIFO. higher If unit costs are decreasing, FIFO will result in If higher COGS and lower EI than LIFO. higher Weighted Average Cost values are always in Weighted between those for LIFO and FIFO for both ending inventory and COGS. ending Must disclose inventory cost flow assumptions in Must footnotes. footnotes. Factors Influencing Method Choice Physical Flow – physical flow is NOT Physical required to match cost flow required Income Taxes and Net Income – Companies choose LIFO to reduce operating Companies income which reduces income tax expense (when prices are rising) (when – LIFO Conformity Rule – IRS states that is LIFO company uses LIFO for tax return, must also use LIFO for financial reporting use LIFO Liquidations When companies purchase less units than they When sell, they liquidate a previous layer of inventory (called a LIFO liquidation) (called – If prices have been rising, this means the liquidated If units have a lower cost than what the company would have to current pay to purchase the inventory today have – This results in a boost to net income A material effect on net income due to LIFO material liquidation must be disclosed in the footnotes. liquidation E8­17, p. 410 Work in class LIFO Reserve LIFO Reserve – results from keeping dual books – Some companies use LIFO for income tax and Some financial reporting (LIFO conformity) but use FIFO for internal accounting (i.e., pricing decisions, bonus computations, etc.) computations, – They use the LIFO Reserve account (a contra They inventory account) to “convert” from FIFO to LIFO at the end of each reporting period. the FIFO Inventory = LIFO Inventory + LIFO Reserve FIFO COGS = LIFO COGS – Increase in LIFO Reserve (or + FIFO Decrease) Decrease) Earnings Quality Gross Profit Ratio = Gross Profit / Net Gross Sales Sales – Measures profitability by indicating the Measures percentage of each sales dollar available to cover other expenses and provide a profit. cover – The higher the ratio, the higher is the markup The on the company’s goods. on – A declining ratio indicates an erosion of declining profitability (i.e., rising costs without the ability to pass cost increases along to the customer) to Methods of Simplifying LIFO Previous method of applying LIFO (unit Previous LIFO) is costly (recordkeeping) because company has to keep track of individual units of inventory. units Two methods of LIFO simplification: – LIFO Inventory Pools – Dollar-Value LIFO (DVL) LIFO Inventory Pools Inventory pools are formed of units that Inventory possess physical similarities. possess Average cost for all of the pool purchases Average during the period is applied to the current year’s LIFO layer. year’s Difficult to maintain consistencies in pools Difficult because of new product introductions and old product discontinuances. old Dollar­Value LIFO (DVL) DVL combines large variety of goods into DVL one pool. one – Can have multiple pools but are formed on Can cost similarities (increasing, decreasing, stable) rather than on physical similarities of the goods. the Units are ignored when computing ending Units inventory and COGS. inventory – Instead layers are comprised of dollar values. Cost Indexes The cost index for the base year (the year The DVL is initially adopted) is set at 1.00. DVL Subsequent year’s cost indexes are Subsequent computed as follows: computed – Cost Index in Layer Year = Cost in Layer Cost Year/Cost in Base Year Year/Cost – Often use a public price index such as the Often Consumer Price Index (CPI) or the Producer Price Index Price Steps ­ Dollar Value LIFO 1. Determine ending inventory at current (end-ofyear) prices 2. Convert the ending inventory to base-year prices. 2. Compare ending inventory (base-year prices) to Compare beginning inventory at base-year prices. beginning 3. Compute the difference. An increase represents Compute a new LIFO layer. Convert the new layer to endnew of-year prices 4. LIFO ending inventory is beginning inventory (as LIFO reported in the balance sheet at the end of the prior year) plus the new LIFO layer. prior The DVL Inventory Estimation Technique Dollar-Value LIFO: Multi-Year Example: This example illustrates how dollar-value LIFO works when LIFO layers are liquidated. Assume the index numbers and inventories at end-of-year prices for Rudd W holesale Company are as follows: Year-end Price Index 1.00 1.20 1.32 1.40 1.25 Inventory at End-of-Year Prices $38,000 54,000 66,000 56,000 55,000 Date Dec. 31, 1995 Dec. 31, 1996 Dec. 31, 1997 Dec. 31, 1998 Dec. 31, 1999 Inventory at End-of-Year Date Prices Dec. 31, 1995 $38,000 Dec. 31, 1996 $54,000 Inventory at Year-End B ase-Year Price Index Prices ÷ 1.00 = $38,000 ÷ 1.20 = $45,000 Dec. 31, 1997 $66,000 ÷ 1.32 = $50,000 Dec. 31, 1998 $56,000 ÷ 1.40 = $40,000 Dec. 31, 1999 $55,000 ÷ 1.25 = $44,000 Layers in Base-Year Prices $38,000 $38,000 7,000 $45,000 $38,000 7,000 5,000 $50,000 $38,000 2,000 $40,000 $38,000 2,000 4,000 $44,000 Incremental Layer Dollar-Value Index LIFO Cost x 1.00 = $38,000 x 1.00 = $38,000 x 1.20 = 8,400 $46,400 x 1.00 = $38,000 x 1.20 = 8,400 x 1.32 = 6,600 $53,000 x 1.00 = $38,000 x 1.20 = 2,400 $40,400 x 1.00 = $38,000 x 1.20 = 2,400 x 1.25 = 5,000 $45,400 ...
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