Slide 8-1UCSB, AndersonValuation of Inventories:A Cost Basis ApproachChapterValuation of Inventories:A Cost Basis ApproachClassificationErrorsPerpetual v. PeriodicCost FlowSlide 8-3UCSB, AndersonWhat is Inventory?Asset items held for sale in the ordinary course of business or ...goods that will be used or consumed in the production of goods to be sold.Generally a significant assetGenerally a primary source of revenueImpacts both balance sheet and income statementSlide 8-4UCSB, AndersonManufacturing CompaniesClassification of inventories:zRaw MaterialszWork in ProgresszFinished Goods
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Slide 8-5UCSB, AndersonInventory- the basicsWhere does inventory go?COS- Therefore Pretty importantIf inventory is overstated, then what else is impacted?–COS is understated (rollforward)–Net income AND gross profit are overstated–Various ratios impacted–Next year it reverses (COS is overstated etc.)It is stated at Lower of Cost or Market (LCM)8-6UCSB, AndersonInventory issues introducedFour basic questions/ issues:1.What is it?The costs necessary to make the product available for sale, including costs of holding it once completed.2.Whose is it?It belongs to the party with whom the risks and rewards lie.3.How many units are there?zPerpetual, ORzPeriodic4.How much did it cost?Can be tricky, because prices change over time and consequently how do you know which unit you sold and how you paid for it.zSpecific identification- no “methodology” or assumptions, but costly and perhaps not possible;zAverage or weighted average, can be moving averagezFIFO (first in first out, aka last in still here)zLIFO (last in first out, aka first in still here)zCan result in some strange results when inventory levels are depleted (called LIFO Liquidation). Consequently the following has been designed to mitigate:zSpecific goods pooled LIFO approachzDollar Value LIFOSlide 8-7UCSB, AndersonItems to be Included in InventoryPurchase costSales with high rates of returnGoods in transitConsigned goodsSales with buybackSlide 8-8UCSB, AndersonItems to be Included in InventoryPurchase costSales with high rates of returnGoods in transitConsigned goodsSales with buybackProduct cost --zinvoice cost, freight in, labor, and other direct production costs (up to time of sale)Period costs --zselling, general, and administrativeznot inventoriable