ch08 - CHAPTER 8 VALUATION OF INVENTORIES: VALUATION A...

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Unformatted text preview: CHAPTER 8 VALUATION OF INVENTORIES: VALUATION A COST-BASIS APPROACH COST-BASIS Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield Chapter 8 -1 Learning Objectives 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. I de ntify m classifications of inve ajor ntory. Distinguish be e pe tual and pe twe n rpe riodic inve ntory syste s. m I de ntify thee cts of inve ffe ntory e rrors on thefinancial state e m nts. Unde rstand theite s to includeas inve m ntory cost. De scribeand com parethecost flow assum ptions use to account for inve d ntorie s. Explain thesignificanceand useof a LI FO re rve se . Unde rstand thee ct of LI FO liquidations. ffe Explain thedollar-valueLI FO m thod. e I de ntify them advantage and disadvantage of LI FO. ajor s s Unde rstand why com panie se ct give inve s le n ntory m thods. e Chapter 8 -2 Valuation of Inventories: Cost-Basis Approach Physical Physical Goods Goods Included in Inventory Goods in transit Consigned Consigned goods goods Special sales Special agreements agreements Inventory errors Inventory Issues Classification Cost flow Control Basic inventory Basic valuation valuation Costs Costs Included Included in Inventory Product costs Period costs Purchase Purchase discounts discounts Cost Flow Cost Assumptions Assumptions Specific Specific identification identification Average cost FIFO LIFO LIFO: Special LIFO: Issues Issues LIFO reserve LIFO liquidation Dollar-value Dollar-value LIFO LIFO Comparison of Comparison LIFO approaches LIFO Advantages of Advantages LIFO LIFO Disadvantages of Disadvantages LIFO LIFO Basis for Basis Selection Selection Summary of Summary inventory valuation methods methods Chapter 8 -3 Inventory Issues Classification I nve ntorie are s: ite s he for sale or m ld , goods to beuse in theproduction of goods to besold. d Businesses with Inventory: Merchandiser or Manufacturer Chapter 8 -4 LO 1 Identify major classifications of inventory. Inventory Issues Classification Oneinve ntory account Purchasegoods re ady f or sale Illustration 8-1 Chapter 8 -5 LO 1 Identify major classifications of inventory. Inventory Issues Classification Thre accounts e Raw m rials ate Work in proce ss Finishe goods d Illustration 8-1 Chapter 8 -6 LO 1 Identify major classifications of inventory. Inventory Issues Inventory Cost Flow Illustration 8-2 Chapter 8 -7 LO 1 Identify major classifications of inventory. Inventory Issues Inventory Cost Flow Illustration 8-3 C panie useoneof two type of syste s for m om s s m aintaining inve ntory re cords — perpetual system or periodic system. Chapter 8 -8 LO 1 Identify major classifications of inventory. Inventory Cost Flow Perpetual System 1. Purchase of m rchandisearede d to I nve s e bite ntory. 2. Fre ight-in is de d to I nve bite ntory. Purchasere turns and allowance and s purchasediscounts arecre d to I nve dite ntory. 3. C of goods sold is de d and Inve ost bite ntory is cre d for e sale dite ach . 4. S ubsidiary re cords show quantity and cost of e typeof inve ach ntory on hand. Thepe tual inve rpe ntory syste provide a continuous re of Inve m s cord ntory and C of Goods S ost old. Chapter 8 -9 LO 2 Distinguish between perpetual and periodic inventory systems. Inventory Cost Flow Periodic System 1. Purchase of m rchandisearede d to Purchase s e bite s. 2. Ending I nve ntory de rm d by physical count. te ine 3. C alculation of C of Goods S ost old: Be ginning inve ntory $ 100,000 Purchase ne s, t 800,000 Chapter 8-10 Goods availablefor sale LO 2 Distinguish between perpetual and periodic inventory systems. Inventory Cost Flow Illustration: Fe ireC pany had thefollowing transactions during the sm om curre ye nt ar. Re the transactions using thePe tual and Pe cord se rpe riodic syste s. m Chapter 8-11 LO 2 Distinguish between perpetual and periodic inventory systems. Inventory Cost Flow Illustration: Illustration 8-4 Chapter 8-12 Solution on notes page LO 2 Distinguish between perpetual and periodic inventory systems. Inventory Cost Flow Illustration: Assum that at thee of there e nd porting pe riod, thepe tual rpe inve ntory account re porte an inve d ntory balanceof $4,000. Howe r, a physical ve count indicate inve s ntory of $3,800 is actually on hand. Thee to re the ntry cord ne ssary write ce -down is as follows. I nve ntory Ove and S r hort I nve ntory 200 200 Note: Inventory Over and Short adjusts Cost of Goods Sold. In practice, companies sometimes report Inventory Over and Short in the “Other revenues and gains” or “Other expenses and losses” section of the income statement. Chapter 8-13 LO 2 Distinguish between perpetual and periodic inventory systems. Inventory Issues Inventory Control All companies ne d pe e riodic ve rification of theinve ntory re cords by actual count, we ight, or m asure e with thecounts com d with the e m nt, pare de d inve taile ntory re cords. C panie should takethephysical inventory ne thee of the om s ar nd ir f iscal ye to prope re inve ar, rly port ntory quantitie in the annual s ir accounting re ports. Chapter 8-14 LO 2 Distinguish between perpetual and periodic inventory systems. Basic Issues in Inventory Valuation Valuation C panie m allocatethecost of all thegoods availablefor sale(or use om s ust ) be e thegoods that we sold or use and thosethat arestill on hand. twe n re d Illustration 8-5 Chapter 8-15 LO 2 Distinguish between perpetual and periodic inventory systems. Basic Issues in Inventory Valuation Valuation requires determining Thephysical goods (goods on hand, goods in transit, consigne d goods, spe sale agre m nts). cial s ee Thecosts to include (product vs. pe costs). riod Thecost flow assumption (FI FO, LI FO, Ave cost, S cific rage pe I de ntification, Re e tail, tc.). Chapter 8-16 LO 2 Distinguish between perpetual and periodic inventory systems. Physical Goods Included in Inventory A com pany should re purchase whe it obtains le titleto the cord s n gal goods. Illustration 8-6 Chapter 8-17 LO 2 Distinguish between perpetual and periodic inventory systems. Effect of Inventory Errors Ending I nve ntory Misstate d Illustration 8-7 Thee ct of an e on ne incom in oneye (2009) will becounte ffe rror t e ar rbalance in thene d xt (2010), howe r theincom state e will bem ve e m nt isstate for both ye d ars. Chapter 8-18 LO 3 Identify the effects of inventory errors on the financial statements. Effect of Inventory Errors Illustration: Jay We m Corp. unde ise an rstate its e s nding inve ntory by $10,000 in 2009; all othe ite s arecorre state rm ctly d. Illustration 8-8 Chapter 8-19 LO 3 Effect of Inventory Errors Purchase and I nve s ntory Misstate d Illustration 8-9 Theunde rstate e doe not affe cost of goods sold and ne incom be m nt s ct t e causethee rrors offse oneanothe t r. Chapter 8-20 LO 3 Identify the effects of inventory errors on the financial statements. Costs Included in Inventory Product Costs - costs dire conne d with bringing the ctly cte goods to thebuye placeof busine and conve r’s ss rting such goods to a salablecondition. Period Costs – ge rally se ne lling, ge ral, and adm ne inistrative e nse xpe s. Purchase Discounts – Gross vs. Ne Me t thod Chapter 8-21 LO 4 Understand the items to include as inventory cost. Costs Included in Inventory Tre e of PurchaseDiscounts atm nt Illustration 8-11 ** * $4,000 x 2% = $80 ** $10,000 x 98% = $9,800 Chapter 8-22 Solution on notes page LO 4 Understand the items to include as inventory cost. Which Cost Flow Assumption to Adopt? FIFO Cost Flow Assumption Adopted does not need to equal Physical Movement of Goods LIFO Average Cost Specific Identification Answer: Me thod adopte should be one that m d ost cle re cts pe arly fle riodic incom . e Chapter 8-23 LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Cost Flow Assumptions Exam ple Young & C razy C pany m s thefollowing purchase om ake s: 1. 2. 3. Oneite on 2/2/11 for $10 m Oneite on 2/15/11 for $15 m Oneite on 2/25/11 for $20 m Young & C razy C pany se oneite on 2/28/11 for $90. What would be om lls m t hebalanceof e nding inve ntory and cost of goods sold for them onth e d nde Fe 2011, assum thecom b. ing pany use theFIFO, LIFO, Average d Cost, and Specific Identification cost flow assum ptions? Assum a e t ax rateof 30% . Chapter 8-24 LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Cost Flow Assumptions “First-In-First-Out (FIFO)” Inventory Balance = $ 45 Purchase on 2/25/07 for $20 Purchase on 2/15/07 for $15 Purchase on 2/2/07 for $10 Chapter 8-25 Young & Crazy Company Income Statement For the Month of Feb. 2007 Sales Cost of goods sold Gross profit Expenses: Administrative Selling Interest Total expenses Income before tax Taxes Net Income $ 90 0 90 14 12 7 33 57 17 $ 40 LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Cost Flow Assumptions “First-In-First-Out (FIFO)” Inventory Balance = $ 35 Purchase on 2/25/07 for $20 Purchase on 2/15/07 for $15 Purchase on 2/2/07 for $10 Chapter 8-26 Young & Crazy Company Income Statement For the Month of Feb. 2007 Sales Cost of goods sold Gross profit Expenses: Administrative Selling Interest Total expenses Income before tax Taxes Net Income $ 90 10 80 14 12 7 33 47 47 14 $ 33 LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Cost Flow Assumptions “Last-In-First-Out (LIFO)” Inventory Balance = $ 45 Purchase on 2/25/07 for $20 Purchase on 2/15/07 for $15 Purchase on 2/2/07 for $10 Chapter 8-27 Young & Crazy Company Income Statement For the Month of Feb. 2007 Sales Cost of goods sold Gross profit Expenses: Administrative Selling Interest Total expenses Income before tax Taxes Net Income $ 90 0 90 14 12 7 33 57 17 $ 40 LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Cost Flow Assumptions “Last-In-First-Out (LIFO)” Inventory Balance = $ 25 Purchase on 2/25/07 for $20 Purchase on 2/15/07 for $15 Purchase on 2/2/07 for $10 Chapter 8-28 Young & Crazy Company Income Statement For the Month of Feb. 2007 Sales Cost of goods sold Gross profit Expenses: Administrative Selling Interest Total expenses Income before tax Taxes Net Income $ 90 20 70 14 12 7 33 37 11 $ 26 LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Cost Flow Assumptions “Average Cost” Inventory Balance = $ 45 Purchase on 2/25/07 for $20 Purchase on 2/15/07 for $15 Purchase on 2/2/07 for $10 Chapter 8-29 Young & Crazy Company Income Statement For the Month of Feb. 2007 Sales Cost of goods sold Gross profit Expenses: Administrative Selling Interest Total expenses Income before tax Taxes Net Income $ 90 0 90 14 12 7 33 57 17 $ 40 LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Cost Flow Assumptions “Average Cost” Inventory Balance = $ 30 Purchase on 2/25/07 for $20 Purchase on 2/15/07 for $15 Purchase on 2/2/07 for $10 Chapter 8-30 Young & Crazy Company Income Statement For the Month of Feb. 2007 Sales Cost of goods sold Gross profit Expenses: Administrative Selling Interest Total expenses Income before tax Taxes Net Income $ 90 15 75 14 12 7 33 42 12 $ 30 30 LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Cost Flow Assumptions “Specific Identification” Inventory Balance = $ 45 Purchase on 2/25/07 for $20 Purchase on 2/15/07 for $15 Purchase on 2/2/07 for $10 Chapter 8-31 Young & Crazy Company Income Statement For the Month of Feb. 2007 Sales Cost of goods sold Gross profit Expenses: Administrative Selling Interest Total expenses Income before tax Taxes Net Income $ 90 0 90 14 12 7 33 57 17 $ 40 LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Cost Flow Assumptions “Specific Identification” Inventory Balance = $ 45 Purchase on 2/25/07 for $20 Purchase on 2/15/07 for $15 Purchase on 2/2/07 for $10 Chapter 8-32 Young & Crazy Company Income Statement For the which Feb. is sold Depends Month of one 2007 Sales Cost of goods sold Gross profit Expenses: Administrative Selling Interest Total expenses Income before tax Taxes Net Income $ 90 0 90 14 12 7 33 57 17 $ 40 LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Cost Flow Assumptions Financial Statement Summary Sales Cost of goods sold Gross profit Operating expenses: Administrative Selling Interest T otal expenses Income before taxes Income tax expense Net income Inventory Balance Chapter 8-33 FIFO $ 90 10 80 14 12 7 33 47 14 33 35 LIFO $ 90 20 70 14 12 7 33 37 11 26 25 Average $ 90 15 75 14 12 7 33 42 12 30 30 $ $ $ LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Cost Flow Assumptions Illustration: C all-Mart I nc. had thefollowing transactions in its first m onth of ope rations. Calculate Goods Available for Sale Be ginning inve ntory (2,000 x $4) Purchase s: 6,000 x $4.40 2,000 x 4.75 Goods availablefor sale Chapter 8-34 $ 8,000 26,400 9,500 $43,900 LO 5 Specific Identification Illustration: Assum that C e all-Mart Inc.’s 6,000 units of inve ntory consists of 1,000 units fromtheMarch 2 purchase 3,000 fromtheMarch 15 purchase and 2,000 fromthe , , March 30 purchase C putetheam . om ount of e nding inve ntory and cost of goods sold. Illustration 8-12 Solution on Chapter page notes 8-35 Average Cost Weighted-Average Illustration 8-13 Chapter 8-36 Solution on notes page LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Average Cost Moving-Ave rage Illustration 8-14 I n this m thod, C e all-Mart com s a new average unit cost e pute ach t im it m s a purchase e ake . Chapter 8-37 Solution on notes page LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used First-In, First-Out (FIFO) Pe riodic Me thod Illustration 8-15 De rm cost of e te ine nding inve ntory by taking thecost of them re nt purchaseand working ost ce back until it accounts for all units in theinve ntory. Chapter 8-38 Solution on notes page LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used First-In, First-Out (FIFO) Pe tual Me rpe thod Illustration 8-16 In all case whe FI FO is use theinve s re d, ntory and cost of goods sold would bethesam at the e e of them nd onth whe r a pe tual or pe the rpe riodic syste is use m d. Chapter 8-39 Solution on notes page LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Last-In, First-Out (LIFO) Pe riodic Me thod Illustration 8-17 Thecost of thetotal quantity sold or issue during them d onth com s fromthem re nt e ost ce purchase s. Chapter 8-40 Solution on notes page LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Last-In, First-Out (LIFO) Pe tual Me rpe thod Illustration 8-18 TheLI FO m thod re e sults in diffe nt e re nding inve ntory and cost of goods sold am ounts than the am ounts calculate unde thepe d r riodic m thod. e Chapter 8-41 Solution on notes page LO 5 Describe and compare the cost flow assumptions LO used to account for inventories. used Special Issues Related to LIFO LI FO Re rve se Many com panie use s LIFO for tax and e rnal financial re xte porting purpose s FIFO, ave cost, or standard cost syste for inte re rage m rnal porting purpose s. Re asons: Pricing de cisions 2. Re cord ke ping e r e asie 3. Profit-sharing or bonus arrange e m nts 4. LI FO trouble efor inte pe som rim riods 1. Chapter 8-42 LO 6 Explain the significance and use of a LIFO reserve. Special Issues Related to LIFO LI FO Re rveis thedifferencebetween theinventory method used for se inte re rnal porting purpose and LI FO. s Example: FI FO valuepe books r LI FO value LI LI FO Re rve se $160,000 145,000 145,000 $ 15,000 15,000 Journal e t o re ntry duceinve ntory to LI FO: C of goods sold ost Allowanceto re duceinve ntory to LI FO 15,000 15,000 C panie should disclosee r theLI FO re rveor there om s ithe se place e cost of theinve m nt ntory. Chapter 8-43 LO 6 Explain the significance and use of a LIFO reserve. Special Issues Related to LIFO Special LI FO Liquidation Olde low cost inve r, ntory is sold re sulting in a lowe cost of goods sold, highe r r ne incom , and highe taxe t e r s. Illustration: Basle C has 30,000 pounds of ste l in its inve r o. e ntory on De m r 31, 2010, with cost de rm d on a ce be te ine spe goods cific LI FO approach. Chapter 8-44 LO 7 Understand the effect of LIFO liquidations. Special Issues Related to LIFO LI FO Liquidation Illustration: At thee of 2011, only 6,000 pounds of ste l re aine in nd em d inve ntory. Illustration 8-21 Chapter 8-45 LO 7 Understand the effect of LIFO liquidations. Special Issues Related to LIFO Dollar-ValueLI FO C hange in a pool arem asure in te s of total dollar value not s e d rm , physical quantity. Advantage : Broade rangeof goods in pool. r Pe its re rm place e of goods that aresim m nt ilar. He prote LI FO laye frome lps ct rs rosion. Chapter 8-46 LO 8 Explain the dollar-value LIFO method. Special Issues Related to LIFO Dollar-ValueLI FO Exercise 8-26 (partial): Thefollowing inform ation re s to the late C hoctaw C pany. om Usethedollar-valueLI FO m thod to com e putethee nding inve ntory for 2007 t hrough 2009. Chapter 8-47 LO 8 Explain the dollar-value LIFO method. Special Issues Related to LIFO Exercise 8-26 Solution I nvent ory at Prices $ 70, 000 88, 200 End- of - Year Year 2007 2 008 I ndex 1 . 00 1 . 05 I nvent ory at Base- Year Prices $ 7 0, 000 8 4, 000 Base Layers $ 7 0, 000 7 0, 000 1 4, 000 2 009 95, 120 1 . 16 8 2, 000 7 0, 000 1 2, 000 Dec. 31 2007 $ 70, 000 $ 7 0, 000 Dec. 31 2008 $ 8 8, 200 ( 3, 500) $ 8 4, 700 3, 500 (3, 500) $ Value $ Value I ndex 1 . 00 1 . 00 1 . 05 1 . 00 1 . 05 LI FO $ 7 0, 000 7 0, 000 1 4, 700 7 0, 000 1 2, 600 Dec. 31 2009 $ 9 5, 120 ( 12, 520) $ 8 2, 600 9 , 020 ( 9, 020) LI FO TOTAL $ 7 0, 000 $ LI FO Reserve - 8 4, 700 3 , 500 8 2, 600 1 2, 520 Balance Sheet I nvent or y LI FO Reser ve J our nal ent r y Cost of goods sold Lif o r eser ve Chapter 8-48 LO 8 Explain the dollar-value LIFO method. Special Issues Related to LIFO C parison of LI FO Approache om s S cific-goods LI FO - costing goods on a unit basis is e nsiveand pe xpe t im consum e ing. S cific-goods Poole LI FO approach pe d re s re ke ping and cle duce cord e rical costs. m difficult to e thelaye ore rode rs. using quantitie as m asure e basis can le to untim ly LI FO s e m nt ad e liquidations. Dollar-valueLI FOis use by m com d ost panie s. Chapter 8-49 LO 8 Explain the dollar-value LIFO method. Special Issues Related to LIFO Advantage s Matching Tax Be fits/I m ne prove C d ash Flow FutureEarnings He dge Disadvantage s Re d e duce arnings I nve ntory unde rstate d Physical flow I nvoluntary Liquidation / Poor Buying Habits Chapter 8-50 LO 9 Identify the major advantages and disadvantages of LIFO. Identify Basis for Selection of Inventory Method LI FO is ge rally pre rre ne fe d: 1. if se lling price areincre s asing faste than costs and r 2. if a com pany has a fairly constant “basestock.” LI FO is not appropriate : 1. if price te to lag be s nd hind costs, 2. if spe cific ide ntification traditionally use and d, 3. whe unit costs te to n nd de aseas cre production incre s. ase Chapter 8-51 LO 10 Understand why companies select given inventory methods. Chapter 8-52 Chapter 8-53 Chapter 8-54 Chapter 8-55 ...
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