ch06 - CHAPTER 6 CHAPTER Inventories Chapter 6- 1 Study...

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Unformatted text preview: CHAPTER 6 CHAPTER Inventories Chapter 6- 1 Study Objectives Study Objectives 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 lower­of­cost­or­market basis of accounting for inventories. 5. Indicate the effects of inventory errors on the financial statements. 6. Compute and interpret the inventory turnover ratio. Chapter 6-2 Reporting and Analyzing Inventory Reporting and Analyzing Inventory Classifying Classifying Inventory Inventory Merchandising Merchandising inventory inventory Manufacturing Manufacturing inventory inventory Chapter 6- 3 Determining Determining Inventory Quantities Quantities Taking a Taking physical inventory inventory Determining Determining ownership of goods goods Inventory Inventory Costing Costing Specific Specific identification identification Cost flow Cost assumptions assumptions Financial Financial statement and tax effects effects Consistent Consistent use use Lower-ofcost-ormarket Inventory Inventory Errors Errors Income Income statement effects effects Balance sheet Balance effects effects Statement Statement Presentation and Analysis and Presentation Analysis Classifying Inventory Classifying Inventory Merchandising Company One Classification: Merchandise Inventory Manufacturing Company Three Classifications: Raw Materials Work in Process Finished Goods Regardless of the classification, companies report all inventories under Current Assets on the balance sheet. Chapter 6- 4 Determining Inventory Quantities Determining Inventory Quantities Physical Inventory taken for two reasons: Perpetual System 1. Check accuracy of inventory records. 2. Determine amount of inventory lost (wasted raw materials, shoplifting, or employee theft). Periodic System 1. Determine the inventory on hand 2. Determine the cost of goods sold for the period. Chapter 6- 5 SO 1 Describe the steps in determining inventory quantities. Determining Inventory Quantities Determining Inventory Quantities Determining Taking a Physical Inventory 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. Chapter 6- 6 SO 1 Describe the steps in determining inventory quantities. Determining Inventory Quantities Determining Inventory Quantities Determining Ownership of Goods Goods in Transit Purchased goods not yet received. Sold goods not yet delivered. 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 6-7 SO 1 Describe the steps in determining inventory quantities. Determining Inventory Quantities Determining Inventory Quantities Terms of Sale Illustration 6­1 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. Chapter 6-8 SO 1 Describe the steps in determining inventory quantities. Determining Inventory Quantities Determining Inventory Quantities Determining Ownership of Goods Consigned Goods Goods held for sale by one party although ownership of the goods is retained by another party. Chapter 6- 9 SO 1 Describe the steps in determining inventory quantities. Inventory Costing Inventory Costing Unit costs can be applied to quantities on hand using the following costing methods: Specific Identification First­in, first­out (FIFO) Last­in, first­out (LIFO) Cost Flow Assumptions Average­cost Chapter 6-10 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions Assumptions Cost Flow Assumption does not need to equal Physical Movement of Goods Illustration 6-11 Use of cost flow methods in major U.S. companies Chapter 6-11 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions Assumptions Example Young & Crazy Company makes the following purchases: 1. One item on 2/2/07 for $10 2. One item on 2/15/07 for $15 3. 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%. Chapter 6-12 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions Assumptions “First-In-First-Out (FIFO)” Earliest goods purchased are first to be sold. Often parallels actual physical flow of merchandise. Generally good business practice to sell oldest units first. Chapter 6-13 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions 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 6-14 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 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions 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 6-15 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 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions Assumptions “Last-In-First-Out (LIFO)” 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. Chapter 6-16 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions 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 6-17 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 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions 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 6-18 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 26 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions Assumptions “Average Cost” 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. Chapter 6-19 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions 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 6-20 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 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions 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 6-21 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 SO 2 Explain the accounting for inventories and SO apply the inventory cost flow methods. apply IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions AssumptionsFinancial Statement Summary Comparative Comparative Financial Statement Summary FIFO Sales Average LIFO $90 $90 Cost of goods sold 10 15 20 Gross profit 80 75 70 Admin. & selling expense 33 33 33 Income before taxes 47 42 37 Income tax expense 14 12 11 Net income $33 $30 $26 Inventory balance Chapter 6-22 $90 $35 $30 $25 LO 3 Explain the financial effects of the inventory cost flow assumptions. IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions Assumptions In Period of Rising Prices, FIFO Reports: In Period of Rising Prices, FIFO Reports: FIFO LIFO $90 Cost of goods sold 10 15 20 Gross profit 80 75 70 33 33 33 47 42 37 Income tax expense 14 12 11 Net income $33 $30 $26 Inventory balance Chapter 6-23 $90 Income before taxes Highest $90 Admin. & selling expense Lowes t Sales Average $35 $30 $25 LO 3 Explain the financial effects of the inventory cost flow assumptions. IInventory Costing – Cost Flow Inventory Costing – Cost Flow nventory Inventory Assumptions Assumptions Assumptions Assumptions In Period of Rising Prices, LIFO Reports: In Period of Rising Prices, LIFO Reports: FIFO LIFO $90 Cost of goods sold 10 15 20 80 75 70 33 33 33 Income before taxes 47 42 37 Income tax expense 14 12 11 Net income $33 $30 $26 Inventory balance Chapter 6-24 $90 Admin. & selling expense Lowes t $90 Gross profit Highest Sales Average $35 $30 $25 LO 3 Explain the financial effects of the inventory cost flow assumptions. Inventory Costing Inventory Costing Lower-of-Cost-or-Market 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 6-25 SO 4 Explain the lower-of-cost-or-market SO basis of accounting for inventories. basis Inventory Costing Inventory Costing Lower-of-Cost-or-Market Exercise: Alou Appliance Center accumulates the following cost and market data at December 31. I nvent ory Cost Market Lower of Cat egories Dat a Dat a Cost or Market $ 12, 000 $ 1 2, 100 $ 12,000 9, 000 9 , 700 14, 000 1 2, 800 9,000 12,800 $ 33,800 Cameras Camcorders VCRs Compute the lower­of­cost­or­market valuation for the company’s total inventory. Chapter 6-26 SO 4 Explain the lower-of-cost-or-market SO basis of accounting for inventories. basis Inventory Errors Inventory Errors 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 6-27 SO 5 Indicate the effects of inventory errors on the financial statements. Inventory Errors Inventory Errors Income Statement Effects Inventory errors affect the computation of cost of goods sold and net income. Illustration 6­16 Illustration 6­17 Chapter 6-28 SO 5 Indicate the effects of inventory errors on the financial statements. Inventory Errors Inventory Errors Income Statement Effects 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. Chapter 6-29 SO 5 Indicate the effects of inventory errors on the financial statements. Inventory Errors Inventory Errors 2 008 Illustration 6­18 2009 I ncorrect Correct I ncorrect Correct $ 80, 000 $ 8 0, 000 $ 9 0, 000 $ 9 0, 000 O pen invent or y(er r or :over st at e) 20, 000 2 0, 000 1 2, 000 1 5, 000 Cost of goods purchased 40, 000 4 0, 000 6 8, 000 6 8, 000 Cost of goods available 60, 000 6 0, 000 8 0, 000 8 3, 000 Close invent or y(er r or :under st at e) 12, 000 1 5, 000 2 3, 000 2 3, 000 Cost of good sold 48, 000 4 5, 000 5 7, 000 6 0, 000 Gross prof it 32, 000 3 5, 000 3 3, 000 3 0, 000 Operat ing expenses 10, 000 1 0, 000 2 0, 000 2 0, 000 $ 22, 000 $ 2 5, 000 $ 1 3, 000 $ 1 0, 000 Sales N et income Combined income for 2­year period is correct. Chapter 6-30 ($3,000) Net Income understated $3,000 Net Income overstated SO 5 Indicate the effects of inventory errors on the financial statements. Inventory Errors Inventory Errors Review Question Understating ending inventory will overstate: a. assets. b. cost of goods sold. c. net income. d. owner's equity. Chapter 6-31 SO 5 Indicate the effects of inventory errors on the financial statements. Inventory Errors Inventory Errors Balance Sheet Effects Effect of inventory errors on the balance sheet is determined by using the basic accounting equation:. Illustration 6­16 Illustration 6­19 Chapter 6-32 SO 5 Indicate the effects of inventory errors on the financial statements. Statement Presentation and Analysis Statement Presentation and Analysis Presentation 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). Chapter 6-33 Statement Presentation and Analysis Statement Presentation and Analysis Analysis Inventory management is a double­edged 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. Chapter 6-34 SO 6 Compute and interpret the inventory turnover ratio. Statement Presentation and Analysis Statement Presentation and Analysis Inventory turnover measures the number of times on average the inventory is sold during the period. Inventory Turnover = Cost of Goods Sold Average Inventory Days in inventory measures the average number of days inventory is held. Days in Year (365) Days in = Inventory Inventory Turnover Chapter 6-35 SO 6 Compute and interpret the inventory turnover ratio. Statement Presentation and Analysis Statement Presentation and Analysis 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. Inventory Turnover Days in Inventory Chapter 6-36 $270,000 ($60,000 + 40,000) / 2 365 5.4 = 5.4 = 67.59 days SO 6 Compute and interpret the inventory turnover ratio. ...
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