CH 06

6-1
6
REPORTING AND ANALYZING INVENTORY
6-2
Financial Accounting, Sixth Edition
Study Objectives
1. 2. Describe the steps in determining inventory quantities. Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Explain the financial statement and tax effects of each of the inventory cost flow assumptions. Explain the lower-of-cost-or-market basis of accounting for inventories. Compute and interpret the inventory turnover ratio. Describe the LIFO reserve and explain its importance for comparing results of different companies.
3.
4.
5. 6.
6-3
Reporting and Analyzing Inventory
Classifying Inventory
Merchandising Manufacturing Just-in-time
Determining Inventory Quantities

Taking a physical inventory Determining ownership of goods
Inventory Costing
Specific identification Cost flow assumptions Financial statement and tax effects Consistent use Lower-of-costor-market
Analysis of Inventory
Inventory turnover ratio LIFO reserve
6-4
Classifying Inventory
Merchandising Company
One Classification:
Manufacturing Company
Three Classifications:

Merchandise Inventory
Raw Materials Work in Process Finished Goods
Regardless of the classification, companies report all inventories under Current Assets on the balance sheet.
6-5
6-6

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.
6-7
SO 1 Describe the steps in determining inventory quantities.

Taking a Physical Inventory
Involves counting, weighing, or measuring each kind of inventory on hand.
Taken,
when the business is closed or business is slow.

at end of the accounting period.
6-8
6-9

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.
6-10

Goods in Transit
Illustration 6-1 Terms of sale
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.
6-11
Determining Inventory Quantities Review Question

Goods in transit should be included in the inventory of the buyer when the:
a. public carrier accepts the goods from the seller. b. goods reach the buyer. c. terms of sale are FOB destination.
d. terms of sale are FOB shipping point.
6-12

Determining Ownership of Goods
Consigned Goods
Goods held for sale by one party although ownership of the goods is retained by another party.
6-13
6-14
Inventory Costing
Unit costs can be applied to quantities on hand using the following costing methods:
Specific Identification First-in, first-out (FIFO) Last-in, first-out (LIFO) Average-cost
Cost Flow Assumptions
6-15
SO 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.
Inventory Costing
Illustration: Assume that Crivitz TV Company purchases three identical 50-inch TVs on different dates at costs of $700, $750, and $800. During the year Crivitz sold two sets at $1,200 each. These facts are summarized below.
Illustration 6-2
6-16
Inventory Costing
Specific Identification
If Crivitz sold the TVs it purchased on February 3 and May 22, then its cost of goods sold is $1,500 ($700 + $800), and its ending inventory is $750.
Illustration 6-3
6-17
Inventory Costing
Specific Identification
Actual physical flow costing method in which items still in inventory are specifically costed to arrive at the total cost of the ending inventory. Practice is relatively rare.
Most companies make assumptions (Cost Flow Assumptions) about which units were sold.
6-18
Inventory Costing
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
6-19
Inventory Cost Flow Assumptions

Illustration: Data for Houston Electronics Astro condensers.
Illustration 6-4
(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold

6-20

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.
6-21

Illustration 6-5
6-22
SO 2

Illustration 6-5
6-23

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.
6-24

Illustration 6-7
6-25

Illustration 6-7
6-26

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.
6-27

Average-Cost
Illustration 6-10
6-28

Average-Cost
Illustration 6-10
6-29
Financial Statement and Tax Effects

Comparative Financial Statement Summary
FIFO Average LIFO
Sales
$9,000
$9,000
$9,000
Cost of goods sold

Gross profit Admin. & selling expense
6,200
2,800 330
6,600
2,400 330
7,000
2,000 330
Income before taxes

Income tax expense Net income
2,470
140 $2,330
2,070
120 $1,950
1,670
110 $1,560
Inventory balance
6-30
$5,800
$5,400
$5,000
LO 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions.

In Period of Rising Prices, FIFO Reports:
FIFO Average LIFO
Sales
$9,000
$9,000
$9,000
Lowest
Cost of goods sold

6,200
2,800 330
6,600
2,400 330
7,000
2,000 330
Income before taxes

Income tax expense
2,470
140 $2,330
2,070
120 $1,950
1,670
110 $1,560
Highest
Net income
Inventory balance
6-31
$5,800
$5,400
$5,000

In Period of Rising Prices, LIFO Reports:
FIFO Average LIFO
Sales
$9,000
$9,000
$9,000
Highest
Cost of goods sold

6,200
2,800 330
6,600
2,400 330
7,000
2,000 330
Income before taxes

Income tax expense
2,470
140 $2,330
2,070
120 $1,950
1,670
110 $1,560
Lowest
Net income
Inventory balance
6-32
$5,800
$5,400
$5,000
Inventory Cost Flow Assumptions Review Question

The cost flow method that often parallels the actual physical flow of merchandise is the:
a. FIFO method.
b. LIFO method.
c. average cost method. d. gross profit method.
6-33
Inventory Cost Flow Assumptions Review Question

In a period of inflation, the cost flow method that results in the lowest income taxes is the:
a. FIFO method.
b. LIFO method.
c. average cost method. d. gross profit method.
6-34
6-35
Inventory Costing
Using Cost Flow Methods Consistently
Method should be used consistently, enhances comparability. Although consistency is preferred, a company may change its inventory costing method.
Illustration 6-14 Disclosure of change in cost flow method
6-36
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.
6-37
SO 4 Explain the lower-of-cost-or-market basis of accounting for inventories.
Inventory Costing
Lower-of-Cost-or-Market
Illustration: Assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated.
Illustration 6-15
6-38
SO 4 Explain the lower-of-cost-or-market basis of accounting for inventories.
Inventory management is a double-edged 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.
6-39
SO 5 Compute and interpret the inventory turnover ratio.
Inventory Turnover Ratio
Illustration 6-16
6-40
Illustration: Data available for Wal-Mart.
Illustration 6-16
6-41
6-42
Analysts Adjustments for LIFO Reserve
Companies using LIFO are required to report the amount that inventory would increase (or occasionally decrease) if the company had instead been using FIFO. This amount is referred to as the LIFO reserve.
Illustration 6-17
6-43
SO 6 Describe the LIFO reserve and explain its importance for comparing results of different companies.
Analysts Adjustments for LIFO Reserve
The LIFO reserve can have a significant effect on ratios analysts commonly use.
Illustration 6-19
6-44
SO 6 Describe the LIFO reserve and explain its importance for comparing results of different companies.
appendix 6A
Illustration:
Perpetual Inventory System

Illustration 6A-1
Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Average cost.
6-45
SO 7 Apply the inventory cost flow methods to perpetual inventory records.
appendix 6A

Illustration 6A-2
Cost of Goods Sold

6-46
Ending Inventory
appendix 6A

Illustration 6A-3
Cost of Goods Sold

6-47
Ending Inventory
appendix 6A
Average-Cost

Illustration 6A-4
Cost of Goods Sold
Ending Inventory
6-48
appendix 6B
Inventory Errors
Common Cause:

Inventory Errors
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.
6-49
SO 8 Indicate the effects of inventory errors on the financial statements.
appendix 6B
Income Statement Effects
Inventory Errors
Inventory errors affect the computation of cost of goods sold and net income.
Illustration 6-B1
Illustration 6-B2
6-50
appendix 6B
Income Statement Effects
Inventory Errors
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.
Ending inventory depends entirely on the accuracy of taking and costing the inventory.
6-51
appendix 6B
Illustration 6-B3
Inventory Errors
2011 Incorrect Correct $ 80,000 20,000 40,000 60,000 12,000 48,000 32,000 10,000 $ 22,000 $ $ 80,000 20,000 40,000 60,000 15,000 45,000 35,000 10,000 25,000 $ 2012 Incorrect Correct $ 90,000 12,000 68,000 80,000 23,000 57,000 33,000 20,000 13,000 $ $ 90,000 15,000 68,000 83,000 23,000 60,000 30,000 20,000 10,000
Sales Beginning inventory Cost of goods purchased Cost of goods available Ending inventory Cost of good sold Gross profit Operating expenses Net income
Combined income for 2-year period is correct.

6-52
($3,000) Net Income understated
$3,000 Net Income overstated
appendix 6B
Review Question
Inventory Errors
Understating ending inventory will overstate: a. assets. b. cost of goods sold. c. net income. d. owner's equity.
6-53
appendix 6B
Balance Sheet Effects
Inventory Errors
Effect of inventory errors on the balance sheet is determined by using the basic accounting equation:
Illustration 6-B1
Illustration 6-B4
6-54
Key Points
The requirements for accounting for and reporting inventories are more principles-based under IFRS. That is, GAAP provides more detailed guidelines in inventory accounting. The definitions for inventory are essentially similar under IFRS and GAAP. Both define inventory as assets held-forsale in the ordinary course of business, in the process of production for sale (work in process), or to be consumed in the production of goods or services (e.g., raw materials).
6-55
Key Points
Who owns the goodsgoods in transit or consigned goodsas well as the costs to include in inventory, are accounted for the same under IFRS and GAAP.
Both GAAP and IFRS permit specific identification where appropriate. IFRS actually requires that the specific identification method be used where the inventory items are not interchangeable (i.e., can be specifically identified). If the inventory items are not specifically identifiable, a cost flow assumption is used. GAAP does not specify situations in which specific identification must be used.
6-56
Key Points
A major difference between IFRS and GAAP relates to the LIFO cost flow assumption. GAAP permits the use of LIFO for inventory valuation. IFRS prohibits its use. FIFO and average-cost are the only two acceptable cost flow assumptions permitted under IFRS. IFRS requires companies to use the same cost flow assumption for all goods of a similar nature. GAAP has no specific requirement in this area.
6-57
Key Points
In the lower-of-cost-or-market test for inventory valuation, IFRS defines market as net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and estimated selling expenses. In other words, net realizable value is the best estimate of the net amounts that inventories are expected to realize. GAAP, on the other hand, defines market as essentially replacement cost.
6-58
Key Points
Under GAAP, if inventory is written down under the lower-ofcost-or-market valuation, the new value becomes its cost basis. As a result, the inventory may not be written back up to its original cost in a subsequent period. Under IFRS, the write-down may be reversed in a subsequent period up to the amount of the previous write-down. Both the write-down and any subsequent reversal should be reported on the income statement as an expense. An item-by-item approach is generally followed under IFRS.
6-59
Key Points
Unlike property, plant, and equipment, IFRS does not permit the option of valuing inventories at fair value. As indicated above, IFRS requires inventory to be written down, but inventory cannot be written up above its original cost. Similar to GAAP, certain agricultural products and mineral products can be reported at net realizable value using IFRS.
6-60
Looking into the Future

One convergence issue relates to the use of the LIFO cost flow assumption. IFRS specifically prohibits its use. Conversely, the LIFO cost flow assumption is widely used in the United States because of its favorable tax advantages. With a new conceptual framework being developed, it is highly probable that the use of the concept of conservatism will be eliminated. Similarly, the concept of prudence in the IASB literature will also be eliminated. This may ultimately have implications for the application of the lower-of-cost-or-net realizable value.
6-61
Which of the following should not be included in the inventory of a company using IFRS? a) Goods held on consignment from another company.
b) Goods shipped on consignment to another company. c) Goods in transit from another company shipped FOB shipping point.
d) None of the above.
6-62
Which method of inventory costing is prohibited under IFRS? a) Specific identification. b) FIFO. c) LIFO. d) Average-cost.
6-63
Specific identification: a) must be used under IFRS if the inventory items are not interchangeable. b) cannot be used under IFRS. c) cannot be used under GAAP. d) must be used under IFRS if it would result in the most
conservative net income.
6-64
Copyright
Copyright 2011 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in

Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser

may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.
6-65

CH 06

Transféré par

Informations du document

Description originale:

Titre original

Copyright

Formats disponibles

Partager ce document

Partager ou intégrer le document

Options de partage

Avez-vous trouvé ce document utile ?

Ce contenu est-il inapproprié ?

Droits d'auteur :

Formats disponibles

CH 06

Transféré par

Droits d'auteur :

Formats disponibles

6-1

Financial Accounting, Sixth Edition

Reporting and Analyzing Inventory

Determining Inventory Quantities

Raw Materials Work in Process Finished Goods

Determining Inventory Quantities

SO 1 Describe the steps in determining inventory quantities.

Determining Inventory Quantities

when the business is closed or business is slow.

SO 1 Describe the steps in determining inventory quantities.

Determining Inventory Quantities

SO 1 Describe the steps in determining inventory quantities.

Determining Inventory Quantities

Determining Inventory Quantities Review Question

d. terms of sale are FOB shipping point.

SO 1 Describe the steps in determining inventory quantities.

Determining Inventory Quantities

SO 1 Describe the steps in determining inventory quantities.

Illustration 6-11 Use of cost flow methods in major U.S. companies

Inventory Cost Flow Assumptions

(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold

Inventory Cost Flow Assumptions

Inventory Cost Flow Assumptions

Inventory Cost Flow Assumptions

Inventory Cost Flow Assumptions

Inventory Cost Flow Assumptions

Inventory Cost Flow Assumptions

Inventory Cost Flow Assumptions

on hand to determine cost of the ending inventory.

Inventory Cost Flow Assumptions

Inventory Cost Flow Assumptions

Financial Statement and Tax Effects

Cost of goods sold

Income before taxes

Financial Statement and Tax Effects

Cost of goods sold

Income before taxes

Financial Statement and Tax Effects

Cost of goods sold

Income before taxes

Inventory Cost Flow Assumptions Review Question

Inventory Cost Flow Assumptions Review Question

SO 4 Explain the lower-of-cost-or-market basis of accounting for inventories.

SO 4 Explain the lower-of-cost-or-market basis of accounting for inventories.

costs (e.g., investment, storage, insurance, obsolescence, and damage).

SO 5 Compute and interpret the inventory turnover ratio.

SO 5 Compute and interpret the inventory turnover ratio.

SO 5 Compute and interpret the inventory turnover ratio.

Perpetual Inventory System

SO 7 Apply the inventory cost flow methods to perpetual inventory records.

Perpetual Inventory System

Cost of Goods Sold

SO 7 Apply the inventory cost flow methods to perpetual inventory records.

Perpetual Inventory System

Cost of Goods Sold

SO 7 Apply the inventory cost flow methods to perpetual inventory records.

Perpetual Inventory System

Cost of Goods Sold

SO 7 Apply the inventory cost flow methods to perpetual inventory records.

SO 8 Indicate the effects of inventory errors on the financial statements.

SO 8 Indicate the effects of inventory errors on the financial statements.

SO 8 Indicate the effects of inventory errors on the financial statements.