ch06 inventry practice.docx
- 1. Chapter 6- 1
- 2. Chapter 6- 2 Chapter 3 Inventories Accounting Principles, Ninth Edition
- 3. Chapter 6- 3 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 lower-of-cost-or-market basis of accounting for inventories.
- 4. Chapter 6- 4 5. Indicate the effects of inventory errors on the financial statements. 6. Compute and interpret the inventory turnover ratio.
- 5. • • Work in process Raw materials • inventory Determining ownership of goods • • • • Cost flow assumptions Financial statement and tax effects Consistent use Lower- ofcost- ormarket • effects Balance sheet effects Chapter 6- 4
- 6. • Specific identification Statement Presentation and Analysis Reporting and Analyzing Inventory • Taking a physical Classifying Inventory Determining Inventory Quantities Inventory Costing Inventory Errors • Finished goods • Income statement • Presentation • Analysis
- 7. Classifying Inventory Merchandising Company One Classification: • Merchandise Inventory Manufacturing Company Three Classifications: • Raw Materials • Work in Process • Finished Goods
- 8. Regardless of the classification, companies report all inventories under Current Assets on the balance sheet. Chapter 6-5
- 10. Chapter 6- 6
- 11. Determining Inventory Quantities Chapter6- 11 SO 1 Describe the steps in 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.
- 12. Determining Inventory Quantities Chapter6- 12 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 when business is slow. • at end of the accounting period.
- 13. Determining Inventory Quantities Chapter6- 13 SO 1 Describe the steps in 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. Illustration 6-1
- 14. Determining Inventory Quantities Chapter6- 14 SO 1 Describe the steps in determining inventory quantities. 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.
- 15. Determining Inventory Quantities Chapter6- 15 SO 1 Describe the steps in 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.
- 16. Determining Inventory Quantities Chapter6- 16 SO 1 Describe the steps in determining inventory quantities. d. terms of sale are FOB shipping point. Determining Ownership of Goods Consigned Goods • In some lines of business, it is common to hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership of goods. • These are called consigned goods.
- 17. Inventory Costing Chapter SO 2 Explain the accounting for inventories 6-17 and apply the inventory cost flow thd 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
- 18. Inventory Costing Chapter SO 2 Explain the accounting for inventories 6-18 and apply the inventory cost flow thd Specific Identification Method An 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. Illustration: Assume that Crivitz TV Company purchases three identical 46-inch TVs on different dates at costs
- 19. Inventory Costing Chapter SO 2 Explain the accounting for inventories 6-19 and apply the inventory cost flow thd of $700, $750, and $800. During the year Crivitz sold two sets at $1,200 each. Illustration: If Crivitz sold the TVs it purchased on February 3 and May 22, then its cost of goods sold is Illustration 6-2
- 20. Inventory Costing Chapter SO 2 Explain the accounting for inventories 6-20 and apply the inventory cost flow thd $1,500 ($700 $800), and its ending inventory is $750. Illustration 6-3
- 21. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-21 and apply the inventory cost flow thd Illustration 6-11
- 22. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-22 and apply the inventory cost flow thd Use of cost flow methods in major U.S. companies
- 23. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-23 and apply the inventory cost flow thd Cost Flow Assumption does not need to
- 24. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-24 and apply the inventory cost flow thd equal Physical Movement of Goods Illustration: Assume that Houston Electronics uses a periodic inventory system.
- 25. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-25 and apply the inventory cost flow thd A physical inventory at the end of the year determined that during the year Houston sold 550 units and had 450 units in inventory at December 31. Illustration 6-4
- 26. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-26 and apply the inventory cost flow thd “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.
- 27. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-27 and apply the inventory cost flow thd “First-In-First-Out (FIFO)”
- 28. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-28 and apply the inventory cost flow thd Illustration 6-5
- 29. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-29 and apply the inventory cost flow thd “First-In-First-Out (FIFO)”
- 30. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-30 and apply the inventory cost flow thd Illustration 6-5
- 31. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-31 and apply the inventory cost flow thd “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.
- 32. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-32 and apply the inventory cost flow thd “Last-In-First-Out (LIFO)”
- 33. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-33 and apply the inventory cost flow thd Illustration 6-7
- 34. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-34 and apply the inventory cost flow thd “Last-In-First-Out (LIFO)”
- 35. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-35 and apply the inventory cost flow thd Illustration 6-7
- 36. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-36 and apply the inventory cost flow thd “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.
- 37. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-37 and apply the inventory cost flow thd “Average Cost”
- 38. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-38 and apply the inventory cost flow thd Illustration 6-10
- 39. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-39 and apply the inventory cost flow thd “Average Cost”
- 40. Inventory Costing – Cost Flow Assumptions Chapter SO 2 Explain the accounting for inventories 6-40 and apply the inventory cost flow thd Illustration 6-10
- 41. Inventory Costing – Cost Flow Assumptions Financial Statement and Tax Effects Illustration 6-12
- 42. Inventory Costing – Cost Flow Assumptions Chapter6- 42SO 3 Explain the financial effects of the inventory cost flow assumptions.
- 43. Inventory Costing – 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.
- 44. Inventory Costing – Cost Flow Assumptions Chapter6- 44SO 3 Explain the financial effects of the inventory cost flow assumptions. Chapter SO 2 Explain the accounting for inventories 6-29 and apply the inventory cost flow 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.
- 45. Inventory Costing – Cost Flow Assumptions d. gross profit method.
- 46. Inventory Costing – Cost Flow Assumptions Chapter6- 46 SO 3 Explain the financial effects of the inventory cost flow assumptions. Discussion Question Q6-12 Casey Company has been using the FIFO cost flow method during a prolonged period of rising prices. During the same time period, Casey has been paying out all of its net income as dividends. What adverse effects may result from this policy? See notes page for discussion
- 47. Chapter 6- 47 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
- 48. Inventory Costing Chapter6- 48 SO 3 Explain the financial effects of the inventory cost flow assumptions.
- 49. Inventory Chapter 6- 49 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.
- 50. Inventory Errors Chapter6- 50 SO 5 Indicate the effects of inventory errors on the financial statements. SO 4 Explain the lower-of-cost- ormarket basis of accounting for 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.
- 51. Inventory Chapter 6- 51 SO 4 Explain the lower-of-cost- ormarket basis of accounting for Common Cause: Illustration 6-15
- 52. Inventory Errors Chapter6- 52 SO 5 Indicate the effects of inventory errors on the financial statements. • 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.
- 53. Inventory Errors Chapter6- 53 SO 5 Indicate the effects of inventory errors on the financial statements. Income Statement Effects Inventory errors affect the computation of cost of goods sold and net income. Illustration 6-16 Illustration 6-17
- 54. Inventory Errors Chapter6- 54 SO 5 Indicate the effects of inventory errors on the financial statements. 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.
- 55. Inventory Errors Chapter6- 55 SO 5 Indicate the effects of inventory errors on the financial statements. Illustration 6-18
- 56. Inventory Errors Chapter6- 56 SO 5 Indicate the effects of inventory errors on the financial statements. Combined income for 2-year period is correct. ($3,000) Net Income understated $3,000 Net Income overstated Review Question Understating ending inventory will overstate: a. assets. b. cost of goods sold. c. net income.
- 57. Inventory Errors Chapter6- 57 SO 5 Indicate the effects of inventory errors on the financial statements. d. owner's equity. Balance Sheet Effects Effect of inventory errors on the balance sheet is determined by using the basic accounting equation:.
- 58. Inventory Errors Chapter6- 58 SO 5 Indicate the effects of inventory errors on the financial statements. Illustration 6-16 Illustration 6-19
- 59. 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
- 60. Statement Presentation and Analysis Chapter6- 60 SO 6 Compute and interpret the inventory turnover ratio. 6-42 Analysis 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. Inventory turnover measures the number of times on average the inventory is sold during the period.
- 61. Statement Presentation and Analysis Chapter6- 61 SO 6 Compute and interpret the inventory turnover ratio. Inventory = Cost of Goods Sold Turnover Average Inventory Days in inventory measures the average number of days inventory is held. Days in = Days in Year (365) Inventory Inventory Turnover
- 62. Statement Presentation and Analysis Chapter6- 62 SO 6 Compute and interpret the inventory turnover ratio. Illustration: Wal-Mart reported in its 2008 annual report a beginning inventory of $33,685 million, an ending inventory of $35,180 million, and cost of goods sold for the year ended January 31, 2008, of $286,515 million. The inventory turnover formula and computation for Wal-Mart are shown below. Illustration 6-21
- 63. Statement Presentation and Analysis Chapter6- 63 SO 6 Compute and interpret the inventory turnover ratio. Days in Inventory: Inventory turnover of 8.3 times divided into 365 is approximately 44 days. This is the approximate time that it takes a company to sell the inventory.
- 64. Chapter6- 64 SO 7 Apply the inventory cost flow methods to perpetual inventory records. Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Average cost. Example Cost Flow Methods in Perpetual Systems Appendix 6A
- 65. Cost Flow Methods in Perpetual Systems Chapter6- 65 SO 7 Apply the inventory cost flow methods to perpetual inventory records. “First-In-First-Out (FIFO)” Illustration 6A-2
- 66. Cost Flow Methods in Perpetual Systems Chapter6- 66 SO 7 Apply the inventory cost flow methods to perpetual inventory records.
- 67. Cost Flow Methods in Perpetual Systems Chapter6- 67 SO 7 Apply the inventory cost flow methods to perpetual inventory records. “Last-In-First-Out (LIFO)” Illustration 6A-3
- 68. Cost Flow Methods in Perpetual Systems Chapter6- 68 SO 7 Apply the inventory cost flow methods to perpetual inventory records. “Average Cost” (Moving-Average System) Illustration 6A-4
- 69. Cost Flow Methods in Perpetual Systems Chapter6- 69 SO 7 Apply the inventory cost flow methods to perpetual inventory records.
- 70. Estimating Inventories Chapter6- 70 SO 8 Describe the two methods of estimating inventories. Gross Profit Method The gross profit method estimates the cost of ending inventory by applying a gross profit rate to net sales. Illustration 6B-1 Illustration: Kishwaukee Company’s records for January show net sales of $200,000, beginning inventory $40,000, and cost of
- 71. Estimating Inventories Chapter6- 71 SO 8 Describe the two methods of estimating inventories. goods purchased $120,000. The company expects to earn a 30% gross profit rate. Compute the estimated cost of the ending inventory at January 31 under the gross profit method. Illustration 6B-2
- 72. Estimating Inventories Chapter6- 72 SO 8 Describe the two methods of estimating inventories. Retail Inventory Method Company applies the cost-to-retail percentage to ending inventory at retail prices to determine inventory at cost. Illustration 6B-3
- 73. Estimating Inventories Chapter6- 73 SO 8 Describe the two methods of estimating inventories. Illustration: Note that it is not necessary to take a physical inventory to determine the estimated cost of goods on hand at any given time. Illustration 6B-4
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- 75. caused by the use of these programs or from the use of the information contained herein.” Chapter 6-54