Chapter 6

Reporting and Analyzing Inventory

6

Manufacturing Inventory

• Finished goods inventory

• Work in process

• Raw materials

7

Finished Goods Inventory

Manufactured items that are complete and ready for sale.

8

Work in Process

Manufactured inventory that has been placed into production but is not yet complete.

9

Raw Materials

The basic goods that will be used in production, but have not been placed in production.

Key difference between

periodic and perpetual inventory…

is the point at which the costs of goods sold is

computed.

7

Determine Inventory Quantities

• Determine inventory quantities by counting, weighting or measuring each type of inventory.

• Determine ownership of goods, including goods in transit, consigned goods.

8

Questions Concerning Ownership

• Do all the goods included in the count belong to the company?

• Does the company own any goods not included in the count?

9

Goods in Transit

Goods are on board a truck, train, ship, or plane at the end of the period.

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Who includes them in inventory?

Seller?Buyer? The

Company with Legal Title

Terms of Sale- FOB (free-on-board)

Consigned Goods

• Goods of others you hold. You do not pay for the goods until they sell.

• The company does not take ownership.

What Is a Cost Flow Assumption?

To presume the order in which goods are sold even if flow of costs is unrelated to the physical flow of goods.

Inventory Cost Flows

• Specific Identification--The tracking of actual costs for specifically identified units.

• FIFO (first-in, first-out)--Assumption that the first goods bought are the first goods sold.

• LIFO (last-in, first-out)--Assumption that the last goods purchased are the first goods sold.

• Weighted Average Cost –Assumption that when similar units are combined in inventory the costs are merged and averaged between all parts.

Specific Identification

• Used by companies that sell limited products at a high price.

• Requires that each unit has a specific cost associated with it.

Data for Examples

Beginning Inventory 10 hats @ $10 each = $100

Purchases (February) 15 hats @ $15 each = $225

Sales (June) 20 hats

Purchases (July) 10 hats @ $18 each = $180

Ending Inventory 15 hats

Use the following data to show the journal entry for the sales in June and the value of ending inventory using the FIFO Perpetual method.

FIFO 2007 Inventory

Purchase Sale Balance `Date Units Total Units Total Units Cost Total

Jan 1 10 $10 $100

Feb 15 $225 10 $10 $100 15 $15 $225

June 10 $100 10 $150 5 $15 $ 75

July 10 $180 5 $15 $ 75 10 $18 $180

FIFO Perpetual

Cost of Goods Sold:

Beginning Inventory 10 @ $10 = $ 100

February Purchases 10 @ $15 = $ 150

Total $ 250

Ending Inventory:

February Purchases 5 @ $15 = $ 75

December Purchases 10 @ $18 = $ 180

Total $ 255

FIFO Perpetual Journal Entry

In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:

Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.

In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:

Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.

Cost of Goods Sold............... .. 250 Inventory........................... 250To recognize expenses from selling hats.

FIFO Perpetual Journal Entry

Using FIFO - - - both perpetual and periodic inventory systems result in the same results.

FIFO Periodic Inventory

Beg. 10

Jan

Purch. 15

Feb

Purch. 10

July

Sale 20

June

LIFO Perpetual Inventory

Purchase Sale Balance `Date Units Total Units Total Units Cost Total

Jan 1 10 $10 $100

Feb 15 $225 10 $10 $100 15 $15 $225

June 15 $225 5 $ 50 5 $10 $ 50

Dec 10 $180 5 $10 $ 50 10 $18 $180

Using LIFO - - - perpetual removes the latest items received at the time of each sale.

LIFO Perpetual Inventory

Beg. 10

Jan

Purch. 15

Feb

Purch. 10

July

Sale 20

June

LIFO Perpetual Journal Entry

In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:

Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.

LIFO Perpetual Journal Entry

In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:

Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.

Cost of Goods Sold............... .. 275 Inventory........................... 275To recognize expenses from selling hats.

Inventory Costing - Periodic

1. Determine quantity of units of inventory

2. Apply unit costs to the quantities

3. Determine total cost of inventory

4. Determine cost of goods sold

Process can be complicated if units are purchased at different times and at different prices!

LIFO Periodic

Cost of Goods Sold:

July Purchases 10 @ $18 = $ 180

February Purch 10 @ $15 = $ 150

Total $ 330

Ending Inventory:

Beginning Inventory 10 @ $10 = $ 100

February Purchases 5 @ $15 = $ 75

Total $ 175

Using LIFO - - - periodic removes the latest items received as of the end of the period.

LIFO Periodic Inventory

Beg. 10

Jan

Purch. 15

Feb

Purch. 10

July Sale 20

June

Weighted-Average Perpetual

In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:

Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.

Weighted-Average Perpetual

In June, the Hat Company sold 20 hats for $25 each. The entry is as follows:

Accounts Receivable............... 500 Sales Revenue.................. 500To recognize revenues from June sales.

Cost of Goods Sold................. 260 Inventory........................... 260To recognize expenses from selling hats.

Weighted-Average 2007 Inventory

Purchase Sale Balance `Date Units Total Units Total Units Cost Total

Jan 1 10 $10.00 $100

Feb 15 $225 25 $13.00 $325

June 20 $260 5 $13.00 $ 65

July 10 $180 15 $16.33 $245

Weighted Average

Cost of Goods Sold:

Units Sold 20 @ $13.00 = $ 260

Total $ 260

Ending Inventory:

Units Remaining 15 @ $16.33 = $ 245

Total $ 245

Using Weighted Average - - - perpetual removes units at the average cost of all goods on hand.

Weighted Average Inventory

Beg. 10

Jan

Purch. 15

Feb

Purch. 10

July

Sale 20

June

Question 1Question 1

Which inventory cost flow method produces Which inventory cost flow method produces the the highesthighest net income in a period of rising net income in a period of rising prices?prices?

a.a. Weighted average costWeighted average costb.b.LifoLifoc.c. FifoFifod.d.Specific Identification.Specific Identification.

Question 1Question 1

Which inventory cost flow method produces Which inventory cost flow method produces the the highesthighest net income in a period of rising net income in a period of rising prices?prices?

a.a. Weighted average costWeighted average costb.b.LifoLifoc.c. FifoFifod.d.Specific Identification.Specific Identification.

Which inventory cost flow method produces Which inventory cost flow method produces the the lowestlowest income taxes in a period of rising income taxes in a period of rising prices?prices?

Question 2Question 2

a.a. Weighted average costWeighted average costb.b. LifoLifoc.c. FifoFifod.d. Specific Identification.Specific Identification.

Which inventory cost flow method produces Which inventory cost flow method produces the the lowestlowest income taxes in a period of rising income taxes in a period of rising prices?prices?

Question 2Question 2

a.a. Weighted average costWeighted average costb.b. LifoLifoc.c. FifoFifod.d. Specific Identification.Specific Identification.

Comparison of Inventory Costing Methods -- Perpetual

Weighted FIFO LIFO Average

EndingInventory $255 $230 $245

Comparison of Inventory Costing Methods -- Perpetual

Weighted FIFO LIFO Average

EndingInventory $255 $230 $245

Cost ofGoods Sold $250 $275 $260

Income Statement Effects

The Lower of Cost or Market Basis of Accounting for Inventories

When the value of inventory is lower than

its cost, the inventory is written down to

its market value by valuing the inventory

at the lower of cost or market (LCM) in

the period in which the price decline

occurs.

Lower of Cost or Market (LCM)

• departure from cost principle

• follows conservatism concept

• can be used only after one of the cost flow methods ( Specific Identification FIFO, LIFO, or Average Cost)

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Market Is...

CURRENT REPLACEMENT COST

How Much Inventory Should a Company Have?

– Only enough for sales needs

– Excess inventory costs:

• storage costs

• interest costs

• obsolescence - technology, fashion

Inventory Turnover Ratio =

An indication of how quickly a company sells its goods.

Higher is better.

Inventory Turnover Ratio =

Cost of Goods Sold

Average Inventory

Days in Inventory =

An indication of how quickly a company sells its goods.

Lower is better.

Days in Inventory =

365 days

Inventory Turnover Ratio

Lifo Reserve And Its Importance For Comparing Results Of Different Companies

• Accounting standards require firms using LIFO to

report the amount by which inventory would be

increased (or on occasion decreased) if the firm had

instead been using FIFO.

• This amount is referred to as the LIFO reserve.

Reporting the LIFO reserve enables analysts to

make adjustments to compare companies that use

different cost flow methods.