Chapter 6-1

CHAPTER CHAPTER 66

INVENTORIESINVENTORIES

Accounting Principles, Eighth Edition

Chapter 6-2

Reporting and Analyzing InventoryReporting and Analyzing InventoryReporting and Analyzing InventoryReporting and Analyzing Inventory

Taking a Taking a physical physical inventoryinventory

Determining Determining ownership of ownership of goodsgoods

Classifying Classifying

InventoryInventory

Classifying Classifying

InventoryInventory

Determining Determining

Inventory Inventory

QuantitiesQuantities

Determining Determining

Inventory Inventory

QuantitiesQuantities

Inventory Inventory

CostingCosting

Inventory Inventory

CostingCostingInventory Inventory

ErrorsErrors

Inventory Inventory

ErrorsErrors

Statement Statement

Presentation Presentation

and Analysisand Analysis

Statement Statement

Presentation Presentation

and Analysisand Analysis

Finished Finished goodsgoods

Work in Work in processprocess

Raw materialsRaw materials

Specific Specific identificationidentification

Cost flow Cost flow assumptionsassumptions

Financial Financial statement statement and tax and tax effectseffects

Consistent Consistent useuse

Lower-of-Lower-of-cost-or-cost-or-marketmarket

Income Income statement statement effectseffects

Balance sheet Balance sheet effectseffects

PresentationPresentation

AnalysisAnalysis

Chapter 6-3

Classifying InventoryClassifying InventoryClassifying InventoryClassifying Inventory

One Classification:

Merchandise Inventory

Three Classifications:

Raw Materials

Work in Process

Finished Goods

Merchandising Company

Manufacturing Company

Regardless of the classification, companies report all inventories under Current Assets on the balance sheet.

Chapter 6-4

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

Inventory CostingInventory CostingInventory CostingInventory Costing

LO 2 Explain the accounting for LO 2 Explain the accounting for inventories and apply the inventory inventories and apply the inventory cost flow methods.cost flow methods.

Cost Flow Assumptio

ns

Chapter 6-5

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.

Specific Identification MethodSpecific Identification Method

Inventory CostingInventory CostingInventory CostingInventory Costing

LO 2 Explain the accounting for LO 2 Explain the accounting for inventories and apply the inventory inventories and apply the inventory cost flow methods.cost flow methods.

Chapter 6-6

LO 2 Explain the accounting for LO 2 Explain the accounting for inventories and apply the inventory inventories and apply the inventory cost flow methods.cost flow methods.

Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptionsInventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions

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

Cost Flow

Assumption

does not need to

equal

Physical Movement

of Goods

Chapter 6-7

Earliest goods purchased are first to be sold.

Often parallels actual physical flow of merchandise.

Generally good business practice to sell oldest units first.

““First-In-First-Out (FIFO)”First-In-First-Out (FIFO)”

LO 2 Explain the accounting for LO 2 Explain the accounting for inventories and apply the inventory inventories and apply the inventory cost flow methods.cost flow methods.

Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptionsInventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions

Chapter 6-8

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.

““Last-In-First-Out (LIFO)”Last-In-First-Out (LIFO)”

LO 2 Explain the accounting for LO 2 Explain the accounting for inventories and apply the inventory inventories and apply the inventory cost flow methods.cost flow methods.

Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptionsInventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions

Chapter 6-9

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.

““Average-Cost”Average-Cost”

LO 2 Explain the accounting for LO 2 Explain the accounting for inventories and apply the inventory inventories and apply the inventory cost flow methods.cost flow methods.

Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptionsInventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions

Chapter 6-10

FIFO

LO 3 Explain the financial effects of the inventory cost flow LO 3 Explain the financial effects of the inventory cost flow assumptions.assumptions.

Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptionsInventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions

Sales $90 $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 13 11

Net income $33 $29 $26

Inventory balance $35 $30 $25

LIFOAverage

Comparative Financial Statement SummaryComparative Financial Statement Summary

Chapter 6-11

Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors

LO 5 Indicate the effects of inventory errors on the financial LO 5 Indicate the effects of inventory errors on the financial statements.statements.

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 6-12

Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors

LO 5 Indicate the effects of inventory errors on the financial LO 5 Indicate the effects of inventory errors on the financial statements.statements.

Inventory errors affect the computation of cost of goods sold and net income.

Income Statement EffectsIncome Statement Effects

Illustration 6-17

Illustration 6-16

Chapter 6-13

Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors

LO 5 Indicate the effects of inventory errors on the financial LO 5 Indicate the effects of inventory errors on the financial statements.statements.

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.

Income Statement EffectsIncome Statement Effects

Chapter 6-14

Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors

LO 5 Indicate the effects of inventory errors on the financial LO 5 Indicate the effects of inventory errors on the financial statements.statements.

Incorrect Correct Incorrect Correct

Sales 80,000$ 80,000$ 90,000$ 90,000$

Beginning inventory 20,000 20,000 12,000 15,000

Cost of goods purchased 40,000 40,000 68,000 68,000

Cost of goods available 60,000 60,000 80,000 83,000

Ending inventory 12,000 15,000 23,000 23,000

Cost of good sold 48,000 45,000 57,000 60,000

Gross profit 32,000 35,000 33,000 30,000

Operating expenses 10,000 10,000 20,000 20,000

Net income 22,000$ 25,000$ 13,000$ 10,000$

2008 2009

($3,000)Net Income understated

$3,000Net Income overstated

Combined income for 2-year period is

correct.

Illustration 6-18

Chapter 6-15

Inventory ErrorsInventory ErrorsInventory ErrorsInventory Errors

LO 5 Indicate the effects of inventory errors on the financial LO 5 Indicate the effects of inventory errors on the financial statements.statements.

Effect of inventory errors on the balance sheet is determined by using the basic accounting equation:.

Balance Sheet EffectsBalance Sheet Effects

Illustration 6-16

Illustration 6-19

Chapter 6-16

Inventory turnover measures the number of times on average the inventory is sold during the period.

Cost of Goods Sold

Average Inventory

Inventory Turnover

=

Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis

Days in inventory measures the average number of days inventory is held.

Days in Year (365)

Inventory Turnover

Days in Inventory

=

LO 6 Compute and interpret the inventory turnover ratio.LO 6 Compute and interpret the inventory turnover ratio.

Chapter 6-17

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.

Statement Presentation and Statement Presentation and AnalysisAnalysisStatement Presentation and Statement Presentation and AnalysisAnalysis

LO 6 Compute and interpret the inventory turnover ratio.LO 6 Compute and interpret the inventory turnover ratio.

$270,000

($60,000 + 40,000) / 2

5.4 =

Inventory

Turnover 365

5.4 67.59 days

=

Days in Inventor

y