CHAPTER 6 - INVENTORIES. Material Copyright- Protected: Barbara Wagers
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1 CHAPTER 6 - INVENTORIES Material Copyright- Protected: Barbara Wagers
2 CHAPTER 6 Inventories Learning Objectives 1. Internal Control of Inventories 2. Inventory Flow Assumptions 3. Perpetual Inventory ing Methods 4. Omit! 5. Comparing Inventory ing Methods 6. Reporting Inventory on Financials
3 YOUR CHAPTER GUIDES
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5
6 WHO SAID IT? I can't bring myself to regret the decisions that brought me to Forks. They also brought me to Edward.
7 WHO SAID IT? Edward Your number was up the first time I met you.
8 DESCRIBE THE IMPORTANCE OF CONTROL OVER INVENTORIES
9 WHAT ARE INVENTORIES? Goods owned and held for resale to customers A current asset
10 INVENTORY ACQUISITION COST Includes: Invoice price less purchase discount Transportation in In-transit insurance Taxes
11 INTERNAL CONTROLS Why? Safeguard inventory and properly report it on statements Prenumbered receiving reports matched to purchase order and invoice before paid Security measures damage, employee theft, customer theft Perpetual inventory system Periodic inventory count
12 DESCRIBE THREE INVENTORY COST FLOW ASSUMPTIONS AND HOW THEY IMPACT THE INCOME STATEMENT AND BALANCE SHEET
13 DETERMINE COST OF INVENTORY UNDER PERPETUAL INVENTORY USING THE FIFO, LIFO METHODS (OMIT AVERAGE)
14 REVIEW OF PERPETUAL JOURNAL ENTRIES
15 Transaction We purchase merchandise from vendor We return merchandise to a vendor We sell merchandise to a customer Customer returns merchandise to us Perpetual Inventory Journal Entries Merchandise Inventory ( ) Cash ( ) or Accounts Payable ( ) Cash ( ) or Accounts Payable ( ) Merchandise Inventory ( ) Cash ( ) or Accounts Receivable ( ) Sales ( ) (amount = sales price) Sales Tax Payable ( ) (amt = tax collected) of Merchandise Sold ( ) Merchandise Inventory ( ) (amount = cost) Sales Returns & Allowances ( ) Cash ( ) or Account Receivable ( ) (amount = sales price) Merchandise Inventory ( ) of Mdse. Sold ( ) (amount = cost)
16 Transaction We purchase merchandise from vendor We return merchandise to a vendor We sell merchandise to a customer Customer returns merchandise to us Perpetual Inventory Journal Entries Merchandise Inventory ( ) Cash ( ) or Accounts Payable ( ) Cash ( ) or Accounts Payable ( ) Merchandise Inventory ( ) Cash ( ) or Accounts Receivable ( ) Sales ( ) (amount = sales price) Sales Tax Payable ( ) (amt = tax collected) of Merchandise Sold ( ) Merchandise Inventory ( ) (amount = cost) Sales Returns & Allowances ( ) Cash ( ) or Account Receivable ( ) (amount = sales price) Merchandise Inventory ( ) of Mdse. Sold ( ) (amount = cost)
17 Transaction We purchase merchandise from vendor We return merchandise to a vendor We sell merchandise to a customer Customer returns merchandise to us Perpetual Inventory Journal Entries Merchandise Inventory ( ) Cash ( ) or Accounts Payable ( ) Cash ( ) or Accounts Payable ( ) Merchandise Inventory ( ) Cash ( ) or Accounts Receivable ( ) Sales ( ) (amount = sales price) Sales Tax Payable ( ) (amt = tax collected) of Merchandise Sold ( ) Merchandise Inventory ( ) (amount = cost) Sales Returns & Allowances ( ) Cash ( ) or Account Receivable ( ) (amount = sales price) Merchandise Inventory ( ) of Mdse. Sold ( ) (amount = cost)
18 Transaction We purchase merchandise from vendor We return merchandise to a vendor We sell merchandise to a customer Customer returns merchandise to us Perpetual Inventory Journal Entries Merchandise Inventory ( ) Cash ( ) or Accounts Payable ( ) Cash ( ) or Accounts Payable ( ) Merchandise Inventory ( ) Cash ( ) or Accounts Receivable ( ) Sales ( ) (amount = sales price) Sales Tax Payable ( ) (amt = tax collected) of Merchandise Sold ( ) Merchandise Inventory ( ) (amount = cost) Sales Returns & Allowances ( ) Cash ( ) or Account Receivable ( ) (amount = sales price) Merchandise Inventory ( ) of Mdse. Sold ( ) (amount = cost)
19 WHY DO WE NEED A COST FLOW METHOD? Changing prices Identical products may be purchased at different prices
20 WHY DO WE NEED A COST FLOW METHOD? If we SELL the goods, their costs go into COST OF MERCHANDISE SOLD If the goods remain ON HAND, their costs remain in ending MERCHANDISE INVENTORY
21 WHY DO WE NEED A COST FLOW METHOD? Often impossible to tell exactly which products have been sold and which are left in inventory
22 WHY DO WE NEED A COST FLOW METHOD? Must make assumptions about the order in which items have been sold Assumption is about the flow of costs rather than the flow of physical inventory
23 WHY DO WE NEED A COST FLOW METHOD? If the goods are IDENTICAL, it is impossible to tell the cost of the ones that were sold vs. the ones left in inventory!
24 WHY DO WE NEED A COST FLOW METHOD? We buy 3 identical dolls - one for $20, one for $22 and one for $27. We sell two dolls.
25 WHY DO WE NEED A COST FLOW METHOD? What is the cost of the one doll in ending inventory? What is the cost of the two dolls sold? $20 $22 $27
26 WHY DO WE NEED A COST FLOW METHOD? It depends on the cost flow assumption that we make!
27 PHYSICAL (GOODS) FLOW VERSUS COST FLOW PHYSICAL (GOODS) FLOW: Physical movement of goods through the business (usually we try to sell the oldest items first!)
28 GOODS FLOW VERSUS COST FLOW COST FLOW: Refers to the cost associated with the assumed flow of goods
29 GOODS FLOW VERSUS COST FLOW Normally impossible to keep track of ACTUAL order of items sold and their cost, so we make ASSUMPTIONS! Result: flow may not be same as goods flow!
30 METHODS OF PRICING INVENTORY 1. Specific Identification (omit) 2. Average 3. First-in, first-out (FIFO) 4. Last-in, first-out (LIFO)
31 METHODS OF PRICING INVENTORY Each method: Is based on DIFFERENT cost flow assumption Results in DIFFERENT value for COMS and Ending Inventory Complies with GAAP
32 WHO SAID IT? Do I dazzle Edward you?
33 WHO SAID IT? Ah... you brought a snack.
34 FIFO
35 FIRST-IN, FIRST-OUT (FIFO) The costs of the FIRST items we purchase are assigned to the FIRST items we sell! Did she say FIFO or FIDO? ( Out means sold! )
36 FIRST-IN, FIRST-OUT (FIFO) of Mdse. Sold consists of the cost of our earliest purchases Ending inventory consists of the cost of our most recent purchases
37 FIRST-IN, FIRST-OUT (FIFO) How to figure COMS in each sale? Start with oldest available purchase and work forward (but if you have already sold it, you can t sell it again!!)
38 FIRST-IN, FIRST-OUT (FIFO) How to figure cost of Ending Inv? Multiply units left X cost per unit
39 WELCOME BARBIE!
40 BARBIE EXAMPLE - FIFO Beginning Inventory $10 May 5 Purchase $11 May 12 Purchase $12 May 25 Purchase $13 What is COMS if we sell a doll on May 8? $10
41 BARBIE EXAMPLE - FIFO Beginning Inventory $10 May 5 Purchase $11 May 12 Purchase $12 May 25 Purchase $13 What is COMS if we sell a doll on May 20? $11 What is ending inventory? = $25
42 GRAB YOUR CALCULATOR AND HIGHLIGHTER!!
43 EXAMPLE - TWILIGHT'S INVENTORY OF JACOB DOLLS
44 FIRST-IN, FIRST-OUT (FIFO) PUR. UNITS UNIT TOTAL DATE PURCHASED COST COST Beg. Inv /5/ /16/ $2,400 4,500 9,000 $15,900
45 FIRST-IN, FIRST-OUT (FIFO) SALES 100 on April 12 to Bella 30 on April 28 to Alice 120 on April 29 to Edward 20 on April 30 to James
46 WHAT HAPPENS FIRST? Beginning inventory 60 dolls at $40 each
47 FIRST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot. BI ,400
48 WHAT HAPPENS NEXT? Purchase on 4/5 90 dolls at $50 each
49 FIRST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot. BI ,400 4/ , , ,500
50 WHAT HAPPENS NEXT? Sale to Bella on 4/ dolls
51 FIRST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot. BI ,400 4/ , ,400 4/ , , , ,500
52 WHAT HAPPENS NEXT? Purchase on 4/ dolls at $60 each
53 FIRST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot ,500 4/ , , ,000
54 WHAT HAPPENS NEXT? Sale to Alice on 4/28 30 dolls
55 FIRST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot ,500 4/ , , ,000 4/ , , ,000
56 WHAT HAPPENS NEXT? Sale to Edward on 4/ dolls
57 FIRST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot , ,000 4/ , , ,000
58 WHAT HAPPENS NEXT? Sale to James on April dolls
59 FIRST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty 50 Unit Tot. 60 3,000 4/ , ,800
60 FIRST-IN, FIRST-OUT (FIFO) WHAT IS TWILIGHT'S COST OF MERCHANDISE SOLD TO REPORT ON THE INCOME STATEMENT?
61 FIRST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot ,500 4/ , ,500 4/ , , , ,400
62 FIRST-IN, FIRST-OUT (FIFO) WHAT IS TWILIGHT'S COST OF MERCHANDISE SOLD TO REPORT ON THE INCOME STATEMENT? $2,400 2,000 1,500 1,000 6,000 1,200 $14,100
63 FIRST-IN, FIRST-OUT (FIFO) WHAT IS TWILIGHT'S ENDING MERCHANDISE INVENTORY TO REPORT ON THE BALANCE SHEET?
64 FIRST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot ,000 4/ , ,800
65 FIRST-IN, FIRST-OUT (FIFO) WHAT IS TWILIGHT'S ENDING MERCHANDISE INVENTORY TO REPORT ON BALANCE SHEET? $1,800 CHECK FIGURE: $14, ,800 = $15,900
66 FIRST-IN, FIRST-OUT (FIFO) PUR. UNITS UNIT TOTAL DATE PURCHASED COST COST Beg. Inv /5/ /16/ $2,400 4,500 9,000 $15,900 AGREES!!
67 HOMEWORK: EXERCISE 6-3 EXERCISE 6-6 PROBLEM 6-1A FIFO figure ending inventory and COMS (hint: don t need the revenue amounts for units sold in problem 6-1A)
68 WHO SAID IT? Good luck tended to Bella avoid me.
69 WHO SAID IT? Bella! We're making Italiano for you Esme
70 WHO SAID IT? It sounded as if you were having Bella for lunch, and we came to see if you would share.
71 LIFO
72 LAST-IN, FIRST-OUT (LIFO) The costs of the LAST items we purchase are I bet this is FIFO in disguise assigned to the FIRST items we sell!
73 LAST-IN, FIRST-OUT (LIFO) RESULT: of Merchandise Sold consists of the cost of our most recent purchases Ending inventory consists of the cost of our earliest purchases
74 LAST-IN, FIRST-OUT (LIFO) How to figure COMS in each sale? Start with most recent available purchase and work backwards (but you must have already purchased the units in order to sell them)
75 LAST-IN, FIRST-OUT (LIFO) How to figure cost of Ending Inv? Multiply units left X cost per unit
76 BARBIE EXAMPLE - LIFO Beginning Inventory $10 May 5 Purchase $11 May 12 Purchase $12 May 25 Purchase $13 What is COMS if we sell a doll on May 8? $11
77 BARBIE EXAMPLE - LIFO Beginning Inventory $10 May 5 Purchase $11 May 12 Purchase $12 May 25 Purchase $13 What is COMS if we sell a doll on May 20? $12 What is ending inventory? = $23
78 EXAMPLE - TWILIGHT'S INVENTORY OF JACOB DOLLS
79 LAST-IN, FIRST-OUT (LIFO) PUR. UNITS UNIT TOTAL DATE PURCHASED COST COST Beg. Inv /5/ /16/ $2,400 4,500 9,000 $15,900
80 LAST-IN, FIRST-OUT (LIFO) SALES 100 on April 12 to Bella 30 on April 28 to Alice 120 on April 29 to Edward 20 on April 30 to James
81 WHAT HAPPENS FIRST? Beginning inventory 60 dolls at $40 each
82 LAST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot. BI ,400
83 WHAT HAPPENS NEXT? Purchase on 4/5 90 dolls at $50 each
84 LAST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot. BI ,400 4/ , , ,500
85 WHAT HAPPENS NEXT? Sale to Bella on 4/ dolls
86 LAST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot. BI ,400 4/ , ,400 4/ , , ,000
87 WHAT HAPPENS NEXT? Purchase on 4/ dolls at $60 each
88 LAST-IN, FIRST-OUT (FIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot ,000 4/ , , ,000
89 WHAT HAPPENS NEXT? Sale to Alice on 4/28 30 dolls
90 LAST-IN, FIRST-OUT (LIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot ,000 4/ , , ,000 4/ , , ,200
91 WHAT HAPPENS NEXT? Sale to Edward on 4/ dolls
92 LAST-IN, FIRST-OUT (LIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot , ,200 4/ , ,000
93 WHAT HAPPENS NEXT? Sale to James on April dolls
94 LAST-IN, FIRST-OUT (LIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty 50 Unit Tot. 40 2,000 4/ ,200
95 LAST-IN, FIRST-OUT (LIFO) WHAT IS TWILIGHT'S COST OF MERCHANDISE SOLD TO REPORT ON THEIR INCOME STATEMENT?
96 LAST-IN, FIRST-OUT (LIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot ,500 4/ , ,500 4/ , , , ,400
97 LAST-IN, FIRST-OUT (LIFO) WHAT IS TWILIGHT'S COST OF MERCHANDISE SOLD TO REPORT ON THEIR INCOME STATEMENT? $4, ,800 7, $14,700
98 FIRST-IN, FIRST-OUT (LIFO) WHAT IS TWILIGHT'S ENDING MERCHANDISE INVENTORY TO REPORT ON THEIR BALANCE SHEET?
99 LAST-IN, FIRST-OUT (LIFO) Dt. Qty Unit Purchases COMS End. Inventory Tot. Qty Unit Tot. Qty Unit Tot ,000 4/ ,200
100 LAST-IN, FIRST-OUT (LIFO) WHAT IS TWILIGHT'S ENDING MERCHANDISE INVENTORY TO REPORT ON BALANCE SHEET? $1,200 CHECK FIGURE: $14, ,200 = $15,900
101 LAST-IN, FIRST-OUT (LIFO) PUR. DOLLS UNIT TOTAL DATE PURCHASED COST COST Beg. Inv /5/ /16/ $2,400 4,500 9,000 $15,900 AGREES!!
102 HOMEWORK: EXERCISE 6-4 EXERCISE 6-5 PROBLEM 6-2A LIFO figure BOTH ending inventory and COMS
103 OMIT!!
104 COMPARE AND CONTRAST USE OF THREE INVENTORY COSTING METHODS
105 WHICH METHOD IS BEST?? NONE! Once you decide on a method, you need to stick with it! (consistency)
106 WHICH METHOD IS BEST? Each method is acceptable for financial statements. Each methods has advantages and disadvantages.
107 FIFO ADVANTAGES: Approximates physical flow of goods Good for Balance Sheet because Mdse. Inventory is valued at current costs
108 FIFO DISADVANTAGES: Bad for Income Statement - current revenues are matched against old costs in COMS (bad matching) Can lead to higher net income and paper profits in periods of inflation
109 LIFO ADVANTAGES: Best for Income Statement - current revenues are matched with current costs in COMS
110 LIFO DISADVANTAGES: Bad for Balance Sheet Mdse. Inventory valued at old costs Doesn t match physical flow Potential problem: LIFO Liquidation if Ending Inv. quantity < Beginning Inv. quantity IRS REQUIREMENT
111 AVERAGE COST ADVANTAGES: Middle-of-the-road approach Easy to apply DISADVANTAGES: Really aren t any!
112 IMPACT OF CHANGING PRICES
113 RISING PRICES - FIFO Income Statement: COMS low Net income high, least accurate Why? Balance Sheet: Ending inventory high, most accurate Why?
114 RISING PRICES - LIFO Income Statement: COMS high Net income low, most accurate Why? Balance Sheet: Ending inventory low, least accurate Why?
115 TRADEOFF FIFO VS. LIFO BALANCE SHEET VS. INCOME STATEMENT
116 CHANGING PRICES HOW ABOUT FALLING PRICES?
117 WHO SAID IT? Let's not play with our food Laurent
118 It s better if we re not friends. Trust me. WHO SAID IT?
119 DESCRIBE AND ILLUSTRATE REPORTING OF MERCHANDISE INVENTORY IN FINANCIAL STATEMENTS
120 INVENTORY VALUATION AT LESS THAN COST
121 INVENTORY VALUATION is usual basis for valuing inventory Sometimes shown at less than cost if inventory has gone down in value Loss has occurred
122 INVENTORY VALUATION Why? Conservatism!
123 NET REALIZABLE VALUE
124 NET REALIZABLE VALUE Estimated selling price less any direct costs of disposal Obsolete, spoiled, damaged goods
125 LOWER OF COST OR MARKET
126 LOWER OF COST OR MARKET How does the Lower of or Market work?
127 LOWER OF COST OR MARKET Determine market value of items at year end Compare cost and market for each item pick lowest of the two (item by item approach) Add up individual values Make journal entry if needed
128 LOWER OF COST OR MARKET Loss Due to Decline in Mkt Value ( ) XX Mdse. Inventory ( ) XX Amount is difference between cost and lower-of-cost-ormarket total you figured!
129 LOWER OF COST OR MARKET What is a LOSS account? Like an expense account (makes net income go DOWN) Has a normal DEBIT balance Is reported on the Income Statement What if market values > cost?
130 LOCOM - EXAMPLE AT YEAR-END, THE CULLENS COUNT THEIR ENDING INVENTORY AND IDENTIFY THE FOLLOWING COST AND MARKET VALUES:
131 ITEM # UN. COST UNIT MKT TOT. COST TOT. MKT LOCOM Engagement Rings 40 $20 $21 $800 $840 $800 Stuffed Lambs Stuffed Lions Vampire Fangs Wolf Bracelets TOTAL $1,373 Not Needed $1,284
132 LOWER OF COST OR MARKET How much loss should we record? Inventory 1,373 1,284? 89 $1,373 1,284 = $89 Loss Due to Decline in Market Value ( ) 89 Merchandise Inventory ( ) 89
133 IN CLASS: EXERCISE 6-11 LOCOM Do journal entry also Answers
134 BALANCE SHEET PRESENTATION
135 A CURRENT ASSET DISCLOSE Method of determining cost Method of valuation
136 Current assets: Afro-Arts Balance Sheet December 31, 2004 Assets Cash $ 19,400 Accounts receivable $80,000 Less allowance 3,000 77,000 Merchandise inventory at lower of cost (first-in, first-out method) or market 216,300
137 Edward WHO SAID IT? BUT HE WAS It s healthy to ditch class now and then. WRONG!!!
138 CHAPTER 6 Inventories Learning Objectives 1. Internal Control of Inventories 2. Inventory Flow Assumptions 3. Perpetual Inventory ing Methods 4. Omit! 5. Comparing Inventory ing Methods 6. Reporting Inventory on Financials
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