Chapter 6: Reporting and Analyzing InventoryChapter 6: Reporting and Analyzing InventoryDetermining Inventory Quantities:- Physical Inventory taken for 2 Reasons: Perpetual System:1. Check accuracy of inventory records.2. Determine amount of inventory lost due to 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. - 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 the end of the accounting period. - Determining Ownership of Goods: Goods in Transit Purchased goods not yet received. Sold goods not yet delivered. Inventory Costing:- Inventory is Accounted for at Cost: Cost includes all expenditures necessary to acquire goods and place them in a condition ready for sale.  Unit costs are applied to quantities to determine the total cost of the inventory and the cost of goods sold using the following costing methods: Specific Identification. First-in, first-out (FIFO). Last-in, first-out (LIFO). Average-cost. - Specific Identification: actual physical flow costing method in which itemsstill in inventory are specifically costed to arrive at the total cost of the ending inventory. - Cost of Goods Sold = (Beginning Inventory + Purchases) – Ending Inventory.- First-In, First-Out (FIFO): Costs of the earliest goods purchased are the first to be recognized in determining cost of goods sold.  Often parallels actual physical flow of merchandise. Companies determine the cost of the ending inventory by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed. 2- Last-In, First-Out (LIFO): Costs of the latest goods purchased are the first to be recognized in determining cost of goods sold.  Seldom coincides with actual physical flow of merchandise. Exceptions include goods stored in piles, such as coal or hay. 3- Average Cost: Allocates cost of goods available for sale on the basis of weighted-average unit cost incurred.  Applies weighted-average unit cost to the units on hand to determinecost of the ending inventory. - Lower-of-Cost-or-Market: When the value of inventory is lower than it’s 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.- Analysis of Inventory:4 Inventory management is a critical task.1. High Inventory Levels: storage costs, interest cost, (on funds tied up in inventory), and costs associated with the obsolescence of technical goods or shifts in fashion. 2. Low Inventory Levels: may lead to lost sales. - Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory.- Days in Inventory = 365 / Inventory Turnover Ratio.- Inventory Errors: 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.- 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.  Ending inventory depends entirely on the accuracy of taking and costing the inventory.