Accounting 2001 Chapter 6 Notes 1 Describe the steps in determining inventory quantities 2 Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system 3 Explain the financial statement and tax effects of each of the inventory cost flow assumptions 4 Explain the lower of cost or market basis of accounting for inventories 5 Compute and interpret the inventory turnover ratio 6 Describe the LIFO reserve and explain its importance for comparing results of different companies Classifying Inventory Retailer Inventory Physical inventory taken for 2 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 1 Accounting 2001 Chapter 6 Notes 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 end of the accounting period Determining Ownership of Goods Count All goods company has legal title too 1 Goods on Hand 2 Goods in Transit Purchased goods not yet received Sold goods not yet delivered Legal title is determined by the terms of the sale 3 Consigned Goods Goods held for sale by one party although ownership of the goods is retained by another party Consignor owner count Consignee holding goods not count 2 Accounting 2001 Chapter 6 Notes Inventory Costing which ones Sold Left Unit costs can be applied to quantities on hand using the following costing methods matches exactly what happened don t have to match what actually happened Illustration Assume that Crivitz TV Company purchases three identical 50 inch TVs on different dates at costs of 700 750 and 800 During the year Crivitz sold two sets at 1 200 each These facts are summarized below 1 Specific Identification If Crivitz sold the TVs it purchased on February 3 and May 22 then its cost of goods sold is 1 500 700 800 and its ending inventory is 750 3 Accounting 2001 Chapter 6 Notes Illustration Data for Houston Electronics Astro condensers 2 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 Determine Cost of Goods Sold Determine Ending Inventory 8 24 50x 12 600 11 27 400 x 13 5000 450 5800 1 1 100 x 10 1000 4 15 200 x 11 2200 8 24 250 x 12 3000 550 6200 Check 4 Accounting 2001 Chapter 6 Notes 3 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 Determine Cost of Goods Sold Determine Ending Inventory 150 x 12 1800 200 x 11 2200 100 x 10 1000 5000 ending inventory 400 x 13 5200 150 x 12 1800 550 7000 Check 5 Accounting 2001 Chapter 6 Notes 4 Average Cost a Allocates cost of goods available for sale on the basis of weighted average unit cost incurred b Assumes goods are similar in nature c Applies weighted average unit cost to the units on hand to determine cost of the ending inventory 12 000 1 000 12 average cost Determine Cost of Goods Sold Determine Ending Inventory 12 x 550 6600 12 x 450 5400 Check 6 Financial Statement Effects 1 2 3 4 In periods of rising prices FIFO reports lowest Cost of Goods Sold In periods of rising prices FIFO reports highest net income ending inventory In periods of rising prices LIFO reports lowest net income ending inventory In periods of rising prices LIFO reports highest Cost of Goods Sold Accounting 2001 Chapter 6 Notes 7 Accounting 2001 Chapter 6 Notes Using Cost Flow Methods Consistently Method should be used consistently enhances comparability Although consistency is preferred a company may change its costing method Must disclose if they change Lower of Cost or Market When the value of inventory is lower than its cost in which the price decline occurs Market value Replacement Cost Example of Conservatism Companies can write down the inventory to its market value in the period Inventory management is a double edged sword 1 High Inventory Levels may incur high carrying costs 2 Low Inventory Levels may lead to stockouts and lost sales Inventory Ratios Illustration Data available for Wal Mart 8 Accounting 2001 Chapter 6 Notes In Class Exercises E6 5 and P 2A 9