Accounting 2001Chapter 6 Notes1. 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 costflow 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 resultsof different companies.Classifying InventoryRetailer“Inventory”Physical inventory taken for 2 reasons:Perpetual System1. Check accuracy of inventory records.2. Determine amount of inventory lost (wasted raw materials, shoplifting, or employee theft).Periodic System1. Determine the inventory on hand2. Determine the Cost of Goods Sold for the period.1Accounting 2001Chapter 6 NotesTaking 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 too1. Goods on Hand2. 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!2Accounting 2001Chapter 6 NotesInventory 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 happenedIllustration: 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 $750.3Accounting 2001Chapter 6 NotesIllustration: 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: 1/1 100 x $10=1000 8/24 50x $12= 6004/15 200 x $11=2200 11/27 400 x $13= 50008/24 250 x $12=3000450=$5800550=$6200Check: 4Accounting 2001Chapter 6 Notes3. 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: 400 x $13= 5200 150 x $12=1800150 x $12= 1800 200 x $11=2200100 x $10=1000$5000=ending inventory 550=7000Check: 5Accounting 2001Chapter 6 Notes4. 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 costDetermine Cost of Goods Sold: Determine Ending Inventory: $12 x 550= $6600 $12 x 450= $5400Check: 6Accounting 2001Chapter 6 NotesFinancial Statement Effects:1. In periods of rising prices, FIFO reports lowest Cost of Goods Sold.2. In periods of rising prices, FIFO reports highest net income & ending inventory.3. In periods of rising prices, LIFO reports lowest net income & ending inventory.4. In periods of rising prices, LIFO reports highest Cost of Goods Sold.7Accounting 2001Chapter 6 NotesUsing 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 changeLower-of-Cost-or-Market:When the value of inventory is lower than its 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.Inventory management is a double-edged sword1. 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.8Accounting 2001Chapter 6 Notes**** In-Class Exercises: E6-5 and