Accounting 2000 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 Ex car manufacturing co Steel plastic glass Cars on the assembly line Cars waiting to be sold Physical inventory taken for 2 reasons Perpetual System scanner 1 Check accuracy of inventory records 2 Determine amount of inventory lost wasted raw materials shoplifting or employee theft Periodic System mom and pop 1 Determine the inventory on hand ending inventory balance sheet 2 Determine the COGS for the period income statement Taking a Physical Inventory 1 Accounting 2000 Chapter 6 Notes 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 Goods in hand in warehouse Purchased goods not yet received Sold goods not yet delivered Legal title is determined by the terms of sale freight terms Buyer Seller Consigned Goods Goods held for sale by one party although ownership of the goods is retained by another party Consignor owner include in inventory count Consignee holder of the goods do not include in inventory do not count Inventory Costing 2 Accounting 2000 Chapter 6 Notes Which ones are sold or left Unit costs can be applied to quantities on hand using the following costing methods Illustration Assume that Crivitz TV Company purchases three identical 50 inch TVs on different dates at costs of 700 750 and 800 cost During the year Crivitz sold two sets at 1 200 selling price 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 Illustration Data for Houston Electronics Astro condensers Match exactly what happened ex car dealership Does not match exactly what happened make same assumptions Sold Sold 1500 COGS Ch 5 a r 2400 s e 2400 Beg inv COGS 1500 Purchases Inv 150 goods available 3 Accounting 2000 Chapter 6 Notes 2 First In First Out FIFO first ex grocery store First goods in first goods sold selling oldest items 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 FIFO 1 1 100 x 10 1000 8 24 50 x 12 600 4 15 200 x 11 2200 8 24 250 x 12 3000 sold 550 6200 COGS 400 x 13 5200 ending inventory 5800 Check 4 Accounting 2000 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 pile such as coal or hay Determine Cost of Goods Sold 11 27 400 x 13 5200 8 24 150 x 12 1800 550 7000 COGS Determine Ending Inventory 8 21 150 x 12 1800 4 15 200 x 11 2200 Check 5 Accounting 2000 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 aending inventory weighted avg goods available goods available Determine Cost of Goods Sold Determine Ending Inventory 6 Accounting 2000 Chapter 6 Notes Weighted avg x sold 12 x 550 6600 COGS weighted avg x EI 12 x 450 5400 ending inventory Check Financial Statement Effects 1 2 3 4 In periods of rising prices FIFO reports lowest COGS In periods of rising prices FIFO reports highest net income ending inv In periods of rising prices LIFO reports lowest net income ending inv In periods of rising prices LIFO reports highest COGS 12000 5400 6600 7 Accounting 2000 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 Lower of Cost or Market inventory 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 100 40 Inventory accts payable 100 Expense loss Inventory 40 60 left in ending inventory 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 8 Accounting 2000 Chapter 6 Notes Illustration Data available for Wal Mart in millions Ending inventory Cost of goods sold 2011 2010 36 318 32 713 315 287 In Class Exercises E6 5 and P 2A Beg invt end invt 2 9 Accounting 2000 Chapter 6 Notes Horne Inc uses a periodic inventory system Its records show the following for the month of May in which 74 units were sold Date Explanation Units Unit Cost Total Cost Inventory Purchase Purchase Total 30 25 38 93 9 10 11 270 250 418 938 Exercise 6 5 May 1 May 15 May 24 Instructions Calculate the ending inventory at May 31 using the a FIFO b average cost and c LIFO Prove the amount allocated to cost of goods sold under each method 10 Accounting 2000 Chapter 6 Notes Problem 6 2A Dunbar Distribution markets CDs of numerous performing artists At the beginning of March Dunbar had in beginning inventory 2 500 CDs with a unit cost of 7 During March Dunbar made the following purchases of CDs March 5 March 13 2 000 units at 8 3 500 units at 9 March 21 March 26 5 000 units at 10 2 000 units at 11 During March 12 000 units were sold Dunbar uses a periodic inventory system Instruction a Determine cost of goods available for sale b Determine 1 ending inventory and 2 cost of goods sold under each of the assumed cost flow methods FIFO LIFO average cost c Which cost flow method results in the 1 highest inventory amount for the balance sheet and 2 the highest cost of goods sold for the income statement Highest inventory is FIFO highest COGS is LIFO Data 3 1 3 5 3 13 3 21 3 26 Explenation Unit cost Total cost Beg inv Purchase Purchase Purchase purchase Units 2500 2000 3500 5000 2000 7 8 9 10