chapter 6-1. chapter 6-2 reporting and analyzing inventory financial accounting, fifth edition
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Chapter 6-1
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Chapter 6-2
Reporting and Analyzing Inventory
Financial Accounting, Fifth Edition
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Chapter 6-3
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.
7. Apply the inventory cost flow methods to perpetual inventory records.
8. Indicate the effects of inventory errors on the financial statements.
Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives
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Chapter 6-4
Illustration 2-2
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
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Chapter 6-5
Classifying InventoryClassifying InventoryClassifying InventoryClassifying Inventory
One Classification:
Merchandise Inventory
Three Classifications:
Raw Materials
Work in Process
Finished Goods
Merchandising Company
Manufacturing Company
Regardless of the classification, companies report all inventories under Current Assets on the balance sheet.
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Chapter 6-6
Physical Inventory taken for two reasons:Perpetual System
1. Check accuracy of inventory records.
2. Determine amount of inventory lost.
Periodic System
1. Determine the inventory on hand.
2. Determine the cost of goods sold for the period.
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
SO 1 Describe the steps in determining inventory quantities.SO 1 Describe the steps in determining inventory quantities.
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Chapter 6-7
when the business is closed or when business is slow.
at end of the accounting period.
Taking a Physical InventoryTaking a Physical Inventory
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
SO 1 Describe the steps in determining inventory quantities.SO 1 Describe the steps in determining inventory quantities.
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Chapter 6-8
Goods in Transit
Purchased goods not yet received.
Sold goods not yet delivered.
Determining Ownership of Determining Ownership of GoodsGoods
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
SO 1 Describe the steps in determining inventory quantities.SO 1 Describe the steps in determining inventory quantities.
Goods in transit should be included in the inventory of the company that has legal title to
the goods. Legal title is determined by the terms of sale.
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Chapter 6-9
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
SO 1 Describe the steps in determining inventory quantities.SO 1 Describe the steps in determining inventory quantities.
Illustration 6-1
Ownership of the goods passes to the buyer
when the public carrier accepts the goods from
the seller.
Ownership of the goods remains with the seller
until the goods reach the buyer.
Terms of SaleTerms of Sale
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Chapter 6-10
Consigned Goods
Goods held for sale by one party although ownership of the goods is retained by another party.
Determining Ownership of Determining Ownership of GoodsGoods
Determining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory QuantitiesDetermining Inventory Quantities
SO 1 Describe the steps in determining inventory quantities.SO 1 Describe the steps in determining inventory quantities.
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Chapter 6-11
Unit costs can be applied to quantities on hand using the following costing methods:
Specific Identification
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
Average-cost
Inventory CostingInventory CostingInventory CostingInventory Costing
SO 2 SO 2 Explain the basis of accounting for inventories and apply Explain the basis of accounting for inventories and apply the the inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.inventory system.
Cost Flow Assumptio
ns
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Chapter 6-12
An actual physical flow costing method.
Practice is relatively rare.
Most companies make assumptions (Cost
Flow Assumptions) about which units were
sold.
Specific Identification MethodSpecific Identification Method
Inventory CostingInventory CostingInventory CostingInventory Costing
SO 2 SO 2 Explain the basis of accounting for inventories and apply Explain the basis of accounting for inventories and apply the the inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.inventory system.
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Chapter 6-13
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Illustration 6-11Use of cost flow methods in major U.S. companies
Cost Flow
Assumption
does not need to
equal
Physical Movement
of Goods
SO 2 SO 2 Explain the basis of accounting for inventories and apply Explain the basis of accounting for inventories and apply the the inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.inventory system.
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Chapter 6-14
Illustration: Data for Houston Electronics’ Astro condensers.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Illustration 6-4
(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold
SO 2 SO 2 Explain the basis of accounting for inventories and apply Explain the basis of accounting for inventories and apply the the inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.inventory system.
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Chapter 6-15
Earliest goods purchased are first to be
sold.
Often parallels actual physical flow of
merchandise.
Generally good business practice to sell
oldest units first.
““First-In-First-Out (FIFO)”First-In-First-Out (FIFO)”
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
SO 2 SO 2 Explain the basis of accounting for inventories and apply Explain the basis of accounting for inventories and apply the the inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.inventory system.
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Chapter 6-16
“First-In-First-Out (FIFO)”
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Illustration 6-5
SO 2 SO 2 Explain the basis of accounting for inventories and apply Explain the basis of accounting for inventories and apply the the inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.inventory system.
SolutioSolution on n on
notes notes pagepage
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Chapter 6-17
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.
““Last-In-First-Out (LIFO)”Last-In-First-Out (LIFO)”
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
SO 2 SO 2 Explain the basis of accounting for inventories and apply Explain the basis of accounting for inventories and apply the the inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.inventory system.
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Chapter 6-18
““Last-In-First-Out Last-In-First-Out (LIFO)”(LIFO)”
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Illustration 6-7
SO 2 SO 2 Explain the basis of accounting for inventories and apply the Explain the basis of accounting for inventories and apply the inventory inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.system.
SolutioSolution on n on
notes notes pagepage
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Chapter 6-19
Allocates cost of goods available for sale on
the basis of weighted average unit cost
incurred.
Assumes goods are similar in nature.
Applies weighted average unit cost to the
units on hand to determine cost of the ending
inventory.
““Average Cost”Average Cost”
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
SO 2 SO 2 Explain the basis of accounting for inventories and apply Explain the basis of accounting for inventories and apply the the inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.inventory system.
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Chapter 6-20
““Average Cost”Average Cost”
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Illustration 6-10
SO 2 SO 2 Explain the basis of accounting for inventories and apply Explain the basis of accounting for inventories and apply the the inventory cost flow methods under a periodic inventory cost flow methods under a periodic inventory system.inventory system.
SolutioSolution on n on
notes notes pagepage
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Chapter 6-21
FIFO
LO 3 LO 3 Explain the financial statement and tax effects Explain the financial statement and tax effects of of each of the inventory cost flow each of the inventory cost flow assumptions.assumptions.
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Sales $9,000 $9,000 $9,000
Cost of goods sold 6,200 6,600 7,000
Gross profit 2,800 2,400 2,000
Admin. & selling expense 330 330 330
Income before taxes 2,470 2,070 1,670
Income tax expense 140 120 110
Net income $2,330 $1,950 $1,560
Inventory balance $5,800 $5,400 $5,000
LIFOAverage
Comparative Financial Statement Summary
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Chapter 6-22
FIFO
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Sales $9,000 $9,000$9,000
Cost of goods sold 6,200 6,6007,000
Gross profit 2,800 2,4002,000
Admin. & selling expense 330 330330
Income before taxes 2,470 2,0701,670
Income tax expense 140 120110
Net income $2,330 $1,950$1,560
Inventory balance $5,800 $5,400$5,000
LIFOAverage
In Period of Rising Prices, FIFO Reports:
Highest
Lowest
LO 3 LO 3 Explain the financial statement and tax effects Explain the financial statement and tax effects of of each of the inventory cost flow each of the inventory cost flow assumptions.assumptions.
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Chapter 6-23
FIFO
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
Sales $9,000 $9,000$9,000
Cost of goods sold 6,200 6,6007,000
Gross profit 2,800 2,4002,000
Admin. & selling expense 330 330330
Income before taxes 2,470 2,0701,670
Income tax expense 140 120110
Net income $2,330 $1,950$1,560
Inventory balance $5,800 $5,400$5,000
LIFOAverage
In Period of Rising Prices, LIFO Reports:
Lowest
Highest
LO 3 LO 3 Explain the financial statement and tax effects Explain the financial statement and tax effects of of each of the inventory cost flow each of the inventory cost flow assumptions.assumptions.
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Chapter 6-24
The cost flow method that often parallels the actual physical flow of merchandise is the:
a. FIFO method.
b. LIFO method.
c. average cost method.
d. gross profit method.
Review Question
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
LO 3 LO 3 Explain the financial statement and tax effects Explain the financial statement and tax effects of of each of the inventory cost flow each of the inventory cost flow assumptions.assumptions.
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Chapter 6-25
In a period of inflation, the cost flow method that results in the lowest income taxes is the:
a. FIFO method.
b. LIFO method.
c. average cost method.
d. gross profit method.
Review Question
Inventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow AssumptionsInventory Costing – Cost Flow Assumptions
LO 3 LO 3 Explain the financial statement and tax effects Explain the financial statement and tax effects of of each of the inventory cost flow each of the inventory cost flow assumptions.assumptions.
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Chapter 6-26
Lower-of-Cost-or-MarketLower-of-Cost-or-Market
Inventory CostingInventory CostingInventory CostingInventory Costing
SO 4 Explain the lower-of-cost-or-SO 4 Explain the lower-of-cost-or-market basis of accounting for market basis of accounting for inventories.inventories.
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.
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Chapter 6-27
Lower-of-Cost-or-MarketLower-of-Cost-or-Market
Inventory CostingInventory CostingInventory CostingInventory Costing
SO 4 Explain the lower-of-cost-or-SO 4 Explain the lower-of-cost-or-market basis of accounting for market basis of accounting for inventories.inventories.
Illustration: Assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated.
Inventory Cost Market Lower ofCategories Data Data Cost or Market
TVs 60,000$ 55,000$
Radios 45,000 52,000
DVD recorders 48,000 45,000
DVDs 14,000 12,800
Total inventory
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Chapter 6-28
Analysis of InventoryAnalysis of InventoryAnalysis of InventoryAnalysis of Inventory
Inventory management is a double-edged sword
1. High Inventory Levels - may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage).
2. Low Inventory Levels – may lead to stockouts and lost sales.
Analysis of InventoryAnalysis of Inventory
SO 5 Compute and interpret the inventory turnover ratio.SO 5 Compute and interpret the inventory turnover ratio.
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Chapter 6-29
Inventory turnover measures the number of times on average the inventory is sold during the period.
Cost of Goods Sold
Average Inventory
Inventory Turnover
=
Days in inventory measures the average number of days inventory is held.
Days in Year (365)
Inventory Turnover
Days in Inventory
=
SO 5 Compute and interpret the inventory turnover ratio.SO 5 Compute and interpret the inventory turnover ratio.
Analysis of InventoryAnalysis of InventoryAnalysis of InventoryAnalysis of Inventory
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Chapter 6-30
Illustration: The following data are available for Wal-Mart.
Inventory Turnover
2007
=
SO 5 Compute and interpret the inventory turnover ratio.SO 5 Compute and interpret the inventory turnover ratio.
Analysis of InventoryAnalysis of InventoryAnalysis of InventoryAnalysis of Inventory
=
Days in inventory
2007
=
=
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Chapter 6-31
Illustration: The following data are available for Wal-Mart.
$237,649
(31,910 + 29,419) / 2
Inventory Turnover
2006
=
SO 5 Compute and interpret the inventory turnover ratio.SO 5 Compute and interpret the inventory turnover ratio.
Analysis of InventoryAnalysis of InventoryAnalysis of InventoryAnalysis of Inventory
= 7.7 times
365 Days
7.7
Days in inventory
2006
=
=47.4 Days
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Chapter 6-32
Illustration:
Cost Flow Methods in Perpetual SystemsCost Flow Methods in Perpetual SystemsCost Flow Methods in Perpetual SystemsCost Flow Methods in Perpetual Systems
SO 7 Apply the inventory cost flow methods to perpetual inventory SO 7 Apply the inventory cost flow methods to perpetual inventory records.records.
Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Average cost.
Appendix 6AAppendix 6AAppendix 6AAppendix 6A
Illustration 6A-1
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Chapter 6-33
Cost Flow Methods in Perpetual Cost Flow Methods in Perpetual SystemsSystemsCost Flow Methods in Perpetual Cost Flow Methods in Perpetual SystemsSystems
SO 7 Apply the inventory cost flow methods to perpetual inventory SO 7 Apply the inventory cost flow methods to perpetual inventory records.records.
“First-In-First-Out (FIFO)”
Cost of Goods SoldEnding Inventory
Illustration 6A-2
Solution on notes page
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Chapter 6-34
Cost Flow Methods in Perpetual Cost Flow Methods in Perpetual SystemsSystemsCost Flow Methods in Perpetual Cost Flow Methods in Perpetual SystemsSystems
SO 7 Apply the inventory cost flow methods to perpetual inventory SO 7 Apply the inventory cost flow methods to perpetual inventory records.records.
Cost of Goods SoldEnding Inventory
“Last-In-First-Out (LIFO)” Illustration 6A-3
Solution on notes page
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Chapter 6-35
Cost Flow Methods in Perpetual Cost Flow Methods in Perpetual SystemsSystemsCost Flow Methods in Perpetual Cost Flow Methods in Perpetual SystemsSystems
SO 7 Apply the inventory cost flow methods to perpetual inventory SO 7 Apply the inventory cost flow methods to perpetual inventory records.records.
““Average Cost”Average Cost” (Moving-Average (Moving-Average System)System) Illustration 6A-
4
Cost of Goods Sold Ending Inventory
Solution on notes page
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Chapter 6-36
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