financial accounting fundamentals john j. wild third edition john j. wild third edition copyright ©...

Financial Accounting Fundamentals

John J. Wild

Third Edition

John J. Wild

Third Edition

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 05

Accounting for Inventories

Conceptual Chapter Objectives

C1: Identify the items making up merchandise inventory.

C2: Identify the costs of merchandise inventory.

5-3

Analytical Chapter Objectives

A1: Analyze the effects of inventory methods for both financial and tax reporting.

A2: Analyze the effects of inventory errors on current and future financial statements.

A3: Assess inventory management using both inventory turnover and days’ sales in inventory.

5-4

Procedural Chapter Objectives

P1: Compute inventory in a perpetual system using the methods of specific identification, FIFO, LIFO, and weighted average.

P2: Compute the lower of cost or market amount of inventory.

P3: Appendix 5A – Compute inventory in a periodic system using the methods of specific identification, FIFO, LIFO, and weighted average (see text for details).

P4: Appendix 5B – Apply both the retail inventory and gross profit methods to estimate inventory (see text for details).

5-5

Determining Inventory Items

Merchandise inventory includes all goods that a company owns and holds for sale, regardless of where the goods are located when inventory is counted.

Items requiring special attention include:

Goods in Transit

Goods Damaged or

ObsoleteGoods on Consignment

C 1

5-6

FOB Destination Point

Public Carrier

Seller Buyer

Goods in Transit

Public Carrier

Seller Buyer

FOB Shipping Point

Ownership passes to the buyer here.

C 1

5-7

Determining Inventory Costs

Invoice Cost

Include all expenditures necessary to bring an item to a salable condition and location.

Minus Discounts

and Allowances

Plus Import Duties Plus

Freight

Plus Storage

Plus Insurance

C 2

5-8

Internal Controls and Taking a Physical Count

Most companies take a physical count of inventory at least once each year.

When the physical count does not match the Merchandise Inventory account, an adjustment must be made.

Most companies take a physical count of inventory at least once each year.

When the physical count does not match the Merchandise Inventory account, an adjustment must be made.

InventoryCount Tag

Countedby _______

Quantity Counted ___

C 2

5-9

Inventory Costing Under a Perpetual System

Accounting for inventory

requires several decisions . . .

Costing Method Specific Identification, FIFO, LIFO,

or Weighted Average

Inventory System Perpetual or Periodic

Costing Method Specific Identification, FIFO, LIFO,

or Weighted Average

Inventory System Perpetual or Periodic

P1

5-10

Frequency in Use of Inventory Methods

P1

5-11

Inventory Cost Flow Assumptions

First-In, First-Out(FIFO)

Assumes costs flow in the order incurred.

Last-In, First-Out(LIFO)

Assumes costs flow in the reverse order incurred.

Weighted Average

Assumes costs flow at an average of the costs available.

P1

5-12

Inventory Costing IllustrationP1

5-13

Specific Identification

The above purchases were made in August. On August 14, a company sold eight bikes originally costing $91 and twelve bikes originally costing $106.

The above purchases were made in August. On August 14, a company sold eight bikes originally costing $91 and twelve bikes originally costing $106.

P1

5-14

The Cost of Goods Sold for the 20 bikes sold on the August 14 sale is $2,000.

8 bikes @ 91 = $ 72812 bikes @ 106 = $1,272

After this sale, there are five units in inventory at $500:

2 bikes @ $91 = $ 182 3 bikes @ $106 = $ 318

The Cost of Goods Sold for the 20 bikes sold on the August 14 sale is $2,000.

8 bikes @ 91 = $ 72812 bikes @ 106 = $1,272


2 bikes @ $91 = $ 182 3 bikes @ $106 = $ 318

Specific IdentificationP1

5-15

Additional purchases were made on August 17 and 28.

The cost of the 23 items sold on August 31 were as follows: 2 @ $91

3 @ $10615 @ $115 3 @ $119


The cost of the 23 items sold on August 31 were as follows: 2 @ $91

3 @ $10615 @ $115 3 @ $119

Specific IdentificationP1

5-16


Cost of Goods Sold for August 31 = $2,582


P1

5-17


Aug. 3 Merchandise inventory 1,590 Accounts payable 1,590

Aug. 14 Accounts receivable 2,600 Sales 2,600

Aug. 14 Cost of goods sold 2,000 Merchandise inventory 2,000





Here are the entries to record the purchases and sales. The numbers in red are determined by the cost flow assumption used.

All purchases and sales are

made on credit.

The selling price of

inventory was as follows:

8/14 $130 8/31 150

P1

5-18

First-In, First-Out (FIFO)

The above purchases were made in August.

On August 14, the company sold 20 bikes.



P1

5-19


The Cost of Goods Sold for the August 14 sale is $1,970.

After this sale, there are five units in inventory at $530: 5 @ $106


After this sale, there are five units in inventory at $530: 5 @ $106

P1

5-20




P1

5-21


Balance Sheet Inventory = $1,420


Income Statement COGS = $4,570

Income Statement COGS = $4,570

P1

5-22









Here are the entries to record the purchases and sales entries. The numbers in red are determined by the cost flow assumption used.


made on credit.



8/14 $130 8/31 150

P1

5-23

Last-In, First-Out (LIFO)





P1

5-24




5 @ $91



5 @ $91

P1

5-25




P1

5-26




Income Statement COGS

= $4,730


= $4,730

P1

5-27









Here are the entries to record the purchases and sales entries. The numbers in red are determined by the cost flow assumption used.


made on credit.



8/14 $130 8/31 150

P1

5-28

Weighted Average

When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold.

When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold.

Cost of Goods Available for

Sale

Units on hand on the date of

sale÷

P1

5-29

Cost of goods available for sale 2,500$ Total units in inventory 25 Weighted average cost per unit 100$


÷

Weighted Average

First, we need to compute the weighted average cost per unit of items in inventory.

P1

The Cost of Goods Sold for the August 14 sale is $2,000. After this sale, there are five units in inventory at $500:

The Cost of Goods Sold for the August 14 sale is $2,000. After this sale, there are five units in inventory at $500:

5-30

Weighted Average


Twenty-three bikes were sold on August 31.


Twenty-three bikes were sold on August 31.

What is the weighted average cost per unit of items in inventory?

P1

5-31

Weighted Average



÷

UnitsInventory 8/14 5 Purchase 8/17 20 Purchase 8/28 10 Units available for sale 35

UnitsInventory 8/14 5 Purchase 8/17 20 Purchase 8/28 10 Units available for sale 35

P1

5-32

Weighted Average



P1

Ending inventory is comprised of 12 units @ an average cost of $114 each or $1,368.

5-33

Weighted Average




= $4,622


= $4,622

P1

5-34

Weighted Average








Here are the entries to record the purchases and sales entries for Trekking. The numbers in red are determined by the cost flow assumption used.


made on credit.



8/14 $130 8/31 150

P1

5-35

Financial Statement Effects of Costing Methods

Because prices change, inventory methods nearly always assign different cost amounts.

Because prices change, inventory methods nearly always assign different cost amounts.

A1

5-36

Financial Statement Effects of Costing Methods

Advantages of MethodsAdvantages of MethodsAdvantages of MethodsAdvantages of Methods

Smoothes out Smoothes out price changes.price changes.Smoothes out Smoothes out price changes.price changes.

Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with

revenues.revenues.

Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with

revenues.revenues.

Ending inventory Ending inventory approximates approximates

current current replacement cost.replacement cost.

Ending inventory Ending inventory approximates approximates

current current replacement cost.replacement cost.

First-In, First-In, First-OutFirst-OutFirst-In, First-In, First-OutFirst-Out

Weighted Weighted AverageAverage

Weighted Weighted AverageAverage

Last-In, Last-In, First-OutFirst-OutLast-In, Last-In,

First-OutFirst-Out

A1

5-37

Tax Effects of Costing Methods

The Internal Revenue Service (IRS) The Internal Revenue Service (IRS) identifies several acceptable identifies several acceptable

methods for inventory costing for methods for inventory costing for reporting taxable income.reporting taxable income.

The Internal Revenue Service (IRS) The Internal Revenue Service (IRS) identifies several acceptable identifies several acceptable

methods for inventory costing for methods for inventory costing for reporting taxable income.reporting taxable income.

If LIFO is used for If LIFO is used for tax tax purposespurposes, the IRS requires , the IRS requires

it be used in financial it be used in financial statements.statements.

If LIFO is used for If LIFO is used for tax tax purposespurposes, the IRS requires , the IRS requires

it be used in financial it be used in financial statements.statements.

A1

5-38

Consistency in Using Costing Methods

The The consistency conceptconsistency concept requires a requires a company to use the same accounting company to use the same accounting methods period after period so that methods period after period so that financial statements are comparable financial statements are comparable across periods.across periods.

The The consistency conceptconsistency concept requires a requires a company to use the same accounting company to use the same accounting methods period after period so that methods period after period so that financial statements are comparable financial statements are comparable across periods.across periods.

A1

5-39

Lower of Cost or Market

Inventory must be reported at market Inventory must be reported at market value when value when marketmarket is is lowerlower than than

cost.cost.

Inventory must be reported at market Inventory must be reported at market value when value when marketmarket is is lowerlower than than

cost.cost.

Can be applied three ways:Can be applied three ways:(1)(1) separately to each separately to each

individual item.individual item.(2)(2) to major categories of to major categories of

assets.assets.(3)(3) to the whole inventory.to the whole inventory.

Can be applied three ways:Can be applied three ways:(1)(1) separately to each separately to each

individual item.individual item.(2)(2) to major categories of to major categories of

assets.assets.(3)(3) to the whole inventory.to the whole inventory.

Defined as current Defined as current replacement costreplacement cost (not sales price).(not sales price).Consistent withConsistent withthe conservatismthe conservatismprinciple.principle.

Defined as current Defined as current replacement costreplacement cost (not sales price).(not sales price).Consistent withConsistent withthe conservatismthe conservatismprinciple.principle.

P2

5-40


A motorsports retailer has the following items in A motorsports retailer has the following items in inventory:inventory:

A motorsports retailer has the following items in A motorsports retailer has the following items in inventory:inventory:

P2

5-41


Here is how to compute lower of cost or Here is how to compute lower of cost or market for market for individual inventory itemsindividual inventory items..

Here is how to compute lower of cost or Here is how to compute lower of cost or market for market for individual inventory itemsindividual inventory items..

P2

5-42

Financial Statement Effects of Inventory Errors

Income Statement EffectsIncome Statement Effects

A2

5-43

Financial Statement Effects of Inventory Errors

Balance Sheet EffectsBalance Sheet Effects

A2

5-44

Inventory Turnover

Shows how many times a company turns over its inventory during a period. Indicator of how well management is controlling the amount of inventory available.

Shows how many times a company turns over its inventory during a period. Indicator of how well management is controlling the amount of inventory available.

Inventory Inventory turnoverturnover ==

Cost of goods sold Cost of goods sold

Average inventoryAverage inventory

A3

5-45

Days’ Sales in Inventory

Reveals how much inventory is available in Reveals how much inventory is available in terms of the number of days’ sales.terms of the number of days’ sales.

Reveals how much inventory is available in Reveals how much inventory is available in terms of the number of days’ sales.terms of the number of days’ sales.

Days' sales in Days' sales in inventoryinventory ==

Ending inventory Ending inventory

Cost of goods soldCost of goods sold ×× 365365

A3

5-46

End of Chapter 05

5-47

financial accounting fundamentals john j. wild third edition john j. wild third edition copyright ©...

Documents

compute inventory

retail inventory

inventory turnover

inventory management

physical count of inventory

costs of merchandise

effects of inventory

merchandise inventory