inventories: cost measurement and flow assumptions c hapter 8 copyright © 2010...

Inventories: Cost Measurement and Flow

Assumptions

Chapter8

COPYRIGHT © 2010 South-Western/Cengage Learning

Intermediate AccountingIntermediate Accounting 11th edition 11th edition

Nikolai Bazley JonesNikolai Bazley Jones

An electronic presentationAn electronic presentationBy Norman SundermanBy Norman Sundermanand Kenneth Buchananand Kenneth BuchananAngelo State University

2

Flow of Inventory Costs

Merchandising CompanyMerchandising Company

Cost of Goods Sold

Accounts Payable (or Cash)

Merchandise Inventory

Goods Purchased

Goods Sold

3

Manufacturing CompanyManufacturing Company

Accounts Payable (or Cash)

Raw Materials Inventory

Materials Purchased

Materials Used in

Production

To Work in Process Inventory

ContinuedContinuedContinuedContinued


4

Direct Labor

Actual Direct Labor

Manufacturing (Factory) Overhead

Actual Mfg. Over-head Overhead Applied

to Production


Labor Charged to Production





5

Work in Process Inventory

Materials Used

Direct Labor

Overhead Applied

Finished Goods Inventory

Goods Finished (Manufactured)

Goods Sold to Cost of Goods Sold



6

Alternative Inventory Systems

A company using a perpetual system maintains a continuous record of the physical quantities

in its inventory.

A company using a perpetual system maintains a continuous record of the physical quantities

in its inventory.

7

A company using a periodic system does not maintain a

continuous record of the physical quantities of inventory on hand.

A company using a periodic system does not maintain a

continuous record of the physical quantities of inventory on hand.

Alternative Inventory Systems

8

Computation of Net Purchases

Purchases

+ Freight-in

– Purchases Returns and Allowances

– Purchases Discounts Taken

= Net Purchases

Purchases

+ Freight-in

– Purchases Returns and Allowances

– Purchases Discounts Taken

= Net Purchases

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Beginning Inventory

+ Purchases (net)

– Goods Sold

= Ending Inventory

Beginning Inventory

+ Purchases (net)

– Goods Sold

= Ending Inventory

Perpetual Inventory System

Beginning Inventory

+ Purchases (net)

– Ending Inventory

= Goods Sold

Beginning Inventory

+ Purchases (net)

– Ending Inventory

= Goods Sold

PeriodicInventory System

Comparison of Systems

10

Determination of Inventory Costs

Price paid or consideration given

Freight-in Receiving Unpacking Inspecting Storage Insurance Applicable taxes

Price paid or consideration given

Freight-in Receiving Unpacking Inspecting Storage Insurance Applicable taxes

11

Under the gross price method, a company records the purchase at the gross price and records the amount of the discount in the accounting system only if the discount is

taken.

Under the gross price method, a company records the purchase at the gross price and records the amount of the discount in the accounting system only if the discount is

taken.

Under the net price method, a company records the purchase at its net price and records the amount of the discount in the

accounting system only if the discount is not taken.

Under the net price method, a company records the purchase at its net price and records the amount of the discount in the

accounting system only if the discount is not taken.

Purchases Discounts

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If the company does not pay promptly, it is forfeiting 2% in order to keep the money for an additional 20

days.

If the company does not pay promptly, it is forfeiting 2% in order to keep the money for an additional 20

days.

A company purchases $1,000 of goods under terms of 2/10, n/30. What is the annual discount rate?

A company purchases $1,000 of goods under terms of 2/10, n/30. What is the annual discount rate?

The company can forfeit this discount 18 times during a year. (360 days/20 additional each time =

18)

The company can forfeit this discount 18 times during a year. (360 days/20 additional each time =

18)

Annual Rate on Discounts

2% forfeited 18 times equals an annual interest rate of 36%

2% forfeited 18 times equals an annual interest rate of 36%

13

Specific Identification

100 units @ $10 per unitApr. 1

Apr. 10

Apr. 20

80 units @ $11 per unit


On April 27, 90 units were sold from the beginning inventory and 50 units from the

April 10 purchase.

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Apr. 10

Apr. 20


Apr. 20 0 units @ $12 per unit







Sold 90

Sold 50

Ending Inventory…………

= $ 100

= 330

= 840

$1,270

Cost of Goods Sold………. $1,450

= $ 900

= 550

= 0

Sold 0

15



Apr. 10

Apr. 20


Apr. 20

Apr. 1

Apr. 10




70 units @ $12 per unitEnding Inventory…………

Goods Available for Sale…

= $ 1,000

= 880

= 840

$2,720

= $ 100

= 330

= 840

$1,270Cost of Goods Sold…………. $1,480Cost of Goods Sold………..

16


Apr. 10

Apr. 20


Sold 140 units during April


Sold all0 units @ $10 per unit

Sold 40

Sold 070 units @ $12 per unit

First-In, First-Out (FIFO)

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Apr. 10

Apr. 20

80 units @ $11 per unit40 units @ $11 per unit



Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold

= $ 0

= 440

= 840

$1,280

$1,000 + $1,720 – $1,280 = $1,440


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The ending inventory and the cost of goods sold under perpetual and periodic FIFO are

identical.

The ending inventory and the cost of goods sold under perpetual and periodic FIFO are

identical.


19

= $1,000

= 880

= 840

$2,720

Average Cost


Apr. 10

Apr. 20




250 units


$2,720 250 units = $10.88

$10.88 × 110 units = Ending Inventory of $1,197

$1,000 + $1,720 – $1,197 = $1,523

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$1,780 $1,780 160 160

Apr. 18 Sales (90) units @ $10.44 (940)Apr. 18 Balance 90 units @ $10.44 $ 940Apr. 20 Purchases 70 units @ $12 840Apr. 20 Balance 160 units @ $11.125 $1,780

Moving Average

Apr. 1 Beginning Inventory 100 units @ $10 $1,000Apr. 10 Purchases 80 units @ $11 880Apr. 10 Balance 180 units @ $10.44 $1,880

Apr. 27 Sales (50) units @ $11.125 (556)Apr. 30 Balance 110 units @ $11.125 $1,224

Cost of Goods Sold (140 units) $940 + $556 $1,496Ending Inventory (110 units @ $11.125) $1,224

$1,880 $1,880 180 180$1,880 $1,880 180 180

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Last-In, First-Out (LIFO)


Apr. 10

Apr. 20




Sold 0

Sold 70Sold all70 units @ $12 per unit

Periodic Inventory SystemPeriodic Inventory System


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Apr. 10

Apr. 20

80 units @ $11 per unit10 units @ $11 per unit70 units @ $12 per unit

Periodic Inventory SystemPeriodic Inventory System



= $1,000

= 110

= 0

$1,110

Last-In, First-Out (LIFO)

$1,000 + $1,720 – $1,110 = $1,610

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100 units @ $10 per unit90 units @ $10 per unitApr. 1

Apr. 10

Apr. 20

80 units @ $11 per unitPurchased 80


Perpetual Inventory SystemPerpetual Inventory System

Sold 8080 units @ $11 per unit0 units @ $11 per unit

Sold 10

Purchased 70Sold 50

Last-In, First Out (LIFO)


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Apr. 1

Apr. 10

Apr. 20

Perpetual Inventory SystemPerpetual Inventory System



= $ 900

= 0

= 240

$1,140

$1,000 + $1,720 – $1,140 = $1,580




Last-In, First Out (LIFO)

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Cost of Goods Cost of Available Goods Ending for Sale Sold Inventory

Cost Flow Assumption and MethodFIFO, periodic $2,720 $1,440 $1,280FIFO, perpetual 2,720 1,440 1,280Weighted average 2,720 1,523 1,197Moving average 2,720 1,496 1,224LIFO, periodic 2,720 1,610 1,110LIFO, perpetual 2,720 1,580 1,140

Comparison of Inventory Assumptions

Holding Gains Comparisons

FIFO matches the oldest cost with revenue.FIFO matches the oldest cost with revenue.

LIFO matches the most recent cost with revenue.LIFO matches the most recent cost with revenue.

26

27

10,000 units @ $20 per unit




= $200,000

= 132,000

= 192,000

= 120,000

$644,000Inventory, Jan. 1, 2010…..

In 2010 the company purchases 50,000 units at $35 per unit but sells 60,000 units.

In 2010 the company purchases 50,000 units at $35 per unit but sells 60,000 units.

2006:

2007:

2008:

2009:

Liquidation of LIFO Layers

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8,000 units at $24 per unit

4,000 units at $30 per unit

2006:

2007:

2008:

2009:

2010:

= $ 200,000

= 132,000

= 192,000

= 120,000

= $1,750,00050,000 units at $35 per unit0 units @ $35 per unitSold 4,000Sold 4,000

Sold 6,000Sold 6,0000 units @ $30 per unit



In 2010 the company purchases 50,000 units at $35 per unit and sells 60,000 units.

In 2010 the company purchases 50,000 units at $35 per unit and sells 60,000 units.

Sold 50,000Sold 50,000

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2006:

2007:

2008:

= $ 144,000

= 120,000

= 1,750,000

$2,014,00050,000 units @ $35 per unit


2008:

2009:

2010:Cost of Goods Sold………..


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1. The LIFO method requires a company to keep numerous detailed records.

2. Fluctuations in the physical quantities of similar inventory items may occur.

3. As technological changes take place, inventory made up with one material is replaced by inventory made with substitute materials, or an outdated design is replaced by a newer design.

Difficulties in Applying Simple LIFO

31

Step 1: Value the total ending inventory at current-year costs.

01/01/09 $10,000

12/31/09 $12,100

12/31/10 $13,125

12/31/11 $16,800

12/31/12 $12,360

Dollar-Value LIFO

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Step 2: Convert the ending inventory cost to base-year costs.

12/31/09 $12,100

12/31/10 $13,125

12/31/11 $16,800

12/31/12 $12,360

Ending Inventory at

Current Costs×

Base-Year Cost Index

Current Cost Index

× 100/110 = $11,000

12/31/0912/31/09

Dollar-Value LIFO

33

Step 3: Compute the change in the inventory level for the year at base-year costs.

$11,000

$10,500

$12,000

$10,300

12/31/09

12/31/10

12/31/11

12/31/12

Base year, $10,000Base year, $10,000

$11,000 $11,000 –– $10,000 $10,000

$1,000$1,000

1/1/0912/31/0912/31/09

Dollar-Value LIFO

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Step 4a: If there is an increase in the inventory levels at base-year costs, convert this increase to current-year costs.

Base year, $10,000Base year, $10,000Base year, $10,000Base year, $10,000

$1,000$1,000$1,000$1,000

12/31/0912/31/09

× 110/100 = $ 1,100

× 100/100 = 10,000$11,100

Ending inventory, 12/31/09

Dollar-Value LIFO

35


12/31/09 $12,100

12/31/10 $13,125

12/31/11 $16,800

12/31/12 $12,360

Ending Inventory at

Current Costs×


Current Cost Index

× 100/110 = $11,000

× 100/125 = $10,500

12/31/1012/31/10

Dollar-Value LIFO

36


$11,000

$10,500

$12,000

$10,300

12/31/09

12/31/10

12/31/11

12/31/12


12/31/1012/31/10

$1,000$1,000

$11,000 – $10,500

Dollar-Value LIFO

37


$11,000

$10,500

$12,000

$10,300

12/31/09

12/31/10

12/31/11

12/31/12


12/31/1012/31/10

$500$500

Dollar-Value LIFO

38

Step 4b: If there is a decrease in the inventory levels at base-year costs, this decrease reduces the inventory.


$500$500

12/31/1012/31/10

× 110/100 = $ 550

× 100/100 = 10,000$10,550


Dollar-Value LIFO

39


12/31/09 $12,100

12/31/10 $13,125

12/31/11 $16,800

12/31/12 $12,360

× 110/100 = $11,000

× 100/125 = $10,500

× 100/140 = $12,000

12/31/1112/31/11

Dollar-Value LIFO

Ending Inventory at

Current Costs×


Current Cost Index

40


$11,000

$10,500

$12,000

$10,300

12/31/09

12/31/10

12/31/11

12/31/12


12/31/1112/31/11

$500$500$12,000 – $10,500 = $1,500

Dollar-Value LIFO

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$500$500

$11,000

$10,500

$12,000

$10,300

12/31/09

12/31/10

12/31/11

12/31/12


12/31/1112/31/11

$1,500$1,500


Dollar-Value LIFO

42

Step 4a: If there is an increase in inventory levels at base-year costs, convert this increase to current-year costs.


12/31/1112/31/11

× 140/100 = $ 2,100

× 110/100 = 550

× 100/100 = 10,000$12,650


$500$500

$1,500$1,500

Dollar-Value LIFO

43


12/31/09 $12,100

12/31/10 $13,125

12/31/11 $16,800

12/31/12 $12,360

× 110/100 = $11,000

× 100/125 = $10,500

× 100/140 = $12,000

× 100/120 = $10,300

12/31/1212/31/12

Dollar-Value LIFO

Ending Inventory at

Current Costs×


Current Cost Index

44

$500$500

$11,000

$10,500

$12,000

$10,300

12/31/09

12/31/10

12/31/11

12/31/12


12/31/1212/31/12

$1,500$1,500

Dollar-Value LIFO

45

$500$500

$11,000

$10,500

$12,000

$10,300

12/31/09

12/31/10

12/31/11

12/31/12


12/31/1212/31/12

Dollar-Value LIFO

46

$300$300

$11,000

$10,500

$12,000

$10,300

12/31/09

12/31/10

12/31/11

12/31/12


12/31/1212/31/12

Dollar-Value LIFO

47

Step 4a: If there is an increase in the inventory levels at base-year costs, convert this increase to current-year costs.


12/31/1212/31/12

× 110/100 = $ 330

× 100/100 = 10,000$10,330


$300$300

Dollar-Value LIFO

48

Cost Index =

Sample of Ending Inventory at Current-Year Costs

Sample of Ending Inventory at Base-Year Costs

× 100

Double-Extension MethodDouble-Extension Method

Determination of Cost Index

49

Cost Index =

Sample of Ending Inventory at Current -Year Costs

Sample of Ending Inventory at Previous-Year Costs

×

Link-Chain MethodLink-Chain Method

Previous-Year Cost

Index

Determination of Cost Index

50

A company may use inventory pools in conjunction with dollar-value LIFO. The purpose of the pools is to maintain the benefits from using LIFO when fluctuations in the physical quantities

or similar inventory items occur and when technological change takes place.

Inventory Pools

51

Life Valuation Adjustment - Frequently, a company uses LIFO for external financial reporting and income tax purposes but uses another method for internal management.

Additional LIFO Considerations

52

Interim Statements Using LIFO – If a company uses LIFO for annual reporting purposes, it must use LIFO for interim reporting purposes. GAAP states that if a company using LIFO has an inventory liquidation at an interim date that it expects to replace by the end of the annual period, it does not include the LIFO liquidation in its inventory, and its cost of sales includes the expected cost of replacement of the liquidated LIFO inventory.


53

Change to or from LIFO - A company may occasionally change its inventory cost flow assumption.

To – Usually, the effect on the results of prior periods is not determinable. Then GAAP requires that the company apply the change prospectively, as of the earliest date practicable.

From – Retroactively restate the results of prior periods and treat the change as a retrospective adjustment.


54

IFRS vs. U.S. GAAP

IFRS do not allow the use of LIFO for both financial and tax purposes.

While both U.S. GAAP and IFRS allow the use of multiple acceptable cost flow assumptions, IFRS require that the same assumption be used for all inventories that have a similar nature and use. No such requirement exists under U.S. GAAP.

55

1. An exchange gain occurs when the exchange rate declines between the date a payable is recorded as a result of a purchase of inventory and the date of the cash payment.

2. An exchange gain occurs when the exchange rate increases between the date a receivable is recorded as a result of a sale of inventory and the date of the cash receipt.

When exchange rates are stated in terms of $ per unit of foreign currency, exchange gains and losses occur for purchases or sales on account as follows:

When exchange rates are stated in terms of $ per unit of foreign currency, exchange gains and losses occur for purchases or sales on account as follows:


Appendix: Foreign Currency Transactions Involving Inventory

56

Appendix: Foreign Currency Transactions Involving Inventory

3. An exchange loss occurs when the exchange rate increases between the date a payable is recorded as a result of a purchase of inventory and the date of the cash payment.

4. An exchange loss occurs when the exchange rate declines between the date a receivable is recorded as a result of a sale of inventory and the date of the cash receipt.

RMBRMB

57

Chapter 8

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inventories: cost measurement and flow assumptions c hapter 8 copyright © 2010...

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