Kieso13eslides8

Chapter 8-1

Chapter 8-2

C H A P T E R C H A P T E R 88

VALUATION OF INVENTORIES: VALUATION OF INVENTORIES:

A COST-BASIS APPROACHA COST-BASIS APPROACH

Intermediate Accounting13th Edition

Kieso, Weygandt, and Warfield

Chapter 8-3

Inventories are:

items held for sale, or

goods to be used in the production of goods to be sold.

Inventory IssuesInventory IssuesInventory IssuesInventory Issues

LO 1 Identify major classifications of inventory.LO 1 Identify major classifications of inventory.

Classification

MerchandiserMerchandiser ManufacturerManufacturer

Businesses with Inventory:

or

Chapter 8-4

One inventory accountPurchase goods ready for sale

Classification



Illustration 8-1Illustration 8-1

Chapter 8-5

Classification



Illustration 8-1Illustration 8-1

Three accountsRaw materialsWork in processFinished goods

Chapter 8-6

Inventory Cost Flow


Illustration 8-Illustration 8-22


Chapter 8-7

Inventory Cost Flow




Companies use one of two types of systems for maintaining inventory records — perpetual system or periodic system.

Chapter 8-8

Inventory Cost FlowInventory Cost FlowInventory Cost FlowInventory Cost Flow

LO 2 Distinguish between perpetual and periodic inventory LO 2 Distinguish between perpetual and periodic inventory systems.systems.

Perpetual System

1. Purchases of merchandise are debited to Inventory.

2. Freight-in is debited to Inventory. Purchase returns and allowances and purchase discounts are credited to Inventory.

3. Cost of goods sold is debited and Inventory is credited for each sale.

4. Subsidiary records show quantity and cost of each type of inventory on hand.

The perpetual inventory system provides a continuous record of Inventory and Cost of Goods

Sold.

Chapter 8-9



Periodic System

1. Purchases of merchandise are debited to Purchases.

2. Ending Inventory determined by physical count.

3. Calculation of Cost of Goods Sold:Beginning inventory

$ 100,000

Purchases, net

800,000

Goods available for sale

900,000

Ending inventory

125,000

Cost of goods sold

$ 775,000

Chapter 8-10



Illustration: Fesmire Company had the following transactions during the current year.

Record these transactions using the Perpetual and Periodic systems.

Chapter 8-11




Illustration:

Solution on notes page

Chapter 8-12



Illustration: Assume that at the end of the reporting period, the perpetual inventory account reported an inventory balance of $4,000. However, a physical count indicates inventory of $3,800 is actually on hand. The entry to record the necessary write-down is as follows.

Inventory Over and Short 200

Inventory 200

Note: Inventory Over and Short adjusts Cost of Goods Sold. In practice, companies sometimes report Inventory Over and Short in the “Other revenues and gains” or “Other expenses and losses” section of the income statement.

Chapter 8-13

Inventory Control



All companies need periodic verification of the inventory records by actual count, weight, or measurement, with the counts compared with the detailed inventory records.

Companies should take the physical inventory near the end of their fiscal year, to properly report inventory quantities in their annual accounting reports.

Chapter 8-14

Basic Issues in Inventory ValuationBasic Issues in Inventory ValuationBasic Issues in Inventory ValuationBasic Issues in Inventory Valuation


Valuation

Companies must allocate the cost of all the goods available for sale (or use) between the goods that were sold or used and those that are still on hand.


Chapter 8-15

Basic Issues in Inventory ValuationBasic Issues in Inventory ValuationBasic Issues in Inventory ValuationBasic Issues in Inventory Valuation


The physical goods (goods on hand, goods in transit, consigned goods, special sales agreements).

The costs to include (product vs. period costs).

The cost flow assumption (FIFO, LIFO, Average cost, Specific Identification, Retail, etc.).

Valuation requires determining

Chapter 8-16

A company should record purchases when it obtains legal title to the goods.

Physical Goods Included in InventoryPhysical Goods Included in InventoryPhysical Goods Included in InventoryPhysical Goods Included in Inventory



Chapter 8-17

Effect of Inventory ErrorsEffect of Inventory ErrorsEffect of Inventory ErrorsEffect of Inventory Errors

LO 3 Identify the effects of inventory errors on the financial LO 3 Identify the effects of inventory errors on the financial statements.statements.

Ending Inventory Misstated

The effect of an error on net income in one year (2009) will be counterbalanced in the next (2010), however the income

statement will be misstated for both years.


Chapter 8-18


Illustration: Jay Weiseman Corp. understates its ending inventory by $10,000 in 2009; all other items are correctly stated.


LO 3LO 3

Chapter 8-19


LO 3 Identify the effects of inventory errors on the financial LO 3 Identify the effects of inventory errors on the financial statements.statements.

Purchases and Inventory Misstated

The understatement does not affect cost of goods sold and net income because the errors offset one another.


Chapter 8-20

Costs Included in InventoryCosts Included in InventoryCosts Included in InventoryCosts Included in Inventory

LO 4 Understand the items to include as inventory cost.LO 4 Understand the items to include as inventory cost.

Product Costs - costs directly connected with bringing the goods to the buyer’s place of business and converting such goods to a salable condition.

Period Costs – generally selling, general, and administrative expenses.

Purchase Discounts – Gross vs. Net Method

Chapter 8-21

Costs Included in InventoryCosts Included in InventoryCosts Included in InventoryCosts Included in Inventory

LO 4 Understand the items to include as inventory cost.LO 4 Understand the items to include as inventory cost.

Treatment of Purchase DiscountsIllustration 8-Illustration 8-

1111

* $4,000 x 2% = $80

*

** $10,000 x 98% = $9,800

**


Chapter 8-22

Answer: Method adopted should be one that most clearly reflects periodic income.

Cost Flow Assumption Adopted

does not need to equal

Physical Movement of Goods

Cost Flow Assumption Adopted

does not need to equal

Physical Movement of Goods

FIFO

Which Cost Flow Assumption to Which Cost Flow Assumption to Adopt?Adopt?

Which Cost Flow Assumption to Which Cost Flow Assumption to Adopt?Adopt?

LIFO

Average Cost

Specific Identification

LO 5 Describe and compare the cost flow LO 5 Describe and compare the cost flow assumptions used to account for assumptions used to account for inventories.inventories.

Chapter 8-23

Young & Crazy Company makes the following purchases:

1. One item on 2/2/11 for $10



Young & Crazy Company sells one item on 2/28/11 for $90. What would be the balance of ending inventory and cost of goods sold for the month ended Feb. 2011, assuming the company used the FIFO, LIFO, Average Cost, and Specific Identification cost flow assumptions? Assume a tax rate of 30%.

Example

Cost Flow AssumptionsCost Flow AssumptionsCost Flow AssumptionsCost Flow Assumptions


Chapter 8-24

Purchase on 2/2/07 for $10



Inventory Balance = $ 45

Young & Crazy CompanyIncome Statement

For the Month of Feb. 2007 Sales $ 90 Cost of goods sold 0 Gross profit 90 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 57 Taxes 17 Net Income $ 40


“First-In-First-Out (FIFO)”


Chapter 8-25







For the Month of Feb. 2007 Sales $ 90 Cost of goods sold 10 10 Gross profit 80 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 4747 Taxes 14 14 Net Income $ 33 $ 33

“First-In-First-Out (FIFO)”


Chapter 8-26








“Last-In-First-Out (LIFO)”


Chapter 8-27







For the Month of Feb. 2007 Sales $ 90 Cost of goods sold 20 20 Gross profit 70 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 37 37 Taxes 11 11 Net Income $ $ 26 26

“Last-In-First-Out (LIFO)”


Chapter 8-28








“Average Cost”


Chapter 8-29







For the Month of Feb. 2007 Sales $ 90 Cost of goods sold 15 15 Gross profit 75 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 42 42 Taxes 12 12 Net Income $ $ 3030

“Average Cost”


Chapter 8-30








“Specific Identification”


Chapter 8-31








“Specific Identification”

Depends which one is Depends which one is soldsold


Chapter 8-32

Financial Statement SummaryFinancial Statement Summary

FIFO LIFO AverageSales 90$ 90$ 90$ Cost of goods sold 10 20 15

Gross profit 80 70 75 Operating expenses:

Administrative 14 14 14 Selling 12 12 12 Interest 7 7 7

Total expenses 33 33 33 Income before taxes 47 37 42 Income tax expense 14 11 12 Net income 33$ 26$ 30$

Inventory Balance 302535



Chapter 8-33


LO 5LO 5

Illustration: Call-Mart Inc. had the following transactions in its first month of operations.

Beginning inventory (2,000 x $4)

$ 8,000

Purchases:

6,000 x $4.40

26,400

2,000 x 4.75

9,500

Goods available for sale

$43,900

Calculate Goods Available for Sale

Chapter 8-34

Specific IdentificationSpecific IdentificationSpecific IdentificationSpecific Identification

Illustration: Assume that Call-Mart Inc.’s 6,000 units of inventory consists of 1,000 units from the March 2 purchase, 3,000 from the March 15 purchase, and 2,000 from the March 30 purchase. Compute the amount of ending inventory and cost of goods sold. Illustration 8-Illustration 8-

1212


Chapter 8-35

Average CostAverage CostAverage CostAverage Cost




Weighted-Average

Chapter 8-36

Average CostAverage CostAverage CostAverage Cost




In this method, Call-Mart computes a new average unit cost each time it makes a purchase.

Moving-Average

Chapter 8-37

First-In, First-Out (FIFO)First-In, First-Out (FIFO)First-In, First-Out (FIFO)First-In, First-Out (FIFO)




Periodic Method

Determine cost of ending inventory by taking the cost of the most recent purchase and working back until it accounts for all units in the inventory.

Chapter 8-38

First-In, First-Out (FIFO)First-In, First-Out (FIFO)First-In, First-Out (FIFO)First-In, First-Out (FIFO)




Perpetual Method

In all cases where FIFO is used, the inventory and cost of goods sold would be the same at the end of the month whether a perpetual or periodic system is used.

Chapter 8-39

Last-In, First-Out (LIFO)Last-In, First-Out (LIFO)Last-In, First-Out (LIFO)Last-In, First-Out (LIFO)




Periodic Method

The cost of the total quantity sold or issued during the month comes from the most recent purchases.

Chapter 8-40

Last-In, First-Out (LIFO)Last-In, First-Out (LIFO)Last-In, First-Out (LIFO)Last-In, First-Out (LIFO)




Perpetual Method

The LIFO method results in different ending inventory and cost of goods sold amounts than the amounts calculated under the periodic method.

Chapter 8-41

Many companies use

LIFO for tax and external financial reporting purposes

FIFO, average cost, or standard cost system for internal reporting purposes.

Reasons:

Special Issues Related to LIFOSpecial Issues Related to LIFOSpecial Issues Related to LIFOSpecial Issues Related to LIFO

LO 6 Explain the significance and use of a LIFO reserve.LO 6 Explain the significance and use of a LIFO reserve.

LIFO Reserve

1. Pricing decisions2. Record keeping easier3. Profit-sharing or bonus arrangements4. LIFO troublesome for interim periods

Chapter 8-42


LO 6 Explain the significance and use of a LIFO reserve.LO 6 Explain the significance and use of a LIFO reserve.

LIFO Reserve is the difference between the inventory method used for internal reporting purposes and LIFO.

Example:FIFO value per booksFIFO value per books $160,000$160,000

LIFO value LIFO value 145,000145,000

LIFO ReserveLIFO Reserve $ $ 15,00015,000

Cost of goods sold 15,000

Allowance to reduce inventory to LIFO 15,000

Journal entry to reduce inventory to LIFO:

Companies should disclose either the LIFO reserve or the replacement cost of the inventory.

Chapter 8-43

Older, low cost inventory is sold resulting in a lower cost of goods sold, higher net income, and higher taxes.


LO 7 Understand the effect of LIFO liquidations.LO 7 Understand the effect of LIFO liquidations.

LIFO Liquidation

Illustration: Basler Co. has 30,000 pounds of steel in its inventory on December 31, 2010, with cost determined on a specific goods LIFO approach.

Chapter 8-44

Illustration: At the end of 2011, only 6,000 pounds of steel remained in inventory.


LO 7 Understand the effect of LIFO liquidations.LO 7 Understand the effect of LIFO liquidations.

LIFO Liquidation


Chapter 8-45

Changes in a pool are measured in terms of total dollar value, not physical quantity.

Advantage:

Broader range of goods in pool.

Permits replacement of goods that are similar.

Helps protect LIFO layers from erosion.


LO 8 Explain the dollar-value LIFO method.LO 8 Explain the dollar-value LIFO method.

Dollar-Value LIFO

Chapter 8-46



Exercise 8-26 (partial): The following information relates to the Choctaw Company.

Use the dollar-value LIFO method to compute the ending inventory for 2007 through 2009.

Dollar-Value LIFO

Chapter 8-47



Inventory at Inventory at $ Value

End- of- Year Base- Year Base $ Value LIFO LIFO

Year Prices Index Prices Layers Index LIFO TOTAL Reserve

2007 70,000$ 1.00 70,000$ 70,000$ 1.00 70,000$ 70,000$ -$

2008 88,200 1.05 84,000 70,000 1.00 70,000

14,000 1.05 14,700 84,700 3,500

2009 95,120 1.16 82,000 70,000 1.00 70,000

12,000 1.05 12,600 82,600 12,520

Dec. 31 Dec. 31 Dec. 31Balance Sheet 2007 2008 2009

I nventory 70,000$ 88,200$ 95,120$ LI FO Reserve - (3,500) (12,520)

70,000$ 84,700$ 82,600$ J ournal entry

Cost of goods sold 3,500 9,020 Lifo reserve (3,500) (9,020)

Exercise 8-26 Solution

Chapter 8-48






2007 70,000$ 1.00 70,000$ 70,000$ 1.00 70,000$ 70,000$ -$

2008 88,200 1.05 84,000 70,000 1.00 70,000

14,000 1.05 14,700 84,700 3,500

2009 95,120 1.16 82,000 70,000 1.00 70,000

12,000 1.05 12,600 82,600 12,520



70,000$ 84,700$ 82,600$ J ournal entry



Chapter 8-49






2007 70,000$ 1.00 70,000$ 70,000$ 1.00 70,000$ 70,000$ -$

2008 88,200 1.05 84,000 70,000 1.00 70,000

14,000 1.05 14,700 84,700 3,500

2009 95,120 1.16 82,000 70,000 1.00 70,000

12,000 1.05 12,600 82,600 12,520



70,000$ 84,700$ 82,600$ J ournal entry



Chapter 8-50

Specific-goods LIFO - costing goods on a unit basis is expensive and time consuming.

Specific-goods Pooled LIFO approach

reduces record keeping and clerical costs.more difficult to erode the layers.using quantities as measurement basis can lead to untimely LIFO liquidations.

Dollar-value LIFO is used by most companies.



Comparison of LIFO Approaches

Chapter 8-51

Matching

Tax Benefits/Improved Cash Flow

Future Earnings Hedge


LO 9LO 9 Identify the major advantages and disadvantages of LIFO.Identify the major advantages and disadvantages of LIFO.

Advantages

Reduced earnings

Inventory understated

Physical flow

Involuntary Liquidation / Poor Buying Habits

Disadvantages

Chapter 8-52

LIFO is generally preferred:

1. if selling prices are increasing faster than costs and

2. if a company has a fairly constant “base stock.”

Basis for Selection of Inventory Basis for Selection of Inventory MethodMethod

Basis for Selection of Inventory Basis for Selection of Inventory MethodMethod

LO 10 Understand why companies select given inventory LO 10 Understand why companies select given inventory methods.methods.

LIFO is not appropriate:

1. if prices tend to lag behind costs,

2. if specific identification traditionally used, and

3. when unit costs tend to decrease as production increases.

Chapter 8-53

Copyright © 2009 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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Kieso13eslides8

Documents

physical inventory

inventory purchases

short inventory

inventory quantities

type of inventory

inventory balance

periodic inventory systems

perpetual inventory