Chap 7 Inventory Valuation & Measurement Issues • Costs included in inventory • Cost of Goods Sold for merchandizers • Concepts ( no calculations) on the different inventory costing methods • Effects of inventory errors on financial statements • Lower of Cost or Market in relation to inventory valuation • Inventory Management & Internal Control • Perpetual vs. Periodic Inventory Systems • Inventory Turnover ratio
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Chap 7 Inventory Valuation & Measurement Issues
• Costs included in inventory• Cost of Goods Sold for merchandizers• Concepts ( no calculations) on the different inventory
costing methods• Effects of inventory errors on financial statements• Lower of Cost or Market in relation to inventory valuation• Inventory Management & Internal Control• Perpetual vs. Periodic Inventory Systems• Inventory Turnover ratio
7-5
Costs Included in Inventory Purchases
The cost principlecost principle requires that inventory be recorded at the price paid or the
current current replacement cost.replacement cost.
First-In, First-OutFirstFirst--In, In, FirstFirst--OutOut
Last-In, First-OutLastLast--In, In,
FirstFirst--OutOut
Smoothes out price changes.Smoothes out Smoothes out price changes.price changes.
Weighted AverageWeighted Weighted AverageAverage
7-31
Managers Choice of Inventory Methods
Net Income EffectsManagers prefer to report higher earnings for their
companies.
Net Income EffectsNet Income EffectsManagers prefer to report Managers prefer to report higher earnings for their higher earnings for their
companies.companies.
Income Tax EffectsManagers prefer to pay
the least amount of taxes allowed by law as late as
possible.
Income Tax EffectsIncome Tax EffectsManagers prefer to pay Managers prefer to pay
the least amount of taxes the least amount of taxes allowed by law as late as allowed by law as late as
possible.possible.
7-41
LIFO and International Comparisons
LIFO Permitted?LIFO Permitted?
YesYesNoNo
ChinaSingapore
Canada
Great Britain
Australia
7-32
Choosing Inventory Costing Methods
LIFO for books
LIFO for books
LIFO for taxes
LIFO for taxes
If . . . Then . . .LIFO Conformity
Rule
7-34
Valuation at Lower of Cost or Market
Ending inventory is reported at the lower of cost or market (LCM).
Ending inventory is reported at the Ending inventory is reported at the lower of cost or market (LCM)lower of cost or market (LCM). .
Replacement CostThe current purchase price
for identical goods.
Replacement CostReplacement CostThe current purchase price The current purchase price
for identical goods.for identical goods.
The company will recognize a “holding” loss in the current period rather than the period in which the
item is sold.This practice is conservative.
The company will recognize a “holding” loss in the The company will recognize a “holding” loss in the current period rather than the period in which the current period rather than the period in which the
item is sold.item is sold.This practice is This practice is conservativeconservative..
Average Inventory is . . .(Beginning Inventory + Ending Inventory) ÷ 2
Average Inventory is . . .Average Inventory is . . .(Beginning Inventory + Ending Inventory) ÷ 2(Beginning Inventory + Ending Inventory) ÷ 2
This ratio reflects how many times average inventory was produced and sold during the period. A higher ratio indicates that inventory moves more quickly thus reducing storage and
obsolescence costs.
This ratio reflects how many times This ratio reflects how many times average inventory was produced and average inventory was produced and sold during the period. A higher ratio sold during the period. A higher ratio indicates that inventory moves more indicates that inventory moves more quickly thus reducing storage and quickly thus reducing storage and
obsolescence costs. obsolescence costs.
7-43
Internal Control of Inventory
Separation of inventory accounting and physical
handling of inventory.
Storage in a manner that protects from theft and
damage.
Limiting access to authorized employees.
Maintaining perpetual inventory records.
Comparing perpetual records to periodic
physical counts.
7-44
Perpetual and Periodic Inventory Systems
Provides up-to-dateinventory records.
Provides Provides upup--toto--datedateinventory records.inventory records.
Provides up-to-date cost of sales records. Provides Provides upup--toto--date date
cost of sales records. cost of sales records.
Perpetual System
Perpetual Perpetual SystemSystem
In a periodic inventory system, ending inventory and cost of goods sold are determined at the end of the accounting
period based on a physical count.
7-45
Perpetual and Periodic Inventory Systems
Inventory System
Item Periodic System Perpetual System
Beginning InventoryCarried over
from prior periodCarried over from
prior period
Add: PurchasesAccumulated in the Purchases
account
Accumulated in the Inventory
account
Less: Ending Inventory
Measured at end of period by
physical
inventory count
Perpetual record updated at every
sale
Cost of Goods Sold
Computed as a residual amount at end of period
Measured at every sale based
on perpetual record
7-46
Errors in Measuring Ending Inventory
Errors in Measuring InventoryEnding Inventory Beginning Inventory
Overstated Understated Overstated Understated
Ending Inventory + - N/A N/A
Retained Earnings + - - +
Goods Available for Sale N/A N/A + -Cost of Goods Sold - + + -Gross Profit + - - +Net Income + - - +
Effect on Current Period's Balance Sheet
Effect on n Current Period's Income Statement
7-37
Inventory Turnover
Cost of Goods Sold=
Average Inventory
Inventory Turnover
Average Inventory is . . .(Beginning Inventory + Ending Inventory) ÷ 2
Average Inventory is . . .Average Inventory is . . .(Beginning Inventory + Ending Inventory) ÷ 2(Beginning Inventory + Ending Inventory) ÷ 2
This ratio reflects how many times average inventory was produced and sold during the period. A higher ratio indicates that inventory moves more
quickly thus reducing storage and obsolescence costs.
This ratio reflects how many times This ratio reflects how many times average inventory was produced and average inventory was produced and sold during the period. A higher ratio sold during the period. A higher ratio indicates that inventory moves more indicates that inventory moves more
quickly thus reducing storage and quickly thus reducing storage and obsolescence costs. obsolescence costs.