Chapter 6 Inventories (存貨 )

Instructor: Chih-Liang Julian Liu

Department of Industrial and Business Management

Chang Gung University

Chapter 6 InventoriesLearning Objectives

1. Describe the steps in determining inventory

quantities (存貨數量 ).

2. Explain the accounting for inventories and

apply the inventory cost flow methods (存貨成本流動方法 ).

3. Explain the financial effects of the inventory

cost flow assumptions.

Chapter 6 InventoriesLearning Objectives

4. Explain the lower-of-cost-or-net realizable value

(成本與淨現值熟低 ) basis of accounting for

inventories.

5. Indicate the effects of inventory errors on the

financial statements.

6. Compute and interpret the inventory turnover

ratio (存貨週轉率 ).

Preview of Chapter 6

One Classification:

Inventory (存貨 )

Three Classifications:

Raw Materials (原料 )

Work in Process (在製品 )

Finished Goods (製成品 )

Merchandising Company

Manufacturing Company

Regardless of the classification, companies report all inventories under Current Assets (流動資產 ) on the

Statement of Financial Position.

Classifying Inventory

Physical Inventory (實地盤點存貨 ) taken for two reasons:

Perpetual System

1. Check accuracy of inventory records (存貨紀錄正確性 ).

2. Determine amount of inventory lost (wasted raw

materials, shoplifting, or employee theft).

Periodic System

1. Determine the inventory on hand (庫存存貨 ).

2. Determine the cost of goods sold for the period.

Determining Inventory Quantities

Involves counting, weighing, or measuring each

kind of inventory on hand.

Taken,

when the business is closed or business is

slow.

at end of the accounting period.

Taking a Physical Inventory

Determining Inventory Quantities

Goods in Transit (在途存貨 )

Purchased goods not yet received.

Sold goods not yet delivered.

Determining Ownership of Goods (商品所有權 )

Goods in transit should be included in the inventory of the company that has legal title (法律所有權 ) to the goods. Legal title is determined

by the terms of sale (銷貨條件 ).

Determining Inventory Quantities

Illustration 6-1 Terms of sale

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.

Goods in Transit

Determining Inventory Quantities

Goods in transit should be included in the

inventory of the buyer when the:

a. public carrier accepts the goods from

the seller.

b. goods reach the buyer.

c. terms of sale are FOB destination.

d. terms of sale are FOB shipping point.

Question

Determining Inventory Quantities

Hargrove Company

• 20,000 units of inventory on hand.

• Goods in transit:

• (1) sales of 1,500 units shipped FOB destination.

• (2) purchases of 2,500 units shipped FOB shipping point by the seller.

• What’s the inventory quantities?

Consigned Goods (寄銷品 )

Goods held for sale by one party.

Ownership of the goods is retained by

another party.

Determining Inventory Quantities

Determining Ownership of Goods

Inventory Cost

Inventory Quantities

Unit costs ?

Determining Inventory Cost?

Unit costs (單位成本 ) can be applied to

quantities on hand using the following costing

methods:

Specific Identification (個別認定 )

First-in, first-out (FIFO) (先進先出 )

Average-cost (平均成本 )

Cost Flow Assumptions

Inventory Costing

Illustration: Crivitz TV Company purchases three

identical 50-inch TVs on different dates at costs of £700,

£750, and £800. During the year Crivitz sold two sets at

£1,200 each. These facts are summarized below.

Illustration 6-2

Inventory Costing

Specific Identification

If Crivitz sold the TVs it purchased on February 3 and May

22, then its cost of goods sold is £1,500 (£700 + £800),

and its ending inventory is £750.

Illustration 6-3

Inventory Costing

Actual physical flow costing method in which

items still in inventory are specifically costed to

arrive at the total cost of the ending inventory.

Practice is relatively rare.

Most companies make assumptions (Cost

Flow Assumptions) about which units were

sold.

Inventory CostingSpecific Identification

Inventory Costing

There are two assumed cost flow methods:

1. First-in, first-out (FIFO)

2. Average-cost

Cost flow does not need be consistent with the

physical movement of the goods.

Illustration: Data for Lin Electronics’ Astro condensers (Periodic System). Illustration 6-4

(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold

Inventory Costing

Earliest goods purchased are first to be sold.

(最先買入的商品是最先被出售 ).

Often parallels actual physical flow of

merchandise (實際商品的流動相符 ).

Generally good business practice to sell

oldest units first (先賣出最舊的產品 ).

First-In-First-Out (FIFO)

Inventory Costing

Illustration 6-5First-In-First-Out (FIFO)

Inventory Costing

Illustration 6-5

Inventory CostingFirst-In-First-Out (FIFO)

Illustration 6-6 Proof of COGS

Assuming the Perpetual Inventory System, compute Cost of Goods

Sold and Ending Inventory under FIFO.

Illustration 6A-1

APPENDIX 6A PERPETUAL INVENTORY SYSTEMS

First-In-First-Out (FIFO)

Cost of Goods Sold

Ending Inventory

Illustration 6A-2

APPENDIX 6A PERPETUAL INVENTORY SYSTEMS

Allocates cost of goods available for sale

on the basis of weighted-average unit

cost incurred (加權平均單位成本 ).

Assumes goods are similar in nature.

Applies weighted-average unit cost to the

units on hand to determine cost of the

ending inventory.

Inventory CostingAverage Cost

Illustration 6-8

Inventory CostingAverage Cost

Inventory CostingAverage Cost

Illustration 6-8

Illustration 6A-3

Cost of Goods Sold

Ending Inventory

APPENDIX 6A PERPETUAL INVENTORY SYSTEMS

Average Cost (Moving-Average System)

Financial Statement and Tax EffectsIllustration 6-9

Inventory Costing

A major advantage of the FIFO method is

that in a period of inflation, the costs

allocated to ending inventory will

approximate their current cost.

A shortcoming of the average-cost method

is that in a period of inflation, the costs

allocated to ending inventory may be

understated in terms of current cost.

Financial Statement Effects

In a period of inflation:

FIFO - inventory and net income

higher.

Average-Cost - lower income taxes.

Tax Effects

In Summary

• Prices are rising (inflation)

• FIFO:

(1) Higher ending inventory cost (Statement of financial position)

(2) Lower cost of good sold, higher net income, and higher income tax (Income statement).

The cost flow method that often parallels the

actual physical flow of merchandise is the:

a. FIFO method.

b. average cost method.

c. gross profit method.

d. none of the above

Question

Inventory Costing

In a period of rising prices, average cost will

produce:

a. higher net income than FIFO.

b. the same net income as FIFO.

c. lower net income than FIFO.

d. net income is equal to the specific

identification method.

Question

Inventory Costing

Using Cost Flow Methods Consistently

Method should be used consistently, enhances

comparability.

Although consistency is preferred, a company

may change its inventory costing method.

When a company adopts a different method, it

should disclose in the financial statements the

change and its effect on net income.

Inventory Costing

Lower-of-Cost-or-Net Realizable Value

When the value of inventory is lower than its cost

Companies must “write down” (沖減 ) the inventory to

its net realizable value in the period in which the price

decline occurs.

Net realizable value (淨變現價值 ) refers to the net

amount (淨值 ) that a company expects to realize

(receive) from the sale of inventory (estimated selling

price in the normal course of business, less estimated

costs to complete and sell).

Inventory Costing

Illustration: Assume that Gao TV has the following

lines of merchandise with costs and net realizable

values as indicated.Illustration 6-10

Inventory CostingLower-of-Cost-or-Net Realizable Value

Common Cause:

Failure to count or price inventory correctly.

Not properly recognizing the transfer of legal

title to goods in transit.

Errors affect both the income statement

and statement of financial position.

Inventory Errors

Inventory errors affect the computation of cost of

goods sold and net income.

Illustration 6-12

Illustration 6-11

Inventory CostingIncome Statement Effects

Sales revenue - Cost of Goods Sold = Gross Profit

Inventory errors affect the computation of cost of goods

sold and net income in two periods.

An error in ending inventory of the current period will

have a reverse effect on net income of the next

accounting period.

Over the two years, the total net income is correct

because the errors offset (扺銷 ) each other.

Ending inventory depends entirely on the accuracy of

taking and costing the inventory.

Inventory CostingIncome Statement Effects

Beginning inventory

Endinginventory

2013 2014

Cost of goods sold

Net income

Cost of goods sold

Net income

Inventory Errors

Incorrect Correct Incorrect Correct

Sales € 80,000 € 80,000 € 90,000 € 90,000

Beginning inventory 20000 20000 12000 15000

Cost of goods purchased 40000 40000 68000 68000

Cost of goods available 60000 60000 80000 83000

Ending inventory 12000 15000 23000 23000

Cost of good sold 48000 45000 57000 60000

Gross profit 32000 35000 33000 30000

Operating expenses 10000 10000 20000 20000

Net income € 22,000 € 25,000 € 13,000 € 10,000

2013 2014

(€3,000)Net Income understated

€3,000Net Income overstated

Combined income for 2-year period is correct.

Illustration 6-13

Inventory Costing

Effect of inventory errors on the statement of financial position

is determined by using the basic accounting equation:

Illustration 6-11

Illustration 6-14

Inventory CostingStatement of Financial Position Effects

Understating ending inventory will overstate:

a. assets.

b. cost of goods sold.

c. net income.

d. equity.

Question

Inventory Costing

Net realizable value - Inventory classified as current asset.

Income Statement - Cost of goods sold subtracted from

sales.

There also should be disclosure of

1) major inventory classifications,

2) basis of accounting (cost or lower-of-cost-or-net

realizable value), and

3) costing method (specific identification, FIFO, or average).

Statement Presentation and Analysis

Presentation

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.

Statement Presentation and Analysis

Analysis

Inventory turnover (存貨週轉率 ) 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

=

Statement Presentation and Analysis

Days in Inventory: Inventory turnover of 5.4 times divided into 365

is approximately 68 days. This is the approximate time that it takes a

company to sell the inventory.

Illustration: Esprit Holdings (HKG) reported in a recent annual report a

beginning inventory of HK$3,170 million, an ending inventory of HK$2,997

million, and cost of goods sold for the year ended of HK$16,523 million.

The inventory turnover formula and computation for Esprit Holdings are

shown below.Illustration 6-16

Statement Presentation and Analysis