Chapter 8/9InventoriesAccounting, 21st EditionWarren Reeve Fess (CH 9)

Facilitator: Se Tin, S.E., M.Si, Ak

IFRS EditionKieso, Weygandt, and Warfield (CH 8)

Valuation of Inventories:COST BASIS APPROACH

Identify major classifications of inventory.Distinguish between perpetual and periodic inventory systems.Identify the effects of inventory errors on the financial statements.Understand the items to include as inventory cost.Describe and compare the methods used to price inventories.Learning Objectives

Goods in transitConsigned goodsSpecial sales agreementsInventory errors

Inventory IssuesPhysical Goods Included in InventoryCost Included in InventoryCost Flow AssumptionsClassification Cost flowControlBasic inventory valuation

Product costsPeriod costsPurchase discountsSpecific identificationAverage costFIFOSummary analysisValuation of Inventories: Cost-Basis Approach

Inventories are:items held for sale, orgoods to be used in the production of goods to be sold.MerchandiserManufacturerBusinesses with InventoryorClassification

One inventory account.Purchase goods in form ready for sale.Classification

Three accountsRaw materialsWork in processFinished goodsClassification

Inventory Cost Flow

Inventory Cost FlowCompanies use one of two types of systems for maintaining inventory records perpetual system or periodic system.

Perpetual System Purchases of merchandise are debited to Inventory.Freight-in is debited to Inventory. Purchase returns and allowances and purchase discounts are credited to Inventory.Cost of goods sold is debited and Inventory is credited for each sale.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.

Periodic System Purchases of merchandise are debited to Purchases.Ending Inventory determined by physical count.Calculation of Cost of Goods Sold:Beginning inventory$ 100,000Purchases, net800,000Goods available for sale900,000Ending inventory125,000Cost of goods sold$ 775,000

Why is Inventory Control Important?Inventory is a significant asset and for many companies the largest asset.Inventory is central to the main activity of merchandising and manufacturing companies.Mistakes in determining inventory cost can cause critical errors in financial statements.Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.

LIABILITIESOWNERSEQUITYREVENUESASSETSCOSTS & EXPENSESEffect of Inventory Errors on Financial StatementsMerchandiseInventoryCost ofMerchandise SoldNet Income

Effect of Inventory ErrorsThe effect of an error on net income in one year (2010) will be counterbalanced in the next (2011), however the income statement will be misstated for both years.Ending Inventory Misstated

Illustration: Yei Chen Corp. understates its ending inventory by HK$10,000 in 2010; all other items are correctly stated.

Effect of Inventory ErrorsThe understatement does not affect cost of goods sold and net income because the errors offset one another.Purchases and Inventory Misstated

Purchased goodsSold goodsInventory Cost Flow Assumptions

Purchased goodsSold goodsInventory Cost Flow Assumptions

Purchased goodsSold goodsInventory Cost Flow Assumptions

Method adopted should be one that most clearly reflects periodic income.Cost Flow Assumption Adopted does not need to equal Physical Movement of GoodsWhich Cost Flow Assumption to Adopt?

Inventory Costing Methods40%

30%

20%

10%

0%43%34%19%4%

Perpetual Inventory CostsInventory cost data to demonstrate FIFO and LIFO Perpetual SystemsCost ofMdse. Sold Item 127B Units Cost Price Jan. 1Inventory10$204Sale7$3010Purchase82122Sale43128Sale23230Purchase1022

Item 127BFIFO Perpetual Inventory AccountPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

Inventory cost data to demonstrate FIFO and LIFO Perpetual SystemsCost ofMdse. Sold Item 127B Units Cost Price Jan. 1Inventory10$204Sale7$3010Purchase82122Sale43128Sale23230Purchase1022FIFO Perpetual Inventory AccountOn January 4, 7 units of Item 127B are sold at $30 each.

Item 127BFIFO Perpetual Inventory AccountPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200 472014032060Jan. 11020200On January 4, 7 units of Item 127B are sold at $30 each.

Inventory cost data to demonstrate FIFO and LIFO Perpetual SystemsCost ofMdse. Sold Item 127B Units Cost Price Jan. 1Inventory10$204Sale7$3010Purchase82122Sale43128Sale23230Purchase1022FIFO Perpetual Inventory AccountOn January 10, the firm purchased eight units at $21 each.

Item 127BFIFO Perpetual Inventory AccountPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200 472014032060 1082116832060 821168On January 10, the firm purchased eight units at $21 each.

FIFO Perpetual Inventory AccountOn January 22, the firm sold four units for $31 each.

Item 127BPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200 472014032060 1082116832060 821168FIFO Perpetual Inventory Account 2232060 12121721147On January 22, the firm sold four units for $31 each.

FIFO Perpetual Inventory AccountOn January 28, the firm sold two units at $32.

Item 127BPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200 472014032060 1082116832060 821168FIFO Perpetual Inventory Account 2232060 12121721147 2822142521105On January 28, the firm sold two units at $32.

FIFO Perpetual Inventory AccountOn January 30, purchased ten additional units of Item 127B at $22 each.

Item 127BPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200 472014032060 1082116832060 821168FIFO Perpetual Inventory Account 2232060 12121721147 2822142521105 301022220521105 1022220 Totals18$38813$26315$325On January 30, purchased ten additional units of Item 127B at $22 each.

Item 127BLIFO Perpetual Inventory AccountPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

Item 127BLIFO Perpetual Inventory AccountPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200 472014032060On January 4, the firm sold 7 units at $30 each.

Item 127BLIFO Perpetual Inventory AccountPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200 472014032060 1082116832060 821168On January 10, the firm purchased eight units at $21 each.Note that a new layer is formed.

Item 127BLIFO Perpetual Inventory AccountPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200 472014032060 1082116832060 821168On January 22, the firm sells four units at $31 each. 22421843206042184Of the 4 units sold, all come from the most recent purchase at a cost of $21 each.

Item 127BLIFO Perpetual Inventory AccountPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200 472014032060 1082116832060 821168On January 28, sold two units at $32 each. 22421843206042184 28221423206022142

Item 127BLIFO Perpetual Inventory AccountPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200 472014032060 1082116832060 821168On January 30, purchase 10 units at $22 each. 22421843206042184 28221423206022142 30102222032060221421022220

Item 127BLIFO Perpetual Inventory AccountPurchasesCost of Mdse. SoldInventory BalanceUnitTotalUnitTotalUnitTotal Date Qty.Cost Cost Qty.CostCost Qty.CostCostJan. 11020200 472014032060 1082116832060 821168 22421843206042184 28221423206022142 30102222032060221421022220 Totals18$38813$26615$322

Fifo Periodic

Jan. 1Beginning Inventory200 units @ $9Mar. 10 Purchase300 units @ $10400 units @ $11Sept. 21 Purchase100 units @ $12Nov. 18 PurchaseFifo Periodic

Fifo Periodic200 units @ $9300 units @ $10400 units @ $11100 units @ $12$10,400

Fifo PeriodicA physical count on December 31 reveals that 700 of the 1,000 units have been sold.Using fifo, the first units purchased are theoretically the first units sold. We begin the count with January 1.

Fifo Periodic200 units @ $9300 units @ $10400 units @ $11100 units @ $12$10,400=$1,800Jan. 1= 3,000Mar. 10=4,400Sept. 21=1,200Nov. 18Sold these 200Sold these 300Sold 200 of these200 units @ $11=$ 0Jan. 1= 0Mar. 10=2,200Sept. 21$ 3,400Ending inventory

Cost of merchandise available for sale$10,400Less ending inventory 3,400Cost of merchandise sold$ 7,000Fifo Periodic

Jan. 1200 units at $9Summary of Fifo PeriodicMar. 10300 units at $10Sep. 21400 units at $11Nov. 18100 units at $12$1,800$3,000$4,400$1,200PurchasesMerchandiseAvailablefor Sale$1,800$3,000$2,200Cost ofMerchandiseSold200 units at $9$10,400$2,200$1,200$7,000MerchandiseInventory$3,400300 units at $10200 units at $11200 units at $11100 units at $121,000 units700 units300 units

Lifo Periodic

Jan. 1Beginning Inventory200 units @ $9Mar. 10 Purchase300 units @ $10400 units @ $11Sept. 21 Purchase100 units @ $12Nov. 18 PurchaseLifo PeriodicUsing lifo, the most recent batch purchased is considered the first batch of merchandise sold.

Jan. 1Beginning Inventory200 units @ $9Mar. 10 Purchase300 units @ $10400 units @ $11Sept. 21 Purchase100 units @ $12Nov. 18 PurchaseLifo PeriodicAssume again that 700 units were sold during the year.

200 units @ $9300 units @ $10400 units @ $11100 units @ $12Lifo PeriodicSold these 100Sold these 400Sold 200 of these100 units @ $10$10,400001,000

Cost of merchandise available for sale$10,400Less ending inventory 2,800Cost of merchandise sold$ 7,600Lifo Periodic

Jan. 1200 units at $9Summary of Lifo PeriodicMar. 10300 units at $10Sep. 21400 units at $11Nov. 18100 units at $12$1,800$3,000$4,400$1,200$1,800$1,000Cost ofMerchandiseSold200 units at $9$10,400$4,400$1,200$2,800$7,600100 units at $10200 units at $10400 units at $11100 units at $12$2,000700 units1,000 units300 unitsPurchasesMerchandiseAvailablefor Salemerchandise inv

Jan. 1Beginning Inventory200 units @ $9Mar. 10 Purchase 300 units @ $10400 units @ $11Sept. 21 Purchase 100 units @ $12Nov. 18 PurchaseThe average cost periodic method is based on the average cost of identical units.Average Cost Periodic

Average Cost Periodic 200 units @ $9 = $ 1,800 300 units @ $10 = $ 3,000 400 units @ $11 = $ 4,400100 units @ $12 = $ 1,200$10,400 Cost of merchandise available for sale

Cost of Merchandise Available for SaleUnits Available for Sale During Year= Average Unit Cost= $10.40 per UnitAverage Cost Periodic

Cost of merchandise available for sale$10,400Less ending inventory ($10.40 x 300) 3,120Cost of merchandise sold$ 7,280To verify this amount, multiply 700 units sold times $10.40 to get the same $7,280.Average Cost Periodic

Inventory Valuation Methods - SummaryNotice that gross profit and net income are lowest under LIFO, highest under FIFO, and somewhere in the middle under average cost.

Inventory Valuation Methods - SummaryLIFO results in the highest cash balance at year-end (because taxes arelower). This example assumes that prices are rising. The opposite result occurs if prices are declining.

Under IFRS, LIFO is not permitted for financial reporting purposes. Nonetheless, LIFO is permitted for financial reporting purposes in the United States, it is permitted for tax purposes in some countries, and its use can result in significant tax savings.

Many companies use LIFO for tax and external financial reporting purposes FIFO, average cost, or standard cost system for internal reporting purposes.Reasons:LIFO ReservePricing decisionsRecord keeping easierProfit-sharing or bonus arrangementsLIFO troublesome for interim periods

The End

Exercise 8-18

+ pointugas

Problem 8-2Problem 8-7

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