Accounting Principles: A Business Perspective, 8e Chapter 7: Measuring and Reporting Inventories

Transcription

1 Accounting Principles: A Business Perspective, 8e Chapter 7: Measuring and Reporting Inventories

2 Inventories and of Goods Sold For merchandising companies, inventory is often the largest asset on the balance sheet and cost of goods sold is often the largest expense on the income statement. Improper inventory valuation can have a material effect upon items reported in the financial statements.

3 Inventories and of Goods Sold Continued Inventory Errors Affects inventory, current assets, total assets, retained earnings, and total equity on the balance sheet. Affects cost of goods sold, gross margin, and net income on the income statement. An error in ending inventory in one year carries forward as an error in beginning inventory in the following year. After two years, the error washes out, and assets and retained earnings are properly stated. Illustrations 7.1 and 7.2

4 Determining Inventory Taking a physical inventory Taking a physical inventory is the procedure of determining the physical quantities of the goods on hand by counting, weighing, measuring, or estimating. Inventory tags, Illustration 7.4

5 Determining Inventory Continued s included in inventory costs Inventory cost includes all outlays necessary to acquire the goods, get the goods ready to sell, and place them in their desired location for sale to customers. Included are the invoice price (less any purchase discount), plus insurance-in-transit, freight incurred by the buyer, and handling costs. Because of practical difficulties in allocating these costs to inventory, the latter three costs are sometimes expensed directly rather than allocated to inventory.

6 Determining Inventory Continued Perpetual inventory procedure Used to enhance internal control. No purchase or purchase related accounts. All purchases and sales of inventory are recorded directly to the inventory account.

7 Determining Inventory Continued Perpetual records show: units on hand units bought units sold including the costs of these units A loss from inventory shortage is computed by comparing perpetual records with physical counts.

8 Determining Inventory Continued Four inventory methods Specific Identification FIFO (first-in, first-out) LIFO (last-in, first-out) Weighted-average

9 Determining Inventory Continued Specific identification Actual cost is attached to an identifiable unit of inventory. Specific identification yields the most precise matching of costs and revenues. This method is most logical where large unique units (autos, real estate lots) are bought and sold. Allows for earnings manipulation, difficult to apply for companies with many small inventory items.

10 Determining Inventory Continued FIFO (first-in, first-out), Old costs are charged to cost of goods sold; new costs are retained in inventory. inventory values are the same under both periodic and perpetual inventory procedures. FIFO matches the actual physical flow of goods. balance sheet amounts for inventory approximate current costs.

11 Determining Inventory Continued Disadvantages of FIFO include the recognition of inventory or paper profits and a higher tax burden if inventory costs are increasing.

12 Determining Inventory Continued LIFO (last-in, first-out), New costs are charged to cost of goods sold; Old costs are retained in inventory. LIFO matches current costs against current revenues and generally, because of constantly increasing prices, reports a lower net income and, thus, lower income taxes.

13 Determining Inventory Continued Disadvantages of LIFO include LIFO does not match the actual physical flow of goods for most companies. If costs are increasing, LIFO understates the cost of inventory on the balance sheet LIFO permits income manipulation.

14 Determining Inventory Continued Weighted-average all units sold and all units in inventory are assigned the same unit cost. Weighted-average takes a middle-of-the-road approach, yielding amounts in between FIFO and LIFO. Inventory is not as up to date as FIFO, but not as out of date as LIFO. Income can be manipulated but not to the extent of that possible under LIFO.

15 Determining Inventory Continued All four methods are acceptable. Each can be used to achieve certain desired results in varying underlying circumstances. Firms cannot switch methods period after period, as this violates the principle of consistency.

16 Determining Inventory Continued Journal entries under perpetual inventory procedure differ from those under periodic inventory procedure because the inventory accounts must be updated for every change in quantity under perpetual inventory procedure. For purchases: The Merchandise Inventory account is debited and Accounts Payable or Cash is credited.

17 Determining Inventory Continued For sales, two entries are required Accounts Receivable or Cash is debited and Sales is credited for the sales price of the goods. of Goods Sold is debited and Merchandise Inventory is credited for the cost of the goods sold.

18 Departures from Basis May depart from historical cost if the utility or value of the goods is less than their cost. Goods should not be carried in inventory at more than their net realizable value selling price less costs to complete and dispose of goods. General rule is that inventories should be valued at the lower-of-cost-or-market (LCM).

19 Estimating Inventory Continued of ending inventory may be estimated for a number of purposes. To permit preparation of interim (monthly or quarterly) financial statements. To compare with physical inventories to see whether shortages exist. To determine the amount of a claim against an insurance company for goods destroyed or stolen.

20 Inventory Valuations Continued The Gross Margin method is based on the assumption that the gross margin rate is stable from period to period. Net sales - Estimated gross margin = Estimated cost of goods sold. Goods available for sale - Estimated cost of goods sold = Estimated inventory.

21 Inventory Valuations Continued Retail Inventory Method Requires that inventory records be kept at cost and retail price. Ending inventory at retail is equal to goods available for sale at retail less sales. /retail price ratio computed by relating cost of goods available for sale to retail price of goods available for sale. Ending inventory cost = /Retail price ratio x Ending inventory at retail.

22 Inventory Turnover Ratio Provides valuable information to management. Inventory Turnover Ratio= COGS/Average Inventory The inventory turnover ratio measures the efficiency of the firm in managing and selling inventory.

23 Illustration 7.1 Effects of an Overstated Ending Inventory Chapter 7 Income Statement ALLEN COMPANY For Year Ended December 31, 2007 Ending Inventory Correctly Stated Ending Inventory Overstated By $5,000 Sales $400,000 $400,000 of goods available for sale $300,000 $300,000 Ending inventory 35,000 40,000 of goods sold 265, ,000 Gross margin $135,000 $140,000 Other expenses $85,000 85,000 Net income $ 50,000 $55,000 Statement of Retained Earnings Beginning retained earnings $120,000 $120,000 Net income 50,000 55,000 Ending retained earnings $170,000 $175,000

24 Illustration 7.2 Effects of an Overstated Beginning Inventory ALLEN COMPANY For Year Ended December 31, 2007 Beginning Income Statement Beginning Inventory Correctly Stated Inventory Overstated By $5,000 Sales $425,000 $425,000 Beginning inventory $ 35,000 $40,000 Purchases 290, ,000 of goods available for sale $300,000 $330,000 Ending inventory 45,000 45,000 of goods sold 280, ,000 Gross margin $145,000 $140,000 Other expenses 53,500 53,500 Net income $ 91,500 $ 86,500 Statement of Retained Earnings Beginning retained earnings $170,000 $175,000 Net income 91,500 86,500 Ending retained earnings $261,500 $261,500

25 Illustration 7.3 Inventory Errors Ending Inventory Beginning Inventory Understated Overstated Understated Overstated of goods sold Overstated Understated Understated Overstated Net income Understated Overstated Overstated Understated

26 Illustration 7.4 Inventory Tag Inventory Tag JMA Corp. Inventory Tag No. 281 Date Description Location Quantity Counted Counted by Checked by Duplicate Inventory Tag Inventory Tag No. 281 Date Description Location Quantity Counted Counted by Checked by

27 Illustration 7.5 Perpetual Inventory Record (FIFO) Item TV Maximum Location Minimum Purchased Sold Balance 2007 Unit Total Unit Total Unit Total Date Units Units Units Beg. inv. 8 $300 $2,400 July 5 10 $300 $3, , $300 $3, , , , , , , , , ,560

28 Illustration 7.6 Beginning Inventory, Purchases and Sales Chapter 7 Beginning Inventory and Purchases Sales Date Units Unit Total Date Units Price Total Beginning inventory 10 $8.00 $ 80 March $12.00 $120 March July May September August November October December $ $780 Ending inventory = 20 units, determined by taking a physical inventory.

29 Illustration 7.7 Determining Ending Inventory under Specific Identification Chapter 7 Unit Total Units Ending inventory composed of purchases made on: August $9.00 $ 90 December Ending inventory 20 $181 of goods sold composed of: Beginning inventory $ 80 Purchases made on: March May October $509 of goods available for sale $690 Ending inventory 181 of goods sold $509

30 Illustration 7.8 Determining FIFO of Ending Inventory under Periodic Inventory Procedure Chapter 7 Unit Total Units Ending inventory composed of purchases made on: December $9.10 $ 91 October Ending inventory 20 $179 of goods sold composed of: Beginning inventory $ 80 Purchases made on: March May August October $511 of goods available for sale $690 Ending inventory 179 of goods sold $511 Used to establish the ending balance in the Merchandise Inventory account.

31 Illustration 7.9 FIFO Flow of s

32 Illustration 7.10 Determining LIFO of Ending Inventory under Periodic Inventory Procedure Chapter 7 Unit Total Units Ending inventory composed of purchases made on: Beginning inventory 10 $8.10 $ 80 March 2 purchase Ending inventory 20 $165 of goods sold composed of purchases made on: December $ 91 October August May $525 of goods available for sale $690 Ending inventory 165 of goods sold $525

33 Illustration 7.11 LIFO Flow of s under Periodic Inventory Procedure

34 Illustration 7.12 Chapter 7 Determining Ending Inventory under Weighted- Average Method Using Periodic Inventory Procedure Units Unit Total Beginning inventory 10 $8.00 $ Purchase March 2 10 $8.50 $ May August October December Total 80 $ Weighted-average unit cost is $690 80, or $8.625 Ending inventory then is $8.625 x of goods sold: $8.625 x 60 $517.50

35 Illustration 7.13 Determining FIFO of Ending Inventory under Perpetual Inventory Procedure Chapter 7 Purchased Sold Balance Date Units Unit Total Units Unit Total Units Unit Total Beg. inv. 10 $ Mar $8.50 $ Mar $8.00 $ May July Aug Sept Oct Nov Dec Total cost of ending inventory = $179 Sales are assumed to be from the oldest units on hand. Total of $179 would agree with balance already existing in Merchandise Inventory account.

36 Illustration 7.14 Determining LIFO of Ending Inventory under Perpetual Inventory Procedure Chapter 7 Purchased Sold Balance Date Units Unit Total Units Unit Total Units Unit Total Beg. inv. 10 $ Mar $8.50 $ Mar $8.50 $ May July Aug Sept Oct Nov Dec Total cost of ending inventory = $171 Sales are assumed to be from the most recent purchases. Total of $171 would agree with balance already existing in Merchandise Inventory account.

37 Illustration 7.15 LIFO Flow of s under Perpetual Inventory Procedure of goods available for sale ($690) Jan $8.00 Mar $8.50 May $8.40 Aug $9.00 Oct $8.80 Dec $9.10 LIFO inventory 10 $8.00 = $80 10 $9.10 = 91 Total $171 of goods sold ($519)

38 Illustration 7.16 Chapter 7 Determining Ending Inventory under Weighted- Average Method Using Perpetual Inventory Procedure Date Units Purchased Sold Balance Unit Total Units Unit Total Units Unit Total Beg. inv. 10 $ Mar $8.50 $ a Mar $8.25 $ May b July Aug c Sept Oct c Nov Dec $8.929 e $ a $165.00/20 = $8.25. b $250.50/30 = $8.35. c $173.50/20 = $ d $262.75/30 = $ e $175.58/20 = $8.929/ * rounding difference. A new unit cost is calculated after each purchase. The unit cost of sales is the most recently calculated unit cost. Balance of $ would agree with balance already existing in the Merchandise Inventory account.

39 Illustration 7.17 Chapter 7 Effects of Different Inventory ing Methods Using Perpetual Inventory Procedure Specific Identification FIFO LIFO Weighted- Average Sales $ $ $ $ of goods sold: Beginning inventory $ $ $ $ Purchases of goods available for sale $ $ $ $ Ending inventory of goods sold $ $ $ $ Gross Margin $ $ $ $268.58

40 Illustration 7.18 Chapter 7 Effects of Different Inventory ing Methods Using Periodic Inventory Procedure Specific Identification FIFO LIFO Weighted- Average Sales $ $ $ $ of goods sold: Beginning inventory $ $ $ $ Purchases of goods available for sale $ $ $ $ Ending inventory of goods sold $ $ $ $ Gross Margin $ $ $ $262.50

41 Illustration 7.19 Application of Lower-of--or- Market Method Chapter 7 Item Quantity Unit Unit Market Total Total Market LCM on Item-by-Item Basis units $10 $9.00 $1,000 $ 900 $ units ,600 1,750 1, units ,500 2,500 2,500 $5,100 $5,150 $5,000

42 Illustration 7.20 Inventory Estimation Using Gross Margin Method Merchandise inventory, January 1, 2007 $ 40,000 Net cost of purchases 480,000 of goods available for sale 520,000 Less estimated cost of goods sold: Net sales $700,000 Gross margin (30% of $700,000) 210,000 Estimated cost of goods sold 490,000 Estimated inventory, December 31, 2007 $ 30,000

43 Illustration 7.21 Inventory Estimation Retail Merchandise inventory, January 1, 2007 $ 22,000 $ 40,000 Purchases 182, ,000 Purchases returns (2,000) (3,000) Purchase allowances (3,000) Transportation-in 5,000 Goods available for sale $204,000 $340,000 /retail price ratio: $204,00/$340,00=60% Sales 280,000 Ending inventory at retail prices $ 60,000 Times cost/retail price ratio x 60% Ending inventory at cost, March 31, 2007 $ 36,000