CHAPTER 8: INVENTORY

Transcription

1 CHAPTER 8: INVENTORY Inventory Categories Merchandise inventory - ready for sale units that are unsold at the end of the fiscal period raw materials inventory - costs assigned to goods and materials on hand, but not yet placed into production work-in-process inventory - cost of the raw material on which production has been started but not completed, plus the direct labour cost applied specifically to this material, and an applicable share of manufacturing overhead costs finished goods inventory - reporting of the costs associated with the completed but unsold units at the end of the fiscal period cost of goods available for sale or use - total of (1) the cost of goods on hand at the beginning of the period + (2) the cost of the goods acquired or produced during the period cost of goods sold - difference between those available for sale during the period and those on hand at the end of the period COGS = beginning inventory + purchases ending inventory Gross profit or net income = sales COGS Reporting Ending Inventory 1. Determine inventory that should be included 2. Cost that should be included in inventory 3. Cost formula 4. Test for impairment Ending Inventory Effect on current year Effect on next year COGS Overstated Understated Net income Understated Overstated Understated Retained earnings Understated No effect Working capital Understated No effect Current ratio Understated No effect Overstated COGS Understated Overstated Net income Overstated Understated Retained earnings Overstated No effect Working capital Overstated No effect Current ratio Overstated No effect

2 Correcting Inventory Errors Assume 2014 ending inventory is understated by $10,000 Error discovered before 2014 books are closed: Inventory 10,000 Cost of goods sold 10,000 Error discovered in 2015: Inventory 10,000 Retained Earnings 10,000 Error discovered in 2015 after 2015 books are closed: No journal entry, but comparative statements must use corrected figures for presentation purposes Example: COGS = $1,400,000 R/E = $5,200,000 December 31 st inventory errors both discovered after 2014 books were closed: 2013: ending inventory overstated by $110, : ending inventory overstated by $45, COGS = 2013 ending inventory purchases ending inventory over by 110,000 over by 45,000 = over by 65,000 (110,000 45,000) = 1,335,000 (1,400,000 65,000) Net income and retained earnings will be overstated by 45, Retained Earnings should be 5,155,000. Since the 2014 books have already been closed, journal entry to correct overstatement would be: Retained Earnings 45,000 Inventory 45,000 Inventories - assets o Held for sale in the ordinary course of business (finished goods) o In the process of production for such sale (work-in-process) o In the form of materials or supplies to be consumed in the production process or in the rendering of services (raw materials) - Represent a future benefit, which the entity has control over or access to - Recognition is through transaction arising from an inventory purchase and risks and rewards of ownership have passed to the purchaser Physical Goods Included in Inventory - generally determined by legal title to goods - purchase commitments should not be included, but should be disclosed if material Items included in seller s inventory: Goods in transit o FOB shipping point legal title passes to the buyer when seller delivers the goods to the common carrier o FOB destination

3 legal title passes when the goods reach destination Goods out on consignment o Possession is with consignee but legal title held by consignor Goods sold under buyback agreements Goods sold with high rates of return that cannot be estimated Inventory Cost - all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition o product costs invoice, freight, and other direct acquisition costs; borrowing cost (interest expense) o conversion costs direct labour and fixed and variable overhead (must always report actual costs but may use standard costs if they approximate actual costs) - does not include period costs (selling, general, and administrative) - purchase discounts - vendor rebates - basket purchases and joint product costs Purchase Discounts Assume Company A purchases goods for $10,000 with terms 2/10, net 30. Company A pays for $4,000 of this amount within the discount period and the rest after the discount period. Gross Method Net Method Purchase: Purchase: Purchases 10,000 Purchases 9,800 A/P 10,000 A/P 9,800 Payment w/in discount period: Payment w/in discount period: A/P 4,000 A/P 3,920 Purchase Discounts 80 Cash 3,920 Cash 3,920 Payment after discount period Payment after discount period A/P 5,880 A/P 6,000 Purchase Discounts Lost 120 Cash 6,000 Cash 6,000 E8-3 March 10 purchases = 25,000, 3/10 n/60 discount until march purchases = 26,575, 1/15 n/30 discount until march paid (25,000 x 97%) = 24, purchases = 11,500, 3/10 n/30 discount until april 3 a) net method March 10 Purchases 24,250 A/P 24,250 March 11 Purchases 26,309

4 A/P 26,309 March 19 A/P 24,250 Cash 24,250 March 24 Purchases 11,155 A/P 11,155 b) no purchase or payment transactions as at march 31 March 31 Purchase Discounts Lost 266 A/P 266 c) gross method March 10 Purchases 25,000 A/P 25,000 March 11 Purchases 26,575 A/P 26,575 March 19 A/P 25,000 Cash 24,250 Purchase Discounts 750 March 24 Purchases 11,500 A/P 11,500 d) no additional entries as at march 31 under the gross method e) net method is more theoretically correct and has faithful representation compared to gross method. Also, discounts lost can be tracked for a more effective cash management. However, gross method is more cost-effective. Vendor Rebates - cash rebates related to inventory generally recorded as a reduction to the cost of inventory - record as reduction to inventory if: o non-discretionary on part of supplier o probable and amount reasonably estimated BE8-6 a) volume rebate from Traders can only be accrued if (1) the rebate is non-discretionary on the part of Traders and (2) the receipt of the rebate is probable and its value can be reasonably estimated. b) Amount of rebate to be accrued at June 30, 2014 Current units on hand 3,000 Estimated number of units to be purchased 3,000 Less: number of units (3,500) Units that will qualify for rebate 2,500 Rebate = 2,500 x $0.25 = 625

5 Jun 30/14 rebate receivable 625 Inventory 625 c) Unit cost of wood frames Current inventory on hand (3,000 x $2.50) 7,500 Add: Estimated inventory to be purchased 7,500 Less: Rebate to be received (625) Total cost of inventory 14,375 Unit cost = 14,375/(3, ,000) = $2.40 per unit Basket Purchases and Joint Product Costs - total costs allocated to units based on relative sales value BE8-8 Group # of CDs price per CD total price % share cost allocated cost/unit % x 7,500 = $375 $ , % x 7,500 = $6,000 $ , % x 7,500 = $1,125 $11.25 total 1,000 10, $7,500 Inventory Accounting System Accurate inventory accounting system is important for: ensuring availability of inventory items preventing excessive accumulation of inventory items just-in-time (JIT) inventory order systems - helped reduce inventory levels (minimize storage costs) - only purchase inventory when needed - made to order; Dell, car manufacturers (customized) perpetual system - maintains a continuous record of inventory changes - costly to implement but gives up-to-date information at any given time periodic system - updates inventory records in the ledger only periodically - recommended for smaller businesses perpetual system Purchases, cost of freight, purchase returns, discounts are all directly debited to the Inventory account COGS and Inventory accounts are up to date Physical count is still required periodically to ensure physical stock = accounting stock BE8-3 periodic system Purchases, cost of freight, purchase returns, discounts are debited to their respective accounts COGS and Inventory accounts are updated after the physical inventory count COGS is a residual amount COGS = beg. inventory + purchases end. inventory

6 Beginning inventory = 50 x $100 = $5,000 Sept purchase = 200 x $100 = $20,000 (AP) Sept purchase returns = 6 x $100 = $600 credit Sept sales = 150 x $200 = $30,000 (AR) Perpetual system: Purchase Inventory 20,000 A/P 20,000 Purchase returns A/P 600 Inventory 600 Sales A/R 30,000 Sales revenue 30,000 COGS (150 x $100) 15,000 Inventory 15,000 Periodic System: Purchase Purchases 20,000 A/P 20,000 Purchase returns A/P 600 Purchase returns 600 Sales A/R 30,000 Sales revenue 30,000 Month-end adj = ending inventory beginning inventory = (94 50) x $100 = $4,400 COGS = 5,000 + (20, ) 9,400 = 15,000 Month-end adj Inventory 4,400 Purchase returns 600 COGS 15,000 Purchases 20,000 Cost Formula - determines the costs that should be assigned to ending inventory and COGS o specific identification o weighted average cost o first-in, first-out (FIFO) Special Identification - each item sold and purchased is individually identified - required for goods that are not ordinarily interchangeable, and that are produced and segregated for specific projects Advantages: Matches actual costs with revenue Ending inventory repeated at specific cost

7 Disadvantages: May be costly to implement and maintain May lead to income manipulation May be difficult to allocate certain costs (storage, shipping) to specific inventory items Weighted Average Cost - reasonable to cost inventory based on an average cost - costs assigned closely follows the actual physical flow - simple to apply, objective, less subject to income manipulation - ending inventory cost on balance sheet is made up of average costs - (for periodic inventory) moving average cost formula - refers to average method used with perpetual records (both units and dollars) Example: March transactions Date Purchases Cost Sales Balance (units) 1 beginning $1, $6,000 2, $26,400 8, ,000 4, $9,500 6,000 total 10,000 $43,800 weighted average: inventory cost = 43,800/10,000 = $4.38/unit ending inventory = $4.38 x 6,000 = $26,280 COGS = $4.38 x (10,000 6,000) = $17,520 Moving average: Date Purchases Cost Sales Balance (units) cost/unit 1 beginning $1, $6,000 2, $26,400 8,000 $ ,000 4, $9,500 6,000 total 10,000 $43,800 COGS = $ x 4,000 = $17,150 Ending inventory = ($ x 4,000) + $9,500 = $26,650 ($4.4417/unit) FIFO Advantages:

8 Attempts to approximate physical flow of goods Ending inventory made up of most recent costs, therefore close to its replacement cost Does not permit manipulation of income Disadvantages: Current costs not matched to current revenues, as oldest cost of goods are used with current revenue When prices are changing rapidly, gross profit and net income are distorted Example: Date Purchases Unit Cost Purchase Cost Units Sold on Mar 19 Mar $3.80 $1, Mar $4.00 $6, Mar $4.40 $26, Mar $4.75 $9,500 10,000 $43,800 Mar units sold COGS = $1,900 + $6,000 + (2000 x $4.40) = $16,700 Ending Inventory = (4000 x $4.40) + $9,500 = $27,100 E8-16 The following information is for the inventory of mini kettles at Funnell Company Ltd for the month of May: Date Transaction Units In Unit Cost Total Units Sold Unit Price Total May 1 Balance 100 $ 4.10 $ Purchase ,360 7 Sale 300 $ 7.00 $ 2, Sale , Purchase , Sale , Purchase , Sale , Purchase , Sale ,500 Totals 2,100 $ 9,240 1,400 $ 10,230 1) FIFO Ending inventory = 2,100-1,400 = 700 units Cost of ending inventory = (500 x $4.58) + (200 x $4.60) = $3,210 * higher cost of ending inventory higher gross profit/net income 2) Weighted average Average unit cost = ($9,240/2,100) = $4.40/unit COGS = $4.40 x 1,400 = $6,160 Ending inventory = $4.40 x (2,100-1,400) = $3,080 Ending Inventory Valuation Inventory is initially recorded at cost Inventory is valued at the lower of cost and NRV (LC&NRV)

9 NRV is the estimated selling price less the estimated costs to complete and sell Compare cost with NRV, item by item, or if appropriate, group similar items then compare by groups Example Item Cost NRV LC&NRV Spinach 80, ,000 80,000 Carrots 100, , ,000 Cut beans 50,000 40,000 40,000 Peas 90,000 72,000 72,000 Mixed vegetables 95,000 92,000 92,000 Final inventory value $384,000 Item Cost NRV LC&NRV Spinach 80, ,000 Carrots 100, ,000 Cut beans 50,000 40,000 Frozen 230, , ,000 Peas 90,000 72,000 $394,000 Mixed vegetables 95,000 92,000 Canned 185, ,000 $164,000 LC&NRV: Periodic vs Perpetual Inventory At Cost At NRV Beginning $65,000 $65,000 End of year $82,000 $70,000 Direct method Allowance method COGS 65,000 COGS 65,000 Inventory 65,000 Inventory 65,000 Periodic Inventory 70,000 Inventory 82,000 COGS 70,000 COGS 82,000 Loss on Inventory 12,000 Allowance to reduce Inventory to NRV 12,000 Perpetual COGS 12,000 Loss on Inventory 12,000 Inventory 12,000 Allowance to reduce Inventory to NRV 12,000 Exceptions to LC&NRV Inventories measured at Net Realizable Value if:

10 Sale is assured, or there is active market and minimal risk of not completing the sale, and Costs of disposal can be estimated Inventories measured at Fair Value Less Cost to Sell include: Inventories of commodity broker-traders Biological assets and agricultural produce at point of harvest o There is no specific ASPE guidance on measurement of these assets E8-19 The following information is for Takin Enterprises Ltd.: Jan. 31 Feb. 28 Mar. 31 Apr. 30 Inventory at cost 25,000 25,100 29,000 23,000 Inventory at the lower of cost and NRV 24,500 17,600 22,600 17,300 Allowance balance 500 7,500 6,400 5,700 Purchases for the month 20,000 24,000 26,500 Sales for the month 29,000 35,000 40,000 Jan 31 Loss on Inventory 500 Allow. to reduce Inventory to NRV 500 Feb 28 Loss on Inventory 7,000 Allow. to reduce Inventory to NRV 7,000 Mar 31 Allow. to reduce Inventory to NRV 1,100 Gain on Inventory 1,100 Apr 30 Allow. to reduce Inventory to NRV 700 Gain on Inventory 700 Takin Enterprises Ltd. Statement of Income February 28 March 31 April 30 Sales Revenue 29,000 35,000 40,000 Less: COGS Beginning Inventory 25,000 25,100 29,000 Purchases 20,000 24,000 26,500 Cost of Goods Available for Sale 49,100 45,000 55,500 Ending Inventory (25,100) (29,000) (23,000) COGS 19,900 20,100 32,500 Gross Profit 9,100 14,900 7,500 Gain (loss) due to market fluctuation of inventory (7,000) 1, Net Income 2,100 16,000 8,200 Gross Profit Method to estimate Ending Inventory Estimates may be required in such situations:

11 interim reporting fire loss testing reasonableness of cost from an actual inventory count Method is based on three assumptions: 1. Beginning inventory + purchases = cost of goods available for sale 2. Goods not sold are in ending inventory 3. Cost of goods available for sale cost of goods sold = ending inventory Example: Beginning inventory (at cost): $60,000 Purchases (at cost): $200,000 Sales (at selling price): $280,000 Gross profit percentage on sales: 30% Beginning Inventory + Purchases COGS = Estimated Ending Inventory COGS = sales gross profit = sales (30% x sales) = 70% x sales Ending inventory = 60, ,000 (0.7 x 280,000) = $64,000 Understanding Markups Assume you are given markup on cost What is gross profit on selling price? Assume markup on cost is 25%: Sales = COGS + Gross Profit = COGS + (25% x COGS) = 125% x COGS COGS = Sales/125% Gross Profit = Sales x (1 - (1/1.25)) = sales x 20% If Sales is $1: Gross profit % = 1 - (1/1.25) = (1.25 1)/1.25 = 0.25/1.25 = 20% Gross Profit % = Markup % / (1 + markup %) E8-22 Linsang Corporation's retail store and warehouse closed for the entire weekend while the year-end inventory was counted. When the count was finished, the controller gathered all the count books and information from the clerical staff, completed the ending inventory calculations, and prepared the following partial income statement for the general manager for Monday morning: Sales 2,750,000 Beginning inventory 650,000 Purchases 1,550,000 Total goods available for sale 2,200,000 Less ending inventory 650,000 Cost of goods sold 1,550,000 Gross profit 1,200,000

12 The general manager called the controller into her office after quickly reviewing the preliminary statements. You've made an error in the inventory, she stated. My pricing all year has been carefully controlled to provide a gross profit of 35%, and I know the sales are correct. Gross profit = 0.35 x 2,750,000 = 962,500 COGS = sales gross profit = 2,750, ,500 = 1,787,500 ending inventory = 650, ,550,000 1,787,500 = $412,500 Presentation and Disclosure Examples of required disclosures: 1. Measurement policy (using FIFO or weighted average?) 2. Total inventory, as well as inventory by classification (raw materials, work-in-process, finished goods) 3. Amount of inventory recognized as expense on the income statement (usually reported as COGS) 4. Any amount of inventory pledged as security for liabilities (collateral for borrowing) * IFRS has more disclosure requirements than ASPE Activity Ratios Inventory Turnover = Cost of Goods Sold / Average Inventory (Measures number of times on average inventory was sold during the period) Average Days to Sell Inventory = 365 / Inventory Turnover Accounts Receivable Turnover = Net Sales/Revenue / Average Trade Receivables (Net) Days Sales Uncollected = 365 Days / A/R Turnover Recommended Practice Problems Inventory error: E8-5 Relative Sales Value Method: E8-12 FIFO, Moving Average Cost Perpetual: E8-17 FIFO, Weighted Average Periodic: P8-6 Lower of cost and net realizable value: E8-13, P8-11 Gross Profit Method: E8-21