Chapter 19 Inventories PowerPoint presentation by Anne Abraham University of Wollongong 2009 John Wiley & Sons Australia, Ltd DETERMINING INVENTORY ON HAND Perpetual system Detailed records required Periodic system Stock-take required Transfer of ownership EXW DDP Goods on consignment 2 DETERMINING COST OF INVENTORY Refer AASB 102 Inventories Inventories Assets held for sale in the ordinary course of business raw materials work in progress finished goods supplies awaiting use in production 3 1
ASSIGNMENT OF COST TO ENDING INVENTORY AND COST OF SALES Four methods Specific identification First-in, first-out (FIFO) Last-in, last-out (LIFO) Average cost weighted average system moving average system periodic perpetual 4 ASSIGNMENT OF COST TO ENDING INVENTORY AND COST OF SALES No. Unit Total Date of units cost cost 1 Jul Beginning Inventory 10 $10 $100 Purchases made in current period 15 Sep Purchase 12 11 132 7 Dec Purchase 15 12 180 Total purchases 27 312 Goods available for sale 37 412 Sales made in current period 20 Sep Sales 8?? 12 Jan Sales 10?? Total cost of sales 18? 30 June Ending Inventory 19? 5 Specific identification method periodic Units sold and on hand are identified with a specific invoice If 18 units sold (per previous slide), assume: 1 unit from beginning inventory ($10) 12 units from 15 September purchase ($11) 5 units from 7 December purchase ($12) 2
Specific identification method periodic Remaining inventory: 9 units Beginning inventory @ $ 10 $ 90 10 units 7 December 12 120 Cost of Ending Inventory $ 210 Cost of goods available for sale $ 412 Less ending inventory 19 units 210 Cost of Goods Sold 18 units $ 202 7 First-in, first-out (FIFO) method periodic Remaining inventory: 4 units 15 September @ $ 11 $ 44 15 units 7 December 12 180 Cost of Ending Inventory $ 224 Cost of goods available for sale $ 412 Less ending inventory 19 units 224 Cost of Goods Sold 18 units $ 188 8 FIFO 9 3
Last-in, first-out (LIFO) method periodic Remaining inventory: 10 units Beginning inventory @ $ 10 $ 100 9 units 15 September 11 99 Cost of Ending Inventory 199 Cost of goods available for sale $ 412 Less ending inventory 19 units 199 Cost of Goods Sold 18 units $ 213 10 Weighted average method periodic Average cost per unit of ending inventory = Total cost of goods available for sale Number of units available for sale = $412 / 37 units = $11.14 per unit Remaining inventory: 19 units @ $11.14 $ 211.66 Cost of Ending Inventory $ 211.66 Cost of goods available for sale $ 412.00 Less ending inventory 19 units 211.66 Cost of Goods Sold 18 units $ 200.34 11 Comparison of costing methods Specific FIFO LIFO Weighted ID Average Sales $360 $360 $360 $360 Beginning inventory 100 100 100 100 Purchases 312 312 312 312 Goods available for sale 412 412 412 412 less: Ending inventory 210 224 199 212 Cost of Goods Sold 202 188 213 200 Gross Profit 158 172 147 160 Less: expenses 120 120 120 120 Net Profit $ 38 $ 52 $ 27 $ 40 Ending Inventory in Balance Sheet $210 $224 $199 $212 12 4
FIFO/LIFO 13 Comparison of costing methods Specific ID Consistent with the actual movement of the inventory Offers room for manipulating profit FIFO Reflects current prices in ending inventory Does not permit manipulation of profit 14 Comparison of costing methods LIFO Results in matching current COS with current revenue Balance sheet values become outdated Profits can be manipulated Weighted average Results in identical items being assigned the same value Tends to smooth out profit and inventory values 5
Comparison of costing methods Which method? Consistency Need to be consistent Must use the same accounting methods and procedures from period to period AASB 102 requirements COSTING METHODS IN THE PERPETUAL INVENTORY SYSTEM Inventory record maintained for each item of inventory Inventory control account maintained in the general ledger Inventory records collectively for the inventory subsidiary ledger Provides continuous record of transactions 17 COSTING METHODS IN THE PERPETUAL INVENTORY SYSTEM Item Sandwich Toaster Code B1800 Location Store Display Minimum Stock 10 Maximum Stock 30 Purchases Cost of sales Balance Unit Total Unit Total Unit Total Date Explanation Units cost cost Units cost cost Units cost cost 1/7 Beginning bal 10 10 100 15/9 Purchases 12 11 132 10 10 100 12 11 132 20/9 Sales 8 10 80 2 10 20 12 11 132 7/12 Purchases 15 12 180 2 10 20 12 11 132 15 12 180 18 FIFO Method 6
COSTING METHODS IN THE PERPETUAL INVENTORY SYSTEM First-in, first-out (FIFO) Last-in, last-out (LIFO) Moving Average New average cost calculated after each purchase 19 Comparison of inventory systems Specific ID and FIFO Same amount of cost assigned to ending inventory and COS Units identified as sold are the same under both systems LIFO Different results due to the timing of the calculation of COS 20 LOWER OF COST AND NET REALISABLE VALUE RULE Where selling price of inventory is lower than the cost price, the selling price is to be used as the basis for valuation AASB 102 Net realisable value 21 7
SALES RETURNS AND PURCHASE RETURNS (Perpetual) FIFO Purchase returns recorded at price negotiated with supplier Sales returns are brought in at the latest price attached to the relevant sale Moving average Purchase returns recorded as price negotiated with supplier 22 INVENTORY ERRORS Perpetual inventory Physical stock take made to confirm perpetual records Difference may be due to theft, damage or inaccurate recording Periodic inventory Counting and pricing errors 23 ESTIMATING INVENTORIES Two methods Retail inventory method Gross method Need to estimate inventory when full count is inappropriate: Monthly reporting Destruction of records As a reasonable check To detect theft 8
Retail inventory method Used by businesses in the retail environment For interim reporting In lieu of stock-take Need to maintain records of the following: Beginning inventory at cost and retail Purchases at cost and retail sales for each month Retail inventory method Estimate ending inventory as follows: COGAS (retail and cost) = beginning inventory + purchases Ending inventory at retail = COGAS (retail) net sales Ending inventory at cost = ending inventory retail x ratio of cost to retail = COGAS (cost) / COGAS (retail) Retail Inventory Method 27 9
Retail inventory method Cost Retail Beginning inventory $24 500 $ 40 000 Net purchases 35 500 60 000 100 000 Add: Additional mark-ups 1 200 Less: Mark-up cancellations (800) Staff discounts (3 000) Mark-downs (1 800) Add: Mark-down cancellations 300 Goods available for sale $60 000 $ 95 900 Ratio of cost to retail: $60 000/ $95 900 = 62.565% Less: Net Sales (excluding GST) 80 000 Estimate of ending inventory at retail 15 900 Cost ratio x 62.565% Ending inventory at cost 28 $ 9 948 Gross profit method Assumes that: The rate at which gross profit earned in the previous year is the same for current year Historical position applied to current period We know that: Gross Profit = Net Sales - COS Net Sales = 100% GP Rate = 40% Therefore, COS = 60% Gross profit method Once the GP% is known, ending inventory can be estimated as follows: Determine COGAS Estimate Gross Profit using GP% from previous periods Determine estimated COS by deducting Gross Profit from sales Deduct COS from COGAS to determine estimated ending inventory 30 10
Gross Profit Method 31 Gross profit method SALES REVENUE $140 000 Less: Sales returns and allowances 8 000 Net sales revenue 132 000 100% Cost of Sales: Beginning inventory $16 300 Purchases $83 100 Less: Purchases R&A (2 500) Add: Freight inwards 700 Net purchases 81 300 Goods available for sale 97 600 Less: Estimated ending inventory? Estimates cost of sales ($132 000 x 0.60) 79 200 60% ESTIMATED GROSS PROFIT ($132 000 x 0.40) $ 58 200 40% 32 PRESENTATION IN FINANCIAL STATEMENTS AASB 102 Sub-classifications Valuation basis 33 11
EFFECT OF COSTING METHODS ON DECISION MAKING Gross profit ratio = Profit margin = Gross Profit Net Sales Profit Net Sales Inventory turnover = Cost of Sales Average inventory 34 35 12