© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter Six Accounting for Inventories.
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Transcript of © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter Six Accounting for Inventories.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Chapter Six
Accounting for Inventories
6-2
LO 1Explain how
different inventory cost flow methods
(specific identification,
FIFO, LIFO, and weighted
average) affect financial
statements.
6-3
Inventory Cost Flow Methods
Four Common Inventory Cost Flow Methods
Specific Identificatio
n
First-in, First-Out
(FIFO)
Last-in, First-Out
(LIFO)
Weighted Average
6-4
Specific Identification
When a company’s inventory consists
of many high-priced, low-
turnover goods the record keeping
necessary to use specific
identification is more practical.
6-5
Specific Identification
Assume TMBC Company purchased two identical inventory items: the first for $100 and the second
for $110.
Using specific identification, when the first item is sold, cost of
goods sold would be $100. When the second item is sold, cost of goods sold
would be $110.
6-6
First-in, First-out
The first-in, first-out cost flow
method requires that the cost of the
items purchased first be assigned to Cost of Goods Sold.
6-7
First-in, First-out
Assume TMBC Company purchased two identical inventory items: the first for $100 and the second
for $110.
Using first-in, first-out, the cost assigned to the first item sold would be $100
(the first cost in). The cost of goods sold assigned to
the second item sold would be $110.
6-8
Last-in, First-out
The last-in, first-out cost flow
method requires that the cost of the
items purchased last be assigned to Cost of Goods Sold.
6-9
Last-in, First-out
Assume TMBC Company purchased two identical inventory items: the first for $100 and the second
for $110.
Using last-in, first-out, the cost assigned to the first item sold would be $110
(the last cost in). The cost of goods sold assigned to
the second item sold would be $100.
6-10
Weighted Average
The weighted average cost flow
method assigns the average cost of the items available to
Cost of Goods Sold.
6-11
Weighted Average
Assume TMBC Company purchased two identical inventory items: the first for $100 and the second
for $110.
Using weighted average, the cost assigned to the first item sold would be $105 (the average cost).
Total CostTotal
Number
=$210
2= $105
6-12
Physical Flow
Our discussions about inventory cost flow
methods pertain to the flow of costs through
the accounting records, not the actual physical flow of goods.
Cost flows can be done on a different basis than physical flow.
6-13
Effect of Cost Flow on Income Statement
FIFO LIFOWeighted Average
Sales 120$ 120$ 120$ Cost of Goods Sold 100 110 105 Gross Margin 20$ 10$ 15$
The cost flow method a company uses can significantly affect the gross margin reported in the income
statement.
6-14
Effect of Cost Flow on Balance Sheet
FIFO LIFOWeighted Average
Ending Inventory 110$ 100$ 105$
Since total product costs are allocated between costs of goods sold and
ending inventory, the cost flow method used affects its balance sheet as well.
6-15
6-16
LO 2
Demonstrate the computational procedures for FIFO, LIFO, and
weighted average.
6-17
Inventory Cost Flow Under a Perpetual System
Jan. 1 Beginning Inventory 10 units at $200 = $2,000
Mar. 18 First purchase 20 units @ $220 =
$4,400
Aug. 21 Second purchase 25 units @ $250 =
$6,250
$12,650
TMBC Inventory
Total cost of bikes (goods) available for sale =
Goods Available for Sale
First-in, First-Out
(FIFO)
Last-in, First-Out
(LIFO)
Weighted Average
Sold 43 bikes for $350 each
55 Units
6-18
Inventory Cost Flow Under a Perpetual System
First-in, First-Out
(FIFO)
Last-in, First-Out
(LIFO)
Weighted Average
Goods Available for Sale must be allocated between the Cost of Goods Sold and Ending Inventory
We use one of these three methods:
6-19
First-in, First-out Inventory Cost Flow
Jan. 1 Beginning inventory 10 units @ 200$ = 2,000$ Mar. 18 First purchase 20 units @ 220$ = 4,400 Aug. 21 Second purchase 13 units @ 250$ = 3,250 Total cost of the 43 bikes sold 9,650$
FIFO Cost of Goods Sold
6-20
Last-in, First-out Inventory Cost Flow
Aug. 21 Second purchase 25 units @ 250$ = 6,250$ Mar. 18 First purchase 18 units @ 220$ = 3,960 Total cost of the 43 bikes sold 10,210$
LIFO Cost of Goods Sold
6-21
Weighted Average Inventory Cost Flow
Total cost of the 43 bikes sold 43 units @ 230$ = 9,890$ Weighted Average Cost of Goods Sold
Total CostTotal
Number
=$12,650
55= $230
6-22
Comparative Financial Statements
$350 x 43 =
Mdse Avail – CGS = E.INV.
MDSE AVAIL. $12,650
6-23
Inventory Cost Flow When Sales and Purchases Occur Intermittently
In our previous examples, all
purchases were made before any goods were
sold. This section addresses more
realistic conditions when sales
transactions occur intermittently with
purchases.
6-24
Never Stop Energy Bar
Date TransactionJan. 1 Beginning inventory 100 units @ 20.00$ = 2,000$ Feb. 14 Purchased 200 units @ 21.50$ = 4,300 Apr. 5 Sold 220 units @ 30.00$ = 6,600 June 21 Purchased 160 units @ 22.50$ = 3,600 Aug. 18 Sold 100 units @ 30.00$ = 3,000 Sept. 2 Purchased 280 units @ 23.50$ = 6,580 Nov. 10 Sold 330 units @ 30.00$ = 9,900
Never StopDescription
Let’s use FIFO to determine the cost of goods sold and inventory at the end of 2008.
This table shows beginning inventory, purchases & sales transactions for Never Stop during 2008.
6-25
-100 120 =
=
=
6-26
Never Stop: First-in, First-out
FIFOSales (650 @ $30) 19,500$ Cost of Goods Sold 14,365 Gross Margin 5,135$
Jan. 1 Beginning inventory 100 units @ 20.00$ = 2,000$ Feb. 14 Purchased 120 units @ 21.50$ = 2,580 Total cost of goods sold for April 5 sale 4,580$
FIFO Cost of Goods Sold for April 5
6-27
Weighted Average and LIFO Cost FlowsWhen
maintaining perpetual inventory
records, using the weighted
average or LIFO cost flow
methods leads to timing
difficulties.
Further discussion of these methods
is beyond the scope of this text.
6-28
LO 3
Apply the lower-of-cost-or-market rule to inventory
valuation.
6-29
Lower of Cost or Market (LCM)
Inventory must be reported at Inventory must be reported at lowerlower of of cost or market.cost or market.
Inventory must be reported at Inventory must be reported at lowerlower of of cost or market.cost or market.
Applied three ways:(1) separately to each individual item.(2) to major classes or categories of assets.(3) to the whole
inventory.
Applied three ways:(1) separately to each individual item.(2) to major classes or categories of assets.(3) to the whole
inventory.
Market is defined as current
replacement cost (not sales price).Consistent with
the conservatismprinciple.
Market is defined as current
replacement cost (not sales price).Consistent with
the conservatismprinciple.
6-30
Lower of Cost or Market (LCM)
To illustrate lower of cost or market, assume The Mountain Bike Company has in ending inventory 100 t-shirts purchased at a cost of
$14 each.
To illustrate lower of cost or market, assume The Mountain Bike Company has in ending inventory 100 t-shirts purchased at a cost of
$14 each.
Cost Market LCMSituation 1 14$ 18$ 14$ Situation 2 14$ 11$ 11$
6-31
A company with 4 types of inventory must apply LCM:
6-32
LO 4
Explain how fraud can be avoided
through inventory control.
6-33
Fraud Avoidance in Merchandising Businesses
Because inventory and cost of goods sold accounts are so significant, they are
attractive targets for concealing fraud.
Because of this, auditors and financial analysts carefully examine them for signs of
fraud.
6-34
If Ending Inventory is overstated then Cost of Goods Sold will be understated.
6-35
If Cost of Goods Sold is understated, then Gross Margin is overstated.
Resulting in overstatement of Net Income.
6-36
Then, on the balance sheet Inventory is overstated and Retained Earnings is overstated.
6-37
LO 5
Use the gross margin method to estimate ending
inventory.
6-38
For interim financial statements, we may need to estimate ending inventory and cost of goods sold.
6-39
Estimating the Ending Inventory Balance
Many companies
use the gross margin
method to estimate the
current period’s ending
inventory.
6-40
Calculate the expected gross margin ratio using prior period’s income statement.
Multiply the expected gross margin ratio by the current period’s sales to estimate the amount of gross margin.
Subtract the estimated gross margin from sales to estimate cost of goods sold.
Subtract the estimated cost of goods sold from the amount of goods available for sale to estimate the ending inventory.
Calculate the expected gross margin ratio using prior period’s income statement.
Multiply the expected gross margin ratio by the current period’s sales to estimate the amount of gross margin.
Subtract the estimated gross margin from sales to estimate cost of goods sold.
Subtract the estimated cost of goods sold from the amount of goods available for sale to estimate the ending inventory.
The Gross Margin Method
6-41
*Historically, gross margin has amounted to approximately 25 percent of sales.
22000 x .25=5,500
16,500
7,100
6-42
LO 6
Explain the importance of
inventory turnover to a company’s
profitability.
6-43
Inventory Turnover
Cost of Goods SoldInventory
This measures how quickly a company
sells its merchandise inventory.
This is the first step in calculating the average number of days to sell
inventory.
6-44
Average Number of Days to Sell Inventory
365Inventory Turnover
This measures how many days, on average, it takes to sell inventory.
Other things being equal, the company with the lower average
number of days to sell inventory is doing better.
6-45
6-46
End of Chapter Six