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1、Chapter 7InventoryAlbrecht, Stice, Stice, Swain1Types of InventoryRaw materialsMaterials purchased for use in manufacturing process.Work in processPartially completed units in production.Finished goodsManufactured products ready for sale.Cost of goods soldCosts incurred to purchase or manufacture th
2、e merchandise sold during the period.2Costs Included in InventoryWhat costs are included in inventory?Raw materialsLabor costsManufacturing overheadThe indirect manufacturing costs associated with producing inventory.Freight in costs3Who Owns the Inventory?When goods are in transit?Q: Who owns inven
3、tory on a truck or railroad car?A: The party who is paying the shipping costs.When goods are on consignment?Q: Who owns inventory stocked in a warehouse?A: The supplier until the inventory is sold. The warehouse owner stocks and sells the inventoryand receives a commission on sales as payment for se
4、rvices rendered.4Perpetual vs. Periodic SystemsPerpetual inventory systemDetailed records of the number of units and the cost of each purchase and sale are prepared THROUGHOUT the period.Periodic inventory systemSystem of accounting where cost of goods sold is determined and inventory is adjusted at
5、 the END of the accounting period, not when merchandise is purchased or sold.5Perpetual vs. Periodic MethodInventory is purchased:Inventory500Accounts Payable 500Transportation costs:Inventory 10Cash 10Purchase returns:Accounts Payable 50Inventory 50Purchase discounts:Account Payable450Inventory 9Ca
6、sh 441Inventory is purchased:Purchases500Accounts Payable 500Transportation costs:Freight In 10Cash 10Purchase returns:Accounts Payable 50Purchase Returns 50Purchase discounts:Accounts Payable450Purchase Discounts 9Cash 4416Perpetual vs. Periodic MethodWhen inventory is sold:Accounts Receivable 50Sa
7、les 50Cost of Goods Sold 30Inventory 30Closing Entry:NoneWhen inventory is sold:Accounts Receivable 50Sales 50No inventory entry at time of saleClosing Entries:Inventory451Purchase Returns 50Purchase Discounts 9Freight In 10Purchases 500Cost of Goods Sold 30Inventory 307Inventory CountsInventory cou
8、ntsNecessary under both the periodic and the perpetual method.With a periodic system, a physical count is the only way to get the information necessary to compute cost of goods sold.Under perpetual method, physical counts allow companies to determine inventory shrinkage.Shrinkage equals the differen
9、ce between what ending inventory should be what the count reveals it is.8Cost of Goods Sold ComputationsPeriodic MethodBeginning Inventory+ Net Purchases= Cost of Goods Available for Sale Ending Inventory= Cost of Good SoldPerpetual MethodEnding Inventory (from inventory system) Ending Inventory (fr
10、om inventory count)= Inventory Shrinkage+ Cost of Goods Sold (from inventory system)= Total Cost of Goods Sold9Inventory Cost Flow AssumptionsFIFO (first in, first out)Oldest units sold first.LIFO (last in, last out)Newest units sold first.Average CostAverage cost per unit is calculated by taking th
11、e average cost of goods available for sale.Specific Identification Each item is specifically identified.Usually used for large or expensive items (cars).10Inventory Cost FlowRice King buys and sells rice and had the following transactions for the year:June 10 Purchased 10 tons at $6 per ton.July 28
12、Purchased 10 tons at $9 per ton.October 10 Sold 10 tons at $11 per ton.How much did Rice King make during the year?FIFOLIFOAvg. CostSoldSoldSoldOld RiceNew RiceMixed RiceSales ($11 x 10 tons)$110$110$110COGS (10 tons) 60 90 75Gross margin$ 50 $ 20 $ 3511LIFO vs. FIFOFIFO gives a better measure of in
13、ventory on the balance sheet.Therefore, FIFO is a better measure of inventory value.LIFO gives a better reflection of COGS on the income statement.Therefore, LIFO is a better measure of net income.12Managing InventoryIts a balance!Avoid tying up resources in inventory.Vs.Maintaining sufficient inven
14、tory for smooth business operations.13Measuring the Management of InventoryInventory TurnoverHow many times during the year a company sells all of its inventory.Cost of Goods SoldAverage Inventory14Measuring the Management of InventoryNumber of Days Sales in InventoryHow many days worth of sales the
15、 company has in inventory.365Inventory TurnoverCalculated as cost of goods sold divided by average inventory. (Shown in previous slide).15Managing the Operating CycleNumber of Days Purchases in Accounts PayableHow many days worth of inventory the company has in accounts payable.365Purchases / Averag
16、e Account PayableDays Purchases in Accounts PayableExternal FinancingDays Sales in InventoryAverage Collection Period30 Days80 Days38 Days72 Days16Inventory ErrorsInventory errorsBeginning inventoryPurchasesEnding inventoryAffects Cost of goods soldGross marginNet income17Inventory ErrorsUnderstateE
17、nding Inventory SalesOKBeginning inventoryOKNet purchasesOKGoods availableOKEnding inventoryLOWCost of goods soldHIGHGross marginLOWExpensesOKNet incomeLOWUnderstatePurchasesUnderstateBeginningInventoryUnderstate SalesOKOKLOWLOWOKLOWHIGHOKHIGHOKLOWOKLOWOKLOWHIGHOKHIGHLOWOKOKOKOKOK LOWOKLOW18Perpetua
18、l LIFO and Average CostComplications arise because the “last in” and average cost change with every new purchase.The cost of goods sold for each sale needs to be recomputed after a new purchase is made.This means a lot more work.These complications do not occur with FIFO because the “first in” will
19、always be the same.19Net Realizable ValueNet Realizable ValueSelling price less selling costs.Used to value inventory when it is damaged, used, or obsolete.When inventory needs to be written down:Loss on Write-down of Inventory . . . . . . 200Inventory . . . . . . . . . . . . . . . . . . . . . . . 2
20、00To write down of inventory to its net realizable value.20Lower of Cost or MarketLower of cost or marketA basis for valuing inventory at the lower of original cost or current market value.Determining market valueCeilingMaximum amount (net realizable value).Replacement CostWhat inventory could curre
21、ntly be purchased for.FloorMinimum amount (net realizable value minus a normal profit).Market value is the middle of these three values.21Example: LCM Market Inventory ReplacementNRV Item Cost Floor Cost Ceiling A 34 20 32 30 B 42 32 36 46 C 52 44 42 62 D 38 50 32 68Define market value as:Replacemen
22、t cost, if it falls between the ceiling and the floor.The floor, , if the replacement cost is less than the floor.The ceiling, , if the replacement cost is higher than the ceiling.When replacement cost, ceiling, and floor are compared, market is always the middle value.Compare the defined market val
23、ue with the original cost and choose the lower amount.22Using LCMLCM can be applied in three ways.By computing cost and market figures for each item of inventory and using the lower of the two figures in EACH case.By computing cost and market figures for the total inventory and then applying the LCM
24、 rule to that TOTAL.By applying the LCM rule to categories of inventory.23Gross Margin MethodGross Margin MethodUsed when a physical count of inventory is impossible or impractical.Cost of goods sold and ending inventory are estimated using available information:Beginning inventory.Purchases.Histori
25、cal gross margin percentage.24Gross Margin Method ExampleOrem Industries has net sales for January 1 to March 31 of $100,000 and net purchases of $65,000. Inventory on January 1 was $15,000 and the company has a historic gross profit percentage of 40%. Dollars % of salesNet sales revenue$100,000100%
26、Cost of goods sold: Beginning inventory$15,000 Purchases 65,000 Total available for sale$80,000 Ending Inventory (3) 20,000Cost of goods sold (2) 60,000 60%Gross margin (1)$ 40,000 40%(1)$100,000 X .40(2) $100,000 - $40,000 (3) $80,000 - $60,00025AssignmentDiscussion questionsPractice exercises: 1,2,3,4,16,17,1826
