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In this chapter, the learning objectives are: Describe the steps in determining inventory quantities, explain the accounting for inventories and apply the inventory cost flow methods, explain the financial effects of the inventory cost flow assumptions.
Chapter 6-1 CHAPTER INVENTORIES Accounting Principles, Eighth Edition Chapter 6-2 Study Objectives Study Objectives Describe the steps in determining inventory quantities Explain the accounting for inventories and apply the inventory cost flow methods Explain the financial effects of the inventory cost flow assumptions Explain the lowerofcostormarket basis of accounting for inventories Indicate the effects of inventory errors on the financial statements Compute and interpret the inventory turnover ratio Chapter 6-3 Reporting and Analyzing Inventory Reporting and Analyzing Inventory Classifying Classifying Inventory Inventory Determining Determining Inventory Inventory Quantities Quantities Finished goods Work in process Raw materials Taking a physical inventory Determining ownership of goods Chapter 6-4 Inventory Inventory Costing Costing Inventory Inventory Errors Errors Specific identification Cost flow assumptions Financial statement and tax effects Consistent use Lower-ofcost-ormarket Income statement effects Balance sheet effects Statement Statement Presentation Presentation and andAnalysis Analysis Presentation Analysis Classifying Inventory Classifying Inventory Merchandising Company One Classification: Merchandise Inventory Manufacturing Company Three Classifications: Raw Materials Work in Process Finished Goods Regardless of the classification, companies report all inventories under Current Assets on the balance sheet Chapter 6-5 Determining Inventory Quantities Determining Inventory Quantities Physical Inventory taken for two reasons: Perpetual System Check accuracy of inventory records Determine amount of inventory lost (wasted raw materials, shoplifting, or employee theft) Periodic System Determine the inventory on hand Determine the cost of goods sold for the period Chapter 6-6 LO 1 Describe the steps in determining inventory quantities Determining Inventory Quantities Determining Inventory Quantities Taking a Physical Inventory Involves counting, weighing, or measuring each kind of inventory on hand Taken, when the business is closed or when business is slow at end of the accounting period Chapter 6-7 LO 1 Describe the steps in determining inventory quantities Determining Inventory Quantities Determining Inventory Quantities Determining Ownership of Goods Goods in Transit Purchased goods not yet received Sold goods not yet delivered Goods in transit should be included in the inventory of the company that has legal title to the goods. Legal title is determined by the terms of sale Chapter 6-8 LO 1 Describe the steps in determining inventory quantities Determining Inventory Quantities Determining Inventory Quantities Terms of Sale Illustration 61 Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller Ownership of the goods remains with the seller until the goods reach the buyer Chapter 6-9 LO 1 Describe the steps in determining inventory quantities Determining Inventory Quantities Determining Inventory Quantities Review Question Goods in transit should be included in the inventory of the buyer when the: a public carrier accepts the goods from the seller. b goods reach the buyer. c terms of sale are FOB destination. d terms of sale are FOB shipping point Chapter 6-10 LO 1 Describe the steps in determining inventory quantities Inventory Errors Inventory Errors Common Cause: Failure to count or price inventory correctly. Not properly recognizing the transfer of legal title to goods in transit Errors affect both the income statement and balance sheet Chapter 6-33 LO 5 Indicate the effects of inventory errors on the financial statements Inventory Errors Inventory Errors Income Statement Effects Inventory errors affect the computation of cost of goods sold and net income Illustration 616 Illustration 617 Chapter 6-34 LO 5 Indicate the effects of inventory errors on the financial statements Inventory Errors Inventory Errors Income Statement Effects Inventory errors affect the computation of cost of goods sold and net income in two periods An error in ending inventory of the current period will have a reverse effect on net income of the next accounting period Over the two years, the total net income is correct because the errors offset each other The ending inventory depends entirely on the accuracy of taking and costing the inventory Chapter 6-35 LO 5 Indicate the effects of inventory errors on the financial statements Inventory Errors Inventory Errors 2008 Illustration 618 2009 I nc o r r e c t Cor r e c t I nc o r r e c t Cor r e c t S a le s $ 8 , 0 $ 8 , 0 $ 9 , 0 $ 9 , 0 Be g inning inve nt o r y 2 , 0 2 , 0 1 , 0 1 , 0 C o s t o f g o o d s pur c h a s e d 4 , 0 4 , 0 6 , 0 6 , 0 C o s t o f g o o d s a va ila b le 6 , 0 6 , 0 8 , 0 8 , 0 End ing inve nt o r y 1 , 0 1 , 0 2 , 0 2 , 0 C o s t o f g o o d s o ld 4 , 0 4 , 0 5 , 0 6 , 0 Gr o s s pr o f it 3 , 0 3 , 0 3 , 0 3 , 0 O pe r a t ing e x pe ns e s 1 , 0 1 , 0 2 , 0 2 , 0 N e t inc o m e $ 2 , 0 $ 2 , 0 $ 1 , 0 $ 1 , 0 Combined income for 2year period is correct Chapter 6-36 ($3,000) Net Income understated $3,000 Net Income overstated LO 5 Indicate the effects of inventory errors on the financial statements Inventory Errors Inventory Errors Review Question Understating ending inventory will overstate: a assets. b cost of goods sold. c net income. d owner's equity Chapter 6-37 LO 5 Indicate the effects of inventory errors on the financial statements Inventory Errors Inventory Errors Balance Sheet Effects Effect of inventory errors on the balance sheet is determined by using the basic accounting equation: Illustration 616 Illustration 619 Chapter 6-38 LO 5 Indicate the effects of inventory errors on the financial statements Statement Presentation and Analysis Statement Presentation and Analysis Presentation Balance Sheet Inventory classified as current asset. Income Statement Cost of goods sold subtracted from sales There also should be disclosure of 1) major inventory classifications, 2) basis of accounting (cost or LCM), and 3) costing method (FIFO, LIFO, or average) Chapter 6-39 LO 5 Indicate the effects of inventory errors on the financial statements Statement Presentation and Analysis Statement Presentation and Analysis Analysis Inventory management is a doubleedged sword High Inventory Levels may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage) Low Inventory Levels – may lead to stockouts and lost sales Chapter 6-40 LO 6 Compute and interpret the inventory turnover ratio Statement Presentation and Analysis Statement Presentation and Analysis Inventory turnover measures the number of times on average the inventory is sold during the period Inventory Turnover = Cost of Goods Sold Average Inventory Days in inventory measures the average number of days inventory is held Days in Year (365) Days in Inventory = Inventory Turnover Chapter 6-41 LO 6 Compute and interpret the inventory turnover ratio Statement Presentation and Analysis Statement Presentation and Analysis BE69 At December 31, 2008, the following information was available for J. Graff Company: ending inventory $40,000, beginning inventory $60,000, cost of goods sold $270,000, and sales revenue $380,000. Calculate inventory turnover and days in inventory for J. Graff Company Inventory Turnover Days in Inventory Chapter 6-42 $270,000 ($60,000 + 40,000) / 2 365 5.4 = 5.4 = 67.59 days LO 6 Compute and interpret the inventory turnover ratio Inventory Cost Flow Methods in Perpetual Inventory Systems The following data from Houston Electronics will be used to illustrate inventory costing under a perpetual system Illustration 6A1 Chapter 6-43 LO 7 Apply the inventory cost flow methods to perpetual inventory records Inventory Cost Flow Methods in Perpetual Inventory Systems Computation of cost of goods sold and ending inventory under FIFO for Houston Electronics Illustration 6A2 Cost of goods sold Ending inventory Chapter 6-44 LO 7 Apply the inventory cost flow methods to perpetual inventory records Inventory Cost Flow Methods in Perpetual Inventory Systems Computation of cost of goods sold and ending inventory under LIFO for Houston Electronics Illustration 6A3 Cost of goods sold Ending inventory Chapter 6-45 LO 7 Apply the inventory cost flow methods to perpetual inventory records Inventory Cost Flow Methods in Perpetual Inventory Systems Computation of cost of goods sold and ending inventory under moving average for Houston Electronics Illustration 6A4 Cost of goods sold Ending inventory Chapter 6-46 LO 7 Apply the inventory cost flow methods to perpetual inventory records Copyright Copyright “Copyright © 2008 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make backup copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” Chapter 6-47 .. .CHAPTER? ? INVENTORIES Accounting? ?Principles, Eighth Edition Chapter 6-2 Study Objectives Study Objectives Describe the steps in determining inventory quantities Explain the? ?accounting? ?for inventories and apply the inventory cost ... Assumptions) about which units were sold Chapter 6-15 LO 2 Explain the? ?accounting? ?for inventories and apply the inventory cost flow methods Inventory Costing? ?–? ?Cost Flow Assumptions Inventory Costing? ?–? ?Cost Flow Assumptions... Use of cost flow methods in major U.S. companies Chapter 6-16 LO 2 Explain the? ?accounting? ?for inventories and apply the inventory cost flow methods Inventory Costing? ?–? ?Cost Flow Assumptions Inventory Costing? ?–? ?Cost Flow Assumptions