Professional Documents
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Intermediate I Chapter 8
Intermediate I Chapter 8
Valuation of
of Inventories:
Inventories:
A
A Cost-Basis
Cost-Basis Approach
Approach
Chapter
Chapter
8-1
Learning
Learning Objectives
Objectives
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Chapter
8-2
Valuation
Valuation of
of Inventories:
Inventories:
Cost-basis
Cost-basis Approach
Approach
Inventory
Classification
and Control
Classification
Control
Basic
inventory
valuation
issues
Chapter
8-3
Physical
Goods
Included in
Inventory
Goods in
transit
Consigned
goods
Special sales
agreements
Inventory
errors
Costs
Included
in Inventory
Product costs
Period costs
Purchase
discounts
Cost Flow
Assumptions
Specific
identification
Average cost
FIFO
LIFO
LIFO:
Special
Issues
LIFO reserve
LIFO
liquidation
Dollar-value
LIFO
Comparison of
LIFO
approaches
Advantages of
LIFO
Disadvantages
of LIFO
Basis for
Selection
Summary of
inventory
valuation
methods
Inventory
Inventory Classification
Classification and
and Systems
Systems
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.
Chapter
8-4
or
Manufacturer
Inventory
Inventory Classification
Classification and
and Systems
Systems
Type of Business
Merchandiser
One inventory
account
Purchase goods
ready for sale
Chapter
8-5
$ 285,000
530,000
149,000
777,000
33,000
1,774,000
321,657
253,980
150,000
550,000
225,000
653,798
Inventory
Inventory Classification
Classification and
and Systems
Systems
Type of Business
Manufacturer
Three accounts
Raw materials
Work in process
Finished goods
Chapter
8-6
Inventory
Inventory Classification
Classification and
and Systems
Systems
Flow of Costs
Chapter
8-7
Illustration 8-2
Inventory
Inventory Classification
Classification and
and Systems
Systems
Control
Two systems for maintaining inventory records:
Perpetual system
Periodic system
Chapter
8-8
Inventory
Inventory Classification
Classification and
and Systems
Systems
Perpetual System
Features:
1.
Inventory
Inventory Classification
Classification and
and Systems
Systems
Periodic System
Features:
1.
Beginning inventory
$ 100,000
Purchases, net
Chapter
8-10
800,000
Goods available for sale
Inventory
Inventory Classification
Classification and
and Systems
Systems
Perpetual System
vs.
Periodic System
|
|
Inventory
Accounts payable
6,300
6,300
Purchases
Accounts payable
6,300
Accounts receivable
Sales
8,400
6,300
|
|
Accounts receivable
Sales
Cost of goods sold
Inventory
8,400
8,400
4,200
8,400
4,200
|
|
No Entry Necessary
|
|
|
Chapter
8-11
Inventory
Cost of goods sold
Purchases
2,100
4,200
6,300
Basic
Basic Issues
Issues in
in Inventory
Inventory Valuation
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).
Chapter
8-12
Physical
Physical Goods
Goods Included
Included in
in Inventory
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.
Special Consideration:
Goods in Transit (FOB shipping point, FOB destination)
Consigned goods
Sales with buyback agreement
Sales with high rates of return
Sales on installment
Inventory errors
Chapter
8-13
Effect
Effect of
of Inventory
Inventory Errors
Errors
Ending Inventory Understated
Illustration 8-6
Effect
Effect of
of Inventory
Inventory Errors
Errors
Purchases and Inventory Understated
Illustration 8-8
The understatement does not affect cost of goods sold and net
income because the errors offset one another.
Chapter
8-15
Costs
Costs Included
Included in
in Inventory
Inventory
Product Costs - costs directly connected with
bringing the goods to the buyers place of
business and converting such goods to a salable
condition.
Period Costs generally selling, general, and
administrative expenses.
Purchase Discounts Gross vs. Net Method
Chapter
8-16
Treatment
Treatment of
of Purchase
Purchase Discounts
Discounts
Gross Method
vs.
Net Method
Purchases
Accounts payable
20,000
20,000
Purchases
Accounts payable
19,600
19,600
Accounts payable
Purchase discounts
Cash
15,000
300
14,700
Accounts payable
Cash
14,700
14,700
|
|
Accounts payable
Cash
5,000
5,000
|
|
Chapter
8-17
Accounts payable
Purchase discount lost
Cash
4,900
100
5,000
What
What Cost
Cost Flow
Flow Assumption
Assumption to
to Adopt?
Adopt?
FIFO
LIFO
Average Cost
Specific Identification
Cost
Cost Flow
Flow Assumptions
Assumptions
Example
Young & Crazy Company makes the following purchases:
1.
2.
3.
Cost
Cost Flow
Flow Assumptions
Assumptions
First-In-First-Out (FIFO)
Inventory
Balance = $ 45
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-20
$ 90
0
90
14
12
7
33
57
17
$ 40
Cost
Cost Flow
Flow Assumptions
Assumptions
First-In-First-Out (FIFO)
Inventory
Balance = $ 35
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-21
$ 90
10
80
14
12
7
33
47
14
$ 33
Cost
Cost Flow
Flow Assumptions
Assumptions
Last-In-First-Out (LIFO)
Inventory
Balance = $ 45
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-22
$ 90
0
90
14
12
7
33
57
17
$ 40
Cost
Cost Flow
Flow Assumptions
Assumptions
Last-In-First-Out (LIFO)
Inventory
Balance = $ 25
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-23
$ 90
20
70
14
12
7
33
37
11
$ 26
Cost
Cost Flow
Flow Assumptions
Assumptions
Average Cost
Inventory
Balance = $ 45
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-24
$ 90
0
90
14
12
7
33
57
17
$ 40
Cost
Cost Flow
Flow Assumptions
Assumptions
Average Cost
Inventory
Balance = $ 30
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-25
$ 90
15
75
14
12
7
33
42
12
$ 30
Cost
Cost Flow
Flow Assumptions
Assumptions
Specific Identification
Inventory
Balance = $ 45
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-26
$ 90
0
90
14
12
7
33
57
17
$ 40
Cost
Cost Flow
Flow Assumptions
Assumptions
Specific Identification
Inventory
Balance = $ 45
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-27
$ 90
0
90
14
12
7
33
57
17
$ 40
Cost
Cost Flow
Flow Assumptions
Assumptions
Financial Statement Summary
Sales
Cost of goods sold
Gross profit
Operating expenses:
Administrative
Selling
Interest
Total expenses
Income before taxes
Income tax expense
Net income
Inventory Balance
Chapter
8-28
FIFO
$ 90
10
80
LIFO
$ 90
20
70
Average
$ 90
15
75
14
12
7
33
47
14
33
14
12
7
33
37
11
26
14
12
7
33
42
12
30
35
25
30
Cost
Cost Flow
Flow Assumptions
Assumptions
Example Perpetual and Periodic Methods
Inventory information for Part 686 for the month of June.
June 1
Beg. Balance
10
Sold
11
Purchased
15
Sold
20
Purchased
27
Sold
9,600
Goods
Available
$19,100
6,500
Cost
Cost Flow
Flow Assumptions
Assumptions
Perpetual
Inventory
+
FIFO Method
FIFO:
Transactions:
Inventory Balance:
Date
Units
Layer 1
Layer 2
Layer 3
Jun 1
300
300
Jun 10
(200)
(200)
Jun 11
800
800
Jun 15
(500)
(100)
(400)
Jun 20
500
500
Jun 27
(300)
(300)
100
500
Cost
$
10 $
12 $
13
600
$
$ 1,200 $
6,500
Calculation of Cost of Goods Sold:
Beg. inventory
Purchases
Goods available
Ending inventory
COGS
Chapter
8-30
Total
600
$
7,700
Units
Dollars
300 $
3,000
1,300
16,100
1,600
19,100
(600)
(7,700)
1,000 $ 11,400
Cost
Cost Flow
Flow Assumptions
Assumptions
Perpetual
Inventory
+
LIFO Method
LIFO:
Transactions:
Inventory Balance:
Date
Units
Layer 1
Layer 2
Layer 3
Total
Jun 1
300
300
Jun 10
(200)
(200)
Jun 11
800
800
Jun 15
(500)
(500)
Jun 20
500
500
Jun 27
(300)
(300)
100
300
200
600
Cost
$
10 $
12 $
13
600
$ 1,000 $ 3,600 $
2,600 $
7,200
Calculation of Cost of Goods Sold:
Beg. inventory
Purchases
Goods available
Ending inventory
COGS
Chapter
8-31
Units
Dollars
300 $
3,000
1,300
16,100
1,600
19,100
(600)
(7,200)
1,000 $ 11,900
Cost
Cost Flow
Flow Assumptions
Assumptions
Perpetual Inventory
Transactions:
Date
Units
Jun 1
300
Jun 10
(200)
Jun 11
800
Jun 15
(500)
Jun 20
500
Jun 27
(300)
600
Cost
$ 10.00
10.00
12.00
11.78
13.00
12.46
Total
$ 3,000
(2,000)
9,600
(5,890)
6,500
(3,738)
$ 7,472
Moving Average
Units
Dollars
300 $ 3,000
1,300
16,100
1,600
19,100
(600)
(7,472)
1,000 $ 11,628
Cost
Cost Flow
Flow Assumptions
Assumptions
Perpetual Inventory
Transactions:
Date
Units
Jun 1
300
Jun 10
(200)
Jun 11
800
Jun 15
(500)
Jun 20
500
Jun 27
(300)
600
Cost
$ 10.00
10.00
12.00
11.78
13.00
12.46
Total
$ 3,000
(2,000)
9,600
(5,890)
6,500
(3,738)
$ 7,472
Moving Average
Units
Dollars
300 $ 3,000
1,300
16,100
1,600
19,100
(600)
(7,472)
1,000 $ 11,628
Cost
Cost Flow
Flow Assumptions
Assumptions
Periodic
Inventory
+
FIFO Method
FIFO:
Transactions:
Inventory Balance:
Date
Units
Layer 1
Layer 2
Jun 1
300
Jun 10
(200)
Jun 11
800
100
Jun 15
(500)
Jun 20
500
Jun 27
(300)
100
Cost
$
10 $
12
600
$
$ 1,200
Calculation of Cost of Goods Sold:
Beg. inventory
Purchases
Goods available
Ending inventory
COGS
Chapter
8-34
Layer 3
Total
500
$
$
500
13
6,500
600
$
7,700
Units
Dollars
300 $
3,000
1,300
16,100
1,600
19,100
(600)
(7,700)
1,000 $ 11,400
Cost
Cost Flow
Flow Assumptions
Assumptions
Periodic
Inventory
+
LIFO Method
LIFO:
Transactions:
Inventory Balance:
Date
Units
Layer 1
Layer 2
Jun 1
300
300
Jun 10
(200)
Jun 11
800
300
Jun 15
(500)
Jun 20
500
Jun 27
(300)
300
300
Cost
$
10 $
12
600
$ 3,000 $ 3,600
Calculation of Cost of Goods Sold:
Beg. inventory
Purchases
Goods available
Ending inventory
COGS
Chapter
8-35
Layer 3
Total
$
$
600
13
6,600
Units
Dollars
300 $
3,000
1,300
16,100
1,600
19,100
(600)
(6,600)
1,000 $ 12,500
Cost
Cost Flow
Flow Assumptions
Assumptions
Periodic Inventory
Chapter
8-36
Weighted Average
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
LIFO Reserve
Many companies use
LIFO for tax and external financial reporting purposes
FIFO, average cost, or standard cost system for
internal reporting purposes.
Reasons:
Pricing decisions
2. Record keeping easier
3. Profit-sharing or bonus arrangements
4. LIFO troublesome for interim periods
1.
Chapter
8-37
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
LIFO Reserve is the difference between the
15,000
15,000
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
LIFO Liquidation
Older, low cost inventory is sold resulting in a lower cost
of goods sold, higher net income, and higher taxes.
Illustration 8-20
Chapter
8-39
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Dollar-Value LIFO
Changes in a pool are measured in terms of total
dollar value, not physical quantity.
Advantage:
Broader range of goods in pool.
Permits replacement of goods that are similar.
Helps protect LIFO layers from erosion.
Chapter
8-40
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Dollar-Value LIFO
Exercise 8-26 The following information relates to the
Jimmy Johnson Company.
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Exercise 8-26 Solution
Inventory at
Inventory at
End-of-Year
Base-Year
Base
Prices
Layers
Year
2003
2004
2005
Prices
$
Index
$ Value
Index
LIFO
LIFO
LIFO
TOTAL
Reserve
70,000
1.00
$ 70,000
$ 70,000
1.00
90,300
1.05
86,000
70,000
1.00
70,000
16,000
1.05
16,800
70,000
1.00
70,000
12,000
1.05
12,600
95,120
1.16
82,000
70,000
70,000
86,800
3,500
82,600
12,520
Dec. 31
2004
$
90,300
(3,500)
$
86,800
Dec. 31
2005
$
95,120
(12,520)
$
82,600
Journal entry
Cost of goods sold
Lifo reserve
3,500
(3,500)
9,020
(9,020)
Chapter
8-42
Balance Sheet
Inventory
LIFO Reserve
Dec. 31
2003
$
70,000
$
70,000
$ Value
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Comparison of LIFO Approaches
Specific-goods LIFO - costing goods on a unit basis
is expensive and time consuming.
Specific-goods Pooled LIFO approach
reduces record keeping and clerical costs.
more difficult to erode the layers.
using quantities as measurement basis can lead to
untimely LIFO liquidations.
Special
Special Issues
Issues Related
Related to
to LIFO
LIFO
Advantages
Matching
Reduced earnings
Tax Benefits/Improved
Cash Flow
Inventory understated
Chapter
8-44
Disadvantages
Physical flow
Involuntary Liquidation /
Poor Buying Habits
Basis
Basis for
for Selection
Selection of
of Inventory
Inventory Method
Method
LIFO is generally preferred:
1.
increases.
Chapter
8-45