WELCOME BACK

TO

22107
ACCOUNTING FOR BUSINESS
DECISIONS A

WORKSHOP SEVEN
I NV E NT O R Y
ANY QUESTIONS?
 Mid-session exam held next week on
May 13
 One hour to complete the exam
between 2pm and 8pm
 Plagiarism checks
 Support – Asking questions in class and
UTSonline discussion boards
 Learning Objectives
In this workshop you will:

(1) Describe inventory and how it is recorded,

expensed, and reported.
(2) Calculate the cost of goods sold using different
inventory costing methods.
(3)Understand the income and tax effects of
inventory cost flow assumptions.
(4) Analyse the effects of inventory errors.
(5) Demonstrate how inventory is estimated.
 Learning Objectives
In addition, information presented in workshop 6 will
help you:

(6) Apply the lower-of-cost-or-net-realisable-value

rule to inventory.
(7) Evaluate inventory through the calculation of
horizontal, vertical, and ratio analyses.
(8) Appendix: Record purchases and calculate the
cost of goods sold under a periodic system.
LO1 Inventory
Describe inventory and how it is recorded,
expensed, and reported.

The physical products we sell, from bobby

pins to battle ships. The aim is to sell them
for more than we paid for them – enough
‘mark-up’ to pay the wages, rent, advertising
and have some profit at the end.
 Inventory

• Inventory is a tangible resource that is held for

resale in the normal course of operations.
– The phrase “intended for resale” differentiates
inventory from other assets.
– Following the cost principle, inventory is recorded at
its acquisition cost – this includes all costs incurred to
get the inventory delivered or prepared for resale.
CarMax purchased a vehicle for $5,000, paid
$100 to transport it to the place of sale, a
mechanic $450 to service the vehicle, a detailer
$150 to clean the vehicle. Once sold, CarMax
paid $200 commission to the sales person. What
is the inventory cost of the vehicle for CarMax:
• $5,000
• $5,100
• $5,550
• $5,700
• $5,900
Consolidated Balance Sheet -
CSL
 Types of Inventory Systems
• The recording of inventory purchases & cost of
goods sold depends on a company’s inventory
system.
– Perpetual system: cost of goods sold is updated each
time inventory is sold—that is, perpetually.
– Periodic system: cost of goods sold is calculated and
recorded only at the end of the period—that is,
periodically.

We concentrate on the perpetual method today.

The periodic method is shown in the last
(appendix) objective.
 Recording of Inventory

Devon Gifts purchases $20,000 of inventory

on account (on credit) on October 10 and
records the purchase as follows:

GENERAL
JOURNAL
Date De s c ription De bit Cre dit
Oct. 10 Inventory 20,000
Accounts Payable 20,000
 Transportation-In
Suppose Devon pays a third-party carrier
$300 to transport the inventory to its
warehouse. Devon records the payment as
follows:
GENERAL
JOURNAL
Date De s c ription De bit Cre dit
Oct. 10 Inventory 300
Cash 300
 Purchase Returns and Allowances

On October 12, Devon is granted a $1,000 reduction

in the cost of the merchandise due to blemishes on
the inventory. Devon records the reduction of the
inventory cost and payable as follows:

GENERAL
JOURNAL
Date De s c ription De bit Cre dit
Oct. 12 Accounts Payable 1,000
Inventory 1,000
 Purchase Discount
(The Other Side of Sales Discount)
Devon pays its remaining $19,000 bill to the
vendor on October 15 and qualifies for a 1%
early payment discount (or $19,000 x 1% = $190),
recorded as follows:
GENERAL
JOURNAL
Date De s c ription De bit Cre dit
Oct. 15 Accounts Payable 19,000
Inventory 190
Cash 18,810
 Summary of Net Purchases

Given the preceding activity, Devon’s net purchases

of inventory can be calculated as follows:
 Expensing Inventory
The account Cost of Goods Sold or Cost of Sales is
used to capture the amount of inventory expensed
during a period. On Nov. 2, if Devon sells inventory
costing $400 for $600 cash, the following entries
would be recorded.
GENERAL
JOURNAL
Date De s c ription De bit Cre dit
Nov. 2 Cash w 600
ney F lo
Mo
Sales 600
Cost of Goods Sold w 400
o d s F l o
InventoryGo 400
Consolidated Income Statement
- CSL
Reporting Inventory and Cost of Goods Sold

• Balance sheet: Inventory is expected to be sold

within a year – reported as a current asset.
• Income statement: Usually large, cost of goods
sold is reported as a separate line.
LO2 Inventory Costing
Calculate the cost of goods sold using
different inventory costing methods.

To determine the cost of inventory sold,

companies can use one of the following
four inventory costing methods:
1. specific identification
2. first-in, first-out (FIFO)
3. last-in, first-out (LIFO)
4. moving average
 Illustration
Assume that Wombat General Stores sells goanna oil
that it purchases from Dingo. The following is
Wombat’s inventory activity for September.

Net Income Units Unit Cost Total

Sep.1 Begin Inventory 40 $12 $480
Sep.4 Purchase 60 $13 $780
Sep.10 Sale (65) $?
Sep.15 Purchase 30 $14 $420
Sep.23 Purchase 45 $15 $675
Sep.30 Sale (50)
 Specific Identification
• Know we sold 65 units made up of;
– 30 of the original units and
– 35 the recently purchased units.
 Specific Identification
Cost of Goods Sold

Ending Inventory
Specific identification
 Which retailer is the specific identification
model most appropriate for:
• Antique dealer
• Aldi
• Bing Lee
OK if you can identify each item
bought and sold

But if not, you need to make an

ASSUMPTION
 First-in-First-Out (FIFO)
Cost of Goods Sold

Ending Inventory
 First-in-first-out (FIFO)

All of these

The remainder from here

 Last-in-First-Out (LIFO)
Cost of Goods Sold

Ending Inventory
 Moving Average
Cost of Goods Sold

Ending Inventory
Calculating Moving (Weighted) Average
LO3 Understand the income and tax
effects of inventory cost flow
assumptions.

• Accountants can legally (honestly,

ethically) produce different profit figures.
• Inventory flow assumptions are one way
in which different expenses can be
calculated – although in Australia we
don’t use LIFO
 Comparing Inventory
Costing Methods
• Specific identification is not possible if one item
cannot be distinguished from another Then we need
to make an inventory flow ASSUMPTION such as:
• FIFO: assigns the costs of the first and, in this case,
less expensive units purchased to COGS, thereby
giving the lowest COGS. It also assigns the costs of
the last and more expensive units to ending
inventory, thereby yielding the highest ending
inventory.
 Comparing Inventory
Costing Methods
• LIFO: assigns the costs of the last, and in this case,
more expensive units to COGS, resulting in the
highest COGS. The costs of the first and less
expensive units are assigned to ending inventory.
We do not use LIFO for reporting or tax in Australia.
• Moving average (weighted average): assigns the
average costs of all units purchased to COGS.
Therefore, it yields COGS and ending inventory that
fall in between the FIFO and LIFO extremes.
 Relations Summarised
When Inventory Costs are Rising
When inventory prices are falling (e.g. Flat Screen
TVs) which will give the highest COGS and the
lowest closing inventory value:

(a) FIFO
(b) LIFO
(c) Moving Average
(d) It cannot be determined from the limited information given
LO4 Inventory Errors

Analyse the effects of inventory errors.

Errors in the counting of inventory affect

both the balance sheet and income
statement through cost of goods sold.
 Inventory Errors
• The effect of the counting error is not limited to
the year of the error.
• Some errors are counterbalancing errors, or
errors whose effects on profits (income) are
corrected in the period after the error.
• Not all inventory errors are counterbalancing.
For example, if a particular warehouse of
inventory is not counted year after year, the error
will not work itself out.
LO5 Estimating Inventory

Demonstrate how inventory is estimated.

In the Notes of financial statements

“Significant Accounting Policies –
Inventory” it frequently says ‘inventories
are stated at the lower or cost or net
realisable value with cost primarily being
determined by the retail inventory
method.’
 Estimating Ending Inventory
• A company must sometimes estimate its
inventory balance – e.g. inventory destroyed.
– Gross profit method : estimates inventory using
a company’s gross profit percentage to
estimate cost of goods sold and then ending
inventory.
 Example

3
Sale revenue for the year is $200,000. Gross
profit is 30%. What is the estimated cost of
goods sold:

• $60,000
• $140,000
LO6 Lower-of-cost-and-NRV

Apply the lower-of-cost-and-net-

realisable-value rule to inventory.

While we do not recognise the increase

in inventory value until it is sold, even if
the purchase price to us has risen, we
do recognise a fall in value if the net
amount we are likely to receive from the
sale is lower than cost.
 Lower-of-Cost-and- Net-Realisable-Value
• The cost principle requires that inventory be
recorded at its cost.
• However, because of the principle of
conservatism, accounting require that inventory
be reported at its net realisable value if the NRV
is lower than the inventory’s cost.
• This is known as the lower-of-cost-and-net-
realisable-value LCNRV (sometimes called the
lower of cost or market)
• This is applied at the end of each accounting
period.
 Application of LCNRV

• The lower-of-cost-and-net-realisable-value rule

is applied at the end of each accounting period
by comparing inventory costs to NRV.
• The accounting standard AASB 102 Inventories
does not allow decreases in one category of
inventory to be offset against gains in another.
An antique dealer holds the following inventory:
- A lamp shade: purchased for $100, currently
worth $140
- A table: purchased for $80, currently worth
$50
What is the value of inventory is reported in the
balance sheet:
• $150
• $180
• $190
• $240
LO7 Management of Inventory

Evaluate a company’s management of

inventory

For a retailer, inventory is a major asset,

representing a substantial proportion of
total assets. It is important that the
inventory is not damaged or stolen but
equally important not to allow too much
inventory to become unsalable.
Assessing Inventory Using Horizontal &
Vertical Analysis
 Inventory Analysis (figures in $ millions)

Woolworths (Woolies, BigW, Masters)

Percentage increase 2013 to 2014 = 12%
Inv / Total Assets = 4,693 / 24,205 = 19%
COGS / Sales = 44,474 / 60,772 = 73%

Wesfarmers (Coles, Bunnings, Kmart, Target)

Percentage increase 2013 to 2014 = 6%
Inv / Total Assets = 5,336 / 39,727 = 13%
COGS / Sales = 41,424 / 60,181 = 69%
 Inventory Turnover Ratio
• Inventory turnover ratio:
– compares the COGS during a period to the average
inventory balance during that period and measures
the ability to sell inventory.

• Days-in-Inventory Ratio:
– converts the inventory turnover ratio (above) into a
measure of days by dividing the turnover ratio into
365 days.
 COGS for the period is $100,000.
Inventory at the beginning and end of the
period is $10,000 and $30,000 respectively.
What is the inventory turnover ratio:
• 10
• 5
• 3.33
LO8 Periodic Inventory System
Appendix: Record purchases and
calculate the cost of goods sold under a
periodic system.

In a periodic inventory system COGS is

calculated at the end of the period using
the ‘biscuit tin’ approach! We started
with 3 Tim Tams, Dad put in 7 more, they
came back and there were only 2 left.
How many did I eat?
 Appendix
Periodic Inventory System

• Does not update the inventory and COGS

accounts during the period.
• Instead, when purchases are made, they are
recorded in a temporary account called
Purchases and when sales are made, the
resulting revenue is recorded, but not the
COGS.
 Recording of Inventory
(Dr “Purchases” rather than “Inventory”)

Devon Gifts purchases $20,000 of inventory

on account on October 10 and records the
purchase as follows:

GENERAL
JOURNAL
Date De s c ription De bit Cre dit
Oct. 10 Purchases 20,000
Accounts Payable 20,000
 Other Transactions Associated with
Purchases
On October 12, Devon is granted a $1,000
reduction in the cost of the purchases due to
due to blemishes on the inventory. Recorded as
before except “Purchase Returns and
Allowances” is credited

Suppose Devon pays a carrier $300 to transport

the inventory to its warehouse. Recorded as
before except “Transport in” is debited
 Purchase Discount
(Exactly as Before)
Devon pays its remaining $19,000 bill to the
vendor on October 15 and qualifies for a 1%
early payment discount (or $19,000 x 1% =
$190), recorded as follows:

GENERAL
JOURNAL
Date De s c ription De bit Cre dit
Oct. 15 Accounts Payable 19,000
Purchase Discounts 190
Cash 18,810
 Summary of Net Purchases
Given the preceding activity, Devon’s net
purchases of inventory can be calculated as
follows:
 Illustration
Assume that Wombat General Store sells a
specialty goanna oil that it purchases from Dingo
Manufacturing. The following is Wombat’s
inventory purchases for September.

Net Income Units Unit Cost Total

Sep.1 Begin Inventory 40 $12 $480
Sep.4 Purchase 60 $13 $780
Sep.15 Purchase 30 $14 $420
Sep.23 Purchase 45 $15 $675
 Three Steps using Inventory Costing
Methods Under a Periodic System
• Since a periodic system does not update the
Inventory and the Cost of Goods Sold accounts
during the period, balances in these accounts must be
calculated at the end of the period.
• Three steps are used as shown in this slide.
– (1) Count the inventory on hand at the end of the
period;
– (2) Use an inventory costing method to assign a cost to
the ending inventory; and
– (3) Calculate cost of goods sold using the cost of goods
sold model.
 Specific Identification: Periodic
At the end of the month counts 60 units on hand.
5 x $13 units
20 x $14 units
35 x $15 units
 FIFO: Periodic
At the end of the month counts 60 units on hand.

THE 60 NEWEST
 LIFO: Periodic
At the end of the month counts 60 units on hand.

THE 60 OLDEST
 Weighted Average: Periodic
At the end of the month counts 60 units on hand.

$13.46 x 60 = $807.60
(or approximately $808)
Any Questions ?
End of workshop 7