201Lec06.

PPT

INVENTORY ISSUES

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Issues
Issues in
in counting
counting inventory
inventory

Ship to

Sale or consignment?
Reseller
Seller
i p to
Sh
ALL inventory must be
accounted for (also not
double counted).
Question: Who owns it
Buyer at year end?

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 Ownership
Ownership of of inventory
inventory rules
rules
Ownership of Goods on board a carrier (in transit on
a truck, boat, etc) determined by shipping terms :

Buyer considered owner

FOB shipping point when seller ships (carrier
(Free On Board) departs from seller)

Buyer NOT considered

FOB destination owner until the goods
reach the buyer.

Consigned goods are owned by seller until sold by

buyer.

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Inventory
Inventory Errors
Errors
This is the only account which appears on both
the Income Statement and the Balance Sheet.
Inventory errors occur often.
- Unintentional
- Fraudulent manipulation
Consider the effects of inventory errors.

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 in millions
SALES $900
Consider this
CGS example of a
BI $ 300 troubled
+Purchases + 500 company
CGAS 800
- EI - 200
CGS - 600
GROSS PROFIT
300
- expenses
- 350
Net loss
- 50
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 in millions
SALES $900
What happens to
CGS gross profit if:
BI $ 300 EI Overstated by
+Purchases + 500 $150 ?
CGAS 800
- EI - 200 -350
CGS - 600 -450
GROSS PROFIT 450
300
- expenses
- 350 +100
Net loss
- 50
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 in millions
SALES $900
What happens to
CGS gross profit if:
BI $ 300 EI Overstated by
+Purchases + 500 $150 ?
800 What happens next year?
CGAS
BI= last year EI
- EI - 200 -350
CGS - 600 -450
GROSS PROFIT 450
300
- expenses
- 350 +100
Net loss
- 50
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44 COST
COST FLOW
FLOW ASSUMPTIONS
ASSUMPTIONS
BB 10 BB 10 BB 11

COST = $10 each COST = $11.

1.
1. SPECIFIC
SPECIFIC IDENTIFICATION:
IDENTIFICATION:
Tag
Tag each
each item
item with
with purchase
purchase info.
info. Cost
Cost
of
of sale
sale equals
equals amount
amount on
on tag.
tag.

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44 COST
COST FLOW
FLOW ASSUMPTIONS
ASSUMPTIONS
BB BB BB

2.
2. AVERAGE
AVERAGE COST:
COST:
Use
Use formula:
formula: $BI
$BI ++ $Purch
$Purch == Average
Average
Units
Units BI+Purch
BI+Purch Unit
Unit
Cost
Cost
$10+$21
$10+$21 == $10.333/unit
$10.333/unit
33 units
units

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44 COST
COST FLOW
FLOW ASSUMPTIONS
ASSUMPTIONS
BB BB BB

3.
3. FIRST-IN
FIRST-IN FIRST-OUT
FIRST-OUT (FIFO):(FIFO):
Items
Items purchased
purchased first
first are
are recorded
recorded asas sold
sold
first.
first.
Items
Items purchased
purchased last
last go
go into
into ending
ending inventory!
inventory!
In
In above:
above: CGS
CGS == $10
$10 EI
EI == $10+$11=$21
$10+$11=$21

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44 COST
COST FLOW
FLOW ASSUMPTIONS
ASSUMPTIONS
BB BB BB

4.
4. LAST-IN
LAST-IN FIRST-OUT
FIRST-OUT (LIFO):
(LIFO):
Items
Items purchased
purchased last
last are
are recorded
recorded as as sold
sold
first.
first.
Items
Items purchased
purchased first
first stay
stay in
in ending
ending inventory!
inventory!
In
In above:
above: CGS
CGS == $11
$11 EI
EI == 22 xx $$ 10
10 == $20
$20

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DETAILED EXAMPLE:
DATE Transaction Units Price/unit Total
12/31/11 Beginning Inv 10 $10.00 $100.00
1/1/12 Sell 2 $17.50 $35.00
1/5/12 Buy 5 $10.50 $52.50
1/12/12 Sell 4 $17.50 $70.00
1/20/12 Buy 5 $11.00 $55.00
1/31/12 Sell 1 $17.50 $17.50

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 DETAILED EXAMPLE:
DATE Transaction Units Price/unit Total
• 12/31/11
In the accounts:
Beginning Inv 10 $10.00 $100.00
Sales
1/1/12 = $35.00
Sell + $70.00 + 2 $17.50 $35.00
$17.50 = $122.50.
1/5/12 Buy 5 • $10.50 $52.50
Sales = 7 units
Purchases =$52.50 + $55.00
1/12/12 Sell
= $107.50. 4 • $17.50 $70.00
Ending Inventory =
1/20/12 Buy 5 13 units
$11.00 (no
$55.00
shortages)
1/31/12 Sell 1 $17.50 $17.50

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DETAILED EXAMPLE: FIFO PERIODIC
DATE Transaction Units Price/unit Total
Cost of Sales
12/31/11 (7 units)=
Beginning Inv 10 FIFO PERIODIC
$10.00 $100.00
7 @ $10.00
1/1/12 = $70.00
Sell 2 Income Statement:$35.00
$17.50
1/5/12 Buy 5 Sales $10.50 $122.50
$52.50
Ending Inventory (13 units)= BI $100.00
1/12/12 Sell
5 @ $11.00 = $55.00 + 4 $17.50 $70.00
+ Purch 107.50
1/20/12 Buy
5 @ $10.50 = $52.50 + 5 $11.00 $55.00
CGAS $207.50
1/31/12 Sell
3 @ $10.00 = $30.00 1 $17.50 $17.50
- EI - 137.50
13 $137.50 CGS - 70.00
Gross Profit $52.50

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DETAILED EXAMPLE: LIFO PERIODIC
DATE Transaction Units Price/unit Total
Cost of Sales
12/31/11 =
Beginning Inv 10 LIFO PERIODIC
$10.00 $100.00
5 @ $11.00Sell
1/1/12 = $55.00 + 2 Income Statement:
$17.50 $35.00
2 @ $10.50Buy
1/5/12 = 21.00 5 Sales $10.50 $122.50
$52.50
7 BI $100.00
1/12/12 Sell$76.00 4 $17.50 $70.00
LIFO Periodic: + Purch 107.50
1/20/12 Buy 5 $11.00 $55.00
CGAS $207.50
Ending
1/31/12 Inventory
Sell Cost = 1 $17.50 $17.50
- EI - 131.50
10 @ $10.00 = $100.00 +
CGS - 76.00
3 @ $10.50 = $31.50
Gross Profit $46.50
13 $131.50
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DETAILED EXAMPLE: AVERAGE PERIODIC
DATE Transaction Units Price/unit Total
AVERAGE Periodic:
12/31/11 Beginning Inv
($100.00+$52.50+55.00) 10 AVERAGE
$10.00PERIODIC
$100.00
(10+5+5 units) Income Statement:
1/1/12 Sell 2 $17.50 $35.00
= $10.375/unit cost
1/5/12 Buy 5 Sales $10.50 $122.50
$52.50
BI $100.00
1/12/12 Sell
Ending inventory = 4 $17.50 $70.00
13 x $10.375 = $134.88 + Purch 107.50
1/20/12 Buy 5 $11.00 $55.00
CGAS $207.50
1/31/12 Sell 1 $17.50 $17.50
- EI - 134.88
CGS - 72.62
Gross Profit $49.88

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 Summary
METHOD CGS EI Gross
Profit
FIFO 70.00 137.50 52.50
Average 72.62 134.88 49.88
LIFO 76.00 131.50 46.50
Questions for Management to consider:
• Which alternative reports higher net income?
• Which alternative results in lower taxes?
• Which alternative results in a more accurate
ending inventory cost on the balance sheet?
• Changes to above if costs fall versus rise?

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Cost
Cost Flow
Flow Methods
Methods in
in Perpetual
Perpetual Systems
Systems

CGS & Inventory

balance must be
computed for
each sale.

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EXAMPLE: LIFO PERPETUAL
DATE Transaction Units Price/unit Total
12/31/11 Beginning Inv X
10 8 $10.00 $100.00
1/1/12 Sell cost=2($10) 2 $17.50 $35.00
1/5/12 Buy X5 1 8$10.50
@ 10.00 = 80.00
$52.50
1/12/12 Sell cost=4($10.50) 4 1$17.50
@ 10.50 = 10.50
$70.00
1/20/12 Buy X5 4 4$11.00
@ 11.00 = 44.00
$55.00
1/31/12 Sell cost=1($11.00) 1 $17.50 134.50
$17.50
CGS Inventory
20.00 100.00 20.00
42.00 52.50 42.00
11.00 55.00 11.00
73.00 134.50
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SPECIAL
SPECIAL RULE
RULE for
for Inventory
Inventory Costing
Costing

Lower-of-Cost-or-Market (LCM)
When the value of inventory is lower than its cost
Per GAAP, companies must “write down” the
inventory to its market value in the period in
which the price decline occurs.
Market value = Replacement Cost
Example of conservatism.

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LCM Illustration for Chuck’s Electronics Inc.:

Inventory Cost Market Lower of

Categories Data Data Cost or Market
TVs $ 60,000 $ 75,000 $ 60,000
Radios 45,000 52,000 45,000
DVD recorders 48,000 45,000 45,000
DVDs 14,000 12,800 12,800
Total inventory $ 167,000 $162,800

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Analysis
Analysis of
of Inventory
Inventory –– Size
Size of
of inventory
inventory

How much inventory should a company have?

1.Not too much:
High Inventory Levels may incur high
carrying costs (e.g., investment, storage,
insurance, obsolescence, and damage).

2.Not too little:

Low Inventory Levels may lead to
stock outs and lost sales.

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Analysis
Analysis of
of Inventory
Inventory -- Ratios
Ratios
Inventory turnover measures the number of times
on average the inventory is sold during the period.

Inventory =
Cost of Goods Sold
Turnover Average Inventory

Days in inventory measures the average number of

days inventory is held.
Days in =
Days in Year (365)
Inventory Inventory Turnover

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 Analysis
Analysis of
of Inventory
Inventory –– LIFO
LIFO Reserve
Reserve
To enable comparison between companies, GAAP requires
LIFO companies to disclose what inventories would be if
FIFO were used.
In footnotes, companies report the LIFO Reserve which =
FIFO inventory less LIFO inventory.
In my previous example, LIFO reserve is:
EI using FIFO $137.50
EI using LIFO 131.50
LIFO Reserve $ 6.00

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