Describe the issues in managing different types of inventory.

7-1

The primary goals of inventory managers are to:

1. Maintain a sufficient quantity to meet customers’ needs2. Ensure quality meets customers’ expectations and company standards3. Minimize the costs of acquiring and

carrying the inventory

7-2

Merchandisers . . . Buy finished

goods. Sell finished

goods.

Manufacturers . . . Buy raw

materials. Produce and sell

finished goods.

Raw MaterialsWork in ProcessFinished goods

Merchandise inventory

Materials waiting toMaterials waiting tobe processedbe processed

Partially Partially complete productscomplete products

Completed products Completed products awaiting sale awaiting sale

7-3

Explain how to report inventory and cost of

goods sold.

7-4

7-5

Beginning Inventory 4,800$ + Purchases 10,200 = Cost of Goods Available for Sale 15,000 – Cost of Goods sold 9,000 = Ending Inventory 6,000$

Cost of Goods Sold Calculation

BI + P – CGS = EIBI + P – CGS = EI

American Eagle Outfitters’ beginning inventory was $4,800. During the period, the company purchased inventory for $10,200. The cost of goods sold for the period is $9,000.

Compute the ending inventory.

7-6

BeginningInventory

$4,800

BeginningInventory

$4,800+

Goods Availablefor Sale$15,000

Purchases$10,000

Purchases$10,000

EndingInventory

$6,000

EndingInventory

$6,000(Balance Sheet)

Cost ofGoods Sold

$9,000

Cost ofGoods Sold

$9,000(Income Statement)

7-7

Compute costs using four inventory

costing methods.

7-8

First-in, first-out(FIFO)

First-in, first-out(FIFO)

Last-in, first-out(LIFO)

Last-in, first-out(LIFO)

Weighted average

Weighted average

Specificidentification

Specificidentification

7-9

May 3 Purchased 1 unit for $70May 5 Purchased 1 more unit for $75May 6 Purchased 1 more unit for $95May 8 Sold 2 units for $125 each

Consider the following information

This method individually identifies and records the cost of This method individually identifies and records the cost of each item sold as part of cost of goods sold. If the items sold each item sold as part of cost of goods sold. If the items sold were identified as the ones that cost $70 and $95, the total were identified as the ones that cost $70 and $95, the total cost of those items ($70 + 95 = $165) would be reported as cost of those items ($70 + 95 = $165) would be reported as

Cost of Goods Sold. The cost of the remaining item ($75) Cost of Goods Sold. The cost of the remaining item ($75) would be reported as Inventory on the balance sheet at the would be reported as Inventory on the balance sheet at the

end of the period. end of the period.

Specific Identification

May 5$75 cost

May 3$70 cost

May 6$95 cost

7-10

FIFO LIFO Weighted average

May 6$95 cost

May 5$75 cost

May 3$70 cost

May 6$95 cost

May 5$75 cost

May 3$70 cost

May 6$95 cost

May 5$75 cost

May 3$70 cost

So

ld

Sti

ll t

her

e

Net Sales 250$ Cost of Goods Sold 145 Gross Profit 105$

Inventory 95$

Income Statement

Balance Sheet

So

ld

Sti

ll t

her

eNet Sales 250$ Cost of Goods Sold 170 Gross Profit 80$

Inventory 70$

Income Statement

Balance Sheet

Sold

Still there

$2403

= $80per unit

Net Sales 250$ Cost of Goods Sold 160 Gross Profit 90$

Inventory 80$

Income Statement

Balance Sheet

7-11

WeightedFIFO LIFO Average

Cost of Goods sold (Income Statement) Oldest cost Newest cost Average costInventory (Balance sheet) Newest cost Oldest cost Average cost

Summary

Date Description # of Units Cost per Unit Total CostOct 1 Beginning Inventory 10 7 70$ Oct 3 Purchase 30 8 240 Oct 5 Purchase 10 10 100 Oct 6 Sales (35) To calculate To calculate

Ending Inventory 15 To calculate To calculate

Let’s consider a more complex example.

7-12

FIFO Beginning Inventory 10 units × 7$ = 70$ + Purchases 30 units × 8$ = 240

10 units × 10$ = 100 Cost of Goods Available for Sale 410$ – Ending Inventory = Cost of Goods Sold

FIFO Beginning Inventory 10 units × 7$ = 70$ + Purchases 30 units × 8$ = 240

10 units × 10$ = 100 Cost of Goods Available for Sale 410$ – Ending Inventory 140 = Cost of Goods Sold

FIFO Beginning Inventory 10 units × 7$ = 70$ + Purchases 30 units × 8$ = 240

10 units × 10$ = 100 Cost of Goods Available for Sale 410$ – Ending Inventory 140 = Cost of Goods Sold 270$

(10 units @ $10) + (5 units @ $8)

7-13

LIFO Beginning Inventory 10 units × 7$ = 70$ + Purchases 30 units × 8$ = 240

10 units × 10$ = 100 Cost of Goods Available for Sale 410$ – Ending Inventory Cost of Goods Sold

LIFO Beginning Inventory 10 units × 7$ = 70$ + Purchases 30 units × 8$ = 240

10 units × 10$ = 100 Cost of Goods Available for Sale 410$ – Ending Inventory 110 Cost of Goods Sold

LIFO Beginning Inventory 10 units × 7$ = 70$ + Purchases 30 units × 8$ = 240

10 units × 10$ = 100 Cost of Goods Available for Sale 410$ – Ending Inventory 110 Cost of Goods Sold 300$

(10 units @ $10) + (25 units @ $8)

7-14

# of Cost TotalDescription Units per Unit Cost

Beginning Inventory 10 7 70$ Purchase 30 8 240 Purchase 10 10 100 Cost of Goods Available for Sale 50 410$

Weighted Average

WeightedAverage Cost

=Cost of goods Available for Sale

Number of Units Available for Sale

WeightedAverage Cost

=$410

50 units= $8.20 per unit

7-15

Weighted Average Beginning Inventory 10 units × 7$ = 70$ + Purchases 30 units × 8$ = 240

10 units × 10$ = 100 Cost of Goods Available for Sale 410$ – Ending Inventory Cost of Goods Sold

Weighted Average Beginning Inventory 10 units × 7$ = 70$ + Purchases 30 units × 8$ = 240

10 units × 10$ = 100 Cost of Goods Available for Sale 410$ – Ending Inventory 123 Cost of Goods Sold

Weighted Average Beginning Inventory 10 units × 7$ = 70$ + Purchases 30 units × 8$ = 240

10 units × 10$ = 100 Cost of Goods Available for Sale 410$ – Ending Inventory 123 Cost of Goods Sold 287$

15 units @ $8.20

35 units @ $8.20

7-16

WeightedEffects on the Income Statement FIFO LIFO AverageSales 525$ 525$ 525$ Cost of Goods Sold 270 300 287 Gross Profit 255 225 238 Operating Expenses 125 125 125 Income from Operations 130 100 113 Other Revenue (Expenses) 20 20 20 Income before Income Tax Expense 150 120 133 Income Tax Expense (30%) 45 36 40 Net Income 105$ 84$ 93$

Effects on the Balance SheetInventory 140$ 110$ 123$

7-17

Effects of Increasing Costs on the Financial Statements

FIFO LIFOInventory (Balance sheet) Higher LowerCost of Goods Sold (Income Statement) Lower Higher

Effects of Decreasing Costs on the Financial Statements

FIFO LIFOInventory (Balance sheet) Lower HigherCost of Goods Sold (Income Statement) Higher Lower

7-18

Advantages of MethodsAdvantages of MethodsAdvantages of MethodsAdvantages of Methods

First-In, First-OutFirst-In,

First-OutWeighted Average

Weighted Average

Last-In, First-OutLast-In,

First-Out

7-19

WeightedEffects on the Income Statement FIFO LIFO AverageSales 525$ 525$ 525$ Cost of Goods Sold 270 300 287 Gross Profit 255 225 238 Operating Expenses 125 125 125 Income from Operations 130 100 113 Other Revenue (Expenses) 20 20 20 Income before Income Tax Expense 150 120 133 Income Tax Expense (30%) 45 36 40 Net Income 105$ 84$ 93$

Effects on the Balance SheetInventory 140$ 110$ 123$

7-20

Report inventory at the

lower of cost or market.

7-21

The value of inventory can fall below its recorded cost for two reasons:

1. it’s easily replaced by identical goods at a lower cost, or

2. it’s become outdated or damaged.

The value of inventory can fall below its recorded cost for two reasons:

1. it’s easily replaced by identical goods at a lower cost, or

2. it’s become outdated or damaged.

When the value of inventory falls below its recorded cost, the amount recorded for inventory is written down to its lower

market value. This is known as the lower of cost or market (LCM) rule.

When the value of inventory falls below its recorded cost, the amount recorded for inventory is written down to its lower

market value. This is known as the lower of cost or market (LCM) rule.

7-22

Cost Market LCM Total Lowerper Value per of cost Total

Item Item per Item Item Quantity or Market cost WritedownLeather coats 165$ 150$ 150$ 1,000 150,000$ 165,000$ 15,000$ Vintage jeans 20 25 20 400 8,000 8,000 -

Record2

400 items @ $201,000 items @ $150

1,000 items @ $165

Assets = Liabilities + Stockholders' EquityInventory –15,000 Cost of Goods sold (+E) –15,000

Analyze1

7-23

Analyze and record inventory purchases,

transportation, returns and

allowances, and discounts.

7-24

We will now look at the accounting We will now look at the accounting for purchases, transportation costs, for purchases, transportation costs, purchase returns and allowances, purchase returns and allowances, and purchase discounts. We will and purchase discounts. We will

record all inventory-related record all inventory-related transactions in the Inventory transactions in the Inventory

account. account.

7-25

American Eagle Outfitters purchasesAmerican Eagle Outfitters purchases$10,500 of vintage jeans on credit.$10,500 of vintage jeans on credit.

1

Assets = Liabilities + Stockholders' EquityInventory –10,500 Accounts Payable +10,500

Analyze

2 Record

7-26

American Eagle pays $400 cash to a trucker whoAmerican Eagle pays $400 cash to a trucker whodelivers the $10,500 of vintage jeans to one of its stores.delivers the $10,500 of vintage jeans to one of its stores.

1

Assets = Liabilities + Stockholders' EquityCash - 400Inventory + 400

Analyze

2 Record

7-27

American Eagle returned some of the vintage jeans to theAmerican Eagle returned some of the vintage jeans to thesupplier and received a $500 reduction in the balance owed.supplier and received a $500 reduction in the balance owed.

1

Assets = Liabilities + Stockholders' Equity

Inventory - 500 Accounts Payable - 500

Analyze

2 Record

7-28

American Eagle’s vintage jeans purchase for $10,500 had American Eagle’s vintage jeans purchase for $10,500 had terms of 2/10, n/30. Recall that American Eagle returned terms of 2/10, n/30. Recall that American Eagle returned

inventory costing $500 and received a $500 reduction in its inventory costing $500 and received a $500 reduction in its Accounts Payable. American Eagle paid within Accounts Payable. American Eagle paid within

the discount period.the discount period.

1

Assets = Liabilities + Stockholders' EquityCash - 9,800 Accounts Payable -10,000Inventory -200

Analyze

2 Record

7-29

7-30

Evaluate inventory management by computing and interpreting the

inventory turnover ratio.

7-31

7-32

7-33

The Effects of Errors in Ending

Inventory

Cost of Goods Sold Equation

BI + P – CGS = EIBI + P – CGS = EI

Errors in EndingInventory will affect

the Balance Sheet andthe Income Statement.

Assume that Ending Inventory was overstated in 2009 by$10,000 due to an error that was not discovered until 2010.

2009Beginning Inventory Accurate

+ Purchases Accurate– Ending Inventory Overstated $10,000= Cost of Goods Sold Understated $10,000

7-35

2010Beginning Inventory Overstated $10,000

+ Purchases Accurate– Ending Inventory Accurate= Cost of Goods Sold Overstated $10,000

Now let’s examine the effects of theNow let’s examine the effects of the2009 Ending Inventory Error on 2010.2009 Ending Inventory Error on 2010.

Assume that Ending Inventory was overstated in 2009 by$10,000 due to an error that was not discovered until 2010.

7-36