Chapter 6-1 CHAPTER 6 INVENTORIES Accounting Principles, Eighth Edition.

Chapter 6-1

CHAPTER CHAPTER 66

INVENTORIESINVENTORIES

Accounting Principles, Eighth Edition

Chapter 6-2

Classifying InventoryClassifying InventoryClassifying InventoryClassifying Inventory

One Classification:

Merchandise Inventory

Three Classifications:

Raw Materials

Work in Process

Finished Goods

Merchandising Company

Manufacturing Company

Regardless of the classification, companies report all inventories under Current Assets on the balance sheet.

Chapter 6-3

Manufacturing inventories may not yet be ready for sale

Classified into three categories:1. Raw materials

components on hand waiting to be used2. Work in process

various stages of production(not completed)

3. Finished goods ready for sale

CLASSIFYING INVENTORY IN A CLASSIFYING INVENTORY IN A MANUFACTURING ENVIRONMENTMANUFACTURING ENVIRONMENTCLASSIFYING INVENTORY IN A CLASSIFYING INVENTORY IN A

MANUFACTURING ENVIRONMENTMANUFACTURING ENVIRONMENT

Chapter 6-4

Unit costs can be applied to quantities on hand using the following costing methods:

Specific Identification

First-in, first-out (FIFO)

Last-in, first-out (LIFO)

Average-cost

Inventory Cost flow methodsInventory Cost flow methodsInventory Cost flow methodsInventory Cost flow methods

Cost Flow Assumptio

ns

Chapter 6-5

Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions


Illustration 6-11Use of cost flow methods in major U.S. companies

Cost Flow

Assumption

does not need to

equal

Physical Movement

of Goods

Chapter 6-6

Young & Crazy Company makes the following purchases:

1. One item on 2/2/08 for $10



Young & Crazy Company sells one item on 2/28/08 for $90. What would be the balance of ending inventory, cost of goods sold, and net income for the month ended Feb. 28, 2008, assuming the company used the Specific Identification method to cost inventories and the item purchased on 2/15/08 is sold? Assume a tax rate of 30%.

Example

Inventory CostingInventory CostingInventory CostingInventory Costing

Chapter 6-7

Purchase on 2/15/08 for $15

Young & Crazy CompanyIncome Statement

For the Month of Feb. 2008 Sales $ 90 Cost of goods sold 15 Gross profit 75 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 42 Taxes 13 Net Income $ 29

“Specific Identification”


Inventory Balance = $ 30



Chapter 6-8

An actual physical flow costing method in which items still in inventory are specifically used to arrive at the total cost of the ending inventory.

Practice is relatively rare.

Most companies make assumptions (Cost Flow Assumptions) about which units were sold.

Specific Identification MethodSpecific Identification Method


Chapter 6-9

Young & Crazy Company makes the following purchases:




Young & Crazy Company sells one item on 2/28/08 for $90. What would be the balance of ending inventory, cost of goods sold, and net income for the month ended Feb. 2008, assuming the company used the FIFO, LIFO, and Average-cost flow assumptions? Assume a tax rate of 30%.

Example



Chapter 6-10

Earliest goods purchased are first to be sold.

Often parallels actual physical flow of merchandise.

Generally good business practice to sell oldest units first.

““First-In-First-Out (FIFO)”First-In-First-Out (FIFO)”



Chapter 6-11






For the Month of Feb. 2008 Sales $ 90 Cost of goods sold 10 10 Gross profit 80 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 4747 Taxes 14 14 Net Income $ 33 $ 33

“First-In-First-Out (FIFO)”



Chapter 6-12

Latest goods purchased are first to be sold.

Seldom coincides with actual physical flow of merchandise.

Exceptions include goods stored in piles, such as coal or hay.

““Last-In-First-Out (LIFO)”Last-In-First-Out (LIFO)”



Chapter 6-13






For the Month of Feb. 2008 Sales $ 90 Cost of goods sold 20 20 Gross profit 70 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 37 37 Taxes 11 11 Net Income $ 26$ 26

“Last-In-First-Out (LIFO)”



Chapter 6-14

Allocates cost of goods available for sale on the basis of weighted average unit cost incurred.

Assumes goods are similar in nature.

Applies weighted average unit cost to the units on hand to determine cost of the ending inventory.

““Average-Cost”Average-Cost”



Chapter 6-15






For the Month of Feb. 2008 Sales $ 90 Cost of goods sold 15 15 Gross profit 75 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 42 42 Taxes 13 13 Net Income $ 29$ 29

“Average Cost”



Chapter 6-16

FIFO



Sales $90 $90 $90

Cost of goods sold 10 15 20

Gross profit 80 75 70

Admin. & selling expense 33 33 33

Income before taxes 47 42 37

Income tax expense 14 13 11

Net income $33 $29 $26

Inventory balance $35 $30 $25

LIFOAverage

Comparative Financial Statement SummaryComparative Financial Statement Summary

Chapter 6-17

In Period of Rising Prices,In Period of Rising Prices, FIFO Reports: FIFO Reports:

FIFO



Highest

Lowest

Sales $90 $90 $90








LIFOAverage

Chapter 6-18

In Period of Rising Prices,In Period of Rising Prices, LIFO Reports: LIFO Reports:

FIFO



Highest

Lowest

Sales $90 $90 $90








LIFOAverage

Chapter 6-19

Lower-of-Cost-or-MarketLower-of-Cost-or-Market

Lower-of-cost-or-market basis of Lower-of-cost-or-market basis of accounting for inventoriesaccounting for inventories

Lower-of-cost-or-market basis of Lower-of-cost-or-market basis of accounting for inventoriesaccounting for inventories

When the value of inventory is lower than its cost

Companies can “write down” the inventory to its market value in the period in which the price decline occurs.

Market value = Replacement Cost

Chapter 6-20

COMPUTATION OF LOWER OF COMPUTATION OF LOWER OF COST OR MARKETCOST OR MARKET

COMPUTATION OF LOWER OF COMPUTATION OF LOWER OF COST OR MARKETCOST OR MARKET

$ 159,000

Chapter 6-21

Statement Presentation and Statement Presentation and AnalysisAnalysis


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).

PresentationPresentation

Chapter 6-22



Inventory management is a double-edged sword

1. High Inventory Levels - may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage).

2. Low Inventory Levels – may lead to stockouts and lost sales.

AnalysisAnalysis

Chapter 6-23

End of the Chapter!

Chapter 6-1 CHAPTER 6 INVENTORIES Accounting Principles, Eighth Edition.

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