Chapter 9 Inventory and Cost of Goods Sold - · PDF file01.02.2013 · 9-1 1....
Transcript of Chapter 9 Inventory and Cost of Goods Sold - · PDF file01.02.2013 · 9-1 1....
9-1
1. Inventory for merchandising & manufacturing
business
2. Periodic vs. perpetual inventory systems
3. Recognition of inventory on the books
4. Compute total inventory acquisition cost
5. Inventory valuation methods: specific identification,
average cost, FIFO, and LIFO
6. LIFO inventory layers and the LIFO reserve
7. Choose an inventory valuation method
8. The lower-of-cost-or-market (LCM) valuation
9. The gross profit method valuing inventory
Chapter 9 Inventory and Cost of Goods Sold
9-2
10. Financial statement impact of inventory recording
errors
11. Analyze inventory using financial ratios
12. FIFO, LIFO, average cost, and lower-of-cost-or-
market inventory using the retail inventory method
13. Use LIFO pools, dollar-value LIFO, and dollar-
value LIFO retail to compute ending inventory
14. The impact of changing prices on purchase
commitments
15. Record inventory purchase transactions
denominated in foreign currencies
Chapter 9 Inventory and Cost of Goods Sold
(Continued)
9-3 9-3
9-4 9-4
9-5
What Is Inventory?
• Inventory designates goods held for sale in
the normal course of business or, for a
manufacturer, also includes goods in
production or to be placed into production.
• For some businesses, inventory represents the
most active element in business operations.
• The terms raw materials, work in process,
and finished goods refer to the inventories of
a manufacturing enterprise.
1. Define inventory for a merchandising
business, and identify the different types of
inventory for a manufacturing business
9-6 9-6
9-7
Raw Materials
• Raw Materials are goods acquired to use in
the production process.
• The term direct materials is frequently used
to refer to materials that will be physically
incorporated in the products being
manufactured.
• The term indirect materials is then used to
refer to auxiliary materials, that is, materials
that are necessary in the production process
but not directly incorporated into the product.
9-8
Work in Process
• Work in Process (WIP) consists of
materials partly processed and requiring
further work before they can be sold.
• Work in Process includes three cost
elements.
1. Direct materials
2. Direct labor
3. Manufacturing overhead
(continued)
9-9
1. Direct materials refers to the cost of
materials directly identified with goods in
production.
3. Manufacturing overhead refers to the
portion of factory overhead assignable to
goods in production.
2. Direct labor refers to the cost of labor
directly identified with goods in production.
Work in Process
9-10
Finished Goods
• Finished goods are the manufactured
products awaiting sale.
• As products are completed, the costs
accumulated in the production process are
transferred from Work in Process to the
Finished Goods Inventory account.
9-11 9-11
9-12
Inventory Systems
Two types of inventory systems that keep track of
how much inventory has been sold and at what
price are:
• Periodic inventory system—requires a physical
count of the inventory periodically, and at the
point of sale only records the sale price.
• Perpetual inventory system—at point of sale
records selling price and type of item sold are
recorded. Example: a bar code scanning system.
2. Explain the advantages and disadvantages of
both periodic and perpetual inventory systems
9-13
The following transactions occurred during the
period for CyBorg, Inc.
Beginning inventory 50 units @ $10 $ 500
Purchases during the period 300 units @ $10 3,000
Sales during the period 275 units @ $15 4,125
Ending inventory (physical) 70 units @ $10 700
Beginning inventory 50 units @ $10 $ 500
Purchases during the period 300 units @ $10 3,000
Sales during the period 275 units @ $15 4,125
Ending inventory (physical) 70 units @ $10 700
(continued)
Inventory Systems
9-14
Purchases during the period:
Purchases 3,000
Accounts Payable 3,000
Sales during the period:
Accounts Receivable 4,125
Sales 4,125
Periodic Inventory System Periodic Inventory System
(continued)
Inventory Systems
9-15
Inventory 3,000
Accounts Payable 3,000
Purchases during the period:
Accounts Receivable 4,125
Sales 4,125
Cost of Goods Sold 2,750
Inventory 2,750
Sales during the period:
Perpetual Inventory System Perpetual Inventory System
(continued) 275 units @ $10
Inventory Systems
9-16
Comparison of Methods
The cost of goods sold in the CyBorg example is
computed as follows:
9-17
Whose Inventory Is It?
• As a general rule, goods should be included in the inventory of the business holding legal title.
• The passing of title is a legal term designating the point at which ownership changes.
• Issues that develop:
• Goods in transit
• Goods on consignment
3. Determine when ownership of goods in
transit changes hands and what
circumstances require shipped inventory to
be kept on the books
9-18
Goods in Transit
Whose inventory is it? Whose inventory is it?
When terms of sale are FOB (free on board)
shipping point, title passes to the buyer with
the loading of goods at the point of shipment.
When terms of sale are FOB (free on board)
destination, legal title does not pass until the
goods are received by the buyer.
9-19 9-19
9-20
Goods on Consignment
• Shipper retains title and includes the goods in
inventory until their sale or use by the dealer or
customer.
• Consigned goods are properly reported by
the shipper at the sum of their costs, and the
shipping and handling costs incurred transfer
to the dealer or customer.
9-21
Conditional Sales, Installment Sales, and
Repurchase Agreements
• Conditional sales and installment sales
contracts may provide a retention of title by
the seller until the sales price is fully
recovered.
• As a creative way to obtain cash on a short-
term basis, firms sometimes sell inventory to
another company but at the same time agree
to repurchase the inventory at a future date.
9-22
Inventory costs consist of all expenditures, both
direct and indirect, relating to acquisition,
preparation, and placement for sale.
• Expenditures that are relatively small and
difficult to allocate are period costs.
These are recognized as expenses in the
current period.
Items Included in Inventory Cost
4. Compute total inventory acquisition cost
9-23
• Costs that can be identified with the
product being manufactured are called
product or inventoriable costs.
• Costs arising from idle capacity, excessive
spoilage, and reprocessing are usually
considered abnormal and are expensed in
the current period.
Items Included in Inventory Cost
9-24
• Traditionally, manufacturing overhead costs
have been allocated to products based on the
amount of direct labor required in production.
• Activity-based cost (ABC) systems strive
to allocate overhead based on clearly
identified cost drivers—characteristics of the
production process that are known to create
overhead costs.
Items Included in Inventory Cost
9-25 9-25
9-26
Discounts as Reductions in Cost
• Discounts associated with the purchase of
inventory should be treated as a reduction in
the cost assigned to the inventory.
• Trade discounts refer to the difference
between a catalog price and the price actually
charged to a buyer.
• Cost is defined as the list price less the trade
discount.
9-27
Discounts as Reductions in Cost
• Cash discounts are discounts granted for
payment of invoices within a limited time
period.
• Example: A purchase of $10,000 provides for
payment on a 2/10, n/30 basis. If the buyer
pays by the 10th day, $9,800 settles the
invoice. After that, the full $10,000 is required.
9-28
Discounts as Reductions in Cost
• The net method records inventory at this
discounted amount (i.e., the gross invoice
prices less the allowable discount).
• The net method reflects that discounts not
taken are in effect a finance charge incurred
for failure to pay within the discount period.
9-29 9-29
(continued)
9-30
Discounts as Reductions in Cost
• Under the gross method, cash discounts are
booked only when they are taken.
• While the net method tracks discounts not
taken, the gross method provides no such
information, and inventory records are
maintained at the gross unit price.
• The net method of accounting for purchases
is strongly preferred.
9-31
Purchases Reported Using
the Net Method
To record the purchase of merchandise priced at
$10,000 with a cash discount of 2%:
Inventory 9,800
Accounts Payable 9,800
To record the payment of the invoice within
discount period:
Accounts Payable 9,800
Cash 9,800
9-32
To record payment of the invoice after the
discount period:
Accounts Payable 9,800 Discounts Lost 200 Cash 10,000
To record adjustment at the end of the period if
invoice has not been paid and the discount
period has lapsed:
Discounts Lost 200
Accounts Payable 200
Purchases Reported Using
the Net Method
9-33
Accounts Payable 10,000
Inventory 200
Cash 9,800
To record the purchase of merchandise priced at
$10,000 with a cash discount of 2%:
Inventory 10,000
Accounts Payable 10,000
To record the payment of the invoice within
discount period:
Purchases Reported Using
the Gross Method
9-34
No entry required
To record payment of the invoice after the
discount period:
Accounts Payable 10,000 Cash 10,000
To record adjustment at the end of the period if
invoice has not been paid and the discount
period has lapsed:
Purchases Reported Using
the Gross Method
9-35
Purchase Returns and Allowances
• Adjustments are
also made when
goods are
damaged or are
lesser in quality
than ordered.
• Sometimes the
customer
returns the
goods.
Accounts Payable 400
Purchase Returns
and Allowances 400
Periodic Inventory System
Perpetual Inventory System
Accounts Payable 400
Inventory 400
9-36
Inventory Valuation
Methods Specific
Identification
Last-in, first-
out (LIFO)
Cost
Allocation
Methods
Cost
Allocation
Methods
Average
Cost
First-in, first-
out (FIFO)
5. Use the four basic inventory valuation
methods: specific identification, average
cost, FIFO, and LIFO
9-37 9-37
9-38
Inventory Valuation Methods
The four methods will be illustrated using the
following simple example for Dalton Company.
Note: No beginning inventory
9-39
Specific Identification Method
• This specific identification method requires a
way to identify the historical cost of each
individual unit of inventory.
• From a theoretical standpoint, the specific
identification method is very attractive,
especially when each inventory item is unique
and has a high cost.
• This method opens the door to possible profit
manipulation.
9-40
200 units @ $10 per unit
300 units @ $12 per unit
500 units @ $11 per unit
Sold 200 units from the
January 1 and 500 from
the July 15 purchase.
100 units @ $13 per unit
1,100 units
Jan. 1
Mar. 23
July 15
Nov. 6
Purchases:
Specific Identification Method
9-41
200 units @ $10 per unit
500 units @ $11 per unit
Jan. 1
July 15
= $2,000
= 5,500
Total cost of goods sold $7,500
Specific Identification Method
not sold
not sold
9-42
sold
300 units @ $12 per unit
100 units @ $13 per unit
Mar. 23
Nov. 6
= $3,600
= 1,300
Ending inventory $4,900
sold
Specific Identification Method
9-43
Average Cost Method
• The average cost method assigns the same
average cost to each unit.
• This method is based on the assumption that
goods sold should be charged at an average
cost.
• For periodic inventory, the unit cost is the
weighted average for the entire period.
9-44
200 units @ $10 per unit
300 units @ $12 per unit
500 units @ $11 per unit
100 units @ $13 per unit
1,100 units
Jan. 1
Mar. 23
July 15
Nov. 6
= $ 2,000
= 3,600
= 5,500
= 1,300
$12,400
$12,400 1,100 units = $11.27 per unit (rounded)
Cost of goods sold = $11.27 700 = $7,890
Ending inventory = $11.27 400 = $4,510
Average Cost Method
9-45
• The First-in, first out (FIFO) method is based
on the assumption that the units sold are the
oldest units on hand.
• FIFO assumes a cost flow closely paralleling the
usual physical flow of goods sold.
• With FIFO, the units remaining in ending
inventory are the most recently purchased units,
so their reported cost would most closely match
end-of-year replacement costs.
First-In, First-Out (FIFO) Method
9-46
200 units @ $10 per unit
300 units @ $12 per unit
500 units @ $11 per unit
100 units @ $13 per unit
Jan. 1
Mar. 23
July 15
Nov. 6
Total cost of goods sold $7,800
Sold 200
= $2,000
Sold 300 = 3,600
Sold 200 = 2,200
First-In, First-Out (FIFO) Method
200
9-47
First-In, First-Out (FIFO) Method
Jan. 1
Mar. 23
July 15
Nov. 6
= 2,200
= 1,300
200 units @ $10 per unit
300 units @ $12 per unit
500 units @ $11 per unit
100 units @ $13 per unit
Ending inventory $3,500
200
9-48
Last-In, First-Out (LIFO) Method
• The last-in, first-out (LIFO) method is based
on the assumption that the newest units are
sold first.
• There is no required connection between the
actual physical flow of goods and the
inventory valuation method used.
• LIFO is the best method of matching current
inventory costs with current revenues.
9-49
200 units @ $10 per unit
300 units @ $12 per unit
500 units @ $11 per unit
100 units @ $13 per unit
Jan. 1
Mar. 23
July 15
Nov. 6
Total cost of goods sold $8,000
= $1,300
= $5,500
= $1,200
Last-In, First-Out (LIFO) Method
200 units @ $12 per unit
9-50
Last-In, First-Out (LIFO) Method
200 units @ $10 per unit
300 units @ $12 per unit
500 units @ $11 per unit
100 units @ $13 per unit
Jan. 1
Mar. 23
July 15
Nov. 6
Ending inventory $4,400
= $2,400
= $2,000
200 units @ $12 per unit
9-51
9-52
• The complications of a perpetual system are
Illustrated in Exhibit 9-11 (Slides 9-53 and 9-
54), in which Dalton Company’s cost of goods
sold and ending inventory for 2013 are
computed assuming that 300 units were sold
on June 30 and 400 units were sold on
December 31.
• For FIFO, cost of goods sold and ending
inventory are the same whether a periodic
system or perpetual system is used.
Complications with a
Perpetual Inventory System
9-53
Complications with a
Perpetual Inventory System
• Because the newest units (last in) as of June
30 are not the same as the newest units on
December 31, applying LIFO on a perpetual
basis gives a different cost of goods sold and
ending inventory than if a periodic system is
used.
• Applying average cost on a perpetual and a
periodic basis yields different results.
9-54
Inv
en
tory
Valu
ati
on
Me
tho
ds a
nd
Perp
etu
al
Inv
en
tory
Syste
m
9-55 9-55
Inve
nto
ry V
alu
ati
on
Meth
od
s a
nd
Perp
etu
al
Inve
nto
ry S
yste
m
9-56
The following data are for Ryanes Company for the first three
years of its existence:
6. Explain how LIFO inventory layers are
created, and describe the significance of
the LIFO reserve
9-57
• Each year in which the number of units purchased
exceeds the number of units sold, a new LIFO layer
is created in ending inventory.
• Many companies that use LIFO report the amount of
their LIFO reserve, either as a parenthetical note in
the balance or the notes to the financial statements.
LIFO Layers
• The difference between the LIFO ending inventory
amount and the amount obtained using another
inventory valuation method (like FIFO or average
cost) is called the LIFO reserve. For example, in this
case, the LIFO reserve is $350 ($1,350 FIFO ending
inventory – $1,000 LIFO ending inventory).
9-58
The following data can be used to calculate
FIFO cost of goods sold for Ryanes for 2012.
2011 2012
LIFO ending inventory $ 400 $1,000
LIFO reserve 100 350
LIFO cost of goods sold 1,200 1,800
The FIFO calculations can be done as shown
in the next slide.
LIFO Layers
9-59
LIFO FIFO
$ 400 Beginning inventory $ 500 ($400 + $100 LIFO reserve)
2,400 + Purchases 2,400 (160 units x $15; same for
LIFO and FIFO)
$2,800 = Cost of goods available $2,900
1,000 – Ending inventory 1,350 ($1,000 + $350 LIFO
reserve)
$1,800 = Cost of goods sold $1,550
LIFO Layers (2012)
9-60 9-60
9-61 9-61
9-62
LIFO Liquidation
Ryanes Company’s purchases and sales for
2013 are as follows:
Purchases 60 units @ $20
Sales 150 units @ $25
Because the number of units purchased does
not exceed the number sold, no new LIFO layer
is added in 2013.
9-63
LIFO liquidation causes old LIFO layer costs to flow
through cost of goods sold, sometimes with bizarre
results.
LIFO Liquidation
In this example, if Ryanes had not reduced inventory during
2013, LIFO cost of goods sold would have been $3,000
(150 units × $20 per unit). In this example, Thus, the impact
of reducing inventory levels and dragging old LIFO layers
into cost of goods sold is to reduce reported cost of goods
sold by $800, which should be disclosed in notes.
9-64
9-65
LIFO and Income Taxes
• The LIFO inventory method was developed in
the United States during the late 1930s as a
method of reducing income taxes during
periods of rising prices.
• The LIFO conformity rule specifies that only
those taxpayers who use LIFO for financial
reporting purposes may use it for tax purposes.
The rule has been relaxed.
9-66
LIFO and Income Taxes
• As a means of simplifying the valuation process
and extending the applicability to more items,
the IRS developed the technique of establishing
LIFO inventory pools of substantially identical
goods.
• To further simplify the recordkeeping associated
with LIFO and to eliminate the issues
associated with new products replacing old
products, the dollar-value LIFO inventory
method was developed.
9-67
Income Tax Effects
• If a company has large inventory levels, is
experiencing significant inventory cost
increases, and does not anticipate reducing
inventory levels in the future, LIFO gives
substantial cash flow benefits in terms of tax
deferrals.
• This is the primary reason for LIFO adoption by
most firms.
7. Choose an inventory valuation method
based on the trade-offs among income
tax effects, bookkeeping costs, and the
impact on the financial statements
9-68
9-69
Bookkeeping Costs
• The bookkeeping associated with LIFO is a
bit more complicated than with FIFO or
average cost.
• In dollars and cents, a LIFO system costs
more to operate.
• With information technology and with the
simplification of LIFO pools and dollar-value
LIFO, the incremental bookkeeping costs can
be minimized.
9-70
Impact on Financial Statements
• While LIFO gives tax benefits, it also gives
reduced reported income and reduced
reported inventory.
• These negative financial statement effects
can harm a company by scaring off
stockholders, potential investors, and banks.
• Supplement disclosure using FIFO or
average cost might offset this problem.
9-71
International Accounting and
Inventory Valuation
• In 1992, the IASB decided to officially
endorse FIFO and average cost, to kill the
base stock method, and to let LIFO live on as
a second-class “allowed alternative
treatment.”
• In 2003, the IASB adopted a revised version
of IAS 2 and did away with LIFO once and
for all.
9-72
Inventory Accounting Change
When a company changes its method of valuing
inventory, the change is accounted for as a
change in accounting principle.
Report the effect of changing methods
on the financial statements.
LIFO LIFO Average Cost
or FIFO change to
(continued)
9-73
Any Method Any Method change to LIFO LIFO
No adjustment to financial statements for change to
LIFO, but special disclosure required.
Inventory Accounting Change
(continued)
If the change is to LIFO from another method, a
company’s records are generally not complete
enough to reconstruct the prior years’ inventory
layer.
9-74 9-74
9-75
Applying the Lower of Cost or Market Method
1. Define pertinent values: historical cost, floor
(NRV ‒ normal profit), replacement cost,
ceiling (NRV).
2. Determine “market” (replacement cost as
constrained by ceiling and floor limits).
3. Compare cost with market (as defined in
step 2 above), and select the lower amount.
8. Apply the lower-of-cost-or-market
(LCM) rule to reflect declines in the
market value of inventory
9-76 9-76
9-77
The term market in lower of cost or market
means replacement cost (entry cost).
Replacement
Cost
Ceiling: Also known as the net
realizable value (NRV)
Floor: Net realizable value
less a normal profit margin
Market
Historical Cost
compare to
Range
9-78
Lower of Cost or Market
Fezzig Company sells six products identified with the
letters A through F. For each product, the selling price
per unit is $1.00, selling expenses are $0.20 per unit,
and the normal profit is 25% of sales, or $0.25 per unit.
9-79
$0.70 $0.70
Ceiling: $0.80
Floor: $0.55
$0.65
LCM = $0.65 LCM = $0.65
Market
Historical Cost
Range
CASE A
Lower of Cost or Market
9-80
$0.60 $0.60
Ceiling: $0.80
$0.65
LCM = $0.60 LCM = $0.60
Market
Historical Cost
Range
Floor: $0.55
CASE B
Lower of Cost or Market
9-81
$0.55 $0.50 $0.50
Ceiling: $0.80
$0.65
LCM = $0.55 LCM = $0.55
Market
Historical Cost
Range
Floor: $0.55
CASE C
Lower of Cost or Market
9-82
$0.55 $0.45 $0.45
Ceiling: $0.80
$0.50
LCM = $0.50 LCM = $0.50
Market
Historical Cost
Range
Floor: $0.55
CASE D
Lower of Cost or Market
9-83
$0.80 $0.85
Ceiling: $0.80
$0.75
LCM = $0.75 LCM = $0.75
Market
Historical Cost
Range
Floor: $0.55
Lower of Cost or Market
CASE E
9-84
$1.00 $0.80 $1.00
Ceiling: $0.80
$0.90
LCM = $0.80 LCM = $0.80
CASE F
Market
Historical Cost
Range
Floor: $0.55
Lower of Cost or Market
9-85
Lower of Cost or Market Applied Individually
versus as a Whole
(continued)
9-86
Lower of Cost or Market Applied Individually
versus as a Whole
The journal entry to record the write-down of the
inventory on an individual item basis is usually
made as follows:
Loss from Decline in Value
of Inventory 250
Inventory 250
($4,100 ‒ $3,850)
Once an individual item is reduce to a
lower market price, the new market price
is considered to be the item’s cost for
future inventory valuations.
9-87
Allowance Method
Rather than reducing the inventory directly, the
inventory account can be maintained at cost,
and an allowance account can be used to
record the decline in value.
Loss from Decline in Value
of Inventory 100
Allowance for Decline in Value
of Inventory 100
($4,100 ‒ $4,000)
9-88
Gross Profit Method
• The gross profit method is based on the
observation that the relationship between
sales and cost of goods sold is usually fairly
stable.
• The gross profit percentage [(Sales – Cost
of goods sold)/Sales] is applied to sales to
estimate cost of goods sold.
• To be useful, the gross profit percentage must
be a reliable measure of current experience.
9. Use the gross profit method to estimate
ending inventory
9-89
Gross Profit Method—Rugen Company
Beginning inventory, January 1 $25,000
Sales, January 1–January 31 50,000
Purchases, January 1–January 31 40,000
Historical gross profit percentages:
Last year 40%
Two years ago 37%
Three years ago 42%
Last year’s gross profit
percentage 40% is considered a
good estimate.
9-90
Sales (actual) $50,000 100 %
Cost of goods sold (estimate) 30,000 60 %
Gross profit (estimate) $20,000 40 %
Beginning inventory (actual) $25,000
+ Purchases (actual) 40,000
= Cost of goods available for
sale (actual) $65,000
– Ending inventory (estimate) 35,000
= Cost of goods sold (estimate) $30,000
Gross Profit Method—Rugen Company
9-91 9-91
9-92
(continued)
Gross Profit Method—Rugen Company
• Rugen does a physical inventory count
indicating that January 31 inventory is
$32,000, compared to $35,000 estimate
computed in Slide 9-90.
• One way to determine if the estimated count
is reasonable is to see what range of ending
inventory estimates is possible given the
differences observed in historical gross profit
percentages.
9-93
Gross Profit Method
Sales (actual) $50,000 100 %
Cost of goods sold (estimate) 31,500 63 %
Gross profit (estimate) $18,500 37 %
Beginning inventory (actual) $25,000
+ Purchases (actual) 40,000
= Cost of goods available for
sale (actual) $65,000
– Ending inventory (estimate) 33,500
= Cost of goods sold (estimate) $31,500
9-94
Gross Profit Method
Sales (actual) $50,000 100 %
Cost of goods sold (estimate) 29,000 58 %
Gross profit (estimate) $21,000 42 %
Beginning inventory (actual) $25,000
+ Purchases (actual) 40,000
= Cost of goods available for
sale (actual) $65,000
– Ending inventory (estimate) 36,000
= Cost of goods sold (estimate) $29,000
9-95
Retail Inventory Method
• Like the gross profit method, the retail
inventory method can be used to generate a
reliable estimate of inventory position
whenever desired.
• The retail inventory method is more flexible
than the gross profit method in that it allows
estimates to be based on FIFO, LIFO, or
average cost assumptions.
9-96
Effects of Errors in Recording Inventory
Failure to correctly report inventory results in
misstatements on both the balance sheet and the
income statement. There are three typical inventory
errors:
1. Overstatement of ending inventory through an
improper physical count
2. Understatement of ending inventory through an
improper physical count
3. Understatement of ending inventory through
delay in recording a purchase until the following
year
10. Determine the financial statement
impact of inventory recording errors
9-97
9-98
Consider the financial information relating to inventories
for Deere & Co. provided below.
11. Analyze inventory using financial ratios,
and properly compare ratios of different
firms after adjusting for differences in
inventory valuation methods
9-99
Inventory Turnover
Appropriateness of inventory size and
position can be measured by calculating
the inventory turnover ratio.
Cost of Goods Sold $16,255
Average Inventory $2,719.5 =
= 5.98 times ($2,397 + $3042)/2 = $2,719.5
9-100
Inventory Turnover
If Deere & Co. had used FIFO instead of LIFO,
inventory turnover for 2009 would have been
4.03 (instead of 5.98 under LIFO), computed as
follows:
= 4.03 times
FIFO Cost of Goods Sold $16,212
FIFO Average Inventory $4,020 =
$16,255 +($1,324 – $1,367) =
$16,212
(continued)
9-101
Inventory Turnover
If Deere & Co. had used FIFO instead of LIFO,
inventory turnover for 2009 would have been
4.03 (instead of 5.98 under LIFO), computed as
follows:
= 4.03 times
FIFO Cost of Goods Sold $16,212
FIFO Average Inventory $4,020 =
($3,674 + $4,366)/2 = $4,020
9-102
Number of Days’ Sales in Inventory
Number of days’ sales in inventory = 61.0
Average Inventory
Average Daily Cost of Goods Sold
= $2,719.5
$44.534
($3,042 + $2,397)/2
$16,255/365
Deere’s number of days’ sales in inventory
results mean that, on average, Deere & Co.
has enough inventory to continue operations
for 61.0 days using just its existing inventory.
9-103 9-103
9-104
Retail Inventory Method
• The retail inventory method is widely employed by
retail firms to arrive at reliable estimates of inventory
position whenever desired.
• This method permits the estimation of an inventory
amount without the time and expense of taking a
physical inventory or maintaining detailed perpetual
inventory records.
12. Compute estimates of FIFO,LIFO,
average cost, and lower-of-cost-or-
market inventory using the retail
inventory method
9-105 9-105
9-106
Retail Inventory Method
Inventory, Jan. 1 $30,000 $50,000
Purchases in January 30,000 40,000
Goods available for sale $60,000 $90,000
Cost Retail
Cost percentage ($60,000 ÷
$90,000) = 66.7%
Deduct sales for January 65,000
Inventory, January 31, at retail $25,000
Inventory, January 31, at estimated
cost ($25,000 66.7%) $16,675
One Cost Percentage One Cost Percentage
9-107
Inventory, Jan. 1 $30,000 $50,000
Purchases in January 30,000 40,000
Goods available for sale $60,000 $90,000
Cost Retail
Cost percentage:
Beg. inventory ($30,000 + $50,000) = 60.0%
Purchases ($30,000 + $40,000) = 75.0%
Deduct sales for January 65,000
Multiple Cost Percentages Multiple Cost Percentages
LIFO ($25,000 60.0%) $15,000
Inventory, January 31, at estimated cost:
FIFO ($25,000 75.0%) $18,750
Inventory, January 31, at retail $25,000
Retail Inventory Method
9-108
Retail Inventory Method: Lower of Cost
or Market
Frequently, retail prices change after they are
originally set. The following terms are used to
describe these changes.
• Original retail—the initial sales price,
including the original increase over cost
referred to as the initial markup.
• Markups—increases that raise sales prices
above original retail.
• Markdowns—decreases that reduce sales
prices below original retail.
9-109
Retail Inventory Method: Lower of Cost or Market
9-110
LIF
O P
oo
ls
To illustrate the formation of LIFO pools, the following
data are provided for Elohar Co., a seller of fine neckties:
13. Use LIFO pools, dollar-value LIFO, and dollar-
value LIFO retail to compute ending inventory
9-111
If two types of neckties are accounted for separately,
computations of LIFO ending inventory are as follows:
LIFO Pools
LIFO cost of goods sold:
9-112
Dollar-Value LIFO
• Under dollar-value LIFO, LIFO layers are
determined based on total dollar changes
rather than quantity changes.
• With dollar-value LIFO, the unit of
measurement is the dollar.
• All goods in the inventory pool to which dollar-
value LIFO is to be applied are viewed as
though they are identical items.
9-113
First, the replacement cost of ending inventory is
computed using prices prevailing at the end of the
period.
The beginning inventory was $22,000, so there
was an increase in inventory during the period.
Dollar-Value LIFO
9-114
To determine if a new LIFO layer was added, we need
to find out what the value of the beginning inventory
would be at ending prices.
Dollar-Value LIFO
After adjusting for price increases during the year, we
can see that the dollar value of inventory increased.
Finally, dollar-value LIFO ending inventory is computed
as follows:
9-115 9-115
9-116
Dollar-Value LIFO Retail Method
The following is the LIFO retail layer data for
Miracle Max Department Store as of December
31.
9-117
Assume that the 2013 year-end price index is
1.08. The incremental cost percentages and 2013
ending inventory at end-of-year retail prices are
computed as follows:
Dollar-Value LIFO Retail Method
9-118
Dollar-Value LIFO Retail Method
9-119
Purchase Commitments
• Extreme fluctuations in the price of inventory
purchases can expose a company to excessive
risk.
• Of the different ways to manage this risk, the
simplest is a purchase commitment that locks
in the inventory purchase price in advance.
• Accounting question: Should the company
committing to the future purchase record an
asset and a liability at the commitment date?
14. Account for the impact of changing
prices on purchase commitments
9-120
• Rollins Oat Company entered into a
purchase commitment on November 1,
2012, for 100,000 bushes of wheat at $3.40
per bushel to be delivered on March 2013.
At the end of 2012, the market price for
wheat had dropped to $3.20 per bushel.
Purchase Commitments
• A purchase commitment is an exchange of
promises about future action and is known
as an executory contract.
9-121
2012
Dec. 31 Loss on Purchase Commitments 20,000
Estimated Loss on Purchase
Commitments 20,000
(100,000 bushels $0.20 per bushel)
2013
Mar. 31 Estimated Loss on Purchase
Commitments 20,000
Purchases 320,000
Accounts Payable 340,000
Purchase Commitments
9-122
Foreign Currency Inventory Transactions
• Only transactions denominated in currencies
other than the U.S. dollar are foreign
currency transactions for U.S. companies.
• If the transaction contract is written in terms of
U.S. dollars, there is no foreign currency risk
whether the other company is based in
Azerbaijan or Zimbabwe.
15. Record inventory purchase transactions
denominated in foreign currencies
9-123
Foreign Currency Inventory
Transactions
On November 1, 2012, Washington Company
purchased inventory from Swiss Company and
the invoice was denominated in Swiss francs with
a purchase price of 50,000 francs. At the time,
the spot rate, the rate at which the two
currencies can be exchanged right now, was 5
francs per U.S. dollar.
(continued)
9-124
Washington Company would make the following
journal entry to record the purchase.
2012
Nov.1 Inventory 10,000
Accounts Payable (fc) 10,000 (50,000 francs/5 = $10,000)
Foreign Currency Inventory
Transactions
Assume the spot rate is 4.7 francs per U.S. dollar
on February 1, 2013. 2013
Feb. 1 Accounts Payable (fc) 10,000
Exchange Loss 638
Cash 10,638
$50,000/4.7
(continued)
9-125
Assume the spot rate is 5.1 francs per U.S.
dollar on February 1, 2013. 2013
Feb. 1 Accounts Payable (fc) 10,000
Exchange Gain 196
Cash 9,804
$50,000/5.1
Foreign Currency Inventory
Transactions
(continued)
9-126
Suppose that Washington Company’s fiscal
year ends on December 31 and the exchange
rate on December 31, 2012 is 4.8 francs per
U.S. dollar, the following adjusting entry is
needed: 2012
Dec. 31 Exchange Loss 417
Accounts Payable (fc) 417
($50,000/4.8) $10,000
Foreign Currency Inventory
Transactions
(continued)
9-127
When the liability is subsequently paid on
February 1, 2013, the spot rate is 4.7 francs
per dollar, the journal entry would be as
follows: 2013
Feb. 1 Accounts Payable (fc) 10,417
Exchange Loss 221
Cash 10,638
$50,000/4.7
Foreign Currency Inventory
Transactions