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
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
2. One item on 2/15/08 for $15
3. One item on 2/25/08 for $20
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 CostingInventory CostingInventory CostingInventory Costing
Inventory Balance = $ 30
Purchase on 2/2/08 for $10
Purchase on 2/25/08 for $20
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
Inventory CostingInventory CostingInventory CostingInventory Costing
Chapter 6-9
Young & Crazy Company makes the following purchases:
1. One item on 2/2/08 for $10
2. One item on 2/15/08 for $15
3. One item on 2/25/08 for $20
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
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
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)”
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Chapter 6-11
Purchase on 2/2/08 for $10
Purchase on 2/15/08 for $15
Purchase on 2/25/08 for $20
Inventory Balance = $ 35
Young & Crazy CompanyIncome Statement
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)”
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
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)”
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Chapter 6-13
Purchase on 2/2/08 for $10
Purchase on 2/15/08 for $15
Inventory Balance = $ 25
Purchase on 2/25/08 for $20
Young & Crazy CompanyIncome Statement
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)”
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
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”
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Chapter 6-15
Purchase on 2/2/08 for $10
Purchase on 2/15/08 for $15
Purchase on 2/25/08 for $20
Inventory Balance = $ 30
Young & Crazy CompanyIncome Statement
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”
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Chapter 6-16
FIFO
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
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
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Highest
Lowest
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
Chapter 6-18
In Period of Rising Prices,In Period of Rising Prices, LIFO Reports: LIFO Reports:
FIFO
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Inventory Costing – Cost Flow Inventory Costing – Cost Flow AssumptionsAssumptions
Highest
Lowest
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
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
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
Statement Presentation and Statement Presentation and AnalysisAnalysis
Statement Presentation and Statement Presentation and AnalysisAnalysis
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!
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