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Inven - Cost - 1
InventoryInventoryBasic Valuation MethodsBasic Valuation Methods
Inven - Cost - 2
IMPORTANCE OF INVENTORIES
Largest current asset of most manufacturing and retail firms.
Significant portion of total assets as well.
Inventory accounting methods and management practices can become profit-enhancing tools.
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INVENTORY CATEGORIES
Merchandise inventory -- Goods acquired for resale
Manufacturing inventory -- Raw materials -- Work-in-process -- Finished goods -- Manufacturing supplies
Miscellaneous inventories
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COMPONENTS OF INVENTORY COST
Invoice price
Freight-in
Purchase discounts
Other costs to get the inventory ready forsale
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PERIODIC METHOD
vs.
PERPETUAL METHOD
INVENTORY RECORDINGMETHODS
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INVENTORY RECORDING METHODS
Perpetual inventory system
-- The ongoing physical flow of inventory is monitored, and the cost of the inventory items is maintained on a continual basis.
-- Purchases recorded directly in “Inventory” account
-- May be recorded “gross” or “net”
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Sales revenue recorded in normal fashion
Cost of goods sold recorded immediately upon sale
No adjusting entry necessary for Cost of goods sold
Cost of goods sold account closed along with other expenses
PERPETUAL INVENTORY SYSTEM
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INVENTORY RECORDING METHODS
Periodic inventory system
-- Inventory value is determined only at particular times, such as end of the accounting period.
-- Purchases recorded in “Purchases” account
-- Purchases discount and purchase returns and allowances are recorded in their respective accounts.
• These accounts are contra-purchases accountscontra-purchases accounts, i.e., they have a credit balance.
-- May be recorded “gross” or “net”
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PERIODIC INVENTORY SYSTEM
Sales revenue recorded in normal fashion
No entry for Cost of goods sold at time of sale
Adjusting entry for Cost of goods sold at end of the fiscal period
Cost of goods sold then closed with other expense accounts at year end
Inven - Cost - 10
COST OF GOODS SOLD (COGS)
Beginning InventoryBeginning Inventory+ Purchases (net)+ Purchases (net)= Cost of Goods Available for Sale= Cost of Goods Available for Sale- Ending Inventory - Ending Inventory = Cost of Goods Sold = Cost of Goods Sold
Inven - Cost - 11
PERIODIC SYSTEM
• At the end of the accounting period, the adjusting entry results in:
• Elimination of: • Beginning inventory• Purchases account and any related accounts ( Purchase discounts, Purchase returns and allowances, etc.)
• Records the ending inventory • Records COGS.
• COGS is then closed to Income Summary alongwith other expenses.
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PERIODIC SYSTEMEXAMPLE
The following is a partial adjusted trial balance:
Account Debit Credit
Inventory 1/1/X6 $175,000Purchases 350,000Purchases Discount $ 22,000Purchase Returns & Allowances 6,000Sales 1,250,000Advertising Expense 7,500Salaries Expense 80,000Utilities Expense 20,000
The physical inventory count at 12/31/X6 was $125,000.
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PERIODIC SYSTEMSOLUTION
GENERAL JOURNAL
Page 1
Date Description PR Debit Credit
Cost of Goods Sold 372,000
Inventory, 12/31/X6 125,000
Purchases Discount 22,000
Purchase Returns & Allowances 6,000
Purchases 350,000
Inventory, 1/1/X6 175,000
To close accounts to COGS
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PERIODIC SYSTEMSOLUTION
GENERAL JOURNAL
Page 1
Date Description PR Debit Credit
Sales 1,250,000
Income Summary 1,250,000
To close account
Income Summary 479,500
Cost of Goods Sold 372,000
Advertising Expense 7,500
Salaries Expense 80,000
Utilities Expense 20,000
To close accounts
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COST FLOW METHODS
An allocation of total cost of goods available for sale:
Ending inventory
Cost of goods sold
Cost of goodsavailable
The cost flowcost flow assumption used for accounting purposescan be different from the physical flowphysical flow of goods throughthe company.
Inven - Cost - 16
INVENTORY VALUESCOST FLOW ASSUMPTIONS
Specific costidentification
Average cost
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
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Specific cost of each inventory item must be known
Opportunity to manipulate income by selection of items at time of sale
Allows perpetual inventory
SPECIFIC COST IDENTIFICATION
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WEIGHTED-AVERAGEPERIODIC METHOD
Compute weighted-average cost (WAC) per unit
Beginning inventory cost + Current purchase costBeginning inventory units + Current purchase units
Compute ending inventory
Ending Inv. = Units in Ending Inv. x WAC per Unit
Compute COGS
COGS = Units Sold x WAC per Unit
Inven - Cost - 19
MOVING-AVERAGEPERPETUAL METHOD
A new weighted-average unit cost must be
calculated after each purchase.
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FIRST-IN, FIRST-OUT
The cost of the oldestoldest inventory items are charged to COGS when goods are sold.
The cost of the newestnewest inventory items remain in ending inventory.
The actual physical flow of inventory items may differ from the FIFO cost flow assumptions.
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FIRST-IN, FIRST-OUTRESULTS
Periodic ending inventory cost equalsequals perpetualending inventory cost.
Periodic COGS equalsequals perpetual COGS.
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EVALUATION OF FIFO
Advantages Easy to apply Inventory value
approximates currentcost
Flow of costs tends tobe consistent withusual physical flow ofgoods
Systematic andobjective
Not subject tomanipulation
Disadvantages Does not match current
cost of goods sold withcurrent revenues
Inventory (or phantom)profits
In periods of risingprices, pay higherincome taxes
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LAST-IN, FIRST-OUTUNIT COST APPROACH
The cost of the newest newest inventory items arecharged to COGS when goods are sold.
The cost of the oldest oldest inventory items remain inending inventory.
The actual physical flow of inventory items maydiffer from the LIFO cost flow assumptions.
Inven - Cost - 24
LAST-IN, FIRST-OUTRESULTS
Periodic ending inventory cost is differentdifferent fromperpetual ending inventory cost.
Periodic COGS is differentdifferent from perpetual COGS.
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EVALUATION OF LIFO
Advantages
In periods of risingprices, pay lesstaxes
Matches latestinventory costswith currentrevenues
Disadvantages
LIFO conformityrule for tax andbook purposes
Cost of recordkeeping higher
Inventory valuationis at older costs
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IN PERIODS OF RISING PRICES. . .
LIFOLIFO
Matches high (newer)costs with current(higher) sales
Values inventory onlow (older) cost basis
Results in lowertaxable income
FIFOFIFO
Matches low (older)costs with current(higher) sales
Values inventoryapproximating highercurrent costs
Results in highertaxable income
Inven - Cost - 27
POOLED LIFO
Groups items that are used or sold in relatively constant proportions
Each pool represents a group of different, but related, inventory items that are considered as a single entity for inventory accounting purposes
Uses the average cost for the entire pool to determine COGS and cost of ending inventory
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DOLLAR VALUE (DV) LIFO
Uses price indexesprice indexes related to the inventory instead of units and unit costs
Is applied to inventory poolsinventory pools rather than individual items
Approximates LIFO results used for income tax and external reporting purposes
Inven - Cost - 29
DOLLAR VALUE (DV) LIFOANNUAL PRICE INDEX
Calculate internal index:internal index:
FIFO ending inv. at current yr. unit cost FIFO ending inv. at base yr. unit cost
If an internal index cannot be determined,use an external indexexternal index provided by theBureau of Labor Statistics.
Inven - Cost - 30
DOLLAR VALUE (DV) LIFOINVENTORY POOLS
Single pool—Used when overall operations
constitute a so-called natural businessunit.
Multiple pools
—Separate inventory pools are formed foreach natural business unit.
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– Convert ending inventory in end-of-year
dollars to “base year dollars”base year dollars” (divide by appropriate price index)(divide by appropriate price index)
– Determine annual layers in base year dollarsbase year dollars
– Convert to DV LIFO cost using appropriate price index
DOLLAR VALUE LIFOSteps in Application
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DOLLAR VALUE (DV) LIFOEVALUATION
Advantages
Reduces probability of liquidating LIFO layers.
Reduces accounting costs of using LIFO.– Pooled approach– Fewer layers– Annual index
FIFO or average cost used for internal reporting.
Disadvantages
Establishing appropriate price index.
Subjective makeup of inventory pools.
Inven - Cost - 33
Inventory errors may have dramatic impacts on reported financial results Categories of errors
INVENTORY ERRORS
– Mistakes in physical counts– Errors in computing cost of inventory– Inappropriate recording of purchases– Inappropriate recording of sales
Evaluate impact of each errorDO NOT MEMORIZE PATTERNS!!
Make correcting entries as necessary
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Average Costing
CGSBI 1 2 3
4 5 6 7 8
Ending InventoryBI 1 2 3
4 5 67 8
Purchases1 2 34 5 6
7 8
BI
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FIFO COSTING
Purchases
1 2 34 5 6
7 8
BICGS
BI 1 2 34 5 6
EndingInventory
7 8
Inven - Cost - 36
LIFO COSTING
Purchases
1
2 34 5 6
7 8
BI
CGS2 3
4 5 6 7 8
EndingInventory
BI 1
Inven - Cost - 37
THE END
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