C9 - 1 Learning Objectives 1.Internal Control of Inventories 2.Effect of Inventory Errors 3.Inventory Cost Flow Assumptions 4.Perpetual Inventory Costing

C9 - 1

Learning Objectives

1. Internal Control of Inventories 2. Effect of Inventory Errors 3. Inventory Cost Flow Assumptions 4. Perpetual Inventory Costing Methods 5. Periodic Inventory Costing Methods 6. Comparing Inventory Costing Methods 7. Inventory Valuation Other Than Cost 8. Balance Sheet Presentation of Merchandise 9. Estimating Inventory Cost10. Financial Analysis and Interpretation

Chapter 9 Inventories

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Why is Inventory Control Important?Why is Inventory Control Important?

Inventory is a significant asset and for many companies the largest asset.

Inventory is central to the main activity of merchandising and manufacturing companies.

Mistakes in determining inventory cost can cause critical errors in financial statements.

Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.

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Effects of inventory errors

+ = +

100 20 80 40

Beginninginventory

Purchase Inventorysold

Ending inventory

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LIABILITIES

OWNER’SEQUITY

REVENUES

ASSETS

COSTS & EXPENSES

Inventory Costs and RelationshipsInventory Costs and Relationships

MerchandiseMerchandiseInventoryInventory

Cost ofCost ofMdse. SoldMdse. Sold

If merchandise inventory is . . . . . . . overstated

Cost of merchandise sold is . . . . . .

Gross profit and net income are . . .

Ending owner’s equity is . . . . . . . . .

If merchandise inventory is . . . . . . . overstated




understated

overstated

overstated

Net Income

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LIABILITIES

OWNER’SEQUITY

REVENUES

ASSETS

COSTS & EXPENSES

Inventory Costs and RelationshipsInventory Costs and Relationships

MerchandiseMerchandiseInventoryInventory


If merchandise inventory is . . . . . . . understated




If merchandise inventory is . . . . . . . understated




overstated

understated

understated

Net Income

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Inventory systemInventory system

Inventory must be accounted for periodically or perpetually.

Traditional periodic method is often being replaced by perpetual inventory accounting.

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Continuous determination of inventory value

Continuous determination of gross profit Affordable with computers, scanners, and bar

codes on most products Perpetual inventory accounting provides

management controls. Managers know which items are selling fastest

and the profit margin on those items.

Advantages of Using Perpetual InventoryAdvantages of Using Perpetual Inventory

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Inventory cost flow assumptions

Item Units Cost

May 10 Purchase 1 9

18 Purchase 1 13

24 Purchase 1 14

30 sell 1@$20

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COMPUTE THE COST OF INVENTORY

1. The specific identification method

2. The FIFO method

3. The LIFO method

4. Average cost method

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Perpetual Inventory CostsPerpetual Inventory Costs

Inventory cost data to demonstrate Inventory cost data to demonstrate FIFO and LIFO Perpetual SystemsFIFO and LIFO Perpetual Systems

Inventory cost data to demonstrate Inventory cost data to demonstrate FIFO and LIFO Perpetual SystemsFIFO and LIFO Perpetual Systems


Item 127B Units Cost Price

Jan. 1 Inventory 10 $204 Sale 7 $30

10 Purchase 8 2122 Sale 4 3128 Sale 2 3230 Purchase 10 22

Item 127B Units Cost Price

Jan. 1 Inventory 10 $204 Sale 7 $30

10 Purchase 8 2122 Sale 4 3128 Sale 2 3230 Purchase 10 22

Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

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Jan. 1 10 20 200 4 7 20 140 3 20 60

Item 127B

FIFO Perpetual Inventory AccountFIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

The sale of 7 units leaves a balance of 3 units.

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Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60

8 21 168

Item 127B




Because the purchase price of $21 is different than the cost of the previous 3 units on hand, the inventory balance of 11 units is accounted for separately.

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Item 127B



Unit Total Unit Total Unit TotalDate Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Of the 4 units sold, 3 come from the first units in (FIFO) at a cost of $20.

Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60

8 21 168 22 3 20 60

1 21 21 7 21 147

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Item 127B




Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60

8 21 168 22 3 20 60

1 21 21 7 21 147 28 2 21 42 5 21 105

Sold 2 units from the 7 units on hand. No allocation is necessary.

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Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60

8 21 168 22 3 20 60

1 21 21 7 21 147 28 2 21 42 5 21 105 30 10 22 220 5 21 105

10 22 220

Item 127B




Totals 18 $388 13 $263 15 $325

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Totals 18 $388 13 $263 15 $325

Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60

8 21 168 22 3 20 60

1 21 21 7 21 147 28 2 21 42 5 21 105 30 10 22 220 5 21 105

10 22 220

Item 127B




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DateDate DescriptionDescription DebitDebit CreditCredit

FIFO Perpetual Inventory AccountingFIFO Perpetual Inventory Accounting

Accounts Receivable 390Sales 390

Cost of Merchandise Sold 263Merchandise Inventory 263

Gross Profit = Sales ($390) minus Cost of Merchandise Sold ($263) = $127

Jan. 31

To record January sales of item 127B.(7 units@$30, 4 units@$30, 2 units@$30)

To record cost of January sales of item 127B.

Jan. 31

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Item 127B

LIFO Perpetual Inventory AccountLIFO Perpetual Inventory Account

Jan. 1 10 20 200 4 7 20 140 3 20 60

The sale of 7 units leaves a balance of 3 units.

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Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60

8 21 168

Item 127B


The purchase price of $21 is different than the cost of the previous 3 units on hand; therefore, the inventory balance of 11 units is accounted for separately.

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Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60

8 21 168 22 4 21 84 3 20 60

4 21 84

Item 127B


Of the 4 units sold, all come from the last units in (LIFO) at a cost of $21.

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Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60

8 21 168 22 4 21 84 3 20 60

4 21 84 28 2 21 42 3 20 60

2 21 42

Item 127B


Of the 2 units sold, all come from the last units in (LIFO) at a cost of $21, leaving 2 units from that group.

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Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60

8 21 168 22 4 21 84 3 20 60

4 21 84 28 2 21 42 3 20 60

2 21 42 30 10 22 220 3 20 60

2 21 4210 22 220

Item 127B


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Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60

8 21 168 22 4 21 84 3 20 60

4 21 84 28 2 21 42 3 20 60

2 21 42 30 10 22 220 3 20 60

2 21 4210 22 220

Item 127B

Totals 18 $388 13 $266 15 $322


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DateDate DescriptionDescription DebitDebit CreditCredit

LIFO Perpetual Inventory AccountingLIFO Perpetual Inventory Accounting

Accounts Receivable 390Sales 390

Cost of Merchandise Sold 266Merchandise Inventory 266

Gross Profit = Sales ($390) minus Cost of Merchandise Sold ($266) = $124

Jan. 31

To record January sales of item 127B.(7 units@$30, 4 units@$30, 2 units@$30)

To record cost of January sales of item 127B.

Jan. 31

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Jan. 1200 units at $9

First-In, First-Out Flow of CostsFirst-In, First-Out Flow of Costs

Mar. 10300 units at $10

Sep. 21400 units at $11

Nov. 18100 units at $12

$1,800

$3,000

$4,400

$1,200

Purchases

MerchandiseAvailablefor Sale

$10,400$10,400

Using FIFO costing, which units are assumed

to be sold first?

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$1,800

$3,000

$4,400

$1,200

Purchases


$1,800

$3,000

$2,200

Cost ofMerchandise

Sold

200 units at $9

$10,400$10,400

$7,000$7,000

300 units at $10

200 units at $11

FIFO cost flow assumes merchandise acquired

first is sold first.

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$1,800

$3,000

$4,400

$1,200

Purchases


$1,800

$3,000

$2,200

Cost ofMerchandise

Sold

200 units at $9

$10,400$10,400 $2,200

$1,200

$7,000$7,000

MerchandiseInventory

$3,400$3,400

300 units at $10

200 units at $11

200 units at $11

100 units at $12

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$1,800

$3,000

$4,400

$1,200

Purchases


$1,800

$3,000

$2,200

Cost ofMerchandise

Sold

200 units at $9

$10,400$10,400 $2,200

$1,200

$7,000$7,000


$3,400$3,400

300 units at $10

200 units at $11

200 units at $11

100 units at $12

700 units

1,000 units

300 units

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Last-In, First-Out Flow of CostsLast-In, First-Out Flow of Costs




$1,800

$3,000

$4,400

$1,200

Purchases


$10,400$10,4001,000 units total

Using LIFO costing, which units are assumed

to be sold first?

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$1,800

$3,000

$4,400

$1,200

Purchases


Cost ofMerchandise

Sold

$10,400$10,400

$4,400

$1,200

$7,600$7,600

200 units at $10

400 units at $11

100 units at $12

$2,000

LIFO cost flow assumes merchandise acquired

last is sold first.

1,000 units total

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$1,800

$3,000

$4,400

$1,200

Purchases

MerchandiseAvailablefor Sale $1,800

$1,000

Cost ofMerchandise

Sold

200 units at $9

$10,400$10,400

$4,400

$1,200

$2,800$2,800


$7,600$7,600

100 units at $10

200 units at $10

400 units at $11

100 units at $12

$2,000

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$1,800

$3,000

$4,400

$1,200

Purchases

MerchandiseAvailablefor Sale $1,800

$1,000

Cost ofMerchandise

Sold

200 units at $9

$10,400$10,400

$4,400

$1,200

$2,800$2,800


$7,600$7,600

100 units at $10

200 units at $10

400 units at $11

100 units at $12

$2,000

700 units

1,000 units

300 units

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COMPARING INVENTORY COSTING METHODS

The cost are rising

Balance

sheet

Income statement

FIFO

LIFO

WA

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$ 3,800

2,700

4,650

3,920

Total $15,520 $15,472 $15,070 The market decline is either: 1. Based on total inventory ($15,520 – $15,472) = $48 2. Based on individual items ($15,520 – $15,070) = $450 The decline is reported on the income statement as a separate item or included in the cost of merchandise sold.

Valuation of Inventory at Lower-of-Cost-or-MarketValuation of Inventory at Lower-of-Cost-or-Market

A 400 $10.25 $ 9.50 $ 4,100 $ 3,800

B 120 22.50 24.10 2,700 2,892

C 600 8.00 7.75 4,800 4,650

D 280 14.00 14.75 3,920 4,130

Unit UnitInventory Cost Market Total Total Lower

Item Quantity Price Price Cost Market C or M

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Valuation of Inventory at net realizable valueValuation of Inventory at net realizable value

Cost $1,000

Selling

price

$800

Selling

expense

150 650

350

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Assets

Current assets:

Cash $ 19,400

Accounts receivable $80,000

Less allowance 3,000 77,000

Merchandise inventory

at lower of cost (first-in,

first-out method) or market 216,300

Afro-ArtsBalance Sheet

December 31, 2004

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Retail Method of Estimating Inventory CostRetail Method of Estimating Inventory Cost

Retail method is based on relationship between cost of merchandise available for sale and the retail price.

Retail prices of all merchandise must be accumulated.

Inventory at retail is calculated as retail price of merchandise available for sale less sales.

Ratio is calculated as cost divided by retail price.

Inventory at retail price times cost ratio equals estimated cost of inventory.

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$62,000 $100,000

($62,000 / $100,000 = 62%)

$30,000

($30,000 x 62%) $18,600

Retail Inventory Method CalculationRetail Inventory Method Calculation

Cost Retail

Merchandise inventory, January 1 $19,400 $36,000

Purchases in January (net) 42,600 64,000

Merchandise available for sale

Ratio of cost to retail price:

Sales for January (net) 70,000

Merchandise inventory, January 31, at retail

Merchandise inventory, January 31, at est. cost

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Gross Profit Method of Estimating Inventory CostGross Profit Method of Estimating Inventory Cost

1. A gross profit percentage rate is estimated based on previous experience adjusted for known changes.

2. Estimated gross profit is calculated by multiplying the estimated gross profit rate times the actual net sales.

3. Estimated cost of merchandise sold is calculated by subtracting the gross profit from actual sales.

4. The cost of merchandise sold estimate is deducted from actual merchandise available for sale to determine the estimated cost of merchandise inventory.

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Merchandise inventory, January 1 $ 57,000

Purchases in January (net) 180,000

Merchandise available for sale

Sales in January (net) $250,000Less: Estimated gross profit

Estimated cost of merchandise sold

Estimated merchandise inventory, January 31

Gross Profit Method CalculationGross Profit Method Calculation

$237,000

($250,000 x 30%) 75,000

175,000$ 62,000

Many firms generate a surprisingly stable and predictable gross profit as a percentage of sales.

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Exercise 9-12 p.379

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Inventory Turnover RatiosInventory Turnover Ratios

Inventory turnover

=Cost of merchandise sold

Average inventory

Number of days’Sales in inventory

=Inventory, end of year

Average daily cost ofMerchandise sold

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SUPERVALU ZaleCost of goods sold $15,620,127,000 $ 737,188,000Inventories:

Beginning of year $1,115,529,000 $478,467,000End of year 1,067,837,000 571,669,000Average $1,091,683,000 $525,068,000

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SUPERVALU ZaleCost of goods sold $15,620,127,000 $ 737,188,000Inventories:


Inventory turnoverInventory turnover 14.3 times14.3 times 1.4 times1.4 times

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SUPERVALU La-Z-BoyCost of goods sold $15,620,127,000 $ 737,188,000Inventories:


Inventory turnoverInventory turnover 14.3 times14.3 times 1.4 times1.4 times

Average selling periodAverage selling period 25 days25 days 283 days283 days

Use: To assess the efficiency in the management of inventory

Use: To assess the efficiency in the management of inventory

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Exercise 9-22 p.379

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HOME WORK

READING:1. Illustrative problem2. Self- examination questions3. Multiple choice

Writing:1. Exercise: Exercise 9-21, 9-222. Problem :

Discussion: Activity 9-5

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LIFO USE BY COUNTRY

CountryLIFO

Permitted?Country

LIFO

Permitted?

Australia No Netherlands Yes

Canada Yes Singapore No

France Yes Switzerland No

Germany Yes United Kingdom

No

Japan yes United States yes

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The end of chapter 9

Documents

C9 - 1 Learning Objectives 1.Internal Control of Inventories 2.Effect of Inventory Errors 3.Inventory Cost Flow Assumptions 4.Perpetual Inventory Costing