Chapter 6 - Inventory Valuation1 INVENTORY – Chapt 6. p.277-284 BALANCE SHEET Biggest Asset Inventory see example How can an inventory item be both raw

Chapter 6 - Inventory Valuation 1

INVENTORY – Chapt 6. p.277-284

BALANCE SHEET

Biggest AssetInventory

see example

How can an inventory item be both raw materials and finished goods at the same time?

INCOME STATEMENT

Biggest ExpenseCOGS

Manufacturer inventoryRaw MaterialsWork in Progress (WIP)Finished Goods


The Audiophile sells high end stereo equipment. Windsor Acoustics recently introduced the Carnegie 440, a state of the art speaker system. During the current year the Audiophile purchase 9 of these speaker systems at the following dates and acquisition costs:


The problem is that acquisition costs change so how is inventory evaluated?

Date Units Purchased

Unit Cost Total Cost

Oct 1 2 3000 6000

Nov 17 3 3200 9600

Dec 1 4 3250 13000

Total 9 Average cost = $3177.78

28600


AVERAGE COSTAVERAGE COSTAVERAGE COSTAVERAGE COST

• The average cost method assumes that the goods available for sale are homogeneous.

• The allocation of the cost of goods available for sale is made on the basis of the weighted average unit cost incurred.

• The weighted average unit cost is then applied to the units sold to determine the cost of goods sold and to the units on hand to determine the ending inventory.


Allocation of the cost of goods available for sale in average cost method is made on the

basis of the weighted average unit cost


Average cost method assumes that goods available for sale

are homogeneous


On November 21, The Audiophile sold 4 of these speaker systems to the Hamilton Symphony for $5000 per unit. At

December 31, the other 5 sets remained in inventory.

Compute the COGS and the ending inventory value based on the average inventory costs:

Cash 20,000Revenue 20,000

COGS 12480Inventory 12480

Sale 4 Carnegie speaker systems to Hamilton SymphonyInventory value (ave. cost @ Nov 21) = 15600/5 = $3120

Value of remaining inventory is:28600 – 12480 = 16120


The problem is that acquisition costs change so how is inventory evaluated?

Date Units Purchased

Unit Cost Total Cost

Oct 1 2 3000 6000

Nov 17 3 3200 9600

Dec 1 4 3250 13000

Total 9 28600


FIFO = FIFO = first in first outfirst in first outFIFO = FIFO = first in first outfirst in first out• The FIFO method assumes that the earliest

goods purchased are the first to be sold.• Often reflects the actual physical flow of

merchandise.• Under FIFO, the costs of the earliest goods

purchased are the first to be recognized as cost of goods sold. The costs of the most recent goods purchased are recognized as the ending inventory.


FIFO method assumes earliest goods purchased

are the first to be sold




Compute the COGS and the ending inventory value based on the “First In –First Out” (FIFO) inventory cost:



Sale 4 Carnegie speaker systems to Hamilton SymphonyInventory value (FIFO @ Nov 21)

= 2@ $3000 + 2 @3200 = $12400Value of remaining inventory is:

28600 – 12400 = 16200


Average vs. FIFO

Average FIFO

Income Statement

Slightly higher COGS exp.

lower profit lower taxes

Lower COGS exp.

Higher profit

Balance Sheet Lower ending inventory values

Higher remaining inventory value

Average FIFO

Income Statement

Balance Sheet


LIFOLIFO

• The LIFO method assumes that the latest goods purchased are the first to be sold and that the earliest goods purchased remain in ending inventory.

• Seldom coincides with the actual physical flow of inventory.

• Under the periodic method, all goods purchased during the year are assumed to be available for the first sale, regardless of date of purchase.

• Rarely used in Canada.


LIFO method assumes latest goods purchased are the first

to be sold




Compute the COGS and the ending inventory value based on the “Last In – First Out” (LIFO) inventory costs:



Sale 4 Carnegie speaker systems to Hamilton SymphonyInventory value (LIFO @ Nov 21)

= 3@ $3200 + 1@3000 = $12600Value of remaining inventory is:

28600 – 12600 = 16,000


USING INVENTORY COST FLOW USING INVENTORY COST FLOW METHODS CONSISTENTLYMETHODS CONSISTENTLY

USING INVENTORY COST FLOW USING INVENTORY COST FLOW METHODS CONSISTENTLYMETHODS CONSISTENTLY

• A company needs to use its chosen cost flow method consistently from one accounting period to another.

• Such consistent application enhances the comparability of financial statements over successive time periods.

• When a company adopts a different cost flow method, the change and its effects on net income should be disclosed in the financial statements.

Documents

Chapter 6 - Inventory Valuation1 INVENTORY – Chapt 6. p.277-284 BALANCE SHEET Biggest Asset Inventory see example How can an inventory item be both raw