Chapter 6 Inventories (存貨 )
Instructor: Chih-Liang Julian Liu
Department of Industrial and Business Management
Chang Gung University
Chapter 6 InventoriesLearning Objectives
1. Describe the steps in determining inventory
quantities (存貨數量 ).
2. Explain the accounting for inventories and
apply the inventory cost flow methods (存貨成本流動方法 ).
3. Explain the financial effects of the inventory
cost flow assumptions.
Chapter 6 InventoriesLearning Objectives
4. Explain the lower-of-cost-or-net realizable value
(成本與淨現值熟低 ) basis of accounting for
inventories.
5. Indicate the effects of inventory errors on the
financial statements.
6. Compute and interpret the inventory turnover
ratio (存貨週轉率 ).
One Classification:
Inventory (存貨 )
Three Classifications:
Raw Materials (原料 )
Work in Process (在製品 )
Finished Goods (製成品 )
Merchandising Company
Manufacturing Company
Regardless of the classification, companies report all inventories under Current Assets (流動資產 ) on the
Statement of Financial Position.
Classifying Inventory
Physical Inventory (實地盤點存貨 ) taken for two reasons:
Perpetual System
1. Check accuracy of inventory records (存貨紀錄正確性 ).
2. Determine amount of inventory lost (wasted raw
materials, shoplifting, or employee theft).
Periodic System
1. Determine the inventory on hand (庫存存貨 ).
2. Determine the cost of goods sold for the period.
Determining Inventory Quantities
Involves counting, weighing, or measuring each
kind of inventory on hand.
Taken,
when the business is closed or business is
slow.
at end of the accounting period.
Taking a Physical Inventory
Determining Inventory Quantities
Goods in Transit (在途存貨 )
Purchased goods not yet received.
Sold goods not yet delivered.
Determining Ownership of Goods (商品所有權 )
Goods in transit should be included in the inventory of the company that has legal title (法律所有權 ) to the goods. Legal title is determined
by the terms of sale (銷貨條件 ).
Determining Inventory Quantities
Illustration 6-1 Terms of sale
Ownership of the goods passes to the buyer when the
public carrier accepts the goods from the seller.
Ownership of the goods remains with the seller until the
goods reach the buyer.
Goods in Transit
Determining Inventory Quantities
Goods in transit should be included in the
inventory of the buyer when the:
a. public carrier accepts the goods from
the seller.
b. goods reach the buyer.
c. terms of sale are FOB destination.
d. terms of sale are FOB shipping point.
Question
Determining Inventory Quantities
Hargrove Company
• 20,000 units of inventory on hand.
• Goods in transit:
• (1) sales of 1,500 units shipped FOB destination.
• (2) purchases of 2,500 units shipped FOB shipping point by the seller.
• What’s the inventory quantities?
Consigned Goods (寄銷品 )
Goods held for sale by one party.
Ownership of the goods is retained by
another party.
Determining Inventory Quantities
Determining Ownership of Goods
Unit costs (單位成本 ) can be applied to
quantities on hand using the following costing
methods:
Specific Identification (個別認定 )
First-in, first-out (FIFO) (先進先出 )
Average-cost (平均成本 )
Cost Flow Assumptions
Inventory Costing
Illustration: Crivitz TV Company purchases three
identical 50-inch TVs on different dates at costs of £700,
£750, and £800. During the year Crivitz sold two sets at
£1,200 each. These facts are summarized below.
Illustration 6-2
Inventory Costing
Specific Identification
If Crivitz sold the TVs it purchased on February 3 and May
22, then its cost of goods sold is £1,500 (£700 + £800),
and its ending inventory is £750.
Illustration 6-3
Inventory Costing
Actual physical flow costing method in which
items still in inventory are specifically costed 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.
Inventory CostingSpecific Identification
Inventory Costing
There are two assumed cost flow methods:
1. First-in, first-out (FIFO)
2. Average-cost
Cost flow does not need be consistent with the
physical movement of the goods.
Illustration: Data for Lin Electronics’ Astro condensers (Periodic System). Illustration 6-4
(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold
Inventory Costing
Earliest goods purchased are first to be sold.
(最先買入的商品是最先被出售 ).
Often parallels actual physical flow of
merchandise (實際商品的流動相符 ).
Generally good business practice to sell
oldest units first (先賣出最舊的產品 ).
First-In-First-Out (FIFO)
Inventory Costing
Assuming the Perpetual Inventory System, compute Cost of Goods
Sold and Ending Inventory under FIFO.
Illustration 6A-1
APPENDIX 6A PERPETUAL INVENTORY SYSTEMS
First-In-First-Out (FIFO)
Cost of Goods Sold
Ending Inventory
Illustration 6A-2
APPENDIX 6A PERPETUAL INVENTORY SYSTEMS
Allocates cost of goods available for sale
on the basis of weighted-average unit
cost incurred (加權平均單位成本 ).
Assumes goods are similar in nature.
Applies weighted-average unit cost to the
units on hand to determine cost of the
ending inventory.
Inventory CostingAverage Cost
Illustration 6A-3
Cost of Goods Sold
Ending Inventory
APPENDIX 6A PERPETUAL INVENTORY SYSTEMS
Average Cost (Moving-Average System)
A major advantage of the FIFO method is
that in a period of inflation, the costs
allocated to ending inventory will
approximate their current cost.
A shortcoming of the average-cost method
is that in a period of inflation, the costs
allocated to ending inventory may be
understated in terms of current cost.
Financial Statement Effects
In a period of inflation:
FIFO - inventory and net income
higher.
Average-Cost - lower income taxes.
Tax Effects
In Summary
• Prices are rising (inflation)
• FIFO:
(1) Higher ending inventory cost (Statement of financial position)
(2) Lower cost of good sold, higher net income, and higher income tax (Income statement).
The cost flow method that often parallels the
actual physical flow of merchandise is the:
a. FIFO method.
b. average cost method.
c. gross profit method.
d. none of the above
Question
Inventory Costing
In a period of rising prices, average cost will
produce:
a. higher net income than FIFO.
b. the same net income as FIFO.
c. lower net income than FIFO.
d. net income is equal to the specific
identification method.
Question
Inventory Costing
Using Cost Flow Methods Consistently
Method should be used consistently, enhances
comparability.
Although consistency is preferred, a company
may change its inventory costing method.
When a company adopts a different method, it
should disclose in the financial statements the
change and its effect on net income.
Inventory Costing
Lower-of-Cost-or-Net Realizable Value
When the value of inventory is lower than its cost
Companies must “write down” (沖減 ) the inventory to
its net realizable value in the period in which the price
decline occurs.
Net realizable value (淨變現價值 ) refers to the net
amount (淨值 ) that a company expects to realize
(receive) from the sale of inventory (estimated selling
price in the normal course of business, less estimated
costs to complete and sell).
Inventory Costing
Illustration: Assume that Gao TV has the following
lines of merchandise with costs and net realizable
values as indicated.Illustration 6-10
Inventory CostingLower-of-Cost-or-Net Realizable Value
Common Cause:
Failure to count or price inventory correctly.
Not properly recognizing the transfer of legal
title to goods in transit.
Errors affect both the income statement
and statement of financial position.
Inventory Errors
Inventory errors affect the computation of cost of
goods sold and net income.
Illustration 6-12
Illustration 6-11
Inventory CostingIncome Statement Effects
Sales revenue - Cost of Goods Sold = Gross Profit
Inventory errors affect the computation of cost of goods
sold and net income in two periods.
An error in ending inventory of the current period will
have a reverse effect on net income of the next
accounting period.
Over the two years, the total net income is correct
because the errors offset (扺銷 ) each other.
Ending inventory depends entirely on the accuracy of
taking and costing the inventory.
Inventory CostingIncome Statement Effects
Beginning inventory
Endinginventory
2013 2014
Cost of goods sold
Net income
Cost of goods sold
Net income
Inventory Errors
Incorrect Correct Incorrect Correct
Sales € 80,000 € 80,000 € 90,000 € 90,000
Beginning inventory 20000 20000 12000 15000
Cost of goods purchased 40000 40000 68000 68000
Cost of goods available 60000 60000 80000 83000
Ending inventory 12000 15000 23000 23000
Cost of good sold 48000 45000 57000 60000
Gross profit 32000 35000 33000 30000
Operating expenses 10000 10000 20000 20000
Net income € 22,000 € 25,000 € 13,000 € 10,000
2013 2014
(€3,000)Net Income understated
€3,000Net Income overstated
Combined income for 2-year period is correct.
Illustration 6-13
Inventory Costing
Effect of inventory errors on the statement of financial position
is determined by using the basic accounting equation:
Illustration 6-11
Illustration 6-14
Inventory CostingStatement of Financial Position Effects
Understating ending inventory will overstate:
a. assets.
b. cost of goods sold.
c. net income.
d. equity.
Question
Inventory Costing
Net realizable value - 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 lower-of-cost-or-net
realizable value), and
3) costing method (specific identification, FIFO, or average).
Statement Presentation and Analysis
Presentation
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.
Statement Presentation and Analysis
Analysis
Inventory turnover (存貨週轉率 ) measures the number
of times on average the inventory is sold during the period.
Cost of Goods Sold
Average Inventory
Inventory Turnover
=
Days in inventory measures the average number of days
inventory is held.
Days in Year (365)
Inventory Turnover
Days in Inventory
=
Statement Presentation and Analysis
Days in Inventory: Inventory turnover of 5.4 times divided into 365
is approximately 68 days. This is the approximate time that it takes a
company to sell the inventory.
Illustration: Esprit Holdings (HKG) reported in a recent annual report a
beginning inventory of HK$3,170 million, an ending inventory of HK$2,997
million, and cost of goods sold for the year ended of HK$16,523 million.
The inventory turnover formula and computation for Esprit Holdings are
shown below.Illustration 6-16
Statement Presentation and Analysis