Inventories: Measurement Copyright © 2007 by The McGraw-Hill Companies, Inc All rights reserved 8-2 Inventory Those assets that a company: Intends to sell in the normal course of business Has in production (work in process) for future sale Uses currently in the production of goods to be sold (raw materials) 8-3 Types of Inventories Types of Inventory Merchandise Inventory Manufacturing Inventory Goods acquired for resale •Raw Materials •Work-in-Process •Finished Goods 8-4 Inventory Cost Flows Raw Materials (1) $XX Work in Process $XX (4) $XX $XX (7) Finished Goods $XX $XX (8) Direct Labor (2) $XX Cost of Good Sold $XX (5) Manufacturing Overhead (3) $XX $XX $XX (6) (1) (2) (3) (4) (5) (6) (7) (8) Raw materials purchased Direct labor incurred Manufacturing overhead incurred Raw materials used Direct labor applied Manufacturing overhead applied Work in process transferred to finished goods Finished goods sold 8-5 Learning Objective Explain the difference between a perpetual inventory system and a periodic inventory system 8-6 Inventory Methods Two accounting systems are used to record transactions involving inventory: Perpetual Inventory System Periodic Inventory System The inventory account is continuously updated as purchases and sales are made The inventory account is adjusted at the end of a reporting cycle 8-7 Perpetual Inventory System Matrix, Inc purchases on account $600,000 of merchandise for resale to customers GENERAL JOURNAL Date Description 2006 Inventory Debit Credit 600,000 Accounts Payable 600,000 Returns of inventory are credited to the inventory account Discounts on inventory purchases can be recorded using the gross or net method 8-8 Perpetual Inventory System Matrix, Inc sold, on account, inventory with a retail price of $820,000 and a cost basis of $540,000, to a customer GENERAL JOURNAL Date Description 2006 Accounts Receivable Debit 820,000 Sales Cost of Goods Sold Credit 820,000 540,000 540,000 Inventory 8-9 Periodic Cost of Goods Sold Equation Beginning Inventory + Net Purchases Cost of Goods Available for Sale - Ending Inventory = Cost of Goods Sold 8-10 Periodic Inventory System Matrix, Inc purchases on account $600,000 of merchandise for resale to customers GENERAL JOURNAL Date Description 2006 Purchases Debit Credit 600,000 Accounts Payable 600,000 Returns of inventory are credited to the Purchase Returns and Allowances account Discounts on inventory purchases can be recorded using the gross or net method 8-11 Periodic Inventory System Matrix, Inc sold on account, inventory with a retail price of $820,000 and a cost basis of $540,000, to a customer GENERAL JOURNAL Date Description 2006 Accounts Receivable Debit Credit 820,000 820,000 Sales No entry is made to record Cost of Good Sold Assuming Beginning Inventory of $120,000 A physical count of Ending Inventory shows a balance of $180,000 Let’s calculate Cost of Goods Sold at the end of the accounting period 8-12 Periodic Inventory System Calculation of Cost of Goods Sold Beginning inventory Plus: Purchases Cost of goods available for sale Less: Ending inventory Cost of goods sold $ $ 120,000 600,000 720,000 (180,000) 540,000 Adjusting entry to determine Cost of Goods Sold Date Description 12/31/06 Cost of goods sold Inventory (ending) Inventory (beginning) Purchases Debit Credit 540,000 180,000 120,000 600,000 8-13 Comparison of Inventory Systems Transaction or Event Periodic Inventory Perpetual Inventory Routine purchases of various inventory items Costs debited to purchases account Costs debited to inventory account Sale of inventory No accounting entries made Debit Cost of goods sold and credit inventory End-of-period accounting entries and related activities Physical count of inventory to determine cost of good sold No separate determination of cost of goods sold necessary 8-14 Learning Objective Explain which physical quantities of goods should be included in inventory 8-15 What is Included in Inventory? General Rule All goods owned by the company on the inventory date, regardless of their location Goods in Transit Goods on Consignment Depends on FOB shipping terms 8-16 Learning Objective Determine the expenditures that should be included in the cost of inventory 8-17 Expenditures Included in Inventory Invoice Price Purchase Returns + Freight-in Freight in on Purchases Purchase Discounts 8-18 Purchase Discounts Date 10/5/06 10/14/06 11/4/06 10/5/06 Gross Method Description Debit Purchases Accounts payable Accounts payable Purchase discounts Cash 14,000 Accounts payable Cash Net Method Purchases Accounts payable Credit 20,000 6,000 20,000 280 13,720 6,000 Discount terms are 2/10, n/30 $14,000 x 0.02 $ 280 Partial payment not made within the discount period 19,600 19,600 10/14/06 Accounts payable Cash 13,720 11/4/06 Accounts payable Interest expense Cash 5,880 120 13,720 6,000 8-19 Net Method Using Perpetual and Periodic Matrix, Inc purchased on account $6,000 of merchandise for resale to customers The merchandise was purchased subject to a cash discount of 2/10, n/30 The company incurred $160 in freight-in on the merchandise Upon inspection, the company found that $200 of merchandise was damaged and the seller agreed to accept the merchandise return and credit the account of the company The inventory was sold for $8,300 on account Let’s look at the journal entries under both the perpetual and periodic accounting system assuming Matrix uses the net method to record merchandise purchases 8-20 Net Method Using Perpetual and Periodic Perpetual Inventory Method Description Debit Credit Inventory Accounts payable Inventory Cash Accounts payable Inventory Accounts receivable Sales revenue 5,880 5,880 160 160 200 200 8,300 8,300 Cost of goods sold 5,840 Inventory Periodic Inventory Method Purchases 5,880 Accounts payable Freight-in Cash 200 Accounts receivable Sales revenue 5,880 160 Accounts payable Purchase returns 5,840 8,300 160 200 Beginning inventory Purchases $ 5,880 Less: Returns (200) Plus: Freight-in 160 Net purchases Cost of goods available for sale Less: Ending inventory Cost of goods sold $ - 5,840 5,840 $ 5,840 8,300 8-21 Learning Objective Differentiate between the specific identification, FIFO, LIFO, and average cost methods used to determine the cost of ending inventory and cost of goods sold 8-22 Inventory Cost Flow Methods p Specific cost identification p Average cost p First-in, first-out (FIFO) p Last-in, first-out (LIFO) 8-23 Specific Cost Identification p Items are added to inventory at cost when they are purchased p The specific cost of each inventory item must be known p COGS for each sale is based on the specific cost of the item sold p By selecting specific items from inventory at the time of sale, income can be manipulated 8-24 Average Cost Method Periodic average cost uses a weighted-average unit cost: Weightedaverage unit cost Cost of goods = available for sale ÷ Quantity available for sale Perpetual average cost uses a moving average unit cost that is recomputed each time a new purchase is made 8-25 Weighted-Average Periodic System The following schedule shows the frame inventory for Yore Frame, Inc for September The physical inventory count at September 30 shows 600 frames in ending inventory Use the periodic weighted-average method to weighteddetermine: (1) Ending inventory cost (2) Cost of goods sold 8-26 Weighted-Average Periodic System Yore Frame, Inc Frame Inventory Date Beg Inventory 9/3 9/15 9/21 9/29 Goods Available for Sale Ending Inventory Cost of Goods Sold Units 800 300 250 200 400 $/Unit $ 22.00 24.00 25.00 27.00 28.00 1,950 600 1,350 Total $ 17,600.00 7,200.00 6,250.00 5,400.00 11,200.00 $ 47,650.00 ? ? 8-27 Weighted-Average Periodic System Now, we have to assign costs to ending inventory and cost of goods sold Beginning Inventory (800 units) Purchases (1,150 units) Ending Inventory (600 units) Available for Sale (1,950 units) Goods Sold (1,350) $47,650 ÷ 1,950 = $24.4359 weightedaverage per unit cost 8-28 Weighted-Average Periodic System Yore Frame, Inc Frame Inventory Date Beg Inventory 9/3 9/15 9/21 9/29 Goods Available for Sale Ending Inventory Cost of Goods Sold Units 800 300 250 200 400 1,950 600 1,350 $/Unit 22.00 24.00 25.00 27.00 28.00 Total $ 17,600.00 7,200.00 6,250.00 5,400.00 11,200.00 24.4359 24.4359 $ 47,650.00 14,661.54 $ 32,988.46 $ 8-29 Moving-Average Perpetual System The following schedule shows the Frame inventory for Yore Frame, Inc for September The physical inventory count at September 30 shows 600 frames in ending inventory Use the perpetual weighted-average method to weighteddetermine: (1) Ending inventory cost (2) Cost of goods sold 8-30 Moving-Average Perpetual System Yore Frame, Inc Frame Inventory Date Beg Inventory 9/3 9/15 9/21 9/29 Goods Available for Sale Ending Inventory Cost of Goods Sold Units 800 300 250 200 400 1,950 600 1,350 $/Unit $ 22.00 24.00 25.00 27.00 28.00 Total $ 17,600.00 7,200.00 6,250.00 5,400.00 11,200.00 Date 9/1 9/10 9/30 Sales Units 600 300 450 10 8-46 FIFO - Perpetual System Date Purchased Beg Inv 800 x 22.00 = 17,600 1-Sep 200300 x 24.00 = 3-Sep 7,200 10-Sep (remaining from Beg Inv) (from the 9/3 layer) Sold 600 x 22.00 = 13,200.00 200 x 100 x 22.00 = 24.00 = 4,400.00 2,400.00 Balance $ 17,600.00 4,400.00 11,600.00 7,200.00 4,800.00 The ending inventory on 9/10 consists of: 200 units from the 9/3 purchase @ $24.00 $24 8-47 FIFO - Perpetual System Date Purchased Beg Inv 800 x 22.00 = 17,600 1-Sep 200300 x 24.00 = 3-Sep 7,200 10-Sep (remaining from Beg Inv) (from the 9/3 layer) 15-Sep 250 x 25.00 = 6,250 Sold 600 x 22.00 = 13,200.00 200 x 100 x 22.00 = 24.00 = 4,400.00 2,400.00 Balance $ 17,600.00 4,400.00 11,600.00 7,200.00 4,800.00 11,050.00 The ending inventory on 9/15 consists of: 200 units from the 9/3 purchase @ $24.00 $24 250 units from the 9/15 purchase @ $25.00 $25 8-48 FIFO - Perpetual System Date Purchased Beg Inv 800 x 22.00 = 17,600 1-Sep 200300 x 24.00 = 3-Sep 7,200 10-Sep (remaining from Beg Inv) (from the 9/3 layer) 15-Sep 250 x 25.00 = 6,250 21-Sep 200 x 27.00 = 5,400 Sold 600 x 22.00 = 13,200.00 200 x 100 x 22.00 = 24.00 = 4,400.00 2,400.00 Balance $ 17,600.00 4,400.00 11,600.00 7,200.00 4,800.00 11,050.00 16,450.00 The ending inventory on 9/21 consists of: 200 units from the 9/3 purchase @ $24.00 $24 250 units from the 9/15 purchase @ $25.00 $25 200 units from the 9/21 purchase @ $27.00 $27 16 8-49 FIFO - Perpetual System Date Purchased Beg Inv 800 x 22.00 = 17,600 1-Sep 200300 x 24.00 = 3-Sep 7,200 10-Sep (remaining from Beg Inv) (from the 9/3 layer) 15-Sep 250 x 25.00 = 6,250 21-Sep 200 x 27.00 = 5,400 29-Sep 400 x 28.00 = 11,200 Sold 600 x 22.00 = 13,200.00 200 x 100 x 22.00 = 24.00 = 4,400.00 2,400.00 Balance $ 17,600.00 4,400.00 11,600.00 7,200.00 4,800.00 11,050.00 16,450.00 27,650.00 The ending inventory on 9/29 consists of: 200 units from the 9/3 purchase @ $24.00 $24 250 units from the 9/15 purchase @ $25.00 $25 200 units from the 9/21 purchase @ $27.00 $27 400 units from the 9/29 purchase @ $28.00 $28 8-50 FIFO - Perpetual System Date Purchased Beg Inv 800 x 22.00 = 17,600 1-Sep 3-Sep 300 x 24.00 = 7,200 10-Sep (remaining from Beg Inv) (from the 9/3 layer) 15-Sep 250 x 25.00 = 6,250 21-Sep 200 x 27.00 = 5,400 29-Sep 400 x 28.00 = 11,200 30-Sep (remaining from 9/3 layer) (from the 9/15 layer) Sold 600 x 22.00 = 13,200.00 200 x 100 x 22.00 = 24.00 = 4,400.00 2,400.00 200 x 250 x 24.00 = 25.00 = 4,800.00 6,250.00 Balance $ 17,600.00 4,400.00 11,600.00 7,200.00 4,800.00 11,050.00 16,450.00 27,650.00 22,850.00 16,600.00 31,050.00 Cost of Goods Sold = The ending inventory on 9/30 consists of: 200 units from the 9/21 purchase @ $27.00 $27 400 units from the 9/29 purchase @ $28.00 $28.00 8-51 FIFO - Perpetual System Date Purchased Beg Inv 800 x 22.00 = 17,600 1-Sep 3-Sep 300 x 24.00 = 7,200 10-Sep (remaining from Beg Inv) (from the 9/3 layer) 15-Sep 250 x 25.00 = 6,250 21-Sep 200 x 27.00 = 5,400 29-Sep 400 x 28.00 = 11,200 30-Sep (remaining from 9/3 layer) (from the 9/15 layer) Sold 600 x 22.00 = 13,200.00 200 x 100 x 22.00 = 24.00 = 4,400.00 2,400.00 200 x 250 x 24.00 = 25.00 = 4,800.00 6,250.00 Cost of Goods Sold = Balance $ 17,600.00 4,400.00 11,600.00 7,200.00 4,800.00 11,050.00 16,450.00 27,650.00 22,850.00 16,600.00 31,050.00 Note that this is the same COGS computed using the Periodic approach 17 8-52 Last-In, First-Out Any questions before we run into LIFO? 8-53 Last-In, First-Out The LIFO method assumes that the newest items are sold first, leaving the older units in inventory p The cost of the newest inventory items are charged to COGS when goods are sold p The cost of the oldest inventory items remain in inventory 8-54 Last-In, First-Out Unlike FIFO, using the LIFO method may result in COGS and Ending Inventory Cost that differ under the periodic and perpetual approaches 18 8-55 LIFO - Periodic System The following schedule shows the frame inventory for Yore Frame, Inc for September The physical inventory count at September 30 shows 600 frames in ending inventory Use the periodic LIFO method to determine: (1) Ending inventory cost (2) Cost of goods sold 8-56 LIFO - Periodic System Yore Frame, Inc Frame Inventory Date Beg Inventory 9/3 9/15 9/21 9/29 Goods Available for Sale Ending Inventory Cost of Goods Sold Units 800 300 250 200 400 $/Unit $ 22.00 24.00 25.00 27.00 28.00 Total $ 17,600.00 7,200.00 6,250.00 5,400.00 11,200.00 These are 47,650.00 $ the 600 oldest units in inventory 1,950 600 1,350 8-57 LIFO - Periodic System Yore Frame, Inc Frame Inventory Date Beg Inventory 9/3 9/15 9/21 9/29 Goods Available for Sale Ending Inventory Cost of Goods Sold Units 800 300 250 200 400 1,950 600 1,350 $/Unit 200 $ 22.00 24.00 25.00 27.00 28.00 600 x $22.00 Total $ 17,600.00 7,200.00 6,250.00 5,400.00 11,200.00 $ 47,650.00 13,200.00 19 8-58 LIFO - Periodic System Yore Frame, Inc Frame Inventory Date Beg Inventory 9/3 9/15 9/21 9/29 Goods Available for Sale Ending Inventory Cost of Goods Sold Units 800 300 250 200 400 1,950 600 1,350 $/Unit 200 $ 22.00 24.00 25.00 27.00 28.00 Total $ 17,600.00 7,200.00 6,250.00 5,400.00 11,200.00 These are the $ 47,650.00 most recently 600 x $22.00 13,200.00 acquired 1,350 units 8-59 LIFO - Periodic System Yore Frame, Inc Frame Inventory Date Beg Inventory 9/3 9/15 9/21 9/29 Goods Available for Sale Ending Inventory Cost of Goods Sold Units 800 300 250 200 400 $/Unit 200 $ 22.00 24.00 25.00 27.00 28.00 1,950 600 1,350 $4,400 + $30,050 Total $ 17,600.00 7,200.00 6,250.00 5,400.00 11,200.00 $ 47,650.00 13,200.00 $ 34,450.00 8-60 LIFO - Perpetual System The following schedule shows the frame inventory for Yore Frame, Inc for September The physical inventory count at September 30 shows 600 frames in ending inventory Use the perpetual LIFO method to determine: (1) Ending inventory cost (2) Cost of goods sold 20 8-61 LIFO - Perpetual System Yore Frame, Inc Frame Inventory Date Beg Inventory 9/3 9/15 9/21 9/29 Goods Available for Sale Ending Inventory Cost of Goods Sold Units 800 300 250 200 400 $/Unit $ 22.00 24.00 25.00 27.00 28.00 Total $ 17,600.00 7,200.00 6,250.00 5,400.00 11,200.00 Date 9/1 9/10 9/30 1,950 600 1,350 Sales Units 600 300 450 8-62 LIFO - Perpetual System Date Purchased 200 Beg Inv 800 x 22.00 = 17,600 1-Sep Sold 600 x 22.00 = 13,200.00 Balance $ 17,600.00 4,400.00 In LIFO, we assume that we sell the newest units in inventory first In this case, the 600 “newest” units come from beginning inventory, leaving 200 units in the beginning inventory layer 8-63 LIFO - Perpetual System Date Purchased 200 Beg Inv 800 x 22.00 = 17,600 1-Sep 3-Sep 300 x 24.00 = 7,200 Sold 600 x 22.00 = 13,200.00 Balance $ 17,600.00 4,400.00 11,600.00 The ending inventory on 9/3 consists of: 200 units from beginning inventory @ $22.00 300 units from the 9/3 purchase @ $24.00 21 8-64 LIFO - Perpetual System Date Purchased 200 Beg Inv 800 x 22.00 = 17,600 1-Sep 3-Sep 300 x 24.00 = 7,200 10-Sep (from the 9/3 purchase) Sold 600 x 22.00 = 13,200.00 300 x 24.00 = 7,200.00 Balance $ 17,600.00 4,400.00 11,600.00 4,400.00 For the 9/10 sale, we must identify the 300 newest units They all come from the September purchase Note that all of the 9/3 units have been “sold” and only 200 of the beginning inventory units remain 8-65 LIFO - Perpetual System Date Purchased 200 Beg Inv 800 x 22.00 = 17,600 1-Sep 3-Sep 300 x 24.00 = 7,200 10-Sep (from the 9/3 purchase) 15-Sep 250 x 25.00 = 6,250 Sold 600 x 22.00 = 13,200.00 300 x 24.00 = 7,200.00 Balance $ 17,600.00 4,400.00 11,600.00 4,400.00 10,650.00 20,400.00 Cost of Goods Sold = The ending inventory on 9/15 consists of: 200 units from beginning inventory @ $22.00 250 units from the 9/15 purchase @ $25.00 8-66 LIFO - Perpetual System Date Purchased 200 Beg Inv 800 x 22.00 = 17,600 1-Sep 3-Sep 300 x 24.00 = 7,200 10-Sep (from the 9/3 purchase) 15-Sep 250 x 25.00 = 6,250 21-Sep 200 x 27.00 = 5,400 Sold 600 x 22.00 = 13,200.00 300 x 24.00 = 7,200.00 Balance $ 17,600.00 4,400.00 11,600.00 4,400.00 10,650.00 16,050.00 20,400.00 Cost of Goods Sold = The ending inventory on 9/21 consists of: 200 units from beginning inventory @ $22.00 250 units from the 9/15 purchase @ $25.00 200 units from the 9/21 purchase @ $27.00 22 8-67 LIFO - Perpetual System Date Purchased 200 Beg Inv 800 x 22.00 = 17,600 1-Sep 3-Sep 300 x 24.00 = 7,200 10-Sep (from the 9/3 purchase) 15-Sep 250 x 25.00 = 6,250 21-Sep 200 x 27.00 = 5,400 29-Sep 400 x 28.00 = 11,200 Sold 600 x 22.00 = 13,200.00 300 x 24.00 = 7,200.00 Balance $ 17,600.00 4,400.00 11,600.00 4,400.00 10,650.00 16,050.00 27,250.00 20,400.00 Cost of Goods Sold = The ending inventory on 9/29 consists of: 200 units from beginning inventory @ $22.00 250 units from the 9/15 purchase @ $25.00 200 units from the 9/21 purchase @ $27.00 400 units from the 9/29 purchase @ $28.00 8-68 LIFO - Perpetual System Date Purchased 200 Beg Inv 800 x 22.00 = 17,600 1-Sep 3-Sep 300 x 24.00 = 7,200 10-Sep (from the 9/3 purchase) 15-Sep 250 x 25.00 = 6,250 21-Sep 150200 x 27.00 = 5,400 29-Sep 400 x 28.00 = 11,200 30-Sep (from the 9/29 purchase) (from the 9/21 purchase) Sold 600 x 22.00 = 13,200.00 300 x 24.00 = 7,200.00 400 x 50 x 28.00 = 27.00 = 11,200.00 1,350.00 Cost of Goods Sold = Balance $ 17,600.00 4,400.00 11,600.00 4,400.00 10,650.00 16,050.00 27,250.00 16,050.00 14,700.00 32,950.00 For the 9/30 sale, we must identify the 450 newest units 400 of them come from the 9/29 purchase The other 50 come from the 9/21 purchase 8-69 LIFO - Perpetual System Date Purchased 200 Beg Inv 800 x 22.00 = 17,600 1-Sep 3-Sep 300 x 24.00 = 7,200 10-Sep (from the 9/3 purchase) 15-Sep 250 x 25.00 = 6,250 21-Sep 150200 x 27.00 = 5,400 29-Sep 400 x 28.00 = 11,200 30-Sep (from the 9/29 purchase) (from the 9/21 purchase) Sold 600 x 22.00 = 13,200.00 300 x 24.00 = 7,200.00 400 x 50 x 28.00 = 27.00 = 11,200.00 1,350.00 Cost of Goods Sold = Balance $ 17,600.00 4,400.00 11,600.00 4,400.00 10,650.00 16,050.00 27,250.00 16,050.00 14,700.00 32,950.00 The ending inventory on 9/30 consists of: 200 units from beginning inventory @ $22.00 $22 250 units from the 9/15 purchase @ $25.00 $25 150 units from the 9/21 purchase @ $27.00 $27.00 23 8-70 When Prices Are Rising p p p FIFO Matches low (older) costs with current (higher) sales Inventory is valued at approximate replacement cost Results in higher taxable income p p p p LIFO Matches high (newer) costs with current (higher) sales Inventory is valued based on low (older) cost basis Results in lower taxable income Is not officially endorsed by the IASC 8-71 Comparison of Cost Flow Methods Cost of goods sold Ending inventory Total Perpetual Inventory System Average Cost FIFO LIFO $ 31,941 $ 31,050 $ 32,950 15,709 16,600 14,700 $ 47,650 $ 47,650 $ 47,650 8-72 Comparison of Cost Flow Methods Inventory Method Used by Major Companies 2003 1973 # of Companies FIFO LIFO Average Other Total % of Companies # of Companies % of Companies 384 251 167 31 833 46% 30% 20% 4% 100% 394 150 235 148 927 43% 16% 25% 16% 100% 24 8-73 Learning Objective Discuss the factors affecting a company’s choice of inventory method 8-74 Decision Makers’ Perspective What factors motivate companies to select one inventory method over another? How closely reported costs reflect actual flow of inventory? How well are costs matched against related revenues? How accurate is the timing of reported income and income taxes? 8-75 Learning Objective Understand supplemental LIFO disclosures and the effect of LIFO liquidations on net income 25 8-76 LIFO Liquidation When prices rise LIFO inventory costs on the balance sheet are “out of date” because they reflect old purchase transactions If inventory declines, these “out of date” costs may be charged to current earnings This LIFO liquidation results in “paper profits.” 8-77 LIFO Reserves Many companies use LIFO for external reporting and income tax purposes but maintain internal records using FIFO or average cost The conversion from FIFO or average cost to LIFO takes place at the end of the period The conversion may look like this: 2003 Total inventories at FIFO Less: LIFO allowance Inventories, at LIFO cost 2002 $ 12,541 1,581 $ 10,960 $ 11,544 1,807 $ 9,737 8-78 Learning Objective Calculate the key ratios used by analysts to monitor a company’s investment in inventories 26 8-79 Gross Profit Ratio Gross profit ratio = Gross profit Net sales This measure indicates how much of each sales dollar is left after deducting the cost of goods sold to cover expenses and provide a profit 8-80 Inventory Turnover Ratio Inventory = turnover ratio Cost of goods sold Average inventory This ratio measures how many times a company’s inventory has been sold and replaced during the year If a company’s inventory turnover Is less than its industry average, it either has excessive inventory or the wrong sorts of inventory 8-81 Earnings Quality Many believe that manipulating income reduces earnings quality because it can mask permanent earnings Inventory write-downs and changes in inventory method are two additional inventoryrelated techniques a company could use to manipulate earnings 27 8-82 Learning Objective Determine ending inventory using the dollar-value LIFO inventory method 8-83 LIFO Inventory Pools Inventory Pools consist of inventory units grouped according to similarities Using Inventory Pools with LIFO simplifies record keeping For example, all similar units purchased at the same time can be “pooled” and assigned an average unit cost 8-84 Dollar-Value LIFO (DVL) DVL inventory pools are viewed as layers of value, rather than layers of similar units DVL simplifies LIFO record-keeping DVL minimizes the probability of layer liquidation At the end of the Example period, we determine if The inventory layer a new replacement inventory differs from was added by the old inventory on comparing ending hand We to beginning inventory just create a new layer inventory 28 8-85 Dollar-Value LIFO (DVL) We need to determine if the increase in ending inventory over beginning inventory was due to a price increase or an increase in inventory 1a Compute a Cost Index for the year Cost index in layer year = Cost in layer year ÷ Cost in base year 8-86 Dollar-Value LIFO (DVL) 1b Deflate the ending inventory value using the cost index 1c Compare ending inventory (at base year cost) to beginning inventory Ending Inventory at base year cost Ending = Inventory ÷ Cost Cost Index Ending Change in Inv at Beg = – Inventory Base Year Inventory Cost 8-87 Dollar-Value LIFO (DVL) Next, identify the layers in ending inventory and the years they were created Convert each layer’s base year cost to layer year cost by multiplying times the cost index Sum all the layers to arrive at Ending Inventory at DVL cost 29 8-88 End of Chapter 30 ... damaged and the seller agreed to accept the merchandise return and credit the account of the company The inventory was sold for $8,300 on account Let’s look at the journal entries under both the perpetual... First-Out The FIFO method assumes that items are sold in the chronological order of their acquisition p The cost of the oldest inventory items are charged to COGS when goods are sold p The cost of the. .. 27,250.00 16,050.00 14,700.00 32,950.00 For the 9/30 sale, we must identify the 450 newest units 400 of them come from the 9/29 purchase The other 50 come from the 9/21 purchase 8-69 LIFO - Perpetual