Chapter 8-1 CHAPTER VALUATION OF INVENTORIES: A COST-BASIS APPROACH Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield Chapter 8-2 Learning Learning Objectives Objectives Identify major classifications of inventory Distinguish between perpetual and periodic inventory systems Identify the effects of inventory errors on the financial statements Understand the items to include as inventory cost Describe and compare the cost flow assumptions used to account for inventories Explain the significance and use of a LIFO reserve Understand the effect of LIFO liquidations Explain the dollar-value LIFO method Identify the major advantages and disadvantages of LIFO 10 Understand why companies select given inventory methods Chapter 8-3 Valuation Valuation of of Inventories: Inventories: Cost-Basis Cost-Basis Approach Approach Inventory Issues Classification Cost flow Control Basic inventory valuation Chapter 8-4 Physical Goods Included in Inventory Goods in transit Consigned goods Special sales agreements Inventory errors Costs Included in Inventory Product costs Period costs Purchase discounts Cost Flow Assumptions Specific identification Average cost FIFO LIFO LIFO: Special Issues LIFO reserve LIFO liquidation Dollar-value LIFO Comparison of LIFO approaches Advantages of LIFO Disadvantages of LIFO Basis for Selection Summary of inventory valuation methods Inventory Inventory Issues Issues Classification Inventories are: items held for sale, or goods to be used in the production of goods to be sold Businesses with Inventory: Merchandiser Chapter 8-5 or Manufacturer LO Identify major classifications of inventory Inventory Inventory Issues Issues Classification Illustration 8-1 One inventory account Purchase goods ready for sale Chapter 8-6 LO Identify major classifications of inventory Inventory Inventory Issues Issues Classification Illustration 8-1 Three accounts Raw materials Work in process Finished goods Chapter 8-7 LO Identify major classifications of inventory Inventory Inventory Issues Issues Inventory Cost Flow Chapter 8-8 Illustration 8-2 LO Identify major classifications of inventory Inventory Inventory Issues Issues Inventory Cost Flow Illustration 8-3 Companies use one of two types of systems for maintaining inventory records — perpetual system or periodic system Chapter 8-9 LO Identify major classifications of inventory Inventory Inventory Cost Cost Flow Flow Perpetual System Purchases of merchandise are debited to Inventory Freight-in is debited to Inventory Purchase returns and allowances and purchase discounts are credited to Inventory Cost of goods sold is debited and Inventory is credited for each sale Subsidiary records show quantity and cost of each type of inventory on hand The perpetual inventory system provides a continuous record of Inventory and Cost of Goods Sold Chapter 8-10 LO Distinguish between perpetual and periodic inventory systems Last-In, Last-In, First-Out First-Out (LIFO) (LIFO) Periodic Method Illustration 8-17 The cost of the total quantity sold or issued during the month comes from the most recent purchases Chapter 8-41 Solution on notes page LO Describe and compare the cost flow assumptions used to account for inventories Last-In, Last-In, First-Out First-Out (LIFO) (LIFO) Perpetual Method Illustration 8-18 The LIFO method results in different ending inventory and cost of goods sold amounts than the amounts calculated under the periodic method Chapter 8-42 Solution on notes page LO Describe and compare the cost flow assumptions used to account for inventories Special Special Issues Issues Related Related to to LIFO LIFO LIFO Reserve Many companies use LIFO for tax and external financial reporting purposes FIFO, average cost, or standard cost system for internal reporting purposes Reasons: Pricing decisions Record keeping easier Profit-sharing or bonus arrangements LIFO troublesome for interim periods Chapter 8-43 LO Explain the significance and use of a LIFO reserve Special Special Issues Issues Related Related to to LIFO LIFO LIFO Reserve is the difference between the inventory method used for internal reporting purposes and LIFO FIFO value per books $160,000 Example: LIFO value 145,000 LIFO Reserve $ 15,000 Journal entry to reduce inventory to LIFO: Cost of goods sold 15,000 Allowance to reduce inventory to LIFO 15,000 Companies should disclose either the LIFO reserve or the replacement cost of the inventory Chapter 8-44 LO Explain the significance and use of a LIFO reserve Special Special Issues Issues Related Related to to LIFO LIFO LIFO Liquidation Older, low cost inventory is sold resulting in a lower cost of goods sold, higher net income, and higher taxes Illustration: Basler Co has 30,000 pounds of steel in its inventory on December 31, 2010, with cost determined on a specific goods LIFO approach Chapter 8-45 LO Understand the effect of LIFO liquidations Special Special Issues Issues Related Related to to LIFO LIFO LIFO Liquidation Illustration: At the end of 2011, only 6,000 pounds of steel remained in inventory Illustration 8-21 Chapter 8-46 LO Understand the effect of LIFO liquidations Special Special Issues Issues Related Related to to LIFO LIFO Dollar-Value LIFO Changes in a pool are measured in terms of total dollar value, not physical quantity Advantage: Broader range of goods in pool Permits replacement of goods that are similar Helps protect LIFO layers from erosion Chapter 8-47 LO Explain the dollar-value LIFO method Special Special Issues Issues Related Related to to LIFO LIFO Dollar-Value LIFO Exercise 8-26 (partial): The following information relates to the Choctaw Company Use the dollar-value LIFO method to compute the ending inventory for 2007 through 2009 Chapter 8-48 LO Explain the dollar-value LIFO method Special Special Issues Issues Related Related to to LIFO LIFO Exercise 8-26 Solution Chapter 8-49 LO Explain the dollar-value LIFO method Special Special Issues Issues Related Related to to LIFO LIFO Exercise 8-26 Solution Chapter 8-50 LO Explain the dollar-value LIFO method Special Special Issues Issues Related Related to to LIFO LIFO Exercise 8-26 Solution Chapter 8-51 LO Explain the dollar-value LIFO method Special Special Issues Issues Related Related to to LIFO LIFO Comparison of LIFO Approaches Specific-goods LIFO - costing goods on a unit basis is expensive and time consuming Specific-goods Pooled LIFO approach reduces record keeping and clerical costs more difficult to erode the layers using quantities as measurement basis can lead to untimely LIFO liquidations Dollar-value LIFO is used by most companies Chapter 8-52 LO Explain the dollar-value LIFO method Special Special Issues Issues Related Related to to LIFO LIFO Advantages Matching Reduced earnings Tax Benefits/Improved Cash Flow Inventory understated Future Earnings Hedge Chapter 8-53 Disadvantages Physical flow Involuntary Liquidation / Poor Buying Habits LO Identify the major advantages and disadvantages of LIFO Basis Basis for for Selection Selection of of Inventory Inventory Method Method LIFO is generally preferred: if selling prices are increasing faster than costs and if a company has a fairly constant “base stock.” LIFO is not appropriate: if prices tend to lag behind costs, if specific identification traditionally used, and when unit costs tend to decrease as production increases Chapter 8-54 LO 10 Understand why companies select given inventory methods Copyright Copyright Copyright © 2009 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Chapter 8-55 .. .CHAPTER VALUATION OF INVENTORIES: A COST-BASIS APPROACH Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield Chapter 8-2 Learning Learning Objectives... methods Chapter 8-3 Valuation Valuation of of Inventories: Inventories: Cost-Basis Cost-Basis Approach Approach Inventory Issues Classification Cost flow Control Basic inventory valuation Chapter. .. sale Chapter 8-6 LO Identify major classifications of inventory Inventory Inventory Issues Issues Classification Illustration 8-1 Three accounts Raw materials Work in process Finished goods Chapter