6-1 Reporting and Analyzing Inventory Kimmel ● Weygandt ● Kieso Financial Accounting, Eighth Edition 6-2 CHAPTER OUTLINE LEARNING OBJECTIVES 6-3 Discuss how to classify and determine inventory Apply inventory cost flow methods and discuss their financial effects Explain the statement presentation and analysis of inventory LEARNING OBJECTIVE Discuss how to classify and determine inventory Merchandising Company One Classification: Merchandise Inventory ▼ HELPFUL HINT Regardless of the classification, Manufacturing Company Three Classifications: Raw Materials Work in Process Finished Goods companies report all inventories under Current Assets on the balance sheet 6-4 LO ACCOUNTING ACROSS THE ORGANIZATION A Big Hiccup JIT can save a company a lot of money, but it isn’t without risk An unexpected disruption in the supply chain can cost a company a lot of money Japanese automakers experienced just such a disruption when a 6.8-magnitude earthquake caused major damage to the company that produces 50% of their piston rings The rings themselves cost only $1.50, but you cannot make a car without them As a result, the automakers were forced to shut down production for a few days—a loss of tens of thousands of cars Similarly, a major snowstorm halted production at the Canadian plants of Ford A Ford spokesperson said, “Because the plants run with just-in-time inventory, we don’t have large stockpiles of parts sitting around When you have a somewhat significant disruption, you can pretty quickly run out of parts.” Sources: Amy Chozick, “A Key Strategy of Japan’s Car Makers Backfires,” Wall Street Journal (July 20, 2007); and Kate Linebaugh, “Canada Military Evacuates Motorists Stranded by Snow,” Wall Street Journal (December 15, 2010) 6-5 LO DETERMINING INVENTORY QUANTITIES Physical Inventory taken for two reasons: Perpetual System Check accuracy of inventory records Determine amount of inventory lost due to wasted raw materials, shoplifting, or employee theft Periodic System 6-6 Determine the inventory on hand Determine the cost of goods sold for the period LO Taking a Physical Inventory Involves counting, weighing, or measuring each kind of inventory on hand Taken, 6-7 when the business is closed or business is slow at the end of the accounting period LO ETHICS INSIGHT Leslie Fay Falsifying Inventory to Boost Income Managers at women’s apparel maker Leslie Fay were convicted of falsifying inventory records to boost net income in an attempt to increase management bonuses In another case, executives at Craig Consumer Electronics were accused of defrauding lenders by manipulating inventory records The indictment said the company classified “defective goods as new or refurbished” and claimed that it owned certain shipments “from overseas suppliers” when, in fact, Craig either did not own the shipments or the shipments did not exist 6-8 LO Determining Ownership of Goods GOODS IN TRANSIT Purchased goods not yet received Sold goods not yet delivered Goods in transit should be included in the inventory of the company that has legal title to the goods Legal title is determined by the terms of sale 6-9 LO Determining Ownership of Goods ILLUSTRATION 6-2 Terms of sale Ownership of the goods passes to the buyer Ownership of the goods remains with the seller when the public carrier accepts the goods from until the goods reach the buyer the seller Freight costs incurred by the seller are an operating expense 6-10 LO LAST-IN, FIRST-OUT (LIFO) ILLUSTRATION 6A-3 Perpetual system—LIFO Cost of Goods Sold 6-55 Ending Inventory LO AVERAGE COST ILLUSTRATION 6A-4 Perpetual system—average-cost method Cost of Goods Sold 6-56 Ending Inventory LO LEARNING OBJECTIVE *5 APPENDIX 6B: Indicate the effects of inventory errors on the financial statements Inventory Errors Common Cause: 6-57 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 balance sheet LO INCOME STATEMENT EFFECTS Inventory errors affect the computation of cost of goods sold and net income ILLUSTRATION 6B-1 Formula for cost of goods sold ILLUSTRATION 6B-2 Effects of inventory errors on current year’s income statement 6-58 LO INCOME STATEMENT EFFECTS 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 6-59 Over the two years, the total net income is correct because the errors offset each other Ending inventory depends entirely on the accuracy of taking and costing the inventory LO INCOME STATEMENT EFFECTS ILLUSTRATION 6B-3 Effects of inventory errors on two years’ income statements Combined income for 2-year period is correct 6-60 ($3,000) $3,000 Net Income understated Net Income overstated Errors Cancel LO INCOME STATEMENT EFFECTS Review Question Understating ending inventory will overstate: 6-61 a assets b cost of goods sold c net income d owner's equity LO BALANCE SHEET EFFECTS Effect of inventory errors on the balance sheet is determined by using the basic accounting equation: Assets = Liabilities + Stockholders’ Equity Errors in the ending inventory have the effects shown: ILLUSTRATION 6B-4 Effects of ending inventory errors on balance sheet 6-62 LO A Look at IFRS LEARNING OBJECTIVE Compare the accounting for inventories under GAAP and IFRS KEY POINTS Similarities IFRS and GAAP account for inventory acquisitions at historical cost and value inventory at the lower-of-cost-ormarket subsequent to acquisition Who owns the goods—goods in transit or consigned goods—as well as the costs to include in inventory are essentially accounted for the same under IFRS and GAAP 6-63 LO A Look at IFRS KEY POINTS Differences The requirements for accounting for and reporting inventories are more principles based under IFRS That is, GAAP provides more detailed guidelines in inventory accounting A major difference between IFRS and GAAP relates to the LIFO cost flow assumption GAAP permits the use of LIFO for inventory valuation IFRS prohibits its use FIFO and average-cost are the only two acceptable cost flow assumptions permitted under IFRS Both sets of standards permit specific identification where appropriate 6-64 LO A Look at IFRS KEY POINTS Differences In the lower-of-cost-or-market test for inventory valuation, IFRS defines market as net realizable value GAAP, on the other hand, defines market as replacement cost 6-65 LO A Look at IFRS LOOKING TO THE FUTURE One convergence issue that will be difficult to resolve relates to the use of the LIFO cost flow assumption As indicated, IFRS specifically prohibits its use Conversely, the LIFO cost flow assumption is widely used in the United States because of its favorable tax advantages In addition, many argue that LIFO from a financial reporting point of view provides a better matching of current costs against revenue and, therefore, enables companies to compute a more realistic income 6-66 LO A Look at IFRS IFRS Practice Which of the following should not be included in the inventory of a company using IFRS? 6-67 a) Goods held on consignment from another company b) Goods shipped on consignment to another company c) Goods in transit from another company shipped FOB shipping point d) None of the above LO A Look at IFRS IFRS Practice Which method of inventory costing is prohibited under IFRS? 6-68 a) Specific identification b) FIFO c) LIFO d) Average-cost LO COPYRIGHT “Copyright © 2016 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.” 6-69 ... Kieso Financial Accounting, Eighth Edition 6-2 CHAPTER OUTLINE LEARNING OBJECTIVES 6-3 Discuss how to classify and determine inventory Apply inventory cost flow methods and discuss their financial. .. automakers were forced to shut down production for a few days—a loss of tens of thousands of cars Similarly, a major snowstorm halted production at the Canadian plants of Ford A Ford spokesperson... have been given the information listed below Discuss how this information affects the reported cost of inventory Hasbeen included in the inventory goods held on consignment for Falls Co., costing