Chapter 6-1 Chapter Inventories Chapter 6-2 Accounting Principles, Ninth Edition Study Study Objectives Objectives Describe the steps in determining inventory quantities Explain the accounting for inventories and apply the inventory cost flow methods Explain the financial effects of the inventory cost flow assumptions Explain the lower-of-cost-or-market basis of accounting for inventories Indicate the effects of inventory errors on the financial statements Compute and interpret the inventory turnover ratio Chapter 6-3 Reporting Reporting and and Analyzing Analyzing Inventory Inventory Classifying Classifying Inventory Inventory Determining Determining Inventory Inventory Quantities Quantities Finished goods Work in process Raw materials Taking a physical inventory Determining ownership of goods Chapter 6-4 Inventory Inventory Costing Costing Specific identification Cost flow assumptions Financial statement and tax effects Consistent use Lower-ofcost-ormarket Inventory Inventory Errors Errors Income statement effects Balance sheet effects Statement Statement Presentation Presentation and andAnalysis Analysis Presentation Analysis Classifying Classifying Inventory Inventory Merchandising Company One Classification: Merchandise Inventory Manufacturing Company Three Classifications: Raw Materials Work in Process Finished Goods Regardless of the classification, companies report all inventories under Current Assets on the balance sheet Chapter 6-5 Chapter 6-6 Determining Determining Inventory Inventory Quantities Quantities Physical Inventory taken for two reasons: Perpetual System Check accuracy of inventory records Determine amount of inventory lost (wasted raw materials, shoplifting, or employee theft) Periodic System Determine the inventory on hand Determine the cost of goods sold for the period Chapter 6-7 SO Describe the steps in determining inventory quantities Determining Determining Inventory Inventory Quantities Quantities Taking a Physical Inventory Involves counting, weighing, or measuring each kind of inventory on hand Taken, when the business is closed or when business is slow at end of the accounting period Chapter 6-8 SO Describe the steps in determining inventory quantities Determining Determining Inventory Inventory Quantities Quantities 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 Chapter 6-9 SO Describe the steps in determining inventory quantities Determining Determining Inventory Inventory Quantities Quantities Terms of Sale Illustration 6-1 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 Chapter 6-10 SO Describe the steps in determining inventory quantities Inventory Inventory Errors Errors Review Question Understating ending inventory will overstate: a assets b cost of goods sold c net income d owner's equity Chapter 6-40 SO Indicate the effects of inventory errors on the financial statements Inventory Inventory Errors Errors Balance Sheet Effects Effect of inventory errors on the balance sheet is determined by using the basic accounting equation: Illustration 6-16 Illustration 6-19 Chapter 6-41 SO Indicate the effects of inventory errors on the financial statements Statement Statement Presentation Presentation and and Analysis Analysis Presentation Balance Sheet - 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 LCM), and 3) costing method (FIFO, LIFO, or average) Chapter 6-42 Statement Statement Presentation Presentation and and Analysis Analysis Analysis Inventory management is a double-edged sword High Inventory Levels - may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage) Low Inventory Levels – may lead to stockouts and lost sales Chapter 6-43 SO Compute and interpret the inventory turnover ratio Statement Statement Presentation Presentation and and Analysis Analysis Inventory turnover measures the number of times on average the inventory is sold during the period Inventory Turnover = Cost of Goods Sold Average Inventory Days in inventory measures the average number of days inventory is held Days in Year (365) Days in = Inventory Inventory Turnover Chapter 6-44 SO Compute and interpret the inventory turnover ratio Statement Statement Presentation Presentation and and Analysis Analysis Illustration: Wal-Mart reported in its 2008 annual report a beginning inventory of $33,685 million, an ending inventory of $35,180 million, and cost of goods sold for the year ended January 31, 2008, of $286,515 million The inventory turnover formula and computation for Wal-Mart are shown below Illustration 6-21 Days in Inventory: Inventory turnover of 8.3 times divided into 365 is approximately 44 days This is the approximate time that it takes a company to sell the inventory Chapter 6-45 SO Compute and interpret the inventory turnover ratio Cost Cost Flow Flow Methods Methods in in Perpetual Perpetual Systems Systems Example Appendix Appendix 6A 6A Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and Average cost Chapter 6-46 SO Apply the inventory cost flow methods to perpetual inventory records Cost Cost Flow Flow Methods Methods in in Perpetual Perpetual Systems Systems “First-In-First-Out (FIFO)” Cost of Goods Sold Chapter 6-47 Illustration 6A-2 Ending Inventory SO Apply the inventory cost flow methods to perpetual inventory records Cost Cost Flow Flow Methods Methods in in Perpetual Perpetual Systems Systems “Last-In-First-Out (LIFO)” Cost of Goods Sold Chapter 6-48 Illustration 6A-3 Ending Inventory SO Apply the inventory cost flow methods to perpetual inventory records Cost Cost Flow Flow Methods Methods in in Perpetual Perpetual Systems Systems “Average Cost” (Moving-Average System) Illustration 6A-4 Cost of Goods Sold Chapter 6-49 Ending Inventory SO Apply the inventory cost flow methods to perpetual inventory records Estimating Estimating Inventories Inventories Gross Profit Method The gross profit method estimates the cost of ending inventory by applying a gross profit rate to net sales Illustration 6B-1 Chapter 6-50 SO Describe the two methods of estimating inventories Estimating Estimating Inventories Inventories Illustration: Kishwaukee Company’s records for January show net sales of $200,000, beginning inventory $40,000, and cost of goods purchased $120,000 The company expects to earn a 30% gross profit rate Compute the estimated cost of the ending inventory at January 31 under the gross profit method Illustration 6B-2 Chapter 6-51 SO Describe the two methods of estimating inventories Estimating Estimating Inventories Inventories Retail Inventory Method Company applies the cost-to-retail percentage to ending inventory at retail prices to determine inventory at cost Illustration 6B-3 Chapter 6-52 SO Describe the two methods of estimating inventories Estimating Estimating Inventories Inventories Illustration: Illustration 6B-4 Note that it is not necessary to take a physical inventory to determine the estimated cost of goods on hand at any given time Chapter 6-53 SO Describe the two methods of estimating inventories 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 6-54 .. .Chapter Inventories Chapter 6-2 Accounting Principles, Ninth Edition Study Study Objectives Objectives Describe the steps in determining inventory quantities Explain the accounting. .. lower-of-cost-or-market basis of accounting for inventories Indicate the effects of inventory errors on the financial statements Compute and interpret the inventory turnover ratio Chapter 6-3 Reporting... classification, companies report all inventories under Current Assets on the balance sheet Chapter 6-5 Chapter 6-6 Determining Determining Inventory Inventory Quantities Quantities Physical Inventory