Accounting principles 10e by kieso chapter 06

6-1 CHAPTER6 Inventories 6-2 PreviewofCHAPTER6 6-3 Classifying Inventory Merchandising Company One Classification:  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 6-4 6-5 Determining Inventory 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 6-6 SO Describe the steps in determining inventory quantities Determining Inventory Quantities 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 end of the accounting period SO Describe the steps in determining inventory quantities 6-8 Determining Inventory 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 6-9 SO Describe the steps in determining inventory quantities Determining Inventory Quantities Goods in Transit 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 6-10 APPENDIX6B Estimating Inventories Gross Profit Method Estimates the cost of ending inventory by applying a gross profit rate to net sales Illustration 6B-1 6-51 SO Describe the two methods of estimating inventories Estimating 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 6-52 SO Describe the two methods of estimating inventories Estimating 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 6-53 SO Describe the two methods of estimating inventories Estimating 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 6-54 SO Describe the two methods of estimating inventories Key Points 6-55  The requirements for accounting for and reporting inventories are more principles-based under IFRS That is, GAAP provides more detailed guidelines in inventory accounting  The definitions for inventory are essentially similar under IFRS and GAAP Both define inventory as assets held-forsale in the ordinary course of business, in the process of production for sale (work in process), or to be consumed in the production of goods or services (e.g., raw materials) Key Points 6-56  Who owns the goods—goods in transit or consigned goods —as well as the costs to include in inventory, are accounted for the same under IFRS and GAAP  Both GAAP and IFRS permit specific identification where appropriate IFRS actually requires that the specific identification method be used where the inventory items are not interchangeable (i.e., can be specifically identified) If the inventory items are not specifically identifiable, a cost flow assumption is used GAAP does not specify situations in which specific identification must be used Key Points 6-57  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  IFRS requires companies to use the same cost flow assumption for all goods of a similar nature GAAP has no specific requirement in this area Key Points  6-58 In the lower-of-cost-or-market test for inventory valuation, IFRS defines market as net realizable value Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and estimated selling expenses In other words, net realizable value is the best estimate of the net amounts that inventories are expected to realize GAAP, on the other hand, defines market as essentially replacement cost Key Points  6-59 Under GAAP, if inventory is written down under the lower-ofcost-or-market valuation, the new value becomes its cost basis As a result, the inventory may not be written back up to its original cost in a subsequent period Under IFRS, the write-down may be reversed in a subsequent period up to the amount of the previous write-down Both the write-down and any subsequent reversal should be reported on the income statement as an expense An item-by-item approach is generally followed under IFRS Key Points 6-60  Unlike property, plant, and equipment, IFRS does not permit the option of valuing inventories at fair value As indicated above, IFRS requires inventory to be written down, but inventory cannot be written up above its original cost  Similar to GAAP, certain agricultural products and mineral products can be reported at net realizable value using IFRS Looking to the Future One convergence issue relates to the use of the LIFO cost flow assumption IFRS specifically prohibits its use Conversely, the LIFO cost flow assumption is widely used in the United States because of its favorable tax advantages With a new conceptual framework being developed, it is highly probable that the use of the concept of conservatism will be eliminated Similarly, the concept of “prudence” in the IASB literature will also be eliminated This may ultimately have implications for the application of the lower-of-cost-or-net realizable value 6-61 IFRS Self-Test Questions Which of the following should not be included in the inventory of a company using IFRS? 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 6-62 IFRS Self-Test Questions Which method of inventory costing is prohibited under IFRS? a) Specific identification b) FIFO c) LIFO d) Average-cost 6-63 IFRS Self-Test Questions Specific identification: a) must be used under IFRS if the inventory items are not interchangeable b) cannot be used under IFRS c) cannot be used under GAAP d) must be used under IFRS if it would result in the most conservative net income 6-64 Copyright “Copyright © 2011 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.” 6-65 .. .CHAPTER6 Inventories 6-2 PreviewofCHAPTER6 6-3 Classifying Inventory Merchandising Company One Classification: ... Determining Ownership of Goods Consigned Goods 6-12  Goods held for sale by one party  Ownership of the goods is retained by another party SO Describe the steps in determining inventory quantities... Explain the basis of accounting for inventories and apply the inventory cost flow methods Inventory Costing Average Cost Illustration 6-10 6-27 SO Explain the basis of accounting for inventories