Chapter 19th Edition Inventory and Cost of Goods Sold Intermediate Accounting James D Stice Earl K Stice PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University © 2014 Cengage Learning 9-1 What Is Inventory? • • • Inventory designates goods held for sale in the normal course of business or, for a manufacturer, also includes goods in production or to be placed into production For some businesses, inventory represents the most active element in business operations The terms raw materials, work in process, and finished goods refer to the inventories of a manufacturing enterprise 9-2 Raw Materials • Raw Materials are goods acquired to use in the production process • The term direct materials is frequently used to refer to materials that will be physically incorporated in the products being manufactured • The term indirect materials is then used to refer to auxiliary materials, that is, materials that are necessary in the production process but not directly incorporated into the product 9-3 Work in Process • Work in Process (WIP) consists of materials partly processed and requiring further work before they can be sold • Work in Process includes three cost elements Direct materials Direct labor Manufacturing overhead 9-4 Finished Goods • Finished goods are the manufactured products awaiting sale • As products are completed, the costs accumulated in the production process are transferred from Work in Process to the Finished Goods Inventory account 9-5 Inventory Systems Two types of inventory systems that keep track of how much inventory has been sold and at what price are: • Periodic inventory system—requires a physical count of the inventory periodically, and at the point of sale only records the sale price • Perpetual inventory system—at point of sale records selling price and type of item sold are recorded Example: a bar code scanning system 9-6 Whose Inventory Is It? • • • As a general rule, goods should be included in the inventory of the business holding legal title The passing of title is a legal term designating the point at which ownership changes Issues that develop: • Goods in transit • Goods on consignment 9-7 Goods on Consignment • • Shipper retains title and includes the goods in inventory until their sale or use by the dealer or customer Consigned goods are properly reported by the shipper at the sum of their costs, and the shipping and handling costs incurred transfer to the dealer or customer 9-8 Conditional Sales, Installment Sales, and Repurchase Agreements • Conditional sales and installment sales contracts may provide a retention of title by the seller until the sales price is fully recovered • As a creative way to obtain cash on a short-term basis, firms sometimes sell inventory to another company but at the same time agree to repurchase the inventory at a future date 9-9 Items Included in Inventory Cost Inventory costs consist of all expenditures, both direct and indirect, relating to acquisition, preparation, and placement for sale • Expenditures that are relatively small and difficult to allocate are period costs These are recognized as expenses in the current period (continued) 9-10 Inventory Turnover If Deere & Co had used FIFO instead of LIFO, inventory turnover for 2009 would have been 4.03 (instead of 5.98 under LIFO), computed as follows: FIFO Cost of Goods Sold $16,212 FIFO Average Inventory $16,255 +($1,324 – $1,367) = $16,212 = $4,020 = 4.03 times (continued) 9-51 Inventory Turnover If Deere & Co had used FIFO instead of LIFO, inventory turnover for 2009 would have been 4.03 (instead of 5.98 under LIFO), computed as follows: FIFO Cost of Goods Sold $16,212 FIFO Average Inventory = $4,020 = 4.03 times ($3,674 + $4,366)/2 = $4,020 9-52 Number of Days’ Sales in Inventory ($3,042 + $2,397)/2 Average Inventory $2,719.5 = Average Daily $44.534 Cost of Goods Sold $16,255/365 Number of days’ sales in inventory = 61.0 (continued) 9-53 Number of Days’ Sales in Inventory Deere’s number of days’ sales in inventory results mean that, on average, Deere & Co has enough inventory to continue operations for 61.0 days using just its existing inventory 9-54 Retail Inventory Method • • The retail inventory method is widely employed by retail firms to arrive at reliable estimates of inventory position whenever desired This method permits the estimation of an inventory amount without the time and expense of taking a physical inventory or maintaining detailed perpetual inventory records 9-55 Retail Inventory Method One One Cost Cost Percentage Percentage Cost Inventory, Jan $50,000 Purchases in January 40,000 Goods available for sale ÷ Cost percentage ($60,000 $90,000 $90,000) = 66.7% Deduct sales for January 65,000 Inventory, January 31, at retail $25,000 Inventory, January 31, at estimated cost ($25,000 × 66.7%) $16,675 (continued) Retail $30,000 30,000 $60,000 9-56 Retail Inventory Method Multiple Multiple Cost Cost Percentages Percentages Cost Inventory, Jan $50,000 Purchases in January 40,000 Goods Cost percentage: available for sale $90,000 Beg inventory ($30,000 + $50,000) = 60.0% Purchases ($30,000 + $40,000) = 75.0% Deduct sales for January 65,000 Inventory, January 31, at retail $25,000 January 31, at estimated cost: Inventory, FIFO ($25,000 × 75.0%) LIFO ($25,000 × 60.0%) $15,000 (continued) Retail $30,000 30,000 $60,000 $18,750 9-57 Retail Inventory Method: Lower of Cost or Market Frequently, retail prices change after they are originally set The following terms are used to describe these changes • Original retail—the initial sales price, including the original increase over cost referred to as the initial markup • Markups—increases that raise sales prices above original retail • Markdowns—decreases that reduce sales prices below original retail 9-58 Dollar-Value LIFO • Under dollar-value LIFO, LIFO layers are determined based on total dollar changes rather than quantity changes • With dollar-value LIFO, the unit of measurement is the dollar • All goods in the inventory pool to which dollar-value LIFO is to be applied are viewed as though they are identical items 9-59 Purchase Commitments • Extreme fluctuations in the price of inventory purchases can expose a company to excessive risk • Of the different ways to manage this risk, the simplest is a purchase commitment that locks in the inventory purchase price in advance • Accounting question: Should the company committing to the future purchase record an asset and a liability at the commitment date? (continued) 9-60 Purchase Commitments • A purchase commitment is an exchange of • promises about future action and is known as an executory contract Rollins Oat Company entered into a purchase commitment on November 1, 2012, for 100,000 bushes of wheat at $3.40 per bushel to be delivered on March 2013 At the end of 2012, the market price for wheat had dropped to $3.20 per bushel (continued) 9-61 Purchase Commitments 2012 Dec 31Loss on Purchase Commitments 20,000 Estimated Loss on Purchase Commitments 20,000 2013 (100,000 bushels × $0.20 per bushel) Mar 31 Estimated Loss on Purchase Commitments Purchases Accounts Payable 340,000 20,000 320,000 9-62 Foreign Currency Inventory Transactions • Only transactions denominated in currencies other than the U.S dollar are foreign currency transactions for U.S companies • If the transaction contract is written in terms of U.S dollars, there is no foreign currency risk whether the other company is based in Azerbaijan or Zimbabwe 9-63 Chapter ₵ The The End End $ 9-64 9-65 ... title and includes the goods in inventory until their sale or use by the dealer or customer Consigned goods are properly reported by the shipper at the sum of their costs, and the shipping and handling... Agreements • Conditional sales and installment sales contracts may provide a retention of title by the seller until the sales price is fully recovered • As a creative way to obtain cash on a short-term... period Example: A purchase of $10,000 provides for payment on a 2/10, n/30 basis If the buyer pays by the 10th day, $9,800 settles the invoice After that, the full $10,000 is required (continued)