Accounting Principles Thirteenth Edition Weygandt Kimmel Kieso Chapter Inventories Prepared by Coby Harmon University of California, Santa Barbara Westmont College Chapter Outline Learning Objectives LO Discuss how to classify and determine inventory LO Apply inventory cost flow methods and discuss their financial effects LO Indicate the effects of inventory errors on the financial statements LO Explain the statement presentation and analysis of inventory Copyright ©2018 John Wiley & Son, Inc Classifying and Determining Inventory Classifying Inventory Merchandising Company One Classification: • Inventory LO Manufacturing Company Three Classifications: • Raw Materials • Work in Process Finished Goods Copyright â2018 John Wiley & Son, Inc 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 Determine the inventory on hand Determine the cost of goods sold for the period LO Copyright ©2018 John Wiley & Son, Inc Determining Inventory Quantities Taking a Physical Inventory Involves counting, weighing, or measuring each kind of inventory on hand Companies often “take inventory” when business is closed or business is slow at the end of accounting period LO Copyright ©2018 John Wiley & Son, Inc Determining Inventory Quantities Determining Ownership of Goods Goods in Transit Purchased goods not yet received Sold goods not yet delivered Included in inventory of company that has legal title to goods LO Copyright ©2018 John Wiley & Son, Inc Goods in Transit Ownership of goods passes to buyer when public carrier accepts goods from seller Ownership of goods remains with seller until the goods reach buyer ILLUSTRATION 6.2 Terms of sale LO Freight costs incurred by the seller are an operating expense Copyright ©2018 John Wiley & Son, Inc Goods in Transit Goods in transit should be included in the inventory of the buyer when the: a public carrier accepts the goods from the seller b goods reach the buyer c terms of sale are FOB destination d terms of sale are FOB shipping point LO Copyright ©2018 John Wiley & Son, Inc Determining Ownership of Goods Consigned Goods To hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership of the goods Many car, boat, and antique dealers sell goods on consignment, why? LO Copyright ©2018 John Wiley & Son, Inc DO IT! Rules of Ownership Hasbeen Company completed its inventory count It arrived at a total inventory value of $200,000 As a new member of Hasbeen’s accounting department, you 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 $15,000 The company did not include in the count purchased goods of $10,000 which were in transit (terms: FOB shipping point) The company did not include in the count sold inventory with a cost of $12,000 which was in transit (terms: FOB shipping point) Inventory = $200,000 - $15,000 + $10,000 = $195,000 LO Copyright ©2018 John Wiley & Son, Inc 10 DO IT! Inventory Turnover Early in 2020, Westmoreland Company switched to a just-in-time inventory system Its sales revenue, cost of goods sold, and inventory amounts for 2019 and 2020 are shown below 2019 2020 Sales revenue $2,000,000 $1,800,000 Cost of goods sold 1,000,000 910,000 Beginning inventory 290,000 210,000 Ending inventory 210,000 50,000 Determine the inventory turnover and days in inventory for 2019 and 2020 LO Copyright ©2018 John Wiley & Son, Inc 48 DO IT! Inventory Turnover 2019 2020 Sales revenue $2,000,000 $1,800,000 Cost of goods sold 1,000,000 910,000 Beginning inventory 290,000 210,000 Ending inventory 210,000 50,000 Inventory turnover Days in inventory LO 2019 2020 $1,000,000 $910,000 =4 ($290,000 + $210,000)/2 ($210,000 + $50,000)/2 365 ÷ = 91.3 Days 365 ÷ = 52.1 Days Copyright ©2018 John Wiley & Son, Inc =7 49 Inventory Methods and the Perpetual System Appendix 6A ILLUSTRATION 6A.1 Inventoriable units and costs HOUSTON ELECTRONICS Date 1/1 4/15 8/24 9/10 11/27 Explanation Beginning inventory Purchase Purchase Sale Purchase Units 100 200 300 550 400 Unit Cost $10 11 12 Total Cost $ 1,000 2,200 3,600 13 5,200 $12,000 Balance in Units 100 300 600 50 450 Illustration: Compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and average-cost LO Copyright ©2018 John Wiley & Son, Inc 50 First-In, First-Out (FIFO) Cost of Goods Sold Date 1/1 4/15 Purchases (200 @ $11) $2,200 8/ 24 (300 @ $12) $3,600 9/10 11/27 LO (400 @ $13) $5,200 (100 @ $10) (200 @ $11) (250 @ $12) $6,200 Copyright ©2018 John Wiley & Son, Inc ILLUSTRATION 6A.2 Perpetual system—FIFO Inventory Balance (100 @ $10) $1,000 (100 @ $10) $3,200 (200 @ $11) (100 @ $10) (200 @ $11) $6,800 (300 @ $12) ( 50 @ $12) $600 ( 50 @ $12) (400 @ $13) $5,800 51 Last-In, First-Out (FIFO) Cost of Goods Sold Date 1/1 4/15 Purchases (200 @ $11) $2,200 8/ 24 (300 @ $12) $3,600 9/10 11/27 LO (400 @ $13) $5,200 (300 @ $12) (200 @ $11) ( 50 @ $10) $6,300 Copyright ©2018 John Wiley & Son, Inc ILLUSTRATION 6A.3 Perpetual system—LIFO Inventory Balance (100 @ $10) $1,000 (100 @ $10) $3,200 (200 @ $11) (100 @ $10) (200 @ $11) $6,800 (300 @ $12) ( 50 @ $10) $500 ( 50 @ $10) (400 @ $13) $5,700 52 Moving Average Date 1/1 4/15 8/ 24 9/10 11/27 LO Cost of Goods Sold Purchases (200 @ $11) $2,200 (300 @ $12) $3,600 (400 @ $13) ILLUSTRATION 6A.4 Perpetual system—moving-average method $5,200 (550 @ $11.33) $6,233 Copyright ©2018 John Wiley & Son, Inc Inventory Balance (100 @ $10) $1,000 (300 @ $10.67) $3,200 (600 @ $11.33) $6,800 (50 @ $11.33) $567 (450 @ $12.82) $5,767 53 Appendix 6B Estimating Inventories Gross Profit Method A method of estimating the cost of ending inventory by applying a gross profit rate to net sales ILLUSTRATION 6B.1 Gross profit method formulas LO Step 1: Net Sales Step 2: Cost of Goods Available for Sale - Estimated Gross Profit - Estimated Cost of Goods Sold Copyright ©2018 John Wiley & Son, Inc = Estimated Cost of Goods Sold = Estimated Cost of Ending Inventory 54 Gross Profit Method Illustration: Kishwaukee Company records show net sales of $200,000, beginning inventory $40,000, and cost of goods purchased $120,000 In the preceding year, the company realized a 30% gross profit rate It expects to earn the same rate this year Compute the estimated cost of the ending inventory at January 31 under the gross profit method LO Copyright ©2018 John Wiley & Son, Inc 55 Gross Profit Method ILLUSTRATION 6B.2 Examples of gross profit method Illustration: Compute the estimated cost of the ending inventory at January 31 under the gross profit method LO Step 1: Net sales Less: Estimated gross profit (30% × $200,000) Estimated cost of goods sold $200,000 60,000 $140,000 Step 2: Beginning inventory Cost of goods purchased Cost of goods available for sale Less: Estimated cost of goods sold Estimated cost of ending inventory $ 40,000 120,000 160,000 140,000 $ 20,000 Copyright ©2018 John Wiley & Son, Inc 56 Retail Inventory Method • Retail companies establish a relationship between cost and sales price • Applies cost-to-retail percentage to ending inventory at retail prices to determine inventory at cost Inventory = Ending at Retail Step 1: Goods Available for Sale at Retail - Step 2: Goods Available for Sale at Cost Available = ÷ Goods for Sale at Retail Step 3: LO Ending Inventory at Retail x ILLUSTRATION 6B.3 Retail inventory method formulas Net Sales Cost-toRetail Ratio Copyright ©2018 John Wiley & Son, Inc Cost-toRetail Ratio Cost of = Estimated Ending Inventory 57 Retail Inventory Method Illustration: It is not necessary to take a physical inventory to determine the estimated cost of goods on hand Beginning inventory Goods purchased Goods available for sale Less: Net sales Step (1) Ending inventory at retail = At Cost $14,000 61,000 $75,000 At Retail $ 21,500 78,500 100,000 70,000 $ 30,000 Step (2) Cost-to-retail ratio = $75,000 ÷ $100,000 = 75% Step (3) Estimated cost of ending inventory = $30,000 x 75% = $22,500 ILLUSTRATION 6B.4 Application of retail inventory LO Copyright ©2018 John Wiley & Son, Inc 58 A Look at IFRS Key Points Similarities IFRS and GAAP account for inventory acquisitions at historical cost and value inventory at the lower-of-cost-or-net-realizable value 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 LO Copyright ©2018 John Wiley & Son, Inc 59 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 LO Copyright ©2018 John Wiley & Son, Inc 60 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 LO Copyright ©2018 John Wiley & Son, Inc 61 Copyright Copyright © 2018 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States 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 Copyright ©2018 John Wiley & Son, Inc 62 ... hand Companies often “take inventory” when business is closed or business is slow at the end of accounting period LO Copyright ©2018 John Wiley & Son, Inc Determining Inventory Quantities Determining... inventory count It arrived at a total inventory value of $200,000 As a new member of Hasbeen’s accounting department, you have been given the information listed below Discuss how this information... d gross profit method LO Copyright ©2018 John Wiley & Son, Inc 29 DO IT! Cost Flow Methods The accounting records of Shumway Ag Implements show the following data Beginning inventory 4,000 units