After completing this chapter you should be able to: Identify major classifications of inventory, distinguish between perpetual and periodic inventory systems, identify the effects of inventory errors on the financial statements, understand the items to include as inventory cost, describe and compare the cost flow assumptions used to account for inventories...and other contents.
Chapter 8-1 CHAPTER VALUATION OF INVENTORIES: A COST-BASIS APPROACH Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield Chapter 8-2 Learning Objectives Learning Objectives Identify major classifications of inventory Distinguish between perpetual and periodic inventory systems Identify the effects of inventory errors on the financial statements Understand the items to include as inventory cost Describe and compare the cost flow assumptions used to account for inventories Explain the significance and use of a LIFO reserve Understand the effect of LIFO liquidations Explain the dollarvalue LIFO method Identify the major advantages and disadvantages of LIFO 10 Understand why companies select given inventory methods Chapter 8-3 Valuation of Inventories: Valuation of Inventories: CostBasis Approach CostBasis Approach Inventory Issues Classification Cost flow Control Basic inventory valuation Chapter 8-4 Physical Goods Included in Inventory Goods in transit Consigned goods Special sales agreements Inventory errors Costs Included in Inventory Product costs Period costs Purchase discounts Cost Flow Assumptions Specific identification Average cost FIFO LIFO LIFO: Special Issues LIFO reserve LIFO liquidation Dollar-value LIFO Comparison of LIFO approaches Advantages of LIFO Disadvantages of LIFO Basis for Selection Summary of inventory valuation methods Inventory Issues Inventory Issues Classification Inventories are: items held for sale, or goods to be used in the production of goods to be sold Businesses with Inventory: Merchandiser Chapter 8-5 or Manufacturer LO 1 Identify major classifications of inventory Inventory Issues Inventory Issues Classification Illustration 81 One inventory account Purchase goods ready for sale Chapter 8-6 LO 1 Identify major classifications of inventory Inventory Issues Inventory Issues Classification Illustration 81 Three accounts Raw materials Work in process Finished goods Chapter 8-7 LO 1 Identify major classifications of inventory Inventory Issues Inventory Issues Inventory Cost Flow Chapter 8-8 Illustration 82 LO 1 Identify major classifications of inventory Inventory Issues Inventory Issues Inventory Cost Flow Illustration 83 Companies use one of two types of systems for maintaining inventory records — perpetual system or periodic system Chapter 8-9 LO 1 Identify major classifications of inventory Inventory Cost Flow Inventory Cost Flow Perpetual System Purchases of merchandise are debited to Inventory Freightin is debited to Inventory. Purchase returns and allowances and purchase discounts are credited to Inventory Cost of goods sold is debited and Inventory is credited for each sale Subsidiary records show quantity and cost of each type of inventory on hand The perpetual inventory system provides a continuous record of Inventory and Cost of Goods Sold Chapter 8-10 LO 2 Distinguish between perpetual and periodic inventory systems LastIn, FirstOut (LIFO) LastIn, FirstOut (LIFO) Periodic Method Illustration 817 The cost of the total quantity sold or issued during the month comes from the most recent purchases Chapter 8-41 Solution on notes page LO 5 Describe and compare the cost flow assumptions used to account for inventories LastIn, FirstOut (LIFO) LastIn, FirstOut (LIFO) Perpetual Method Illustration 818 The LIFO method results in different ending inventory and cost of goods sold amounts than the amounts calculated under the periodic method Chapter 8-42 Solution on notes page LO 5 Describe and compare the cost flow assumptions used to account for inventories Special Issues Related to LIFO Special Issues Related to LIFO LIFO Reserve Many companies use LIFO for tax and external financial reporting purposes FIFO, average cost, or standard cost system for internal reporting purposes Reasons: Chapter 8-43 Pricing decisions Record keeping easier Profitsharing or bonus arrangements LIFO troublesome for interim periods LO 6 Explain the significance and use of a LIFO reserve Special Issues Related to LIFO Special Issues Related to LIFO LIFO Reserve is the difference between the inventory method used for internal reporting purposes and LIFO. Example: FIFO value per books LIFO value LIFO Reserve $160,000 145,000 $ 15,000 Journal entry to reduce inventory to LIFO: Cost of goods sold 15,000 Allowance to reduce inventory to LIFO 15,000 Companies should disclose either the LIFO reserve or the replacement cost of the inventory Chapter 8-44 LO 6 Explain the significance and use of a LIFO reserve Special Issues Related to LIFO Special Issues Related to LIFO LIFO Liquidation Older, low cost inventory is sold resulting in a lower cost of goods sold, higher net income, and higher taxes. Illustration: Basler Co. has 30,000 pounds of steel in its inventory on December 31, 2010, with cost determined on a specific goods LIFO approach Chapter 8-45 LO 7 Understand the effect of LIFO liquidations Special Issues Related to LIFO Special Issues Related to LIFO LIFO Liquidation Illustration: At the end of 2011, only 6,000 pounds of steel remained in inventory Illustration 821 Chapter 8-46 LO 7 Understand the effect of LIFO liquidations Special Issues Related to LIFO Special Issues Related to LIFO DollarValue LIFO Changes in a pool are measured in terms of total dollar value, not physical quantity Advantage: Broader range of goods in pool Permits replacement of goods that are similar Helps protect LIFO layers from erosion Chapter 8-47 LO 8 Explain the dollarvalue LIFO method Special Issues Related to LIFO Special Issues Related to LIFO DollarValue LIFO Exercise 826 (partial): The following information relates to the Choctaw Company Use the dollarvalue LIFO method to compute the ending inventory for 2007 through 2009. Chapter 8-48 LO 8 Explain the dollarvalue LIFO method Special Issues Related to LIFO Special Issues Related to LIFO Exercise 826 Solution I nve nt o r y a t I nve nt o r y a t $ Va lue End o f Ye a r Ba s e Ye a r Ba s e $ Va lue LI FO LI FO Re s e r ve Ye a r Pr ic e s I nd e x Pr ic e s La y e r s I nd e x LI FO T O T AL 2007 $ 7 , 0 1 0 $ 7 , 0 $ 7 , 0 1 0 $ 7 , 0 $ 7 , 0 $ 2008 8 , 0 1 8 , 0 7 , 0 1 0 7 , 0 1 , 0 1 1 , 0 8 , 0 3 , 0 7 , 0 1 0 7 , 0 1 , 0 1 1 , 0 8 , 0 1 , 2009 9 , 1 Ba la nc e S h e e t I nve nt or y LI FO Re s e r ve J our na l e nt r y C os t of g oo d s s old Lif o r e s e r ve Chapter 8-49 8 , 0 De c 2007 $ 70, 000 $ 70, 000 De c 2008 $ 8 , 0 ( , 0 ) $ 8 , 0 De c 2009 $ 9 , ( , ) $ 8 , 0 3 , 0 ( , 0 ) 9 , ( , ) LO 8 Explain the dollarvalue LIFO method Special Issues Related to LIFO Special Issues Related to LIFO Exercise 826 Solution I nve nt o r y a t I nve nt o r y a t $ Va lue End o f Ye a r Ba s e Ye a r Ba s e $ Va lue LI FO LI FO Re s e r ve Ye a r Pr ic e s I nd e x Pr ic e s La y e r s I nd e x LI FO T O T AL 2007 $ 7 , 0 1 0 $ 7 , 0 $ 7 , 0 1 0 $ 7 , 0 $ 7 , 0 $ 2008 8 , 0 1 8 , 0 7 , 0 1 0 7 , 0 1 , 0 1 1 , 0 8 , 0 3 , 0 7 , 0 1 0 7 , 0 1 , 0 1 1 , 0 8 , 0 1 , 2009 9 , 1 Ba la nc e S h e e t I nve nt or y LI FO Re s e r ve J our na l e nt r y C os t of g oo d s s old Lif o r e s e r ve Chapter 8-50 8 , 0 De c 2007 $ 70, 000 $ 70, 000 De c 2008 $ 8 , 0 ( , 0 ) $ 8 , 0 De c 2009 $ 9 , ( , ) $ 8 , 0 3 , 0 ( , 0 ) 9 , ( , ) LO 8 Explain the dollarvalue LIFO method Special Issues Related to LIFO Special Issues Related to LIFO Exercise 826 Solution I nve nt o r y a t I nve nt o r y a t $ Va lue End o f Ye a r Ba s e Ye a r Ba s e $ Va lue LI FO LI FO Re s e r ve Ye a r Pr ic e s I nd e x Pr ic e s La y e r s I nd e x LI FO T O T AL 2007 $ 7 , 0 1 0 $ 7 , 0 $ 7 , 0 1 0 $ 7 , 0 $ 7 , 0 $ 2008 8 , 0 1 8 , 0 7 , 0 1 0 7 , 0 1 , 0 1 1 , 0 8 , 0 3 , 0 7 , 0 1 0 7 , 0 1 , 0 1 1 , 0 8 , 0 1 , 2009 9 , 1 Ba la nc e S h e e t I nve nt or y LI FO Re s e r ve J our na l e nt r y C os t of g oo d s s old Lif o r e s e r ve Chapter 8-51 8 , 0 De c 2007 $ 70, 000 $ 70, 000 De c 2008 $ 8 , 0 ( , 0 ) $ 8 , 0 De c 2009 $ 9 , ( , ) $ 8 , 0 3 , 0 ( , 0 ) 9 , ( , ) LO 8 Explain the dollarvalue LIFO method Special Issues Related to LIFO Special Issues Related to LIFO Comparison of LIFO Approaches Specificgoods LIFO costing goods on a unit basis is expensive and time consuming Specificgoods Pooled LIFO approach reduces record keeping and clerical costs more difficult to erode the layers using quantities as measurement basis can lead to untimely LIFO liquidations Dollarvalue LIFO is used by most companies Chapter 8-52 LO 8 Explain the dollarvalue LIFO method Special Issues Related to LIFO Special Issues Related to LIFO Disadvantages Advantages Matching Reduced earnings Tax Benefits/Improved Cash Flow Inventory understated Future Earnings Hedge Chapter 8-53 Physical flow Involuntary Liquidation / Poor Buying Habits LO 9 Identify the major advantages and disadvantages of LIFO Basis for Selection of Inventory Method Basis for Selection of Inventory Method LIFO is generally preferred: if selling prices are increasing faster than costs and if a company has a fairly constant “base stock.” LIFO is not appropriate: Chapter 8-54 if prices tend to lag behind costs, if specific identification traditionally used, and when unit costs tend to decrease as production increases LO 10 Understand why companies select given inventory methods Copyright Copyright Copyright © 2009 John Wiley & Sons, Inc. 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Identify the major advantages and disadvantages? ?of? ?LIFO 10 Understand why companies select given inventory methods Chapter 8-3 Valuation? ?of? ?Inventories: Valuation? ?of? ?Inventories: CostBasis? ?Approach CostBasis? ?Approach. . .CHAPTER VALUATION OF INVENTORIES: A COST-BASIS APPROACH Intermediate? ?Accounting 13th Edition Kieso, Weygandt, and Warfield Chapter 8-2 Learning Objectives Learning Objectives Identify major classifications? ?of? ?inventory... LO 2 Distinguish between perpetual and periodic inventory systems Basic Issues in Inventory? ?Valuation Basic Issues in Inventory? ?Valuation Valuation Companies must allocate the cost? ?of? ?all the goods available for sale (or use) between the goods that were sold or used and those that are still on hand