Reporting and Analyzing Inventory

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Chapter 6

• Reporting and Analyzing Inventory
• Including Appendix 6A (perpetual LIFO and FIFO)
  and Appendix 6B (Inventory Errors)

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Merchandise and Manufacturing Inventory

• Merchandise inventory
• owned by the company
• in form ready to sale to customers
• Manufacturing inventory
• Finished goods inventory ready for sale
• Work in process in production, not complete
• Raw materials goods to be used in production

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Perpetual v. Periodic Inventory

• Perpetual system
• Information about merchandise on hand and cost
  of goods sold is available every time a sale is
  made
• Periodic system
• No attempt is made on date of sale to record the
  cost of merchandise sold
• A physical count of inventory is taken at end of
  period to determine
• Cost of merchandise on hand
• Cost of goods sold

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Merchandise Purchases-Periodic
On May 4 the company bought 3,800 worth of
merchandise from PW Audio Supply, Inc.
May 4 3800

Accounts Payable
Cash
Freight-In
May 4 3,800
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Purchases Returns and Allowances - Periodic
On May 8 the company returned 300 worth of
merchandise to PW Audio Supply, Inc.
May 4 3800

Accounts Payable
Cash
Freight-In
May 4 3,800
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Freight - In Periodic
On May 9 the company paid 150 to have the
merchandise inventory delivered to them.
Purchase Returns All.
Purchase Discounts
Purchases
May 4 3800
May 8 300

Accounts Payable
Cash
Freight-In
May 4 3,800
May 8 300
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Purchases Discounts
Review - Company purchased 3800 of merchandise
and returned 300. The credit terms are 2/10,
n/30 and the invoice was paid within the discount
period. Original Invoice
3,800 -Returns
300 Amount due before discount
3,500 2 discount
70 Net due
3,430
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Sales Revenues - Periodic System

• Sales are recorded when earned (revenue
  recognition principle)
• Recording must be supported by a business
  document (written evidence)
• Only 1 entry is made for each sale
• one to record sale

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Sales Returns and Allowances

• Flip side of purchase returns and allowance

On buyers books GENERAL JOURNAL
Debit
Credit May 8 Accounts Payable
300
Purchase Returns and Allowances
300
To record goods returned that were purchased
on account
On sellers books GENERAL JOURNAL
Debit
Credit May 8 Sales Returns and Allowance
300
Accounts Receivable
300
To record return of goods delivered to Sauk
Stero
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Sales - Under a Periodic System Assume a sale of
3,800 on Account
May 4 3,800

May 4 3,800
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Sales Returns and Allowances Account

• Contra Revenue Account to sales
• Used to show how much came in on returns and
  allowances

• Excessive returns and allowances suggest
• inferior merchandise
• inefficiencies in filing orders
• errors in billing customers
• mistakes in delivery or shipment of goods

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Sales Discount Account

• Contra Revenue Account to sales
• Used to disclose amount of cash discounts taken
  by customers

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Sales Discounts

• Flip side of purchase discounts

On buyers books GENERAL JOURNAL
Debit
Credit May 14 Accounts Payable
3,500



Cash

3,430 Purchase discounts
70
To record payment within discount
period
On sellers books GENERAL JOURNAL
Debit
Credit May 14 Cash
3,430 Sales
Discounts 70
Accounts Receivable
3500
To record collection within
discount period
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Net Purchases Periodic System
Purchases
325,000 Less Purchase
returns and allowances 10,400 Purchase
discounts 6,800 17,200 Net purchases
307,800

• Net Purchases are gross purchases adjusted for
  returns and discounts.

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Cost of Goods Purchased
Illustration 6-3
Purchases
325,000 Less Purchase
returns and allowances 10,400 Purchase
discounts 6,800 17,200 Net purchases 307,800
Add Freight-in 12,200 Cost of goods
purchased 320,000
Cost of goods purchased is net purchases plus
freight-in.
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Taking a Physical Inventory

• Determining inventory quantities by counting,
  weighting or measuring each type of inventory.
• Determining ownership of goods, including goods
  in transit,consigned goods
• Goods in transit belong to the one with legal
  title
• Consigned goods holding goods for another
  party without taking ownership of goods will get
  a fee for selling the goods

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Shipping Terms

• FOB (free on board) shipping point- ownership of
  goods passes to buyer when public carrier accepts
  the goods
• FOB (free on board) destination- ownership of
  goods remains with the seller until the goods
  reach the buyer

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Perpetual v. Periodic SystemIncome Statement
Presentation

• Review differences on page 249
• The income statement for a merchandising company
  is the same whether a periodic or perpetual
  inventory system is used, except for the cost of
  goods sold section

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Select Buy, INC.Income Statement
(Perpetual)For the Year Ended December 31, 2001
Illustration 5-3
Sales revenues Sales 480,000 Less Sales
returns and allowance 12,000 Sales
discounts 8,000
20,000 Net sales 460,000 Cost of goods
sold 316,000 Gross profit
144,000 Operating expenses Selling
expenses Store salaries expense
45,000 Advertising expense
16,000 Depreciation
expense 8,000
Freight-out
7,000 Total selling
expenses 76,000 Administrative expenses
Salaries expense
19,000 Utilities expense
17,000 Insurance
Expense
2,000 Total administrative expenses
38,000 Total
operating expenses 114,000 Income from
operations 30,000
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Income Statement (Periodic)
Illustration 6-6
Sales revenues Sale 480,000 Less Sales
returns and allowance 12,000 Sales
discounts 8,000
20,000 Net sales 460,000 Cost of goods
sold Inventory, January 36,000 Purchases

325,000 Less Purchase returns and
allowances
10,400 Purchase discounts
6,800 17,200 Net Purchases

307,800 Add Freight-in
12,200 Cost
of goods purchased 320,000 Cost of goods
available for sale
356,000 Inventory, December 31

40,000 Cost of goods sold
316,000 Gross profit
144,000 Operating expenses

114,000 Net Income
30,000

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Inventory Costing

• Specific Identification method
• Cost Flow Assumptions
• Needed at times of changing prices
• FIFO- First-in, First-Out- earliest goods
  purchased first to be sold
• LIFO- Last-in,First-Out- latest goods purchased
  the first to be sold
• Average Cost Method- costs are charged on the
  basis of weighted average unit cost
• EXAMPLE

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Cost flow assumptions

• The FIFO method assumes the earliest goods
  purchased are the first to be sold
• The LIFO method assumes the latest goods
  purchased are the first to be sold
• The average cost method assumes that goods
  available for sale are homogeneous.The
  allocation of the cost of goods available for
  sale is made on the basis of the weighted average
  unit cost incurred

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Factors Used in Selecting an Inventory Cost Method
Income statement effects Balance sheet
effects Tax Effects
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Income Statement Effects

• In periods of increasing prices
• FIFO reports the highest net income
• LIFO the lowest
• Average cost falls in the middle
• In periods of decreasing prices
• FIFO will report the lowest net income
• LIFO the highest
• Average cost falls in the middle

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Balance Sheet Effects

• In a period of increasing prices costs allocated
  to ending inventory using
• FIFO will approximate current costs
• LIFO will be understated
• Most companies prefer LIFO
• Higher cost of goods sold
• Lower net income
• Lower income taxes

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The Lower of Cost or Market (LCM) Principle

• When the value of inventory is lower than its
  cost, the inventory is written down to its market
  value by valuing the inventory at the lower of
  cost or market (current replacement cost)in the
  period in which the price decline occurs.
• LCM
• departure from cost principle
• follows conservatism concept
• can be used only after one of the cost flow
  methods (Specific Identification FIFO, LIFO, or
  Average Cost)
• is used to value ending inventory

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Inventory Ratios

• Inventory turnover Cost of goods sold/Average
  inventory
• Days in inventory 365/Inventory turnover ratio

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LIFO Reserve

• Accounting standards require firms using LIFO to
  report the amount by which inventory would be
  increased (or on occasion decreased) if the firm
  had instead been using FIFO.
• This amount is referred to as the LIFO reserve.
  Reporting the LIFO reserve enables analysts to
  make adjustments to compare companies that use
  different cost flow methods.
• Illustrations 6-21 and 6-22

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