Inventories: Measurement

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Inventories Measurement

• CHAPTER 8

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Inventory

• Those assets that a company

1. Intends to sell in the normal course of
business.
2. Has in production for future sale.
3. Uses currently in the production of goods to
be sold.
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Types of Inventories
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Inventory Methods
Periodic Inventory System
The inventory account is adjusted at the end of a
reporting cycle.
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Accounting Entries in a Perpetual System
Returns of inventory are credited to the
inventory account. Discounts on inventory
purchases can be recorded using the gross or net
method.
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Accounting Entries in a Perpetual System
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Periodic Cost of Goods Sold Equation
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Accounting Entries in a Periodic System
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Accounting Entries in a Periodic System
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Accounting Entries in a Periodic System
In addition to Purchases, the contra-purchase
accounts are also closed to COGS at the end of
the period Purchases Discounts Purchase Returns
and Allowances
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Comparison of Inventory Systems
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What is Included in Inventory?

• General Rule
• All goods owned by the company on the inventory
  date, regardless of their location.

Goods in Transit
Goods on Consignment
Depends on FOB shipping terms.
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Expenditures Included in Inventory
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Inventory Cost Flow Methods

• Specific cost identification
• Average cost
• First-in, first-out (FIFO)
• Last-in, first-out (LIFO)

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Specific Cost Identification

• Items are added to inventory at cost when they
  are purchased.
• COGS for each sale is based on the specific cost
  of the item sold.

• The specific cost of each inventory item must be
  known.
• By selecting specific items from inventory at the
  time of sale, income can be manipulated.

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Average Cost Method
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Weighted-Average Periodic Example
The following schedule shows the mouse pad
inventory for Computers, Inc. for September. The
physical inventory count at September 30 shows
800 mouse pads in ending inventory. Use the
periodic weighted-average method to
determine (1) Ending inventory cost. (2)
Cost of goods sold.
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Weighted-AveragePeriodic Example
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Weighted-AveragePeriodic Example
Now, we have to assign costs to ending inventory
and cost of goods sold.
8,370 1,550 5.40 weighted-average
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Weighted-AveragePeriodic Example
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Moving-AveragePerpetual Example
The following schedule shows the mouse pad
inventory for Computers, Inc. for September. The
physical inventory count at September 30 shows
800 mouse pads in ending inventory. Use the
perpetual weighted-average method to
determine (1) Ending inventory cost. (2)
Cost of goods sold.
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Moving-AveragePerpetual Example
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Moving-AveragePerpetual Example
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Moving-AveragePerpetual Example
4,205.00 (1,000-300100) 5.25625
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Moving-AveragePerpetual Example
5,743.75 (800-200150200100) 5.47024
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Moving-AveragePerpetual Example
.
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First-In, First-Out

• The cost of the oldest inventory items are
  charged to COGS when goods are sold.
• The cost of the newest inventory items remain in
  ending inventory.

The FIFO method assumes that items are sold in
the chronological order of their acquisition.
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First-In, First-Out

• Even though the periodic approach and the
  perpetual approach differ in the timing of
  adjustments to inventory . . .
• . . . COGS and Ending Inventory Cost are the same
  under both approaches.

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FIFO - Periodic Example
The following schedule shows the mouse pad
inventory for Computers, Inc. for September. The
physical inventory count at September 30 shows
800 mouse pads in ending inventory. Use the
periodic FIFO method to determine (1) Ending
inventory cost. (2) Cost of goods sold.
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FIFO - Periodic Example
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FIFO - Periodic Example
750
250 x 5.25
1,312.50 3,120
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FIFO - Periodic Example
750
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FIFO - Periodic Example
750
750 x 5.25
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FIFO - Perpetual Example
The following schedule shows the mouse pad
inventory for Computers, Inc. for September. The
physical inventory count at September 30 shows
800 mouse pads in ending inventory. Use the
perpetual FIFO method to determine (1) Ending
inventory cost. (2) Cost of goods sold.
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FIFO - Perpetual Example
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FIFO - Perpetual Example
Note that this is the same COGS computed using
the Periodic approach.
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Last-In, First-Out
Any questions before we run into LIFO?
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Last-In, First-Out

• The cost of the newest inventory items are
  charged to COGS when goods are sold.
• The cost of the oldest inventory items remain in
  inventory.

The LIFO method assumes that the newest items are
sold first, leaving the older units in inventory.
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Last-In, First-Out

• Unlike FIFO, using the LIFO method may result in
  COGS and Ending Inventory Cost that differ under
  the periodic and perpetual approaches.

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LIFO - Periodic Example
The following schedule shows the mouse pad
inventory for Computers, Inc. for September. The
physical inventory count at September 30 shows
800 mouse pads in ending inventory. Use the
periodic LIFO method to determine (1) Ending
inventory cost. (2) Cost of goods sold.
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LIFO - Periodic Example
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LIFO - Periodic Example
200
800 x 5.25
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LIFO - Periodic Example
200
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LIFO - Periodic Example
200
200 x 5.25
1,050 3,120
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LIFO - Perpetual Example
The following schedule shows the mouse pad
inventory for Computers, Inc. for September. The
physical inventory count at September 30 shows
800 mouse pads in ending inventory. Use the
perpetual LIFO method to determine (1) Ending
inventory cost. (2) Cost of goods sold.
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LIFO - Perpetual Example
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LIFO - Perpetual Example
700
In LIFO, we assume that we sell the newest units
in inventory first. In this case, the 300
newest units come from beginning inventory,
leaving 700 units in the beginning inventory
layer.
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LIFO - Perpetual Example
600
700
For the September 10 sale, we must identify the
200 newest units. 100 of them come from the
September 3 purchase. The other 100 come from
beginning inventory. Note that all of the 9/3
units have been sold and only 600 of the
beginning inventory units remain.
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LIFO - Perpetual Example
600
700
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When Prices Are Rising . . .

• LIFO
• Matches high (newer) costs with current (higher)
  sales.
• Inventory is valued based on low (older) cost
  basis.
• Results in lower taxable income.
• Is not officially endorsed by the IASC.

• FIFO
• Matches low (older) costs with current (higher)
  sales.
• Inventory is valued approximates replacement
  cost.
• Results in higher taxable income.

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Decision Makers Perspective
What factors motivate companies to select one
inventory method over another?
How accurate are the timing of reported
income and income taxes?
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LIFO Liquidation
When prices rise . . .
LIFO inventory costs on the balance sheet are
out of date because they reflect old purchase
transactions.
If inventory declines, these out of date costs
may be charged to current earnings.
This LIFO liquidation results in paper profits.
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LIFO Inventory Pools
Inventory Pools consist of inventory units
grouped according to similarities.
Using Inventory Pools with LIFO simplifies record
keeping.
For example, all similar units purchased at the
same time can be pooled and assigned an average
unit cost.
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Dollar-Value LIFO (DVL)
DVL inventory pools are viewed as layers of
value, rather than layers of similar units.
At the end of the period, we determine if a new
inventory layer was added by comparing ending
inventory to beginning inventory.
DVL simplifies LIFO record-keeping.
DVL minimizes the probability of layer
liquidation.
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Dollar-Value LIFO (DVL)
We need to determine if the increase in ending
inventory over beginning inventory was due to a
price increase or an increase in inventory.
1a. Compute a Cost Index for the year.
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Dollar-Value LIFO (DVL)
1b. Deflate the ending inventory value using the
current cost index.
1c. Compare ending inventory (at base year cost)
to beginning inventory.
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Dollar-Value LIFO (DVL)
Next, identify the layers in ending inventory and
the years they were created.
Convert each layers base year cost to layer year
cost by multiplying times the layer year cost
index.
Sum all the layers to arrive at Ending Inventory
at DVL cost.
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End of Chapter 8
Its Over