Inventories

1. Chapter 25 $ Inventories Making Accounting Relevant Businesses have different types of inventories. Service businesses may have inventories of supplies used in their operations. Retailers have inventories of merchandise for sale. $ $ $ Select a business in your area. What types of items does this business have in inventory?

2. Chapter 25 $ Section 1 Determining the Quantity of Inventories $ • What You’ll Learn • The purpose of the Merchandise Inventoryaccount. • The difference between a periodic and a perpetual inventory system. $ $

3. Section 1 Determining the Quantity of Inventories (cont'd.) Chapter 25 $ Why It’s Important For marketing and financial reporting purposes, a merchandising business needs to know the quantity of merchandise on hand. $ $ • Key Terms • perpetual inventory system • point-of-sale terminal • online • periodic inventory system $

4. Section 1 Determining the Quantity of Inventories (cont'd.) Chapter 25 $ Merchandise Inventory $ • The Merchandise Inventory account shows the cost of goods purchased for resale. • Merchandise Inventory typically is one of the largest asset accounts. $ $

5. Section 1 Determining the Quantity of Inventories (cont'd.) Chapter 25 $ Determining the Quantity of Inventories Two methods are used to track merchandise: $ $ • The perpetual inventory system $ • The periodic inventory system

6. Section 1 Determining the Quantity of Inventories (cont'd.) Chapter 25 $ The Perpetual Inventory System • Keeps a constant, up-to-date record of merchandise on hand. • Reports what merchandise is on hand at any point in time. • Every time a purchase or sale occurs, an entry is recorded in the Merchandise Inventory account. • After every sale, the cost of merchandise sold is recorded in the accounting records. $ $ $

7. Section 1 Determining the Quantity of Inventories (cont'd.) Chapter 25 $ The Periodic Inventory System $ • Inventory records are updated only after a physical count of merchandise on hand is made. • Inventory records are NOT adjusted for every purchase and sale. $ $

8. Section 1 Determining the Quantity of Inventories (cont'd.) Chapter 25 $ The Physical Inventory Count • Businesses take a physical count of their merchandise at least once a year. • Inventory is usually counted when it is at its lowest level. • The total number of a particular item on hand is recorded on an inventory card or an inventory sheet. $ $ $

9. Chapter 25 $ Section 2 Determining the Cost of Inventories $ • What You’ll Learn • How to determine the cost of the merchandise on hand. • How to use the four inventory costing methods. $ $

10. Section 2 Determining the Cost of Inventories (cont'd.) Chapter 25 $ Why It’s Important Much time and effort is spent determining the cost of merchandise inventory because it appears on both the balance sheet and the income statement. $ $ • Key Terms • specific identification method • first-in, first-out method • last-in, first-out method • weighted average cost method $

11. Section 2 Determining the Cost of Inventories (cont'd.) Chapter 25 $ Methods of Determining Inventory Costs Businesses use one of four inventory costing methods: $ • specific identification $ • first-in, first-out (FIFO) $ • last-in, first-out (LIFO) • weighted average cost

12. Section 2 Determining the Cost of Inventories (cont'd.) Chapter 25 $ The Specific Identification Costing Method $ • The exact cost of each item is determined and assigned to that item. • The actual cost of each item is obtained from the invoice. • Often used by businesses that sell a small number of items with high unit prices. $ $

13. Section 2 Determining the Cost of Inventories (cont'd.) Chapter 25 $ The First-In, First-Out Costing Method (FIFO) $ • Assumes that the first items purchased (first in) are the first items sold (first out). • Assumes that the items purchased most recently are the ones on hand at the end of the period. $ $

14. Section 2 Determining the Cost of Inventories (cont'd.) Chapter 25 $ The Last-In, First-Out Costing Method (LIFO) • Assumes that the last items purchased (last in) are the first items sold (first out). • Assumes that the items purchased first are still on hand at the end of the period. • Earliest costs are the ones used to assign a cost to the inventory. $ $ $

15. Section 2 Determining the Cost of Inventories (cont'd.) Chapter 25 $ The Weighted Average Cost Method • Assigns the average cost to each unit in inventory. • The average cost is calculated by: $ $ • adding the number of units on hand at the beginning of the period and the number of units purchased • adding the cost of the units on hand at the beginning of the period and the cost of the units purchased • dividing the total cost by the total number of units $

16. Chapter 25 Section 3 Analyzing the Inventory Costing Methods $ • What You’ll Learn • How to choose an inventory costing method. • The effect of the inventory costing method on gross profit. • How to use the lower-of-cost-or-market method. • How to apply to inventory the accounting principles of consistency and conservatism. $ $ $

17. Section 3 Analyzing the Inventory Costing Methods (cont'd.) Chapter 25 $ Why It’s Important It is essential that business owners and managers understand how the choice of an inventory costing method affects the financial statements. $ $ • Key Terms • consistency principle • market value • conservatism principle $

18. Section 3 Analyzing the Inventory Costing Methods (cont'd.) Chapter 25 $ Choosing an Inventory Costing Method $ • When a business applies the same accounting methods from one period to the next, the business is applying the consistency principle • Once a business chooses an inventory costing method, the business must use it consistently. $ $

19. Section 3 Analyzing the Inventory Costing Methods (cont'd.) Chapter 25 $ Comparing the Four Methods of Determining Inventory Costs The following table compares Disk Jockey’s gross profit on sales using the four inventory costing methods. All of the laser disc players were sold for $320 each. Total sales are $16,960 (53 units  $320). $ $ $

20. Section 3 Analyzing the Inventory Costing Methods (cont'd.) Chapter 25 $ Comparing the Four Methods of Determining Inventory Costs (cont'd.) $ Specific First-In, Last-In, Weighted Identification First-Out First-Out Average Sales $16,960.00 $16,960.00 $16,960.00 $16,960.00 $ Less: Cost of merchandise sold 13,378.00 13,344.00 13,460.00 13,421.24 $ Gross profit on sales $ 3,582.00 $ 3,616.00 $ 3,500.00 $ 3,538.76

21. Section 3 Analyzing the Inventory Costing Methods (cont'd.) Chapter 25 $ Reporting Inventory Cost Using the Lower-of-Cost-or-Market Rule • The cost of the ending inventory that appears on the financial statements is the lower of cost (calculated using one of the four inventory methods) or market value. • Market value is the current price that is charged for similar items of merchandise in the market. • Market value is the cost at which the inventory items could be replaced at the date of the financial statements. $ $ $

22. Section 3 Analyzing the Inventory Costing Methods (cont'd.) Chapter 25 $ Conservatism • The conservatism principle is another principle of accounting • The conservatism principle states that it is best to present amounts that are least likely to result in an overstatement of income or assets. $ $ $

23. Section 3 Analyzing the Inventory Costing Methods (cont'd.) Chapter 25 $ Conservatism (cont'd.) • The lower-of-cost-or-market rule is conservative for two reasons: $ (1)Decreases in inventory value (losses) are recognized when they occur, but increases in inventory value are not recorded. (2)Inventory as reported on the balance sheet is never greater, but may be less, than the actual cost of the inventory. $ $