Chapter 6 Inventories ( 存貨 )

1. Chapter 6 Inventories (存貨) Instructor: Chih-Liang Julian Liu Department of Industrial and Business Management Chang Gung University

2. Learning Objectives • Describe the steps in determining inventory quantities (存貨數量). • Explain the accounting for inventories and apply the inventory cost flow methods (存貨成本流動方法). • Explain the financial effects of the inventory cost flow assumptions. Chapter 6 Inventories

3. Learning Objectives • Explain the lower-of-cost-or-net realizable value (成本與淨現值熟低)basis of accounting for inventories. • Indicate the effects of inventory errors on the financial statements. • Compute and interpret the inventory turnover ratio (存貨週轉率). Chapter 6 Inventories

4. Preview of Chapter 6

5. Classifying Inventory Manufacturing Company Merchandising Company • Three Classifications: • Raw Materials (原料) • Work in Process (在製品) • Finished Goods (製成品) • One Classification: • Inventory (存貨) Regardless of the classification, companies report all inventories under Current Assets (流動資產) on the Statement of Financial Position.

6. Determining Inventory Quantities Physical Inventory (實地盤點存貨)taken for two reasons: • Perpetual System • Check accuracy of inventory records (存貨紀錄正確性). • Determine amount of inventory lost (wasted raw materials, shoplifting, or employee theft). • Periodic System • Determine the inventory on hand (庫存存貨). • Determine the cost of goods sold for the period.

7. Determining Inventory Quantities Taking a Physical Inventory • Involves counting, weighing, or measuring each kind of inventory on hand. • Taken, • when the business is closed or business is slow. • at endof the accounting period.

8. Determining Inventory Quantities Determining Ownership of Goods (商品所有權) • Goods in Transit (在途存貨) • Purchased goods not yet received. • Sold goods not yet delivered. Goods in transit should be included in the inventory of the company that has legal title (法律所有權) to the goods. Legal title is determined by the terms of sale (銷貨條件).

9. Determining Inventory Quantities Goods in Transit Illustration 6-1 Terms of sale Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. Ownership of the goods remains with the seller until the goods reach the buyer.

10. Determining Inventory Quantities Question • Goods in transit should be included in the inventory of the buyer when the: • public carrier accepts the goods from the seller. • goods reach the buyer. • terms of sale are FOB destination. • terms of sale are FOB shipping point.

11. Hargrove Company • 20,000 units of inventory on hand. • Goods in transit: • (1) sales of 1,500 units shipped FOB destination. • (2) purchases of 2,500 units shipped FOB shipping point by the seller. • What’s the inventory quantities?

12. Determining Inventory Quantities Determining Ownership of Goods • Consigned Goods (寄銷品) • Goods held for sale by one party. • Ownership of the goods is retained by another party.

13. Determining Inventory Cost? Inventory Cost Inventory Quantities Unit costs ?

14. Inventory Costing • Unit costs (單位成本) can be applied to quantities on hand using the following costing methods: • Specific Identification (個別認定) • First-in, first-out (FIFO) (先進先出) • Average-cost (平均成本) Cost Flow Assumptions

15. Inventory Costing Illustration:Crivitz TV Company purchases three identical 50-inch TVs on different dates at costs of £700, £750, and £800. During the year Crivitz sold two sets at £1,200 each. These facts are summarized below. Illustration 6-2

16. Inventory Costing Specific Identification If Crivitz sold the TVs it purchased on February 3 and May 22, then its cost of goods sold is £1,500 (£700 + £800), and its ending inventory is £750. Illustration 6-3

17. Inventory Costing Specific Identification • Actual physical flow costing method in which items still in inventory are specifically costed to arrive at the total cost of the ending inventory. • Practice is relatively rare. • Most companies make assumptions (Cost Flow Assumptions) about which units were sold.

18. Inventory Costing • There are two assumed cost flow methods: • First-in, first-out (FIFO) • Average-cost • Cost flow does not need be consistent with the physical movement of the goods.

19. Inventory Costing Illustration: Data for Lin Electronics’ Astro condensers (Periodic System). Illustration 6-4 (Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold

20. Inventory Costing First-In-First-Out (FIFO) • Earliest goods purchased are first to be sold. (最先買入的商品是最先被出售). • Often parallels actual physical flow of merchandise (實際商品的流動相符). • Generally good business practice to sell oldest units first (先賣出最舊的產品).

21. Inventory Costing First-In-First-Out (FIFO) Illustration 6-5

22. Inventory Costing First-In-First-Out (FIFO) Illustration 6-5 Illustration 6-6 Proof of COGS

23. APPENDIX 6A PERPETUAL INVENTORY SYSTEMS Illustration 6A-1 Assuming thePerpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO.

24. APPENDIX 6A PERPETUAL INVENTORY SYSTEMS First-In-First-Out (FIFO) Illustration 6A-2 Cost of Goods Sold Ending Inventory

25. Inventory Costing Average Cost • Allocates cost of goods available for sale on the basis of weighted-average unit cost incurred (加權平均單位成本). • Assumes goods are similar in nature. • Applies weighted-average unit cost to the units on hand to determine cost of the ending inventory.

26. Inventory Costing Average Cost Illustration 6-8

27. Inventory Costing Average Cost Illustration 6-8

28. APPENDIX 6A PERPETUAL INVENTORY SYSTEMS Average Cost (Moving-Average System) Illustration 6A-3 Cost of Goods Sold Ending Inventory

29. Financial Statement and Tax Effects Inventory Costing Illustration 6-9

30. Financial Statement Effects • A major advantage of the FIFO method is that in a period of inflation, the costs allocated to ending inventorywill approximate theircurrent cost. • A shortcoming of the average-costmethod is that in a period of inflation, the costs allocated to ending inventory may be understated in terms of current cost.

31. TaxEffects • In a period ofinflation: • FIFO - inventory and net income higher. • Average-Cost - lower income taxes.

32. In Summary • Prices are rising (inflation) • FIFO: (1) Higher ending inventory cost (Statement of financial position) (2) Lower cost of good sold, higher net income, and higher income tax (Income statement).

33. Inventory Costing Question • The cost flow method that often parallels the actual physical flow of merchandise is the: • FIFO method. • average cost method. • gross profit method. • none of the above

34. Inventory Costing Question In a period of rising prices, average cost will produce: • higher net income than FIFO. • the same net income as FIFO. • lower net income than FIFO. • net income is equal to the specific identification method.

35. Inventory Costing Using Cost Flow Methods Consistently • Method should be used consistently, enhances comparability. • Although consistency is preferred, a company may change its inventory costing method. • When a company adopts a different method, it should disclose in the financial statements the change and its effect on net income.

36. Inventory Costing Lower-of-Cost-or-Net Realizable Value • When the value of inventory is lower than its cost • Companies must “write down” (沖減) the inventory to its net realizable value in the period in which the price decline occurs. • Net realizable value(淨變現價值)refers to the net amount (淨值) that a company expects to realize (receive) from the sale of inventory (estimated selling price in the normal course of business, less estimated costs to complete and sell).

37. Inventory Costing Lower-of-Cost-or-Net Realizable Value Illustration: Assume that Gao TV has the following lines of merchandise with costs and net realizable values as indicated. Illustration 6-10

38. Inventory Errors • Common Cause: • Failure to countor price inventory correctly. • Not properly recognizing the transfer of legal title to goods in transit. • Errors affect both the income statement and statement of financial position.

39. Inventory Costing Income Statement Effects Inventory errors affect the computation of cost of goods sold and net income. Illustration 6-11 Sales revenue - Cost of Goods Sold = Gross Profit Illustration 6-12

40. Inventory Costing Income Statement Effects • Inventory errors affect the computation of cost of goods sold and net income in two periods. • An error in ending inventory of the current period will have a reverse effect on net income of the next accounting period. • Over the two years, the total net income is correct because the errors offset (扺銷) each other. • Ending inventory depends entirely on the accuracy of taking and costing the inventory.

41. Inventory Errors 2013 2014 Beginning inventory Ending inventory Cost of goods sold Cost of goods sold Net income Net income

42. Inventory Costing Illustration 6-13 Combined income for 2-year period is correct. €3,000 Net Income overstated (€3,000) Net Income understated

43. Inventory Costing Statement of Financial Position Effects Effect of inventory errors on the statement of financial position is determined by using the basic accounting equation: Illustration 6-11 Illustration 6-14

44. Inventory Costing Question Understating ending inventory will overstate: • assets. • cost of goods sold. • net income. • equity.

45. Statement Presentation and Analysis Presentation • Net realizable value - Inventory classified as current asset. • Income Statement - Cost of goods sold subtracted from sales. • There also should be disclosure of • major inventory classifications, • basis of accounting (cost or lower-of-cost-or-net realizable value), and • costing method (specific identification, FIFO, or average).

46. Statement Presentation and Analysis Analysis • Inventory management is a double-edged sword • High Inventory Levels - may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage). • Low Inventory Levels – may lead to stockouts and lost sales.

47. Statement Presentation and Analysis Inventory turnover(存貨週轉率)measures the number of times on average the inventory is sold during the period. Cost of Goods Sold Inventory Turnover = Average Inventory Days in inventory measures the average number of days inventory is held. Days in Year (365) Days in Inventory = Inventory Turnover

48. Statement Presentation and Analysis Illustration: Esprit Holdings (HKG) reported in a recent annual report a beginning inventory of HK$3,170 million, an ending inventory of HK$2,997 million, and cost of goods sold for the year ended of HK$16,523 million. The inventory turnover formula and computation for Esprit Holdings are shown below. Illustration 6-16 Days in Inventory: Inventory turnover of 5.4 times divided into 365 is approximately 68 days. This is the approximate time that it takes a company to sell the inventory.