Why is Inventory Important?

1. Why is Inventory Important? Ms. Naira

2. Importance of Inventory • Inventory on hand is usually the largest asset of a merchandising business (sell products like clothing, electronics, furniture, cars, CD’s, food). • Successful business must havemerchandise available for sale that customers want (example they need various colors, sizes,) • Keeping track of inventory can assist managers in maintaining inventory of sufficient quantity, variety, price. • Cost of inventory is reported on both the balance sheet and Income statement, therefore needs to be accurate in order to calculate current assets and retained earnings (on BS) and gross profit and net income (on IS). These are official documents for IRS • Most businesses fail because incorrect inventory records

3. Why Keep Efficient Quantity of Inventory? To keep most efficient quantity of inventory, a business makes frequent analysis of purchase, sales and inventory records. If inventory levels are too high, then Net Income may decrease for several reasons: • May require business to spend money on storage and warehouse space. • May Use capital that could be invested in other assets to earn a profit (ei., storage) • May require a business to spend money for expenses, such as taxes and insurance premiums, which increase the cost of merchandise inventory. • Inventory may become obsolete and unsalable (there is no demand for product, ei. Tickle me Elmo)

4. Why Keep Efficient Quantity of Inventory? If inventory levels are too low, then Net Income may decrease for several reasons: • Sales may be lost to competitors if items wanted by customers are not on hand. (Ei. Store doesn’t have your brand) • Sales may be lost to competitors if there is insufficient variety to satisfied customers (Ei. Color, Size) • When business order small quantities of an item, the price paid is often higher per unit than when is order in larger quantities

5. Methods used to Determine the Quantity of Merchandise inventory • The quantity of items in inventory at the end of a fiscal period must be determined in order to calculate the cost of merchandise sold. • Two methods are used to determine the quantity of each item of merchandise on hand – 1) Periodic 2)Perpetual

6. Periodic Vs. Perpetual • Periodic Inventory means that inventory is determined by physically counting, weighing, or measuring items (usually referred to as physical inventory) • Perpetual Inventory means that inventory is determined by keeping continuous record of increases, decreases and balance on hand (usually referred to as book inventory)

7. First In First Out • A. The FIFO Method The FIFO method considers the oldest goods sold first. The ending inventory consists of the newer purchases. During times of rising prices, FIFO will result in a higher ending inventory value and a lower cost of goods sold (i.e., in comparision to LIFO).

8. Last In First Out • B. The LIFO Method The LIFO method considers the most recent purchases as being sold first. The ending inventory consists of the older purchases. During times of rising prices, LIFO will result in a lower ending inventory and a higher cost of goods sold (i.e., in comparison to FIFO)

9. Computing Cost of Goods Sold in a Periodic Inventory System The calculations can be broken down into three basic parts: • determine goods available for sale, • determine the value of ending inventory, and • determining cost of goods sold.

10. Example Beginning Inventory, Jan. 1, 10 units @ $20 per unit Purchases: Jan 10, 8 units @ $21 per unit Jan 30, 10 units @ $22 per unit Sales: Jan 4, 7 units Jan 22, 4 units Jan 28, 2 units

11. Step 1- Determine Goods Available for Sale UnitsCostTotal • Beginning Inventory 10 x $20 = $200 • Purchases, Jan 10 8 x $21 = $168 • Purchases, Jan 30 10 x $22 = $220 • Goods available for sale 28 $588

12. 2- Determine Ending Inventory (28 units available - 13 units sold = 15) • A. FIFO Units Cost Total 10 x $22 = $220 5 x $21 = $105 15$325

13. 2- Determine Ending Inventory (28 units available - 13 units sold = 15) • A. LIFO Units Cost Total 10 x $20 = $200 5 x $21 = $105 15 $305

14. Step 3: Determine Cost of Goods Sold FIFO LIFO Goods Available for Sale $588 $588 Less Ending Inventory 325 305 Cost of Goods Sold $263 $283

15. Case for Critical thinking Pg. 581 • Case 1 • Ballston Company uses the FIFO method of costing its merchandise inventory. The manager is considering a change to the LIFO method. Cost have increased steadily over the past three years. What effect will the change have on the following items? 1) the amount of net income on the income statement. 2) the amount of income taxes to be paid. 3)the quantity of each item of merchandise that must be kept in stock. Why?

16. Cases For critical thinking p. 581 • The net Income on the income statement will be less because the LIFO method gives the lowest possible ending inventory cost during a period of rising prices. Therefore, the cost of merchandise sold will be higher, using the LIFO method. Thus, net income will be less. • The amount of income taxes to be paid will be less because of lower net income. • There will be no effect on the amount of inventory kept on stock.