Inventories

1. Inventories Chapter 7

2. CH1 Types of businesses: • Manufacturing Business e.g. Ford. • Merchandising Business e.g. Debenhams • Servicing Business e.g. Saudi Airlines

3. CH6 Inventory: The raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for sale

4. Why is Inventory Control Important? • Inventory is a significant assetand for many companies the largest asset. • Inventory is central to the main activity of merchandising and manufacturing companies. • Mistakes in determining inventory cost can cause critical errors in financial statements.

5. Learning Objective 1 Describe the importance of control over inventory.

6. Control of Inventory • Two primary objectives of control over inventory are: • Safeguarding the inventory from damage or theft. • Reporting inventory in the financial statements.

7. Safeguarding Inventory • The purchase order authorizes the purchase of the inventory from an approved vendor. • The receiving report establishes an initial record of the receipt of the inventory. • Vendor’s Invoice • Recording inventory using a perpetual inventory system is also an effective means of control. The amount of inventory is always available in the subsidiary inventory ledger.

8. Safeguarding Inventory • Controls for safeguarding inventory should include security measures to prevent damage and customer or employee theft. • examples : • Storing inventory in areas that are restricted to only authorized employees. • Locking high-priced inventory in cabinets. • Using two-way mirrors, cameras, security tags, and guards.

9. Reporting Inventory • A physical inventory or count of inventory should be taken near year-end to make sure that the quantity of inventory reported in the financial statements is accurate.

10. Learning Objective 2 Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet.

11. Inventory Cost Flow Assumptions

12. Inventory Cost Flow Assumptions

13. Inventory Cost Flow Assumptions • Assume that one unit is sold on May 30 for $20. Depending upon which unit was sold, the gross profit varies from $11 to $6 as shown below:

14. Inventory Cost Flow Assumptions • Under the specific identification inventory cost flow method, the unit sold is identified with a specific purchase.

15. Inventory Cost Flow Assumptions (continued)

16. Inventory Cost Flow Assumptions • Under the first-in, first out (FIFO) inventorycost flow method, the first units purchased are assumed to be sold first and the ending inventory is made up of the most recent purchases. FIFO — Milk (or any perishable item). When shelves are restocked, the “older” milk is moved to the front, and the “newer” milk is placed in back to encourage customers to buy the older milk first.

17. Inventory Cost Flow Assumptions (continued)

18. Inventory Cost Flow Assumptions • Under the last-in, first out (LIFO) inventorycost flow method, the last units purchased are assumed to be sold first and the ending inventory is made up of the first units purchased. LIFO — Packages of nails or screws at a hardware store. When shelves are restocked, the older packages are slid to the back of the shelf or rack and the newer packages placed in front. Customers buy the newest hardware first.

19. Summary:

20. Inventory Cost Flow Assumptions (concluded)

21. Inventory Cost Flow Assumptions • Under the weighted average inventory cost flowmethod, the cost of the units sold and in ending inventory is a weighted average of the purchase costs. Average — Gasoline. When new gasoline is delivered to a gas station, it is dumped into the tank with any old gas that has not been sold. Therefore, the customer is buying a mixture of old and new gas.

22. Learning Objective 3 Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and weighted average cost methods.

23. Inventory Costing Methods • For purposes of illustration, the data for Item 127B are used, as shown below. We will examine the perpetual inventory system first.

24. First-In, First-Out Method (continued)

25. First-In, First-Out Method (continued)

26. First-In, First-Out Method (continued)

27. First-In, First-Out Method (continued)

28. First-In, First-Out Method (continued)

29. First-In, First-Out Method (continued)

30. First-In, First-Out Method (continued)

32. Last-In, First-Out Method (continued)

33. Last-In, First-Out Method (continued)

34. Last-In, First-Out Method (continued)

35. Last-In, First-Out Method (continued)

36. Last-In, First-Out Method (continued)

37. Last-In, First-Out Method

38. Last-In, First-Out Method (continued)

40. Weighted Average Cost Method • When the weighted average cost method is used in a perpetual system, an average unit cost for each item is computed each time a purchase is made. • This unit cost is then used to determine the cost of each sale until another purchase is made and a new average is computed. This averaging technique is called a moving average.

41. Weighted Average Cost Method

43. Learning Objective 4 Determine the cost of inventory under the periodic inventory system, using the FIFO, LIFO, and weighted average cost methods.

44. Learning Objective 5 Compare and contrast the use of the three inventory costing methods. ONLY

45. Comparing Inventory Cost Methods Inflation Deflation

46. Comparing Inventory Cost Methods • When the FIFO method is used during a period of inflation or rising prices, FIFO will show a larger profit than the other two inventory costing methods.

47. Comparing Inventory Cost Methods • When the LIFO method is used during a period of inflation or rising prices, LIFO will show a lower profit than the other two inventory costing methods. • During a period of rising prices, using LIFO offers an income tax savings compared to the other two inventory costing methods.

48. Comparing Inventory Cost Methods • The weighted average cost method of inventory costing is a compromise between FIFO and LIFO. Net income for the weighted average cost method is somewhere between the net incomes of LIFO and FIFO.

49. Learning Objective 6 Describe and illustrate the reporting of merchandise inventory in the financial statements.

50. Reporting Merchandise Inventory • Cost is the primary basis for valuing and reporting inventories in the financial statements. However, inventory may be valued at other than cost in the following cases: • The cost of replacing items in inventory is below the recorded cost. • The inventory cannot be sold at normal prices due to imperfections, style changes, or other causes.