Inventories

1. Inventories Chapter 6

2. Learning Objectives Describe the importance of control over inventory. Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet. Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and average cost methods.

3. Learning Objectives Determine the cost of inventory under the periodic inventory system, using the FIFO, LIFO, and average cost methods. Compare and contrast the use of the three inventory costing methods. Describe and illustrate the reporting of merchandise inventory in the financial statements.

4. Learning Objectives Describe and illustrate the inventory turnover and the number of days’ sales in inventory in analyzing the efficiency and effectiveness of inventory management.

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. LO 1

7. Safeguarding Inventory The purchase order authorizes the purchase of the inventory from an approved vendor. LO 1

8. LO 1 Safeguarding Inventory • The receiving report establishes an initial record of the receipt of the inventory.

9. LO 1 Safeguarding Inventory • 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.

10. Safeguarding Inventory 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. LO 1 • Controls for safeguarding inventory should include security measures to prevent damage and customer or employee theft. Some examples of security measures include the following:

11. 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. LO 1

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

13. Inventory Cost Flow Assumptions LO 2

14. Inventory Cost Flow Assumptions LO 2

15. Inventory Cost Flow Assumptions LO 2 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:

16. Inventory Cost Flow Assumptions LO 2 • Under the specific identification inventorycost flow method, the unit sold is identified with a specific purchase.

17. 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. LO 2

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. LO 2

19. Inventory Cost Flow Assumptions Under the average inventory cost flowmethod, the cost of the units sold and in ending inventory is an average of the purchase costs. LO 2

20. Inventory Cost Flow Assumptions LO 2 (continued)

21. Inventory Cost Flow Assumptions LO 2 (continued)

22. Inventory Cost Flow Assumptions LO 2 (concluded)

23. EE 6-1

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

25. Inventory Costing Methods LO 3 For purposes of illustration, the data for Item 127B are used, as shown below. We will examine the perpetual inventory system first.

26. First-In, First-Out Method LO 3 (continued)

27. First-In, First-Out Method LO 3 (continued)

28. First-In, First-Out Method LO 3 (continued)

29. First-In, First-Out Method LO 3 (continued)

30. First-In, First-Out Method LO 3 (continued)

31. First-In, First-Out Method LO 3 (continued)

32. First-In, First-Out Method LO 3 (concluded)

33. EE 6-2

34. Last-In, First-Out Method LO 3 (continued)

35. Last-In, First-Out Method LO 3 (continued)

36. Last-In, First-Out Method LO 3 (continued)

37. Last-In, First-Out Method LO 3 (continued)

38. Last-In, First-Out Method LO 3 (continued)

39. Last-In, First-Out Method LO 3 (continued)

40. Last-In, First-Out Method LO 3 (concluded)

41. EE 6-3

42. Average Cost Method When the 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. LO 3

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

44. First-In, First-Out Method Using FIFO, the earliest batch purchased is considered the first batch of merchandise sold. The physical flow does not have to match the accounting method chosen. This time we will be examining the periodic inventory system. LO 4

45. First-In, First-Out Method LO 4 Beginning inventory and purchases of Item 127B in January are as follows: Cost of merchandise available for sale

46. First-In, First-Out Method LO 4 The physical count on January 31 shows that 150 units are on hand. (Conclusion: 130 units were sold.) What is the cost of the ending inventory?

47. First-In, First-Out Method LO 4 Now we can calculate the cost of merchandise sold as follows:

48. LO 4 First-In, First-Out Method

49. Last-In, First-Out Method Using LIFO, the most recent batch purchased is considered the first batch of merchandise sold. The actual flow of goods does not have to be LIFO. For example, a store selling fresh fish would want to sell the oldest fish first (which is FIFO), even though LIFO is used for accounting purposes. LO 4

50. Last-In, First-Out Method Inventory, January 31 LO 4 Using the last-in, first-out method, the cost of the ending inventory on January 31 is determined as follows: