Inventory Quantities - Merchandiser

2. Inventory Quantities - Merchandiser • Consists of many different items • Owned by the company • In a form ready for sale to customers • One inventory classification: merchandise inventory

3. Inventory Quantities - Manufacturer • Some inventory not ready for sale • Classify inventory into three categories • Finished goods • Work in process • Raw materials

4. Finished Goods Inventory Manufactured items that are complete and ready for sale.

5. Work in Process Manufactured inventory that has been placed into production but is not yet complete.

6. Raw Materials The basic goods that will be used in production, but have not been placed in production.

7. Inventory Accounting Systems • Perpetual systems maintain a running record • to show the inventory on hand at all times. Periodic systems do not keep a continuous record of inventory on hand.

8. Perpetual System • Debit Inventory • Credit Cash or Accounts Payable Debit Cash or Accounts Receivable Credit Sales Revenue Debit Cost of Goods Sold Credit Inventory

9. Cost of Goods Sold Net Purchases $560,000 • Beginning • Inventory • $100,000 = + Ending Inventory $120,000 Cost of Goods Available for Sale $660,000 Cost of Goods Sold $540,000 – =

10. Gross Profit • Sales revenues – Cost of goods sold = • Gross margin (before operating expenses) Gross margin – Operating expenses = Net income

11. Why inventories are so important?

12. 36% of current assets

13. Composition of Inventories INVENTORY = Unit cost * Quantity Quantity • taking a physical count of inventories • determining the ownership of goods. Unit Cost • Cost Flow Assumptions

14. Physical Inventory • Involves counting, weighing, or measuring each kind of inventory on hand

15. Taking Physical Count During the physical count, a company should pay very close attention to the following issues in order to have an effective internal control and also to minimize the errors and fraud: • the employees who are responsible from safekeeping of inventory items should not count them, • it has to be made sure that the items are complete and what they are supposed to be, • items should be re-counted by another independent employee for verification, • counting process should be documented by tagging the inventory items, • a supervisor should oversee that each item has only one tag, and that each item is counted, and • there should be no inventory movements during the count

16. Determine Ownership • Do all the goods included in the count belong to the company? • Does the company own any goods that were not included in the count?

17. Whose ? Determination of the owner of goods: • Consignment goods • consignor (owner of the merchandise) and the consignee (the holder of the goods) • Goods in transit are goods that are on the way to the company (purchases) or goods that are on a carrier being shipped to the customer

18. Goods in Transit • Goods are shipped on board trucks, trains, ships, and airplanes • To arrive at an accurate count, ownership of goods in transit must be determined • Goods in transit should be included in the inventory of the company that has legal title to the goods

19. Goods in Transit FOB (free on board) shipping point Ownership passes to buyer when public carrier accepts goods from seller

20. Goods in Transit FOB (free on board) destination Ownership remains with seller until the goods reach the buyer

21. Consigned Goods • In some lines of business, it is customary to hold the goods of other parties and try to sell the goods for them for a fee, but without taking ownership

22. Inventory Costs Beginning Inventory + Purchases - Ending Inventory = COGS Available for Sale

23. Computing the Cost of Inventory Cost of inventory on hand = Quantity × unit cost • Physical count is made at least once a year, even with a perpetual system. • Consigned goods are excluded.

24. Inventory Cost Flows • Specific Identification Method • First-in First-out • Weighted Average • Last-in First-out – not allowed by IFRS or CMB

25. Specific Identification Method • Works best with limited variety of high-unit items • used when the actual cost of the item is tracked (which particular units were sold and which are still in ending inventory) • closely follows the actual flow of goods • whether a company uses a periodic or perpetual inventory system does not make any difference on cost of goods sold or the amount of inventory

26. Date Explanation Units Unit Cost Total Cost 1/1 Beg. Inventory 1 $20 $20 4/15 Purchase 2 $21 $42 8/24 Purchase 3 $22 $66 Purchase 1 $23 $23 7 $151 Specific Identification Method Dec. 31 physical inventory shows 4 in ending inventory, so how many were sold?

27. Cost Flow Methods • When there is sales of thousand units of identical products, the identity of the goods purchased at a specific cost is lost and management may choose a cost flow method such as FIFO, WA instead of Specific Identification Method.

28. Cost Flow vs. Physical Flow • First-in First-out (FIFO), and weighted average methods assume that flow of costs may be unrelated to physical flow of goods • The accounting regulations do not require that the physical flow of goods and the related cost flow to be the same

29. Example-Cost Flow

30. First-in First-out MethodFIFO • FIFO method assumes that the goods purchased earlier will be sold first • The cost of the first units on hand is assigned to the units sold first • Under FIFO, take the unit cost of most recent purchase and work backward until all units have been costed

31. Start with most recent prices and work backward!

32. FIFO

33. Weighted Average • Goods available are homogeneous and the cost to be assigned to each unit sold is the same • Assumes goods are similar in nature

34. Weighted Average-Perpetual

35. Summary Perpetual Inventory System

36. Summary • In periods of increasing prices • FIFO reports the highest net income • LIFO the lowest • average cost falls in the middle. • In periods of decreasing prices • FIFO will report the lowest net income • LIFO the highest • average cost in the middle.

37. Let’s Review Which of the following should be included in the physical inventory of XYZ Co.? a.Goods in transit from a supplier shipped FOB destination b.Goods in transit to a buyer shipped FOB shipping point c.Goods on consignment from another company d.Goods on consignment to another company

38. Let’s Review Which inventory cost flow method produces the highest net income in a period of rising prices? a.Average cost. b.LIFO. c.FIFO. d.Specific identification.

39. Let’s Review Which inventory cost flow method produces the lowest income taxes in a period of rising prices? a.Average cost. b.LIFO. c.FIFO. d.Specific identification.

40. Let’s Review Using the above data, assume there are 9,000 units on hand at Dec. 31, what is the cost of ending inventory under FIFO? a.$99,000 c.$113,000 b.$108,000 d.$100,000

41. The Lower of Cost or Market Basis of Accounting for Inventories When the value of inventory is lower than its cost, the inventory is written down to its market value by valuing the inventory at the lower of cost or market (LCM) in the period in which the price decline occurs.

42. Lower of Cost or Market • as time passes the value of the inventories might decline in the market because of the obsolescence factor • IFRS specify that the companies should use the lower-of-cost-or market (LCM) valuation basis • the market value is the current replacement cost(market value- NOT SELLING PRICE)of the inventory • LCM rule can be applied with any of the cost flow methods, or the specific identification method • LCM may be applied to individual items or major categories of inventory • the decline in value is not expected to increase in the very near future

43. Example-LCM-1 Item by item

44. Example-LCM-2 on 15 August 2005, the company sold 15 units of Item W at TL 126 per unit

45. Example-LCM-3 Using item-by-item basis 31 December 2005

47. Cost of Goods Sold Formula • Beginning inventory • + Purchases • - Ending inventory • = Cost of Good sold

48. Inventory Errors

49. Inventory Errors