Accounting principles 8th weygars kieso kimmel chapter 06

Chapter
6-1


CHAPTER 6

INVENTORIES

Accounting Principles, Eighth Edition
Chapter
6-2


Study
Study Objectives
Objectives
1.

Describe the steps in determining inventory
quantities.

2.

Explain the accounting for inventories and apply the
inventory cost flow methods.

3.

Explain the financial effects of the inventory cost
flow assumptions.

4.

Explain the lower-of-cost-or-market basis of
accounting for inventories.

5.

Indicate the effects of inventory errors on the
financial statements.

6.

Compute and interpret the inventory turnover ratio.

Chapter
6-3


Reporting
Reporting and
and Analyzing
Analyzing Inventory
Inventory

Classifying
Classifying
Inventory
Inventory
Finished
goods

Work in
process
Raw materials

Chapter
6-4

Determining
Determining
Inventory
Inventory
Quantities
Quantities
Taking a
physical
inventory
Determining
ownership of
goods

Inventory
Inventory
Costing
Costing

Inventory
Inventory
Errors
Errors

Specific
identification
Cost flow
assumptions
Financial
statement
and tax
effects
Consistent
use
Lower-ofcost-ormarket

Income
statement
effects
Balance sheet
effects

Statement
Statement
Presentation
Presentation
and
andAnalysis
Analysis
Presentation
Analysis


Classifying

Classifying Inventory
Inventory
Merchandising
Company
One Classification:
Merchandise
Inventory

Manufacturing
Company
Three Classifications:
Raw Materials
Work in Process
Finished Goods

Regardless of the classification, companies report all
inventories under Current Assets on the balance sheet.
Chapter
6-5


Determining
Determining Inventory
Inventory Quantities
Quantities
Physical Inventory taken for two reasons:
Perpetual System
1. Check accuracy of inventory records.
2. Determine amount of inventory lost (wasted raw

materials, shoplifting, or employee theft).

Periodic System
1. Determine the inventory on hand
2. Determine the cost of goods sold for the period.

Chapter
6-6

LO 1 Describe the steps in determining inventory quantities.


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

Chapter
6-7

LO 1 Describe the steps in determining inventory quantities.

Determining
Determining Inventory
Inventory Quantities
Quantities
Determining Ownership of Goods
Goods in Transit
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 to the goods. Legal
title is determined by the terms of sale.
Chapter
6-8

LO 1 Describe the steps in determining inventory quantities.


Determining
Determining Inventory
Inventory Quantities
Quantities
Terms of Sale

Illustration 6-1

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.
Chapter
6-9

LO 1 Describe the steps in determining inventory quantities.


Determining
Determining Inventory
Inventory Quantities
Quantities

Review Question
Goods in transit should be included in the
inventory of the buyer when the:
a. public carrier accepts the goods from the
seller.
b. goods reach the buyer.
c. terms of sale are FOB destination.
d. terms of sale are FOB shipping point.
Chapter
6-10

LO 1 Describe the steps in determining inventory quantities.


Determining

Determining Inventory
Inventory Quantities
Quantities
Determining Ownership of Goods
Consigned Goods
•In

some lines of business, it is common to hold
the goods of other parties and try to sell the
goods for them for a fee, but without taking
ownership of goods.
•These

Chapter
6-11

are called consigned goods.

LO 1 Describe the steps in determining inventory quantities.


Inventory
Inventory Costing
Costing
Unit costs can be applied to quantities on hand
using the following costing methods:
Specific Identification
First-in, first-out (FIFO)
Last-in, first-out (LIFO)

Cost Flow
Assumptions

Average-cost

Chapter
6-12

LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.


Inventory
Inventory Costing
Costing
Example
Young & Crazy Company makes the following purchases:

Chapter
6-13

1.

One item on 2/2/08 for $10

2.

One item on 2/15/08 for $15

3.

One item on 2/25/08 for $20

Young & Crazy Company sells one item on 2/28/08 for
$90. What would be the balance of ending inventory,
cost of goods sold, and net income for the month ended
Feb. 28, 2008, assuming the company used the Specific
Identification method to cost inventories and the item
purchased on 2/15/08 is sold? Assume a tax rate of
30%.
LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.


Inventory
Inventory Costing
Costing
“Specific Identification”
Inventory
Balance = $ 30
Purchase on
2/25/08 for $20
Purchase on
2/15/08 for $15
Purchase on 2/2/08
for $10
Chapter
6-14

Young & Crazy Company

Income Statement
For the Month of Feb. 2008
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

$ 90
15
75
14
12
7
33
42
13
$ 29

LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.


Inventory

Inventory Costing
Costing
Specific Identification Method
An 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.

Chapter
6-15

LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.


Inventory
Inventory Costing
Costing –– Cost
Cost Flow
Flow Assumptions
Assumptions
Cost Flow Assumption
does not need to equal
Physical Movement of
Goods
Illustration 6-11
Use of cost flow methods in
major U.S. companies

Chapter
6-16

LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.


Inventory
Inventory Costing
Costing –– Cost
Cost Flow
Flow Assumptions
Assumptions
Example
Young & Crazy Company makes the following purchases:
1.

One item on 2/2/08 for $10

2.

One item on 2/15/08 for $15

3.

One item on 2/25/08 for $20

Young & Crazy Company sells one item on 2/28/08 for
$90. What would be the balance of ending inventory,
cost of goods sold, and net income for the month ended

Feb. 2008, assuming the company used the FIFO,
LIFO, and Average-cost flow assumptions? Assume a
tax rate of 30%.
Chapter
6-17

LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.


Inventory
Inventory Costing
Costing –– Cost
Cost Flow
Flow Assumptions
Assumptions
“First-In-First-Out (FIFO)”
Earliest goods purchased are first to be
sold.
Often parallels actual physical flow of
merchandise.
Generally good business practice to sell
oldest units first.

Chapter
6-18

LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.

Inventory
Inventory Costing
Costing –– Cost
Cost Flow
Flow Assumptions
Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = $ 35
Purchase on
2/25/08 for $20
Purchase on
2/15/08 for $15
Purchase on
2/2/08 for $10
Chapter
6-19

Young & Crazy Company
Income Statement
For the Month of Feb. 2008
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses

Income before tax
Taxes
Net Income

$ 90
10
80
14
12
7
33
47
14
$ 33

LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.


Inventory
Inventory Costing
Costing –– Cost
Cost Flow
Flow Assumptions
Assumptions
“Last-In-First-Out (LIFO)”
Latest goods purchased are first to be sold.
Seldom coincides with actual physical flow of
merchandise.
Exceptions include goods stored in piles, such

as coal or hay.

Chapter
6-20

LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.


Inventory
Inventory Costing
Costing –– Cost
Cost Flow
Flow Assumptions
Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = $ 25
Purchase on
2/25/08 for $20
Purchase on
2/15/08 for $15
Purchase on
2/2/08 for $10
Chapter
6-21

Young & Crazy Company
Income Statement
For the Month of Feb. 2008

Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

$ 90
20
70
14
12
7
33
37
11
$ 26

LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.


Inventory
Inventory Costing
Costing –– Cost

Cost Flow
Flow Assumptions
Assumptions
“Average-Cost”
Allocates cost of goods available for sale on
the basis of weighted average unit cost
incurred.
Assumes goods are similar in nature.
Applies weighted average unit cost to the
units on hand to determine cost of the ending
inventory.
Chapter
6-22

LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.


Inventory
Inventory Costing
Costing –– Cost
Cost Flow
Flow Assumptions
Assumptions
“Average Cost”
Inventory
Balance = $ 30
Purchase on
2/25/08 for $20
Purchase on

2/15/08 for $15
Purchase on
2/2/08 for $10
Chapter
6-23

Young & Crazy Company
Income Statement
For the Month of Feb. 2008
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

$ 90
15
75
14
12
7
33
42
13

$ 29

LO 2 Explain the accounting for inventories and
apply the inventory cost flow methods.


Inventory
Inventory Costing
Costing –– Cost
Cost Flow
Flow Assumptions
Assumptions
Comparative Financial Statement Summary
FIFO

Chapter
6-24

Average

Sales
$90

$90

$90

Cost of goods sold
20

10

15

Gross profit
70

80

75

Admin. & selling expense
33

33

33

Income before taxes
37

47

42

Income tax expense

14

13

Net income

$33

$29

LIFO

11

LO 3 Explain the financial effects of the inventory cost flow assumptions.


Inventory
Inventory Costing
Costing –– Cost
Cost Flow
Flow Assumptions
Assumptions
In Period of Rising Prices, FIFO Reports:
FIFO

Lowest

Highest

Chapter
6-25

Average

Sales
$90

$90

$90

Cost of goods sold
20

10

15

Gross profit
70

80

75

Admin. & selling expense
33

33

33

Income before taxes
37

47

42

Income tax expense

14

13

Net income

$33

$29

LIFO

11

LO 3 Explain the financial effects of the inventory cost flow assumptions.