Intermediate accounting 13th kieso warfield chapter 08

Chapter
8-1


CHAPTER

8

VALUATION OF INVENTORIES:
A COST-BASIS APPROACH

Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield
Chapter
8-2


Learning
Learning Objectives
Objectives
1.

Identify major classifications of inventory.

2.

Distinguish between perpetual and periodic inventory systems.

3.

Identify the effects of inventory errors on the financial
statements.

4.

Understand the items to include as inventory cost.

5.

Describe and compare the cost flow assumptions used to account
for inventories.

6.

Explain the significance and use of a LIFO reserve.

7.

Understand the effect of LIFO liquidations.

8.

Explain the dollar-value LIFO method.

9.

Identify the major advantages and disadvantages of LIFO.

10.

Understand why companies select given inventory methods.

Chapter
8-3


Valuation
Valuation of
of Inventories:
Inventories:
Cost-Basis
Cost-Basis Approach
Approach
Inventory
Issues
Classification
Cost flow
Control
Basic inventory
valuation

Chapter
8-4

Physical
Goods
Included in
Inventory
Goods in transit
Consigned

goods
Special sales
agreements
Inventory errors

Costs
Included
in Inventory
Product costs
Period costs
Purchase
discounts

Cost Flow
Assumptions
Specific
identification
Average cost
FIFO
LIFO

LIFO: Special
Issues
LIFO reserve
LIFO liquidation
Dollar-value
LIFO
Comparison of
LIFO approaches
Advantages of

LIFO
Disadvantages of
LIFO

Basis for
Selection
Summary of
inventory
valuation
methods


Inventory
Inventory Issues
Issues
Classification
Inventories are:
items held for sale, or
goods to be used in the production of goods to be sold.

Businesses with Inventory:
Merchandiser

Chapter
8-5

or

Manufacturer

LO 1 Identify major classifications of inventory.


Inventory
Inventory Issues
Issues
Classification

Illustration 8-1

One inventory
account
Purchase goods
ready for sale

Chapter
8-6

LO 1 Identify major classifications of inventory.


Inventory
Inventory Issues
Issues
Classification

Illustration 8-1

Three accounts
Raw materials

Work in process
Finished goods

Chapter
8-7

LO 1 Identify major classifications of inventory.


Inventory
Inventory Issues
Issues
Inventory Cost Flow

Chapter
8-8

Illustration 8-2

LO 1 Identify major classifications of inventory.


Inventory
Inventory Issues
Issues
Inventory Cost Flow

Illustration 8-3

Companies use one of two types of systems for maintaining

inventory records — perpetual system or periodic system.
Chapter
8-9

LO 1 Identify major classifications of inventory.


Inventory
Inventory Cost
Cost Flow
Flow
Perpetual System
1.

Purchases of merchandise are debited to Inventory.

2. Freight-in is debited to Inventory. Purchase returns and
allowances and purchase discounts are credited to
Inventory.
3. Cost of goods sold is debited and Inventory is credited for
each sale.
4. Subsidiary records show quantity and cost of each type of
inventory on hand.
The perpetual inventory system provides a continuous
record of Inventory and Cost of Goods Sold.
Chapter
8-10

LO 2 Distinguish between perpetual and periodic inventory systems.

Inventory
Inventory Cost
Cost Flow
Flow
Periodic System
1. Purchases of merchandise are debited to Purchases.
2. Ending Inventory determined by physical count.
3. Calculation of Cost of Goods Sold:
Beginning inventory
$ 100,000
Purchases, net

Chapter
8-11

800,000
Goods
availablebetween
for sale
LO 2 Distinguish
perpetual and periodic inventory systems.


Inventory
Inventory Cost
Cost Flow
Flow
Illustration: Fesmire Company had the following
transactions during the current year.

Record these transactions using the Perpetual and Periodic
systems.

Chapter
8-12

LO 2 Distinguish between perpetual and periodic inventory systems.


Inventory
Inventory Cost
Cost Flow
Flow
Illustration:

Chapter
8-13

Solution on
notes page

Illustration 8-4

LO 2 Distinguish between perpetual and periodic inventory systems.


Inventory
Inventory Cost
Cost Flow

Flow
Illustration: Assume that at the end of the reporting
period, the perpetual inventory account reported an
inventory balance of $4,000. However, a physical count
indicates inventory of $3,800 is actually on hand. The entry
to record the necessary write-down is as follows.
Inventory Over and Short
Inventory

200
200

Note: Inventory Over and Short adjusts Cost of Goods Sold. In practice,
companies sometimes report Inventory Over and Short in the “Other revenues
and gains” or “Other expenses and losses” section of the income statement.
Chapter
8-14

LO 2 Distinguish between perpetual and periodic inventory systems.


Inventory
Inventory Issues
Issues
Inventory Control
All companies need periodic verification of the inventory
records by actual count, weight, or measurement, with
the counts compared with the detailed inventory
records.
Companies should take the physical inventory near the

end of their fiscal year, to properly report inventory
quantities in their annual accounting reports.

Chapter
8-15

LO 2 Distinguish between perpetual and periodic inventory systems.


Basic
Basic Issues
Issues in
in Inventory
Inventory Valuation
Valuation
Valuation
Companies must allocate the cost of all the goods
available for sale (or use) between the goods that were
sold or used and those that are still on hand.
Illustration 8-5

Chapter
8-16

LO 2 Distinguish between perpetual and periodic inventory systems.


Basic
Basic Issues
Issues in

in Inventory
Inventory Valuation
Valuation
Valuation requires determining
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

Chapter
8-17

LO 2 Distinguish between perpetual and periodic inventory systems.


Physical
Physical Goods
Goods Included
Included in
in Inventory
Inventory
A company should record purchases when it obtains
legal title to the goods.
Illustration 8-6

Chapter
8-18

LO 2 Distinguish between perpetual and periodic inventory systems.

Effect
Effect of
of Inventory
Inventory Errors
Errors
Ending Inventory Misstated

Illustration 8-7

The effect of an error on net income in one year (2009) will be
counterbalanced in the next (2010), however the income statement
will be misstated for both years.
Chapter
8-19

LO 3 Identify the effects of inventory errors on the financial statements.


Effect
Effect of
of Inventory
Inventory Errors
Errors
Illustration: Jay Weiseman Corp. understates its ending inventory
by $10,000 in 2009; all other items are correctly stated.
Illustration 8-8

Chapter

8-20

LO 3


Effect
Effect of
of Inventory
Inventory Errors
Errors
Purchases and Inventory Misstated
Illustration 8-9

The understatement does not affect cost of goods sold and net
income because the errors offset one another.

Chapter
8-21

LO 3 Identify the effects of inventory errors on the financial statements.


Costs
Costs Included
Included in
in Inventory
Inventory
Product Costs - costs directly connected with
bringing the goods to the buyer’s place of
business and converting such goods to a salable

condition.
Period Costs – generally selling, general, and
administrative expenses.
Purchase Discounts – Gross vs. Net Method

Chapter
8-22

LO 4 Understand the items to include as inventory cost.


Costs
Costs Included
Included in
in Inventory
Inventory
Treatment of Purchase Discounts
Illustration 8-11

**

*

* $4,000 x 2% = $80
** $10,000 x 98% = $9,800
Chapter
8-23

Solution on
notes page

LO 4 Understand the items to include as inventory cost.


Which
Which Cost
Cost Flow
Flow Assumption
Assumption to
to Adopt?
Adopt?
FIFO

LIFO

Cost
Cost Flow
Flow Assumption
Assumption Adopted
Adopted
does
does not
not need
need to
to equal
equal
Physical
Physical Movement
Movement of
of Goods

Goods

Average Cost

Specific Identification

Answer: Method adopted should be one
that most clearly reflects periodic income.
Chapter
8-24

LO 5 Describe and compare the cost flow assumptions
used to account for inventories.


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

One item on 2/2/11 for $10

2.

One item on 2/15/11 for $15

3.

One item on 2/25/11 for $20

Young & Crazy Company sells one item on 2/28/11 for
$90. What would be the balance of ending inventory and
cost of goods sold for the month ended Feb. 2011,
assuming the company used the FIFO, LIFO, Average
Cost, and Specific Identification cost flow assumptions?
Assume a tax rate of 30%.
Chapter
8-25

LO 5 Describe and compare the cost flow assumptions
used to account for inventories.