Chapter Inventories Accounting, 21st Edition Warren Reeve Fess PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2004 South-Western, a division of Thomson Learning All rights reserved Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc Some Some of of the the action action has has been been automated, automated, so so click click the the mouse mouse when when you you see see this this lightning lightningbolt bolt in in the the lower lower right-hand right-hand corner corner of of the the screen screen You You can can point point and and click click anywhere anywhere on on the the screen screen Objectives Objectives Summarize and provide examples of internal control procedures that apply to inventories After studying this After studying this Describe the chapter, effect of inventory errors on the financial you should statement chapter, you should be able able to: to: flow assumptions Describe the three be inventory cost and how they impact the income statement and balance sheet Compute the cost of inventory under the perpetual inventory system, using the following cost methods: first-in, first-out; last-in, first-out; average cost Objectives Objectives Compute the cost of inventory under the periodic inventory system, using the following costing methods: first-in, first-out; last-in, first-out; average cost Compare and contrast the use of the three inventory costing methods Compute the proper valuation of inventory at other than cost, using the lower-of-cost-ormarket and net realization value concepts Prepare a balance sheet presentation of merchandise inventory Objectives Objectives Estimate the cost of inventory, using the retail method and the gross profit method 10 Compute the interpret the inventory turnover ratio and number of days’ sales in inventory Why is Inventory Control Important? Important  Inventory is a significant asset and 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  Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees AGREE AG RE E Invoice Purchase order AG RE E Receiving report JOURNAL Date Description Nov Inventory Accounts Payable XYZ Co Purchased merchandise on account Post Ref 222 00 222 00 Effect Effect of of Inventory Inventory Errors Errors on on Financial Financial Statements Statements LIABILITIES Merchandise Inventory ASSETS OWNER’S EQUITY Net Income Cost of Merchandise Sold COSTS & EXPENSES REVENUES IfIfmerchandise merchandiseinventory inventoryisis overstated Cost Costof ofmerchandise merchandisesold soldisis understated Gross Grossprofit profitand andnet netincome incomeare are overstated Ending Endingowner’s owner’sequity equityisis overstated Effect Effect of of Inventory Inventory Errors Errors on on Financial Financial Statements Statements IfIfmerchandise merchandiseinventory inventoryisis understated Cost Costof ofmerchandise merchandisesold soldisis overstated Gross Grossprofit profitand andnet netincome incomeare are understated Ending Endingowner’s owner’sequity equityisis understated Inventory Inventory Cost Cost Flow Flow Assumptions Assumptions Purchased Purchased goods goods Sold Sold goods goods Average Average Cost Cost Periodic Periodic 200 units @ $9 = $ 1,800 300 units @ $10 = $ 3,000 400 units @ $11 = $ 4,400 100 units @ $11 = $ 1,200 1,000 units available for sale during year $10,400 Cost of merchandise available for sale Average Average Cost Cost Periodic Periodic Cost of Merchandise Available for Sale Units Available for Sale During Year $10,400 1,000 Units = Average Unit Cost = $10.40 per Unit Average Average Cost Cost Periodic Periodic Cost Cost of of merchandise merchandise available available for for sale sale $10,400 $10,400 Less Less ending ending inventory inventory ($10.40 ($10.40 xx 300) 300) 3,120 3,120 Cost Cost of of merchandise merchandise sold sold $$ 7,280 To verify this 7,280 amount, multiply 700 units sold times $10.40 to get the same $7,280 Valuation of Inventory at Lower-of-Cost-or-Market Unit Unit Inventory Cost Market 400 $10.25 Price $ 9.50 Quantity Price A Item 3,800 B 120 22.50 2,892 3,800 C 600 8.00 4,650 2,700 D 280 14.00 4,130market decline based on 4,650 The Total Total $ Cost $ 4,100 Market 24.10 2,700 7.75 4,800 14.75 3,920 Lower C or M $ individual items ($15,520 – $15,070) = $450 3,920 Total $15,520 $15,472 Presentation of Merchandise Inventory on the Balance Sheet Metro-Arts Balance Sheet December 31, 2007 Assets Current assets: Cash 19 400 00 Accounts receivable Less allowance for doubtful accounts 77 000 00 Merchandise inventory at lower of cost (first-in, $ $80 000 00 000 00 Estimating Estimating Inventory Inventory Cost Cost Retail Method of Estimating Inventory Cost  Retail method is based on relationship between cost of merchandise available for sale and the retail price  Retail prices of all merchandise must be accumulated and totaled  Inventory at retail is calculated at retail price of merchandise available for sale less net sales at retail  Ratio is calculated as cost divided by retail price  Inventory at retail price times cost ratio equals estimated cost of inventory Retail Retail Inventory Inventory Method Method Cost Retail $19,400 $ Merchandise inventory, Jan 36,000 Purchases in January 42,600 Merchandise available(net) for sale $62,000 64,000 $100,000 $62,000 Ratio of cost to retail price = = 62% $100,000 Step Step 1: 1: Determine Determine the the ratio ratio of of cost cost to to the the retail retail price price Retail Retail Inventory Inventory Method Method Cost Retail $19,400 $ Merchandise inventory, Jan 36,000 Purchases in January 42,600 Merchandise available(net) for sale $62,000 64,000 $100,000 Sales for January (net) 70,000 Merchandise inventory, January 31, at retail $ 30,000 Step Step 2: 2: Determine Determine the the ending ending inventory inventory at at retail retail Retail Retail Inventory Inventory Method Method Cost Retail $19,400 $ Merchandise inventory, Jan 36,000 Purchases in January 42,600 Merchandise available(net) for sale $62,000 64,000 $100,000 Sales for January (net) 70,000 Merchandise inventory, January 31, at retail $ cost 30,000 ($30,000 x 62%) $18,600 Step Step 3: 3: Calculate Calculate the the estimated estimated inventory inventory at at cost cost Gross Profit Method of Estimating Inventory Cost A gross profit percentage rate is estimated based on previous experience adjusted for known changes Estimated gross profit is calculated by multiplying the estimated gross profit rate times the actual net sales Estimated cost of merchandise sold is calculated by subtracting the gross profit from actual sales The cost of merchandise sold estimate is deducted from actual merchandise available for sale to determine the estimated cost of merchandise inventory Gross Profit Method Gross Profit Merchandise inventory, January Method $ 57,000 Purchases in January (net) 180,000 Merchandise available for sale ($250,000 x 30%) Sales in January (net) 175,000 Less: Estimated gross profit $237,000 75,000 $250,000 $ 62,000 Estimated cost of merchandise sold Estimated merchandise inventory, January 31 The The gross gross profit profit method method isis useful useful for for estimating estimating inventories inventories for for monthly monthly or or quarterly quarterly financial financial statements statements in in aa periodic periodic inventory inventory system system Inventory Inventory Turnover Turnover SUPERVALU Zale Cost of merchandise sold $15,620,127,000 $ 737,188,000 Inventories: Beginning of year $1,115,529,000 $478,467,000 End of year 1,067,837,000 571,669,000 Inventory turnover 14.3 times 1.4 Total $2,183,366,000 times $1,050,136,000 $1,091,683,000 Use: Inventory relationship Use:Average Inventory turnover turnover measures measures the the relationship $525,068,000 between between the the volume volume of of goods goods sold sold and and the the amount amount of of inventory inventory carried carried during during the the period period Number Number of of Days’ Days’ Sales Sales in in Inventory Inventory SUPERVALU Average daily cost of merchandise sold: $15,620,127,000/365 $737,188,000/365 $2,019,693 Ending inventory $571,669,000 Average selling period days Zale $42,794,868 $1,067,837,000 25 days Use: Use: To To assess assess the the efficiency efficiency in in the the management management of of inventory inventory 283 Chapter The The End End ... inventories After studying this After studying this Describe the chapter, effect of inventory errors on the financial you should statement chapter, you should be able able to: to: flow assumptions Describe