Chapter 6-1 CHAPTER INVENTORIES Accounting Principles, Eighth Edition Chapter 6-2 Study Study Objectives Objectives Describe the steps in determining inventory quantities Explain the accounting for inventories and apply the inventory cost flow methods Explain the financial effects of the inventory cost flow assumptions Explain the lower-of-cost-or-market basis of accounting for inventories Indicate the effects of inventory errors on the financial statements 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 Check accuracy of inventory records Determine amount of inventory lost (wasted raw materials, shoplifting, or employee theft) Periodic System Determine the inventory on hand Determine the cost of goods sold for the period Chapter 6-6 LO 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 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 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 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 Describe the steps in determining inventory quantities Inventory Inventory Errors Errors Common Cause: Failure to count or price inventory correctly Not properly recognizing the transfer of legal title to goods in transit Errors affect both the income statement and balance sheet Chapter 6-33 LO Indicate the effects of inventory errors on the financial statements Inventory Inventory Errors Errors Income Statement Effects Inventory errors affect the computation of cost of goods sold and net income Illustration 6-16 Illustration 6-17 Chapter 6-34 LO Indicate the effects of inventory errors on the financial statements Inventory Inventory Errors Errors Income Statement Effects Inventory errors affect the computation of cost of goods sold and net income in two periods An error in ending inventory of the current period will have a reverse effect on net income of the next accounting period Over the two years, the total net income is correct because the errors offset each other The ending inventory depends entirely on the accuracy of taking and costing the inventory Chapter 6-35 LO Indicate the effects of inventory errors on the financial statements Inventory Inventory Errors Errors Illustration 6-18 2008 2009 Incorrect Correct Incorrect Correct $ 80,000 $ 80,000 $ 90,000 $ 90,000 Beginning inventory 20,000 20,000 12,000 15,000 Cost of goods purchased 40,000 40,000 68,000 68,000 Cost of goods available 60,000 60,000 80,000 83,000 Ending inventory 12,000 15,000 23,000 23,000 Cost of good sold 48,000 45,000 57,000 60,000 Gross profit 32,000 35,000 33,000 30,000 Operating expenses 10,000 10,000 20,000 20,000 $ 22,000 $ 25,000 $ 13,000 $ 10,000 Sales Net income Combined income for 2-year period is correct Chapter 6-36 ($3,000) Net Income understated $3,000 Net Income overstated LO Indicate the effects of inventory errors on the financial statements Inventory Inventory Errors Errors Review Question Understating ending inventory will overstate: a assets b cost of goods sold c net income d owner's equity Chapter 6-37 LO Indicate the effects of inventory errors on the financial statements Inventory Inventory Errors Errors Balance Sheet Effects Effect of inventory errors on the balance sheet is determined by using the basic accounting equation: Illustration 6-16 Illustration 6-19 Chapter 6-38 LO Indicate the effects of inventory errors on the financial statements Statement Statement Presentation Presentation and and Analysis Analysis Presentation Balance Sheet - Inventory classified as current asset Income Statement - Cost of goods sold subtracted from sales There also should be disclosure of 1) major inventory classifications, 2) basis of accounting (cost or LCM), and 3) costing method (FIFO, LIFO, or average) Chapter 6-39 LO Indicate the effects of inventory errors on the financial statements Statement Statement Presentation Presentation and and Analysis Analysis Analysis Inventory management is a double-edged sword High Inventory Levels - may incur high carrying costs (e.g., investment, storage, insurance, obsolescence, and damage) Low Inventory Levels – may lead to stockouts and lost sales Chapter 6-40 LO Compute and interpret the inventory turnover ratio Statement Statement Presentation Presentation and and Analysis Analysis Inventory turnover measures the number of times on average the inventory is sold during the period Inventory Turnover = Cost of Goods Sold Average Inventory Days in inventory measures the average number of days inventory is held Days in Year (365) Days in = Inventory Inventory Turnover Chapter 6-41 LO Compute and interpret the inventory turnover ratio Statement Statement Presentation Presentation and and Analysis Analysis BE6-9 At December 31, 2008, the following information was available for J Graff Company: ending inventory $40,000, beginning inventory $60,000, cost of goods sold $270,000, and sales revenue $380,000 Calculate inventory turnover and days in inventory for J Graff Company Inventory Turnover Days in Inventory Chapter 6-42 $270,000 ($60,000 + 40,000) / 365 5.4 = 5.4 = 67.59 days LO Compute and interpret the inventory turnover ratio Inventory Cost Flow Methods in Perpetual Inventory Systems The following data from Houston Electronics will be used to illustrate inventory costing under a perpetual system Illustration 6A-1 Chapter 6-43 LO Apply the inventory cost flow methods to perpetual inventory records Inventory Cost Flow Methods in Perpetual Inventory Systems Computation of cost of goods sold and ending inventory under FIFO for Houston Electronics Illustration 6A-2 Cost of goods sold Ending inventory Chapter 6-44 LO Apply the inventory cost flow methods to perpetual inventory records Inventory Cost Flow Methods in Perpetual Inventory Systems Computation of cost of goods sold and ending inventory under LIFO for Houston Electronics Illustration 6A-3 Cost of goods sold Ending inventory Chapter 6-45 LO Apply the inventory cost flow methods to perpetual inventory records Inventory Cost Flow Methods in Perpetual Inventory Systems Computation of cost of goods sold and ending inventory under moving average for Houston Electronics Illustration 6A-4 Cost of goods sold Chapter 6-46 Ending inventory LO Apply the inventory cost flow methods to perpetual inventory records Copyright Copyright “Copyright © 2008 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” Chapter 6-47 .. .CHAPTER INVENTORIES Accounting Principles, Eighth Edition Chapter 6-2 Study Study Objectives Objectives Describe the steps in determining inventory quantities Explain the accounting. .. lower-of-cost-or-market basis of accounting for inventories Indicate the effects of inventory errors on the financial statements Compute and interpret the inventory turnover ratio Chapter 6-3 Reporting... inventory on hand Taken, when the business is closed or when business is slow at end of the accounting period Chapter 6-7 LO Describe the steps in determining inventory quantities Determining Determining