COPYRIGHT?2008ThomsonSouth-Western,apartofTheThomsonCorporation.Thomson,theStarlogo,andSouth-Westernaretrademarksusedhereinunderlicense.1Chapter7InventoryAlbrecht,Stice,Stice,Swain2TypesofInventoryRawmaterialsMaterialspurchasedforuseinmanufacturingprocess.WorkinprocessPartiallycompletedunitsinproduction.FinishedgoodsManufacturedproductsreadyforsale.CostofgoodssoldCostsincurredtopurchaseormanufacturethemerchandisesoldduringtheperiod.3CostsIncludedinInventoryWhatcostsareincludedininventory?RawmaterialsLaborcostsManufacturingoverheadTheindirectmanufacturingcostsassociatedwithproducinginventory.Freightincosts4WhoOwnstheInventory?Whengoodsareintransit?

Q:Whoownsinventoryonatruckorrailroadcar? A:Thepartywhoispayingtheshippingcosts.Whengoodsareonconsignment?

Q: Whoownsinventorystockedinawarehouse? A: Thesupplieruntiltheinventoryissold.The warehouseownerstocksandsellstheinventory and receivesacommissiononsalesaspaymentfor servicesrendered.5Perpetualvs.PeriodicSystemsPerpetualinventorysystemDetailedrecordsofthenumberofunitsandthecostofeachpurchaseandsalearepreparedTHROUGHOUTtheperiod.PeriodicinventorysystemSystemofaccountingwherecostofgoodssoldisdeterminedandinventoryisadjustedattheENDoftheaccountingperiod,notwhenmerchandiseispurchasedorsold.7Perpetualvs.PeriodicMethodWheninventoryissold:AccountsReceivable50 Sales 50CostofGoodsSold30 Inventory 30ClosingEntry:NoneWheninventoryissold:AccountsReceivable50 Sales 50NoinventoryentryattimeofsaleClosingEntries:Inventory 451PurchaseReturns 50PurchaseDiscounts9 FreightIn 10 Purchases 500CostofGoodsSold30

Inventory 308InventoryCountsInventorycountsNecessaryunderboththeperiodicandtheperpetualmethod.Withaperiodicsystem,aphysicalcountistheonlywaytogettheinformationnecessarytocomputecostofgoodssold.Underperpetualmethod,physicalcountsallowcompaniestodetermineinventoryshrinkage.Shrinkageequalsthedifferencebetweenwhatendinginventoryshouldbewhatthecountrevealsitis.10InventoryCostFlowAssumptionsFIFO(firstin,firstout)Oldestunitssoldfirst.LIFO(lastin,lastout)Newestunitssoldfirst.AverageCostAveragecostperunitiscalculatedbytakingtheaveragecostofgoodsavailableforsale.SpecificIdentificationEachitemisspecificallyidentified.Usuallyusedforlargeorexpensiveitems(cars).11InventoryCostFlowRiceKingbuysandsellsriceandhadthefollowingtransactionsfortheyear:June10Purchased10tonsat$6perton.July28Purchased10tonsat$9perton.October10Sold10tonsat$11perton.HowmuchdidRiceKingmakeduringtheyear?

FIFO LIFO Avg.Cost Sold Sold Sold

OldRice

NewRice

MixedRiceSales($11x10tons) $110 $110 $110COGS(10tons) 60

90

75Grossmargin $50 $20 $3512LIFOvs.FIFOFIFOgivesabettermeasureofinventoryonthebalancesheet.Therefore,FIFOisabettermeasureofinventoryvalue.LIFOgivesabetterreflectionofCOGSontheincomestatement.Therefore,LIFOisabettermeasureofnetincome.13ManagingInventoryIt’sabalance!Avoidtyingupresourcesininventory.Vs.Maintainingsufficientinventoryforsmoothbusinessoperations.14MeasuringtheManagementofInventoryInventoryTurnoverHowmanytimesduringtheyearacompanysellsallofitsinventory.

CostofGoodsSoldAverageInventory15MeasuringtheManagementofInventoryNumberofDays’SalesinInventoryHowmanydaysworthofsalesthecompanyhasininventory.365InventoryTurnoverCalculatedascostofgoodssolddividedbyaverageinventory.(Showninpreviousslide).17InventoryErrorsInventoryerrorsBeginninginventoryPurchasesEndinginventoryAffectsCostofgoodssoldGrossmarginNetincome18InventoryErrors

Understate Ending Inventory Sales OKBeginninginventory OKNetpurchases OKGoodsavailable OKEndinginventory LOWCostofgoodssold HIGHGrossmargin LOWExpenses OKNetincome LOWUnderstatePurchasesUnderstateBeginningInventoryUnderstateSalesOKOKLOWLOWOKLOWHIGHOKHIGHOKLOWOKLOWOKLOWHIGHOKHIGHLOWOKOKOKOKOKLOWOKLOW20NetRealizableValueNetRealizableValueSellingpricelesssellingcosts.Usedtovalueinventorywhenitisdamaged,used,orobsolete.Wheninventoryneedstobewrittendown:LossonWrite-downofInventory...... 200 Inventory....................... 200Towritedownofinventorytoitsnetrealizablevalue.

21LowerofCostorMarketLowerofcostormarketAbasisforvaluinginventoryattheloweroforiginalcostorcurrentmarketvalue.DeterminingmarketvalueCeilingMaximumamount(netrealizablevalue).ReplacementCostWhatinventorycouldcurrentlybepurchasedfor.FloorMinimumamount(netrealizablevalueminusanormalprofit).Marketvalueisthemiddleofthesethreevalues.22Example:LCM

MarketInventory Replacement NRV

Item

Cost

Floor

Cost

CeilingA 34 20 32 30B 42 32 36 46C 52 44 42 62D 38 50 32 68Definemarketvalueas:Replacementcost,ifitfallsbetweentheceilingandthefloor.Thefloor,ifthereplacementcostislessthanthefloor.Theceiling,ifthereplacementcostishigherthantheceiling.Whenreplacementcost,ceiling,andfloorarecompared,marketisalwaysthemiddlevalue.Comparethedefinedmarketvaluewiththeoriginalcostandchoosetheloweramount.23UsingLCMLCMcanbeappliedinthreeways.BycomputingcostandmarketfiguresforeachitemofinventoryandusingthelowerofthetwofiguresinEACHcase.BycomputingcostandmarketfiguresforthetotalinventoryandthenapplyingtheLCMruletothatTOTAL.ByapplyingtheLCMruletocategoriesofinventory.24GrossMarginMethodGrossMarginMethodUsedwhenaphysicalcountofinventoryisimpossibleorimpractical.Costofgoodssold