Professional Documents
Culture Documents
ch08 Inventories PDF
ch08 Inventories PDF
From this information, Call-Mart computes the ending inventory of 6,000 units
and the cost of goods available for sale (beginning inventory ⴙ purchases) of $43,900
[(2,000 @ $4.00) ⫹ (6,000 @ $4.40) ⫹ (2,000 @ $4.75)]. The question is, which price or
prices should it assign to the 6,000 units of ending inventory? The answer depends on
which cost flow assumption it uses.
Specific Identification
Specific identification calls for identifying each item sold and each item in inventory.
A company includes in cost of goods sold the costs of the specific items sold. It includes U.S. GAAP
in inventory the costs of the specific items on hand. This method may be used only in PERSPECTIVE
instances where it is practical to separate physically the different purchases made. As U.S. GAAP does not require
a result, most companies only use this method when handling a relatively small num- the use of specific
ber of costly, easily distinguishable items. In the retail trade, this includes some types identification in the situations
of jewelry, fur coats, automobiles, and some furniture. In manufacturing, it includes identified by IFRS.
special orders and many products manufactured under a job cost system.
To illustrate, assume that Call-Mart Inc.’s 6,000 units of inventory consists of 1,000
units from the March 2 purchase, 3,000 from the March 15 purchase, and 2,000 from
the March 30 purchase. Illustration 8-1 shows how Call-Mart computes the ending in-
ventory and cost of goods sold.
8–2 · IFRS Supplement
ILLUSTRATION 8-1
Date No. of Units Unit Cost Total Cost
Specific Identification
Method March 2 1,000 $4.00 $ 4,000
March 15 3,000 4.40 13,200
March 30 2,000 4.75 9,500
Ending inventory 6,000 $26,700
This method appears ideal. Specific identification matches actual costs against ac-
tual revenue. Thus, a company reports ending inventory at actual cost. In other words,
under specific identification the cost flow matches the physical flow of the goods.
On closer observation, however, this method has certain deficiencies in addition to its
lack of practicability in many situations.
Some argue that specific identification allows a company to manipulate net income.
For example, assume that a wholesaler purchases identical plywood early in the year
at three different prices. When it sells the plywood, the wholesaler can select either the
lowest or the highest price to charge to expense. It simply selects the plywood from a
specific lot for delivery to the customer. A business manager, therefore, can manipulate
net income by delivering to the customer the higher- or lower-priced item, depending
on whether the company seeks lower or higher reported earnings for the period.
Another problem relates to the arbitrary allocation of costs that sometimes occurs
with specific inventory items. For example, a company often faces difficulty in relating
freight charges, storage costs, and discounts directly to a given inventory item. This re-
sults in allocating these costs somewhat arbitrarily, leading to a “breakdown” in the
precision of the specific identification method.1
Average Cost
As the name implies, the average cost method prices items in the inventory on the
basis of the average cost of all similar goods available during the period. To illustrate
use of the periodic inventory method (amount of inventory computed at the end of
the period), Call-Mart computes the ending inventory and cost of goods sold using a
weighted-average method as follows.
ILLUSTRATION 8-2
Date of Invoice No. Units Unit Cost Total Cost
Weighted-Average
Method—Periodic March 2 2,000 $4.00 $ 8,000
March 15 6,000 4.40 26,400
Inventory
March 30 2,000 4.75 9,500
Total goods available 10,000 $43,900
$43,900
Weighted-average cost per unit ⫽ $4.39
10,000
Inventory in units 6,000 units
Ending inventory 6,000 ⫻ $4.39 ⫽ $26,340
Cost of goods available for sale $43,900
Deduct: Ending inventory 26,340
Cost of goods sold $17,560
1
The motion picture industry provides a good illustration of the cost allocation problem. Often
actors receive a percentage of net income for a given movie or television program. Some
actors, however, have alleged that their programs have been extremely profitable to the motion
picture studios but they have received little in the way of profit-sharing. Actors contend that
the studios allocate additional costs to successful projects to avoid sharing profits.
Chapter 8 Valuation of Inventories: A Cost-Basis Approach · 8–3
In computing the average cost per unit, Call-Mart includes the beginning inventory, if
any, both in the total units available and in the total cost of goods available.
Companies use the moving-average method with perpetual inventory records.
Illustration 8-3 shows the application of the average cost method for perpetual records.
ILLUSTRATION 8-3
Date Purchased Sold or Issued Balance
Moving-Average
March 2 (2,000 @ $4.00) $ 8,000 (2,000 @ $4.00) $ 8,000 Method—Perpetual
March 15 (6,000 @ 4.40) 26,400 (8,000 @ 4.30) 34,400
Inventory
March 19 (4,000 @ $4.30)
$17,200 (4,000 @ 4.30) 17,200
March 30 (2,000 @ 4.75) 9,500 (6,000 @ 4.45) 26,700
AUTHORITATIVE LITERATURE
Authoritative Literature References
[1] International Accounting Standard 2, Inventories (London, U.K.: International Accounting Standards
Committee Foundation, 2001), paras. 23–25.
[2] International Accounting Standard 2, Inventories (London, U.K.: International Accounting Standards
Committee Foundation, 2001), paras. BC13–BC14.
EXERCISES
E8-1 (FIFO and Average Cost Determination) LoBianco Company’s record of transactions for the
month of April was as follows.
Purchases Sales
April 1 (balance on hand) 600 @ $6.00 April 3 500 @ $10.00
4 1,500 @ 6.08 9 1,300 @ 10.00
8 800 @ 6.40 11 600 @ 11.00
13 1,200 @ 6.50 23 1,200 @ 11.00
21 700 @ 6.60 27 900 @ 12.00
29 500 @ 6.79 4,500
5,300
Instructions
(a) Assuming that periodic inventory records are kept, compute the inventory at April 30 using
(1) FIFO and (2) average cost.
(b) Assuming that perpetual inventory records are kept in both units and dollars, determine the
inventory at April 30 using (1) FIFO and (2) average cost.
8–4 · IFRS Supplement
(c) In an inflationary period, which inventory method—FIFO or average cost—will show the highest
net income?
E8-2 (FIFO and Average Cost Inventory) Esplanade Company was formed on December 1, 2009. The
following information is available from Esplanade’s inventory records for Product BAP.
Instructions
Prepare schedules to compute the ending inventory at March 31, 2010, under each of the following
inventory methods (round to two decimal places).
(a) Specific identification. (b) FIFO. (c) Weighted-average.
Under (a), 400 units from the beginning inventory are on hand and 1,100 units from the January 5 pur-
chase are on hand.
E8-3 (Compute FIFO and Average Cost—Periodic) Presented below is information related to radios
for the Couples Company for the month of July.
Instructions
(a) Assuming that the periodic inventory method is used, compute the inventory cost at July 31
under each of the following cost flow assumptions.
(1) FIFO. (2) Weighted-average.
(b) Answer the following questions.
(1) Which of the methods used above will yield the highest figure for gross profit for the income
statement? Explain why.
(2) Which of the methods used above will yield the highest figure for ending inventory for the
statement of financial position? Explain why.
E8-4 (FIFO and Average Cost, Income Statement Presentation) The board of directors of Oksana Cor-
poration is considering whether or not it should instruct the accounting department to change from a
first-in, first-out (FIFO) basis of pricing inventories to an average cost basis. The following information is
available.
Instructions
Prepare a condensed income statement for the year on both bases for comparative purposes (round to two
decimal places).
E8-5 (Compute Specific Identification, FIFO, and Average Cost) Hull Company’s record of transac-
tions concerning part X for the month of April was as follows.
Purchases Sales
April 1 (balance on hand) 100 @ $5.00 April 5 300
4 400 @ 5.10 12 200
11 300 @ 5.30 27 800
18 200 @ 5.35 28 150
26 600 @ 5.60
30 200 @ 5.80
Instructions
(a) Compute the inventory at April 30 on each of the following bases. Assume that perpetual inven-
tory records are kept in units only. Carry unit costs to the nearest cent.
(1) Specific identification; ending inventory is comprised of 100 units from beginning inventory
and 250 units from the April 26 purchase.
(2) First-in, first-out (FIFO).
(3) Average cost.
(b) If the perpetual inventory record is kept in dollars, and costs are computed at the time of each
withdrawal, what amount would be shown as ending inventory in 1, 2, and 3 above? Carry average
unit costs to four decimal places.
Following is Lumber Supply International’s adapted income statement and information concerning
inventories from its statement of financial position.
Inventories. Inventories are valued at the lower-of-cost-or-market and include material, labor, and
production overhead costs. Inventories consisted of the following:
Current Year Prior Year
Finished goods $27,512,000 $23,830,000
Raw materials and
work-in-progress 34,363,000 33,244,000
61,875,000 57,074,000
Reduction to average cost (5,263,000) (3,993,000)
$56,612,000 $53,081,000
The average cost (AC) method is used for determining the cost of lumber, veneer, Microllam lumber, LSI
joists, and open web joists. Approximately 35 percent of total inventories at the end of the current year
were valued using the AC method. The first-in, first-out (FIFO) method is used to determine the cost of
all other inventories.
Instructions
(a) How much would income before taxes have been if FIFO costing had been used to value all inventories?
(b) If the income tax rate is 46.6%, what would income tax have been if FIFO costing had been used to value
all inventories? In your opinion, is this difference in net income between the two methods material?
Explain.
(c) Does the use of a different costing system for different types of inventory mean that there is a different
physical flow of goods among the different types of inventory? Explain.
Noven also reported in its annual report that its activities to date have consisted of product devel-
opment efforts, some of which have been independent and some of which have been completed in con-
junction with Rhone-Poulenc Rorer (RPR) (FRA) and Ciba-Geigy (USA). The revenues so far have
consisted of money received from licensing fees, “milestone” payments (payments made under licensing
agreements when certain stages of the development of a certain product have been completed), and
interest on its investments. The company expects that it will have significant revenue in the upcoming
fiscal year from the launch of its first product, a transdermal estrogen delivery system.
The current assets portion of Noven’s statement of financial position follows.
Inventory of supplies is recorded at the lower of cost (first-in, first-out) or net realizable value and con-
sists mainly of supplies for research and development.
Instructions
(a) What would you expect the physical flow of goods for a pharmaceutical manufacturer to be most
like: FIFO or random (flow of goods does not follow a set pattern)? Explain.
(b) What are some of the factors that Noven should consider as it selects an inventory measurement
method?
(c) Suppose that Noven had $49,000 in an inventory of transdermal estrogen delivery patches. These
patches are from an initial production run, and will be sold during the coming year. Why do you
think that this amount is not shown in a separate inventory account? In which of the accounts shown
is the inventory likely to be? At what point will the inventory be transferred to a separate inventory
account?
Case 3 SUPERVALU
SUPERVALU (USA) reported that its inventory turnover ratio decreased from 17.1 times in 2006 to 15.8
times in 2007. The following data appear in SUPERVALU’s annual report.
(a) Compute SUPERVALU’s inventory turnover ratios for 2006 and 2007, using:
(1) Cost of sales and LIFO inventory.
(2) Cost of sales and FIFO inventory.
(b) Some firms calculate inventory turnover using sales rather than cost of goods sold in the numerator.
Calculate SUPERVALU’s 2006 and 2007 turnover, using:
(1) Sales and LIFO inventory.
(2) Sales and FIFO inventory.
(c) Describe the method that SUPERVALU’s appears to use.
(d) State which method you would choose to evaluate SUPERVALU’s performance. Justify your choice.
8–8 · IFRS Supplement
Instructions
Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/ ). When you have accessed
the documents, you can use the search tool in your Internet browser to respond to the following ques-
tions. (Provide paragraph citations if necessary.)
(a) Which statement addresses revenue recognition when right of return exists?
(b) When is this statement important for a company?
(c) Sales with high rates of return can ultimately cause inventory to be misstated. Why are returns
allowed? Should different industries be able to make different types of return policies?
(d) In what situations would a reasonable estimate of returns be difficult to make?