WEEK 1  Chapter 6 (Pages 298 – 321)

Balance sheet: inventory, current assets, total assets, and SE retained earnings

ending inventory understated  everything understated.

ending inventory overstated  everything overstated.

Income statement: COGS, Gross profit, and net income

beginning inventory under  everything under

beginning inventory over  everything over

ending inventory under  everything under except COGS over

ending inventory over  everything over except COGS under

Comparing Inventory Costing Methods

when $ increase  FIFO > LIFO in gross profit, net income, and income taxes; (LIFO=less expenses)

when $ decrease  LIFO>FIFO in gross profit, net income, and income taxes
Control of Inventory
1. Safeguarding Inventory from damage or theft
When the inventory is ordered.
The following documents are often used for inventory control:
- Purchase order
- Receiving report
- Vendor’s invoice
2. Reporting Inventory in the financial statements.
• Count of inventory
• Cost of the inventory is assigned for reporting in the financial statements.

Inventory Costing Methods

• FIFO: First-In, First-Out Method

• LIFO: Last-In, First-Out Method

• Weighted Average Cost Method  Each time a purchase is made. $ unit cost = total price/total
units

Inventory Costing Methods Under a Periodic Inventory System

• Only revenue is recorded each time a sale is made.

• No entry is made at the time of the sale to record the cost of the goods sold.

• physical inventory is taken to determine the cost of the inventory and the cost of the goods
sold.

• cost flow assumption must be made when identical units are acquired at different unit costs
during a period.

Reporting Inventory in the Financial Statements

• Cost is the primary basis for valuing and reporting inventories in the financial statements.
However, inventory may be valued at other than cost in the following cases:

- The cost of replacing items in inventory is below the recorded cost.

- The inventory cannot be sold at normal prices due to imperfections, style changes,
spoilage, damage, obsolescence, or other causes.

Inventory on the Balance Sheet

• Inventory is in the current assets section

• In addition to this amount, the following are reported on the balance sheet or in the
accompanying notes:

- The method of determining the cost of the inventory (FIFO, LIFO, or weighted
average)

- The method of valuing the inventory (cost or the lower of cost or market)
Effect of Inventory Errors on the Financial Statements

- reasons: miscounted, costs incorrectly assigned, inventory in transit was incorrectly included
or excluded from inventory, and consigned inventory was incorrectly included or excluded from
the inventory.

• Inventory errors often arise from merchandise that is in transit at year-end.

• Shipping terms determine when the title to merchandise passes.

- When goods are purchased or sold FOB shipping point, title passes to the buyer when
the goods are shipped.

- When the terms are FOB destination, title passes to the buyer when the goods are
received.

• Inventory errors often arise from consigned inventory. Manufacturers sometimes ship
merchandise to retailers who act as the manufacturer’s selling agent.

• manufacturer=consignor, retains title until the goods are sold.

• merchandise is shipped on consignment to the retailer=consignee.

• Any unsold merchandise at year-end is part of the manufacturer’s (consignor’s) inventory,

even though the merchandise is in the hands of the retailer (consignee).

• Inventory errors reverse themselves within two years on the income statement and the
balance sheet.

• The effects are summarized as follows:

Analysis for Decision Making: Inventory Turnover and Number of Days’ Sales in Inventory

• A retail business should keep enough inventory on hand to meet its customers’ needs and a
failure to do so may result in lost sales.

• Too much inventory ties up funds that could be used to improve operations.

• Excess inventory increases expenses (storage and property taxes)

• Excess inventory increases the risk of losses due to price decreases, damage, or changes in
customer tastes.

• The number of days’ sales in inventory measures the length of time it takes to acquire, sell,
and replace the inventory.

Analysis for Decision Making: Inventory Turnover

• measures the relationship between COGS and the inventory carried during the period.

• It measures the number of times inventory is turned into sold goods during the year.

• the larger the inventory turnover, the more efficient and effective the company is in managing
inventory.