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Chapter 8/9

Inventories
Accounting, 21st Edition

Warren Reeve Fess (CH 9)


IFRS Edition Kieso, Weygandt, and Warfield (CH 8)

Facilitator: Se Tin, S.E., M.Si, Ak

Valuation of Inventories:
COST BASIS APPROACH

Learning Objectives
1. 2. Identify major classifications of inventory. Distinguish between perpetual and periodic inventory systems. 3. Identify the effects of inventory errors on the financial statements. 4. 5. Understand the items to include as inventory cost. Describe and compare the methods used to price

inventories.

Valuation of Inventories: Cost-Basis Approach

Inventory Issues

Physical Goods Included in Inventory


Goods in transit Consigned goods Special sales agreements Inventory errors

Cost Included in Inventory


Product costs Period costs Purchase discounts

Cost Flow Assumptions


Specific identification Average cost FIFO Summary analysis

Classification Cost flow Control Basic inventory valuation

Classification

Inventories are:
items held for sale, or goods to be used in the production of goods to be sold.

Businesses with Inventory Merchandiser


or

Manufacturer

Classification

One inventory account. Purchase goods in form ready for sale.

Classification

Three accounts

Raw materials Work in process

Finished goods

Inventory Cost Flow

Inventory Cost Flow

Companies use one of two types of systems for maintaining inventory records perpetual system or periodic system.

Perpetual System
1. Purchases of merchandise are debited to Inventory.
2. Freight-in is debited to Inventory. Purchase returns and allowances and purchase discounts are credited to Inventory. 3. Cost of goods sold is debited and Inventory is credited for each sale. 4. Subsidiary records show quantity and cost of each type of inventory on hand.
The perpetual inventory system provides a continuous record of Inventory and Cost of Goods Sold.

Periodic System
1. Purchases of merchandise are debited to Purchases. 2. Ending Inventory determined by physical count. 3. Calculation of Cost of Goods Sold: Beginning inventory Purchases, net Goods available for sale Ending inventory $ 100,000 800,000 900,000 125,000

Cost of goods sold

$ 775,000

Why is Inventory Control 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.

Effect of Inventory Errors on Financial Statements


LIABILITIES

Merchandise Inventory

ASSETS

OWNERS EQUITY
Net Income

Cost of Merchandise Sold

COSTS & EXPENSES

REVENUES

Effect of Inventory Errors

Ending Inventory Misstated

The effect of an error on net income in one year (2010) will be counterbalanced in the next (2011), however the income statement will be misstated for both years.

Illustration: Yei Chen Corp. understates its ending inventory by HK$10,000 in 2010; all other items are correctly stated.

Effect of Inventory Errors

Purchases and Inventory Misstated

The understatement does not affect cost of goods sold and net income because the errors offset one another.

Inventory Cost Flow Assumptions


Purchased goods

Sold goods

Inventory Cost Flow Assumptions

Sold Purchased goods goods

Inventory Cost Flow Assumptions


Purchased goods

Sold goods

Which Cost Flow Assumption to Adopt?

Cost Flow Assumption Adopted does not need to equal Physical Movement of Goods

Method adopted should be one that most clearly reflects periodic income.

Inventory Costing Methods


43%
40%
30% 20%

34%

19%

10%
0%

4%
Fifo Lifo Average Other

Perpetual Inventory Costs


Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems
Item 127B Units Cost Price $30 21 31 32 22

Jan. 1 Inventory 4 Sale Cost of 10 Purchase Mdse. Sold 22 Sale 28 Sale 30 Purchase

10 7 8 4 2 10

$20

FIFO Perpetual Inventory Account


Item 127B
Purchases Date Jan. 1 Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. Unit Cost Total Cost Inventory Balance Qty. 10 Unit Total Cost Cost 20 200

The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

FIFO Perpetual Inventory Account


Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems
Item 127B Jan. 1 Inventory 4 Sale Cost of 10 Purchase Mdse. Sold 22 Sale 28 Sale 30 Purchase Units 10 7 8 4 2 10 Cost $20 $30 21 31 32 22 Price

On January 4, 7 units of Item 127B are sold at $30 each.

FIFO Perpetual Inventory Account


Item 127B
Purchases Cost of Mdse. Sold Total Cost Inventory Balance

Date
Jan. 1 4

Qty.

Unit Cost

Qty. 7

Unit Cost

Total Cost

Qty.
10 3

Unit Total Cost Cost 20 20 200 60

20

140

The sale of 7 units leaves a balance of 3 units.

On January 4, 7 units of Item 127B are sold at $30 each.

FIFO Perpetual Inventory Account


Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems
Item 127B Jan. 1 Inventory 4 Sale Cost of 10 Purchase Mdse. Sold 22 Sale 28 Sale 30 Purchase Units 10 7 8 4 2 10 Cost $20 $30 21 31 32 22 Price

On January 10, the firm purchased eight units at $21 each.

FIFO Perpetual Inventory Account


Item 127B
Purchases Cost of Mdse. Sold Total Cost Inventory Balance

Date
Jan. 1 4 10

Qty.

Unit Cost

Qty. 7

Unit Cost

Total Cost

Qty.
10 3 3 8

Unit Total Cost Cost 20 20 20 21 200 60 60 168

20

140

21

168

purchased eight units at $21 each.

Because the purchase price of $21 is different than the cost of the previous 3 units On on hand, the inventory balance of January 10, the firm 11 units is accounted for separately.

FIFO Perpetual Inventory Account


Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems
Item 127B Jan. 1 Inventory 4 Sale Cost of 10 Purchase Mdse. Sold 22 Sale 28 Sale 30 Purchase Units 10 7 8 4 2 10 Cost $20 $30 21 31 32 22 Price

On January 22, the firm sold four units for $31 each.

FIFO Perpetual Inventory Account


Item 127B

On January 22, the Unit Total firm sold four units Date Qty. Cost Cost Qty. for $31 each. Jan. 1
4 10
22

Purchases

Cost of Mdse. Sold Unit Cost Total Cost

Inventory Balance

Qty.
10 3 3 8 7

Unit Total Cost Cost 20 20 20 21 21 200 60 60 168 147

7
8 21 168 3 1

20

140

20 21

60 21

Of the four units sold, three are from the first units in (fifo) at a cost of $20.

FIFO Perpetual Inventory Account


Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems
Item 127B Jan. 1 Inventory 4 Sale Cost of 10 Purchase Mdse. Sold 22 Sale 28 Sale 30 Purchase Units 10 7 8 4 2 10 Cost $20 $30 21 31 32 22 Price

On January 28, the firm sold two units at $32.

FIFO Perpetual Inventory Account


Item 127B
Purchases Cost of Mdse. Sold Total Cost Inventory Balance

Date
Jan. 1 4 10 22 28

Qty.

Unit Cost

Qty. 7

Unit Cost

Total Cost

Qty.
10 3 3 8 7 5

Unit Total Cost Cost 20 20 20 21 21 21 200 60 60 168 147 105

20

140

21

168 3 1 2 20 21 21 60 21 42

On January 28, the firm sold two units at $32.

FIFO Perpetual Inventory Account


Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems
Item 127B Jan. 1 Inventory 4 Sale Cost of 10 Purchase Mdse. Sold 22 Sale 28 Sale 30 Purchase Units 10 7 8 4 2 10 Cost $20 $30 21 31 32 22 Price

On January 30, purchased ten additional units of Item 127B at $22 each.

FIFO Perpetual Inventory Account


Item 127B
Purchases Cost of Mdse. Sold Total Cost Inventory Balance

Date
Jan. 1 4 10 22 28 30 Totals

Qty.

Unit Cost

Qty.

Unit Cost

Total Cost

Qty.
10 3 3 8 7 5 5 10 15

Unit Total Cost Cost 20 20 20 21 21 21 21 22 200 60 60 168 147 105 105 220 $325

On January 30, purchased 7 20 8ten additional 21 168 units of Item 127B at $22 each.
3 1 2 20 21 21

140

60 21 42

10
18

22

220
$388 13 $263

LIFO Perpetual Inventory Account


Item 127B
Purchases Date Jan. 1 Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. Unit Cost Total Cost Inventory Balance Qty. 10 Unit Total Cost Cost 20 200

The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

LIFO Perpetual Inventory Account


Item 127B
Purchases Date Jan. 1 4 Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. Unit Cost Total Cost Inventory Balance Qty. 10 3 Unit Total Cost Cost 20 20 200 60

20

140

On January 4, the firm sold 7 units at $30 each.

LIFO Perpetual Inventory Account


Item 127B
Purchases Date Jan. 1 4 10 Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. Unit Cost Total Cost Inventory Balance Qty. 10 3 3 8 Unit Total Cost Cost 20 20 20 21 200 60 60 168

7
8 21 168

20

140

On January 10, the firm purchased eight units at $21 each.

Note that a new layer is formed.

LIFO Perpetual Inventory Account


Item 127B
Purchases Date Jan. 1 4 10 22 Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. Unit Cost Total Cost Inventory Balance Qty. 10 3 3 8 3 4 Unit Total Cost Cost 20 20 20 21 20 21 200 60 60 168 60 84

7
8 21 168 4

20

140

21

84

On 22,sold, the all come Of January the 4 units firm sells four from the most recent purchase units atat a $31 cost each. of $21 each.

LIFO Perpetual Inventory Account


Item 127B
Purchases Date Jan. 1 4 10 22 28 Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. Unit Cost Total Cost Inventory Balance Qty. 10 3 3 8 3 4 3 2 Unit Total Cost Cost 20 20 20 21 20 21 20 21 200 60 60 168 60 84 60 42

7
8 21 168 4 2

20

140

21 21

84 42

On January 28, sold two units at $32 each.

LIFO Perpetual Inventory Account


Item 127B
Purchases Date Jan. 1 4 10 22 28 30 10 22 220 Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. Unit Cost Total Cost Inventory Balance Qty. 10 3 3 8 3 4 3 2 3 2 10 Unit Total Cost Cost 20 20 20 21 20 21 20 21 20 21 22 200 60 60 168 60 84 60 42 60 42 220

7
8 21 168 4 2

20

140

21 21

84 42

On January 30, purchase 10 units at $22 each.

LIFO Perpetual Inventory Account


Item 127B
Purchases Date Jan. 1 4 10 22 28 30 10 22 220 Qty. Unit Cost Total Cost Cost of Mdse. Sold Qty. Unit Cost Total Cost Inventory Balance Qty. 10 3 3 8 3 4 3 2 3 2 10 15 Unit Total Cost Cost 20 20 20 21 20 21 20 21 20 21 22 200 60 60 168 60 84 60 42 60 42 220 $322

7
8 21 168 4 2

20

140

21 21

84 42

Totals

18

$388

13

$266

Fifo Periodic

Fifo Periodic
200 units @ $9 300 units @ $10 400 units @ $11 100 units @ $12 1,000 units available for sale during year Jan. 1 Beginning Inventory Mar. 10 Purchase Sept. 21 Purchase

Nov. 18 Purchase

Fifo Periodic
200 units @ $9 300 units @ $10 400 units @ $11 100 units @ $12 = $1,800 = = 3,000 4,400 Jan. 1 Mar. 10 Sept. 21

1,200

Nov. 18

1,000 units available $10,400 for sale during Cost of merchandise year
available for sale

Fifo Periodic
A physical count on December 31 reveals that 700 of the 1,000 units have been sold. Using fifo, the first units purchased are theoretically the first units sold. We begin the count with January 1.

Fifo Periodic
Sold these 200 200 units @ $9
Sold these 300 units @300 $10 Sold 400 units 200 of @these $11 200 100 units @ $12 $1,800 = $ 0 = = 3,000 0 4,400 2,200

Jan. 1
Mar. 10 Sept. 21

1,200

Nov. 18

1,000 units available $10,400 $ 3,400 for sale during year Ending inventory

Fifo Periodic
Cost of merchandise available for sale $10,400 Less ending inventory 3,400 Cost of merchandise sold $ 7,000

Summary of Fifo Periodic


Purchases
Jan. 1 200 units at $9 Mar. 10 300 units at $10 Sep. 21 400 units at $11 Nov. 18 100 units at $12

Merchandise Available for Sale


$1,800 $3,000

Cost of Merchandise Sold


$1,800 $3,000 $2,200 $7,000 200 units at $9 300 units at $10 200 units at $11

$4,400

700 units

$1,200 $10,400

Merchandise Inventory
$2,200 $1,200 $3,400 200 units at $11 100 units at $12

1,000 units

300 units

Lifo Periodic

Lifo Periodic
200 units @ $9 300 units @ $10 400 units @ $11 100 units @ $12 Jan. 1 Beginning Inventory Mar. 10 Purchase Sept. 21 Purchase

Nov. 18 Purchase

1,000 units lifo, available Using the most recent batch for sale during purchased is considered the first year

batch of merchandise sold.

Lifo Periodic
200 units @ $9 300 units @ $10 400 units @ $11 100 units @ $12 1,000 units available for sale during year

700 units were sold Mar.during 10 Purchase the year.


Sept. 21 Purchase

Jan. 1 Beginning Assume again that Inventory

Nov. 18 Purchase

Lifo Periodic
200 units @ $9 Sold 200 of 100 300 units @these $10 400 Sold units these @400 $11 100 Sold units these @100 $12 = $1,800 = = = 3,000 1,000 4,400 0 1,200 0 Jan. 1 Mar. 10 Sept. 21 Nov. 18

1,000 units available $10,400 $2,800 for sale during year Ending Inventory

Lifo Periodic
Cost of merchandise available for sale $10,400 Less ending inventory 2,800 Cost of merchandise sold $ 7,600

Summary of Lifo Periodic


Purchases
Jan. 1 200 units at $9 Mar. 10 300 units at $10 Sep. 21 400 units at $11 Nov. 18 100 units at $12

Merchandise Available for Sale


$1,800 $3,000

merchandise inv
$1,800

200 units at $9
100 units at $10

$1,000
$2,800 Cost of Merchandise Sold

300 units

$4,400

$2,000
$4,400 $1,200 $7,600

200 units at $10 400 units at $11 100 units at $12

$1,200 $10,400

1,000 units

700 units

Average Cost Periodic


Jan. 1 Beginning 200 units @ $9 The average cost Inventory

periodic method is based 300 units @ $10 Mar. 10 Purchase on the average cost of units.21 Purchase Sept. 400 units @identical $11
100 units @ $12 1,000 units available for sale during year

Nov. 18 Purchase

Average Cost Periodic


200 units @ $9 300 units @ $10 400 units @ $11 = $ 1,800 = $ 3,000 = $ 4,400

100 units @ $12 1,000 units available for sale during year

= $ 1,200 $10,400 Cost of merchandise available for sale

Average Cost Periodic


Cost of Merchandise Available for Sale = Average Unit Cost Units Available for Sale During Year $10,400 1,000 Units

= $10.40 per Unit

Average Cost Periodic


Cost of merchandise available for sale $10,400 Less ending inventory ($10.40 x 300) 3,120 Cost of merchandise sold $ 7,280 To verify this amount, multiply 700 units sold times $10.40 to get the same $7,280.

Inventory Valuation Methods - Summary

Notice that gross profit and net income are lowest under LIFO, highest under FIFO, and somewhere in the middle under average cost.

Inventory Valuation Methods - Summary

LIFO results in the highest cash balance at year-end (because taxes are lower). This example assumes that prices are rising. The opposite result occurs if prices are declining.

Under IFRS, LIFO is not permitted for financial reporting purposes. Nonetheless, LIFO is permitted for financial reporting purposes in the United States, it is permitted for tax purposes in some countries, and its use can result in significant tax savings.

LIFO Reserve

Many companies use


LIFO for tax and external financial reporting purposes FIFO, average cost, or standard cost system for internal reporting purposes. Reasons: 1. 2. 3. 4. Pricing decisions Record keeping easier Profit-sharing or bonus arrangements LIFO troublesome for interim periods

The End

+ poin
Exercise 8-18

tugas
Problem 8-2 Problem 8-7