You are on page 1of 46

# MIT565702

WEEK 9
INVENTORY (2)

Lecture Objectives

## At the end of this lecture you should be able to:

Understand the need for cost-flow assumptions;
Determine how ending inventory and cost of goods
sold is determined under each cost-flow assumption;
Apply each cost-flow assumption using the periodic
and perpetual inventory methods; and
Apply the lower of cost or market rule

## What are Cost-flow Assumptions?

Example
XYZ Company had 1500 shirts on hand at 1 July 2011. These shirts had a
cost of \$8 each to purchase. Throughout the year it made the following
purchases:
22 August
19 October
28 January
12 March
8 June

10 000 shirts
19 000 shirts
8 000 shirts
15 000 shirts
6 000 shirts

at
at
at
at
at

\$13 each
\$10 each
\$12 each
\$15 each
\$13 each

3

1500 @ \$8
19 000 @ \$10

10 000 @ \$13
8000 @ \$12

## Cost of goods sold

56 000 @ \$??

15000 @ \$15

6000 @ \$13

Ending inventory
3500 @ \$??

Cost-flow Assumptions

## Split costs of opening inventory plus purchases into

COGS and ending inventory

COGS

Ending inventory

## How the costs are divided between COGS and ending

inventory impacts net profit and the inventory figure in
the balance sheet
5

## How do we determine the value of ending inventory and COGS?

Track each individual items through the inventory flow (specific
identification)
Accurate
Based on physical flow of goods
Time-consuming and expensive
Technology is making specific identification easier (e.g. bar
code technology)
In cases where the costs of specific identification outweigh the
benefits, cost-flow assumptions are a useful alternative
6

## What Cost-flow Assumptions are

Permitted in Australia?

## AASB 102 (IAS 2) Inventories permits the use of three

cost formulas:
Specific identification;
First-in, first-out (FIFO); and
Weighted average

## A fourth approach, last-in, first-out (LIFO) is not permitted

Specific Identification

## Each unit sold and on hand can be identified by serial

numbers or a specific purchase invoice

## Used when inventory items are not interchangeable

Small volume, high dollar value items
Houses; motor vehicles; expensive jewellery

## Not possible or cost-effective for many entities

FIFO

Assumes the first units acquired are the first units sold
Beginning inventory sold first and earliest purchases
thereafter

## Ending inventory, therefore, is assumed to consist of the

most recently acquired units

## Tends to understate COGS and overstate ending

inventory when cost price increases during the period

Weighted Average
Periodic Method
Weighted average calculated as:
Total cost of goods available for sale for a period
Total number units available for sale for a period

Perpetual Method
Moving weighted average, where average price is
recalculated after every purchase
10

LIFO

sold

para 25)

## It has been popular in the United States where it is

allowed for tax purposes if used for accounting
purposes but currently proposed for repeal

11

## Perpetual vs. Periodic

Recall:
Perpetual method maintains a continuous record of
inventory and COGS
Periodic method calculates inventory and COGS once a
stocktake has occurred

## Choosing the perpetual or periodic methods will influence

COGS and closing inventory under some cost-flow
assumptions
12

Example
Details
Beginning
Inventory
Purchased
Sold
Purchased
Sold

Date

Units

1/1/

200

Unit
cost
\$2

15/1/
17/1/
28/1/
30/1/
Total

300

\$3

Total
cost
\$400
\$900

Units
sold

250
500
1 000

\$4

\$2 000
\$3 300

400
650*

## * For specific identification purposes assume 100 units @ \$2;

150 @ \$3; 400 @ \$4

13

Specific identification
(Perpetual Method)
PURCHASES
Date
1/1
15/1

Units

300

Unit
cost
3

COGS

Total
cost

30/1

500

Total
cost

900

17/1
28/1

Units Unit
cost

ENDING INVENTORY

100
150

2
3

200
450

400

1600

2 000

TOTAL 2 250

Units
200
200
300
100
150
100
150
500
100
150
100

Unit
cost
2
2
3
2
3
2
3
4
2
3
4

Total
cost
400
400
900
200
450
200
450
2 000
200
450
400
1 050
14

Specific identification
(Periodic Method)

## Specific identification traces the movement of each

unit of inventory

## Implies the use of the perpetual inventory method, as

continuous records are maintained

## Specific identification not used in conjunction with the

periodic method

15

FIFO
(Perpetual Method)
PURCHASES
Date
1/1
15/1

Units

300

Unit
cost
3

COGS

Total
cost

30/1

200
50
500

Total
cost

900

17/1
28/1

Units Unit
cost

ENDING INVENTORY

2
3

400
150

2 000
250
3
750
150
4
600
TOTAL 1 900

Units
200
200
300

Unit
cost
2
2
3

Total
cost
400
400
900

250
250
500

3
3
4

750
750
2 000

350

1 400
1 400

16

FIFO
(Periodic Method)
Ending Inventory
Stocktake of 350 units
(Assume 350 units @ \$4)

= \$1 400

## Cost of Goods Available for Sale

Cost of goods available for sale

= \$3 300

## Cost of Goods Sold

650 units sold @ \$3 300 - \$1 400
= \$1 900
(Assume 200 units @ \$2 + 300 units @ \$3 + 150 @ \$4 = \$1900)
17

Weighted Average
(Perpetual Method)
Moving Weighted Average
PURCHASES
Date

Units

Unit
cost

COGS

Total
cost

Units

Unit
cost

ENDING INV.
Total
cost

1/1
15/1

300

900

250
500

## *\$2 650 750

30/1
TOTAL

Unit
cost

Total
cost

200

400

*500

2.60

1300

250

2.60

650

*750

3.53

2 650

350

3.53

1 238

= 2.60

17/1
28/1

Units

2.60

650

2 000

=\$3.53
400

3.53 1 412
2 062

1 238
18

Weighted Average
(Periodic Method)
Total cost of goods available for sale for a period
Total number units available for sale for a period
= \$3.30/unit

Ending inventory

\$3 300
1 000
350 x \$3.30

COGS

650 x \$3.30

= \$2 145

= \$1 155

19

LIFO
(Perpetual Method)
PURCHASES
Date

Units

COGS

Unit

Total

cost

cost

Units

ENDING STOCK/INV.

Unit

Total

cost

cost

1/1
15/1

300

900

17/1
250
28/1

500

750

2 000

30/1
400
TOTAL

1 600
2 350

Units

Unit

Total

cost

cost

200

400

200

400

300

900

200

400

50

150

200

400

50

150

500

2000

200

400

50

150

100

400
950

20

LIFO
(Periodic Method)
Ending Inventory
Stocktake of 350 units
(Assume 200 units @ \$2 + 150 units @ \$3)

## Cost of Goods Available for Sale

Cost of goods available for sale

= \$3 300

\$850

## Cost of Goods Sold

650 units sold @ \$3 300 - \$850
= \$2 450
(Assume 500 units @ \$4 + 150 units @ \$3 = \$2 450)
21

Comparison

## Assume there are no stock losses

22

PERIODIC
FIFO

PERPETUAL

LIFO

Weighted
average

Spec Id

FIFO

LIFO

Moving
average

SALES

6 500

6 500

6 500

6 500

6 500

6 500

6 500

Less COGS

1 900

2 450

2 145

2 250

1 900

2 350

2 062

Gross profit

4 600

4 050

4 355

4 250

4 600

4 150

4 438

Less expenses

50

50

50

50

50

50

50

Net profit

4 550

4 000

4 305

4 200

4 550

4 100

4 388

Ending inventory

1 400

850

1 155

1 050

1 400

950

1 238

23

Comparison
In periods of rising prices:

## FIFO results in the highest ending inventory, highest

gross profit, highest net profit and the lowest COGS

## LIFO results in lowest ending inventory, lowest gross

profit, lowest net profit and the highest COGS

## Weighted average and specific identification results

fall between FIFO and LIFO
24

Student Task

## Have a go at practice problem 1a b and c on Pg 145-6

of the study guide for discussion in 30 minutes.
Note. In part B prepare stock cards for the FIFO,
LIFO and Moving Weighted Average assumptions

25

Date

Particulars

DR

CR

26

Date

Particulars

DR

CR

27

## Income Statement (Periodic)

Income statement for the year ended 30 June

28

DATE

IN

OUT

BALANCE

29

DATE

IN

OUT

BALANCE

30

DATE

IN

OUT

BALANCE

31

Date

Particulars

DR

CR

32

Date

Particulars

DR

CR

33

Date

Particulars

DR

CR

34

Date

Particulars

DR

CR

35

## Income Statement (Perpetual)

Income statement for the year ended 30 June

36

Rule?

## Instances arise when the market price of inventory is less

than the cost price
Obsolescence (perishables past their use by date; audio
cassette players)
Damage (damaged goods basket at supermarket)
Demand (summer clearance sale)

## In accordance with the principle of conservatism, this

decrease in asset value is to be recognised when it occurs

37

## AASB 102 (IAS 2) Inventories states inventory is to be

valued at the lower of cost or net realisable value on an item
by item basis
If not practicable, may group similar or related items

## Net realisable value is the net amount expected to be

realised from the sale of inventory
Selling price less costs incurred to make the sale

sheet
38

Example
Item no.

675
732
957
977
Total

Units

5
10
15
8

Unit
cost

x
x
x
x

\$50
\$40
\$55
\$10

Total
Cost

=
=
=
=

\$250
\$400
\$825
\$ 80
1 555

Units

5
10
15
8

Market
Price

x
x
x
x

\$45
\$48
\$30
\$15

Total
Market
Price

Lower of
Cost or
Market

= \$225
= \$480
= \$450
= \$120
\$1 275

\$225
\$400
\$450
\$ 80
1 155

39

Student Task

## What would be the general journal entry from the

previous example to record the lower of cost or
market rule?

40

Workings
GENERAL JOURNAL
Date Particulars

DR

CR

41

Lecture Outcomes

## You should now be able to:

Understand the need for cost-flow assumptions;
Determine how ending inventory and cost of goods
sold is determined under each cost-flow assumption;
Apply each cost-flow assumption using the periodic
and perpetual inventory methods; and
Apply the lower of cost or market rule

42

43

## Homework Next Week

Case Discussion 1
E. Knight (2001), Inventiveness in inventories, The
Sydney Morning Herald, 9 August, p. 21 (Business).
Issues to consider:
How was the value of inventory determined?
How was this used to manipulate profits?

44

## Homework Next Week

Case Discussion 2
L. Gettler (2005), One-offs uncork the red for Evans
& Tate, The Age, 14 September, p. 2 (Business)
Issues to consider:
Why was the inventory write-down necessary?
Why were the corporate overheads expensed rather
than capitalised?

45

## Required Exercises P8.2, P8.7, P8.12

Chapter 13 of textbook

46