Professional Documents
Culture Documents
CH 08
CH 08
Coby Harmon
University of California, Santa Barbara
Westmont College
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Valuation of CHAPTER 8
Inventories: A Cost-
Basis Approach
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe inventory 3. Compare the cost flow
classifications and different assumptions used to account
inventory systems. for inventories.
2. Identify the goods and costs 4. Determine the effects of
included in inventory. inventory errors on the
financial statements.
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PREVIEW OF CHAPTER 8
Intermediate Accounting
IFRS 3rd Edition
Kieso ● Weygandt ● Warfield
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LEARNING OBJECTIVE 1
Inventory Issues Describe inventory
classifications and different
inventory systems.
Classification
Inventories are asset:
items held for sale in the ordinary course of business, or
goods to be used in the production of goods to be sold.
Merchandising or Manufacturing
Company Company
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Classification
ILLUSTRATION 8.1
One inventory
account.
Purchase
merchandise in
a form ready
for sale.
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Classification
ILLUSTRATION 8.1
Three accounts
Raw Materials
Work in Process
Finished Goods
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ILLUSTRATION 8.2
Flow of Costs through
Manufacturing and
Merchandising Companies
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Inventory Issues
Perpetual System
1. Purchases of merchandise are debited to Inventory.
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Inventory Cost Flow
Periodic System
1. Purchases of merchandise are debited to Purchases.
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Inventory Cost Flow
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Inventory Cost Flow ILLUSTRATION 8.4
Comparative Entries—
Perpetual vs. Periodic
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Inventory Cost Flow
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Inventory Issues
Inventory Control
All companies need periodic verification of the inventory records
by actual count, weight, or measurement, with
counts compared with detailed inventory records.
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Inventory Issues
ILLUSTRATION 8.5
Computation of Cost
of Goods Sold
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LEARNING OBJECTIVE 2
Goods and Costs Identify the goods and costs
included in inventory.
Included an
Inventory
Goods Included in Inventory
A company recognizes inventory and accounts payable at
the time it controls the asset.
Passage of title is often used to determine control because
the rights and obligations are established legally.
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LO 2
Goods Included In Inventory
Goods in Transit
Example: LG (KOR) determines ownership by applying the
“passage of title” rule.
If a supplier ships goods to LG f.o.b. shipping point, title
passes to LG when the supplier delivers the goods to the
common carrier, who acts as an agent for LG.
If the supplier ships the goods f.o.b. destination, title
passes to LG only when it receives the goods from the
common carrier.
“Shipping point” and “destination” are often designated by a
particular location, for example, f.o.b. Seoul.
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Goods Included In Inventory
Consigned Goods
Example: Williams Art Gallery (the consignor) ships various art
merchandise to Sotheby’s Holdings (USA) (the consignee), who
acts as Williams’ agent in selling the consigned goods.
Sotheby’s agrees to accept the goods without any liability,
except to exercise due care and reasonable protection from
loss or damage, until it sells the goods to a third party.
When Sotheby’s sells the goods, it remits the revenue, less a
selling commission and expenses incurred, to Williams.
Goods out on consignment remain the property of the consignor
(Williams).
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Goods Included In Inventory
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Goods Included In Inventory
Product Costs
Costs directly connected with bringing the goods to the buyer’s
place of business and converting such goods to a salable
condition.
3. Transportation costs.
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Costs Included In Inventory
Period Costs
Costs that are indirectly related to the acquisition or production
of goods.
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Costs Included In Inventory
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Treatment of Purchase Discounts
**
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LEARNING OBJECTIVE 3
Which Cost Flow Compare the cost flow
assumptions used to account
Assumptions to for inventories.
Adopt?
Cost Flow Methods
Specific Identification
or
Two cost flow assumptions
► First-in, First-out (FIFO) or
► Average Cost
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Cost Flow Methods
To illustrate the cost flow methods, assume that Call-Mart SpA
had the following transactions in its first month of operations.
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Cost Flow Methods
Specific Identification
Method may be used only in instances where it is
practical to separate physically the different purchases
made. Cost of goods sold includes costs of the specific
items sold.
Used when handling a relatively small number of costly,
easily distinguishable items.
Matches actual costs against actual revenue.
Cost flow matches the physical flow of the goods.
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Specific Identification
Illustration: 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. Compute the amount of ending
inventory and cost of goods sold.
ILLUSTRATION 8.7
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Cost Flow Methods
Average-Cost
Prices items in the inventory on the basis of the average
cost of all similar goods available during the period.
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Average-Cost
ILLUSTRATION 8.8
Weighted-Average Method Weighted-Average
Method—Periodic Inventory
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Average-Cost
ILLUSTRATION 8.9
Moving-Average Method Moving-Average Method—
Perpetual Inventory
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Cost Flow Methods
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First-In, First-Out (FIFO)
In all cases where FIFO is used, the inventory and cost of goods
sold would be the same at the end of the month whether a perpetual
or periodic system is used.
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Inventory Valuation Methods—Summary
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Inventory Valuation Methods—Summary
ILLUSTRATION 8.12
Comparative Results of
Average-Cost and FIFO
Methods
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Inventory Valuation Methods—Summary
ILLUSTRATION 8.13
Balances of Selected Items under Alternative
Inventory Valuation Methods
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LEARNING OBJECTIVE 4
Effect of Inventory Errors Determine the effects of
inventory errors on the
financial statements.
The effect of an error on net income in one year will be counterbalanced in the next,
however the income statement will be misstated for both years.
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Ending Inventory Misstated
Illustration: Yei Chen Ltd. understates its ending inventory by
HK$10,000 in 2019; all other items are correctly stated. ILLUSTRATION 8.15
Effect of Ending Inventory
Error on Two Periods
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Effect of Inventory Errors
ILLUSTRATION 8.16
Purchases and Inventory Financial Statement
Effects of Misstated
The understatement does not affect cost of goods sold and net income because the
errors offset one another.
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APPENDIX 8A LIFO Cost Flow Assumption
LEARNING OBJECTIVE 5
Describe the LIFO cost flow assumption.
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Last-In, First-Out (LIFO)
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Last-In, First-Out (LIFO)
ILLUSTRATION 8A.1
Periodic Inventory System LIFO Method—Periodic
Inventory
The cost of the total quantity sold or issued during the month comes
from the most recent purchases.
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Last-In, First-Out (LIFO)
ILLUSTRATION 8A.2
Perpetual Inventory System LIFO Method—Perpetual
Inventory
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Inventory Valuation Methods—Summary
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Inventory Valuation Methods—Summary
ILLUSTRATION 8A.3
Comparative Results of Notice that gross profit and net income are lowest
Average-Cost and FIFO
and LIFO Methods under LIFO, highest under FIFO, and somewhere in
the middle under average-cost.
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Inventory Valuation Methods—Summary
ILLUSTRATION 8A.4
Balances of Selected LIFO results in the highest cash balance at year-end
Items under Alternative
Inventory Valuation (because taxes are lower). This example assumes that
Methods
prices are rising. The opposite result occurs if prices are
declining.
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