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Chapter7InventoryKeyPointsAboutInventoryInventoryRecordingBasicInventoryValuationMethodsAlternativeValuationMethodsEstimatingInventoryInventoryErrorsInventoryCategoriesDefinedaccordingtotypeandnatureofthecompany.Merchandising:

Itemstoberesold. Forasupermarket,foodis inventory,theshoppingcartisnot.Manufacturing:rawmaterialsworkinprocessfinishedgoodsInventoryRecordingMethods

(inChapter3)PERIODICMETHODPERPETUALMETHODExercises:SateliteTrackerssellssatellitetrackingsystemsforreceivingtelevisionbroadcastsfromsatellitesinouterspace.AtDecember31,Year1,thecompany’sinventoryamountedto$22000.DuringthefirstweekofJanuary,thecompanymadeonlyonepurchaseandonesale.Thesetransactionswereasfollows:Jan.3Soldonetrackingsystemcosting$11200toMysteryMountainResortforcash,$18900.Jan.6PurchasedmerchandiseonaccountfromYamaha,$9600.Terms,net30days.Required:(1)PreparejournalentriestorecordthesetransactionsassumingthatSateliteTrackersusestheperpetualinventorysystem.UseseparateentriestorecordthesalesrevenueandthecostofgoodssoldforthesaleonJanuary3.(2)ComputethebalanceoftheInventoryaccountonJanuary7.Answers:(1)Jan.3Cash18,900Sales18,900CostofGoodsSold11,200MerchandiseInventory11,2006MerchandiseInventory9,600AccountsPayable9,600(2)22,000+9,600–11,200=$20,400Required:(3)PreparejournalentriestorecordthetwotransactionsassumingthatSateliteTrackersusestheperiodicinventorysystem.(4)ComputethecostofgoodssoldforthefirstweekofJanuaryassuminguseofaperiodicinventorysystem.Useyouranswertopart(2)astheendinginventory.Answers:(3)Jan.3Cash18,900Sales18,9006Purchases9,600AccountsPayable9,600(4)Thecostofgoodssoldforthefirstweekis$22,000+9,600–20,400=$11,200INVENTORYVALUATIONMETHODSThecostofgoodsavailableforsalecanbedividedinto(1)thecostofthegoodssoldand(2)thecostofthegoodsnotsold,whichcomprisetheendinginventory.INVENTORYVALUATIONMETHODSTherearefourcommonlyusedmethodsofassigningcostsofgoodsavailableforsaleto

goodsremaining

andto

goodssold.InventoryCostFlowMethodsSpecificcostidentificationAveragecostFirst-in,first-out(FIFO)Last-in,first-out(LIFO)AveragecostmethodThismethodvaluesallmerchandise(unitssoldandunitremainingininventory)attheaverageper-unitcost.Thisaveragecostiscomputedbydividingthetotalcostofgoodsavailableforsalebythenumberofunitsininventory.(seenextslide)AverageCostMethodTheperiodicinventorysystemusestheweighted-averageunitcostmethod.Theperpetualinventorysystemusesthemoving-averageunitcostmethod.Inthischapterweuseweighted-averageunitcostmethod.Weighted-AverageMethodWeighted-averagecost(WAC)perunit

Beginninginventorycost+CurrentpurchasecostBeginninginventoryunits+Currentpurchaseunits

EndingInventoryEndingInv.=UnitsinEndingInv.xWACperUnit

CostofGoodsSoldCOGS=UnitsSoldxWACperUnit

First-In,First-OutbasedontheassumptionthatthefirstunitsacquiredarethefirstunitssoldThecostofthe

oldest

inventoryitemsarechargedtoCGSwhengoodsaresold.Thecostofthenewest

inventoryitemsremaininendinginventory.Last-In,First-OutTheactualphysicalflowofinventoryitemsmaydifferfromtheLIFOcostflowassumptions.Thecostofthe

newest

inventoryitemsarechargedtoCGSwhengoodsaresold.Thecostoftheoldest

inventoryitemsremaininendinginventory.ExamplesforinventoryvaluationSeeourtextbookpage148~150EvaluationofSpecificIdentification(textbook)AdvantageItprovidesgood

matchingofCGSwithsalesrevenue.DisadvantagesPossibilityofincomemanipulation.Itislimitedtoafewbusinesses

thatdealinexpensiveoruniqueitems.AverageCostEvaluationObjectiveandconsistent.Matchaverage,ratherthanlatestcosts,withcurrentsalesrevenues.EvaluationofFIFOAdvantagesEasytoapply.Inventoryvalueapproximatescurrentcost.Flowofcoststendstobeconsistentwithusualphysicalflowofgoods.Systematicandobjective.Notsubjecttomanipulation.DisadvantagesDoesnotmatchcurrentcostofgoodssoldwithcurrentrevenues.Inventory(orphantom)profits.(thehigherprofitsreportedbymatchingcurrentrevenueswitholdercostsareknownasinventoryprofits.)Inperiodsofrisingprices,payhigherincometaxes.InPeriodsofRisingPrices...LIFOMatcheshigh(newer)costswithcurrent(higher)sales.Valuesinventoryonlow(older)costbasis.Resultsinlowertaxableincome.

FIFOMatcheslow(older)costswithcurrent(higher)sales.Valuesinventoryapproximatinghighercurrentcosts.Resultsinhighertaxableincome.

Inventory:AlternativeValuationMethodsLowerofCostorMarket(LCM)GeneralRuleInventoriesmustbecarriedatcostorcurrentmarketvalue,whicheverislower.(page151,section5)CostMarketLowerofCostorMarket(LCM)Marketisthecurrent

replacementcost

ofanitemininventory.NetRealizableValue

(NRV)Estimatedsellingpricelessthecostsofmarketingtheproduct.MarketmaynotbemorethanNRV.Calledthe“Ceiling.”NRVReducedbyaNormalProfitMarginCalledthe“Floor,”marketmaynotbelessthanthisamount.SelectingtheProperMarketValueIfreplacementcostis

below

thefloor,floor=market.Ifreplacementcostis

above

theceiling,ceiling=market.Ifreplacementcostfalls

between

theceilingandfloor,replacementcost=market.Inaword,wechoosethe

middlevalue

ofthethreemarketpricesasourmarketvalueinapplyingtheLCM.LowerofCostorMarket

Example1Diego,Inc.hasoneitemininventorythatiscurrentlycarriedathistoricalcostof$20perunit.AttheBalanceSheetdatewegatherthefollowingperunitinformation:currentreplacementcost$21.50;sellingprice$30;costtocompleteanddispose$4;andnormalprofitmarginof$5.HowwouldDiegovaluetheinventoryitemonitsBalanceSheet?LowerofCostorMarket

Example1LCMLowerofCostorMarket

Example1Currentreplacementcostof$21.50fallsbetweentheceiling($26.00)andthefloor($21.00),socurrentreplacementcostbecomesmarketforcomparisonwithcost.LowerofCostorMarket

Example1Marketis$21.50Costis$20.00

Costisbelowmarket,sotheinventoryitemwillbevaluedontheBalanceSheetatitshistoricalcostof$20.00.ApplicationofLCM(seetextbookpage153)Comparecostandmarketseparatelyforeach:ItemofInventoryClassofinventoryitemsApplicationofLCM(seetextbookpage153)OryoucouldcompareTotalCostTotalMarketFortheentireinventoryExercises

Page162,exercise10Answerforexercise10

case1ProductCostMarketLCMforeachLCMfortotal

X$70*550=38500$75*550=4125038500

Y$65*420=27300$60*420=2520025200

Z$43*300=12900$41*300=1230012300Total78700787507600078700Answerforexercise10

case2ProductCostMarketLCMforeachLCMfortotalV$19*620=11780$18*620=1116011160W$47*1100=51700$38*1100=4180041800TOTAL63480529605296052960Answerforexercise10

case3ProductCostMarketLCMforeachLCMfortotalT$52*650=33800$51*650=3315033150U$15*400=6000$16*400=64006000TOTAL39800395503915039550Reportingdeclineininventoryvalue(LCM)

Recordholdinglossinacontrainventoryaccount,“AllowanceforDeclineinInventoryValue.”(theadjustingentryonpage154)

HoldingLossfromDeclineinInventoryValueAllowanceforDeclineinInventoryValueAccountingPrinciples

andInventories

Businessesshouldusethesameaccountingmethodsandproceduresfromoneperiodtothenext.Acompanymaychangeinventorymethods,butitmustdisclosetheeffectsofthechangeonnetincome.ConsistencyPrincipleEstimatingInventoryBecauseofthecostandtimerequiredtotakeacompletephysicalinventory,itissometimesnecessarytoestimatethecostofendinginventory.Twopopularmethodsare...GrossProfit(GrossMargin)MethodRetailMethodGrossProfitMethodAssumesthatthehistoricalgrossmarginrate

isreasonablyconstantintheshortrun.Wemustknowthefollowing:Netsalesfortheperiod.Costofbeginninginventory.Netpurchasesfortheperiod.Thehistoricalgrossmarginrate.GrossProfitMethod

ExampleNoteCo,Inc.usesthegrossProfitmethodtoestimateendofmonthinventoryvalue.AttheendofMaythecontrollerdevelopsthefollowinginformation:GrossProfit43%ofsales;InventoryatMay1$237,400;netpurchasesforMay$728,300;netsalesforMay$1,213,000.

Let’sestimateInventoryatMay31.GrossProfitMethodExampleGrossProfitMethodExampleGrossProfitMethodExampleGrossProfitMethodExampleProofofEstimateGrossProfitMethod

ExampleExercisesPage163,exercise11Answerforexercise11Goodsavailableforsale:Beginninginventory,Jan.1276,500NetPurchases(824000-15350=)808,650Add:transportation-in27,450Costofgoodsavailableforsale:1,112,600Deduct:Estimatecostofgoodssold:Netsales(945600-19700=)925,900Costratio(100%-33%)67%Estimatecostofgoodssold:620,353Estimatedendinginventory492,247RetailMethodThisme