1、YE SUN AccountingEnglish20092Inventory IssuesnWhat is inventory?nWhat costs are included in inventory?nHow do we separate COGS from End.Inv?YE SUN AccountingEnglish20093Inventories DefinitionAsset items held for sale in the ordinary course of business or goods that will be used or consumed in the pr
2、oduction of goods to be sold.YE SUN AccountingEnglish20094Types of CompaniesnMerchandising companynSells goods in same form as acquired.nManufacturing companynConverts raw material into finished goods.nService companynProvides intangible services.YE SUN AccountingEnglish20095Types of Companies/Inven
3、toriesnMerchandisingnSells goods in same form in which they are acquired.Inventory costs(and costs of goods sold)=acquisition costs.YE SUN AccountingEnglish20096Types of Companies/Inventories(Cont.)Manufacturing company converts raw materials and purchased parts into finished goods.3 types of invent
4、ories;Materials.Work-in-process.Finished goods.YE SUN AccountingEnglish20097Types of Companies/Inventories(Cont.)Service organizations(hotels,beauty parlors,plumbers)May have materials inventories.YE SUN AccountingEnglish20098Types of Companies/Inventories(Cont.)Professional service firms(accounting
5、 firms,legal firms)Intangible inventory costs are costs incurred for client but not yet billed called jobs-in-progress or unbilled costs.YE SUN AccountingEnglish20099SuppliesTangible items that will be consumed in the course of normal operations.e.g.,office supplies,lubricants,repair parts.Not sold
6、and not accounted for as part of cost of goods sold.YE SUN AccountingEnglish200910Merchandise InventoryInventories accounted for at cost.Cost includes cost of Acquiring merchandise(invoice cost of goods,freight-in)Making goods ready for sale.(unpacking and marking)YE SUN AccountingEnglish200911Metho
7、ds of Accounting for Purchase(or cash)DiscountsRecord at invoice price(in china)Record discount when taken.Net of discountCharge discounts not taken when paid.YE SUN AccountingEnglish200912TerminologynPurchase=receipt of merchandise not to placing of a purchase order.Usually title transfers when goo
8、ds are shipped(FOB shipping point).YE SUN AccountingEnglish200913Relationship of Inventory and Cost of Goods SoldBeginning inventory+net purchases=goods available for saleGoods available for sale=cost of goods sold+ending inventory.Equivalently:Beg.inventory+net purchases-ending inventory=cost of go
9、ods sold.Net purchases=gross purchases-purchase returns and allowances+freight-inYE SUN AccountingEnglish200914Measurement IssuenDividing goods available for sale between COGS and End.Inventory.n2 approaches:nPeriodic inventory method.nPerpetual inventory method.YE SUN AccountingEnglish200915Periodi
10、c Inventory MethodDetermine amount of ending inventory and deduce costs of goods sold.Count inventory(i.e.,a physical inventory is taken)at the end of the period.Multiply count times cost for each item to determine total amount of inventory.Beginning inventory of current period=ending inventory of p
11、receding period.COGS=COGA-End.InventoryYE SUN AccountingEnglish200916Perpetual Inventory MethodMeasure amount actually delivered to customers;deduce ending inventory.Perpetual inventory record is kept for each item in the inventory.Advantages of perpetual inventory method:Detailed record is useful.B
12、uilt in check.Identifies shrinkage by item.Income statement can be prepared without taking a physical inventory.YE SUN AccountingEnglish200917Inventory Costing Methods(Cost Flow Assumptions)nSpecific identification.nAverage cost.nFIFOnLIFO()YE SUN AccountingEnglish200918Specific IdentificationBig ti
13、cket(high price)items.Uniquely identified items.May offer opportunity to manipulate costs.YE SUN AccountingEnglish200919Average Cost(Beginning inventory amount+purchases)/units available for sale=per unit inventory costs=per unit cost of goods soldPeriodic method.Computed for the entire period.Perpe
14、tual method.A new unit cost can be calculated after each purchase.YE SUN AccountingEnglish200920First-in,First-out(FIFO)Expenses costs of oldest purchases first.Most recently purchased goods are in inventory.Likely but not necessary to follow actual flow of goods.Ending inventory approximates curren
15、t cost of goods.YE SUN AccountingEnglish200921Last-in,First-out(LIFO)Assumes most recently purchased goods are sold firstInventory based on costs of oldest purchases.Cost of goods sold usually does not reflect physical flow.Ending inventory may be costed at amounts of years ago.Inventory may be well
16、 below current costs.YE SUN AccountingEnglish200922YE SUN AccountingEnglish200923Arguments for FIFOUsually follows physical flow of goods.If prices are based on oldest cost,results in best matching.More accurate balance sheet valuation.Non-theoretical/practical argument:Results in highest income dur
17、ing periods of rising prices.YE SUN AccountingEnglish200924Arguments for LIFOIf prices are based on current costs,results in best matching of revenues and costs and therefore most useful income statement.Closest to reflecting current or replacement costs of goods sold.However,it is still historical
18、costs and does differ from current costs.YE SUN AccountingEnglish200925Arguments for LIFO(cont.)During periods of price increases:Higher costs of goods sold.Lower taxable income.Lower income taxes.Higher cash flows.If LIFO for tax purposes than also financial reporting.YE SUN AccountingEnglish200926
19、Why Not More LIFO?IAS and most countries do not permit.Would require a double set of books.Prices of some items are not increasing.Because of IRS conformity requirement,lower earnings reported to shareholders.YE SUN AccountingEnglish200927The Principle of ConsistencyOnce a company has adopted a part
20、icular accounting method,it should follow that method consistently,rather than switch methods from one year to the next.YE SUN AccountingEnglish200928LCM and Other Write-Downs of InventoryReduces the value of the inventory.ObsolescenceAdjust inventory value to the lower of historical cost or Net rea
21、lizable value(market).Lower of Cost or Market(LCM)YE SUN AccountingEnglish200929Lower of Cost or Market(LCM)Market price may be below cost due to:Physical deterioration.Change in consumer tastes.Technological obsolescence.LCM is a reflection of conservatism concept.Market is defined as net realizabl
22、e valueYE SUN AccountingEnglish200930Net realizable value(NRV)NRV=estimated selling price-estimated costs of selling.So inventory not above cash that will be received.YE SUN AccountingEnglish200931Steps in Applying LCMCompute market,Select lower of cost or market.YE SUN AccountingEnglish200932Invent
23、ory estimation methodYE SUN AccountingEnglish200933The Gross Profit MethodDetermine cost of goods available for sale.Estimate cost of goods sold by multiplying the net sales by the cost ratio.Deduct cost of goods sold from cost of goods available for sale to determine ending inventory.YE SUN Account
24、ingEnglish200934The Gross Profit Method ExampleIn March of 1999,Chemicos inventory was destroyed by fire.Chemicos normal gross profit ratio is 30%of net sales.At the time of the fire,Chemico showed the following balances:YE SUN AccountingEnglish200935The Gross Profit Method Example Estimate Cost of
25、Goods Sold.YE SUN AccountingEnglish200936The Gross Profit Method ExampleSince gross margin=30%,then the COGS ratio must be 70%.YE SUN AccountingEnglish200937The Gross Profit Method Example 70%YE SUN AccountingEnglish200938Retail MethodnVariation of perpetual method.Record purchases at cost and at re
26、tail.Calculate gross margin percent and its complement(the cost of goods sold as a percent of retail).Cost of goods sold=Retail sales for the period*cost of goods sold percent.Ending inventory=Beginning inventory+purchases-cost of goods sold.YE SUN AccountingEnglish200939Analysis of InventoryInventory turnover=Cost of goods sold/InventoryCan use average or ending inventory.Measures efficiency of asset usage.Differs by industry.Days inventory=Inventory/(Cost of goods sold 365)YE SUN AccountingEnglish200940End of lesson 6
