Chapter 6
Reporting and
Analyzing Inventory
Manufacturing Inventory
• Finished goods inventory
• Work in process
• Raw materials
6
Finished Goods Inventory
Manufactured items that are complete and
ready for sale.
7
Work in Process
Manufactured inventory that has been
placed into production but is not yet
complete.
8
Raw Materials
The basic goods that will be used in
production, but have not been placed
in production.
9
Key difference between
periodic and perpetual
inventory…
is the point at which
the costs of goods
sold is computed.
Determine Inventory Quantities
• Determine inventory quantities by
counting, weighting or measuring
each type of inventory.
• Determine ownership of goods,
including goods in transit, consigned
goods.
7
Questions Concerning
Ownership
• Do all the goods included in the count
belong to the company?
• Does the company own any goods not
included in the count?
8
Goods in Transit
Goods are on board a truck, train, ship, or
plane at the end of the period.
Who includes them in inventory?
➢Seller?
➢Buyer?
The
Company
with Legal
Title 9 36
Terms of Sale- FOB (free-on-board)
Consigned Goods
• Goods of others you hold. You do not
pay for the goods until they sell.
• The company does not take
ownership.
What Is a Cost Flow Assumption?
To presume the order in which goods are
sold even if flow of costs is unrelated to
the physical flow of goods.
Inventory Cost Flows
• Specific Identification--The tracking of actual
costs for specifically identified units.
• FIFO (first-in, first-out)--Assumption that the
first goods bought are the first goods sold.
• LIFO (last-in, first-out)--Assumption that the
last goods purchased are the first goods sold.
• Weighted Average Cost –Assumption that
when similar units are combined in inventory
the costs are merged and averaged between all
parts.
Specific Identification
• Used by companies that sell limited
products at a high price.
• Requires that each unit has a specific
cost associated with it.
Data for Examples
Use the following data to show the journal
entry for the sales in June and the value of
ending inventory using the FIFO Perpetual
method.
Beginning Inventory 10 hats @ $10 each = $100
Purchases (February) 15 hats @ $15 each = $225
Sales (June) 20 hats
Purchases (July) 10 hats @ $18 each = $180
Ending Inventory 15 hats
FIFO 2007 Inventory
Purchase Sale Balance `
Date Units Total Units Total Units Cost Total
Jan 1 10 $10 $100
Feb 15 $225 10 $10 $100
15 $15 $225
June 10 $100
10 $150 5 $15 $ 75
July 10 $180 5 $15 $ 75
10 $18 $180
FIFO Perpetual
Cost of Goods Sold:
Beginning Inventory 10 @ $10 = $ 100
February Purchases 10 @ $15 = $ 150
Total $ 250
Ending Inventory:
February Purchases 5 @ $15 = $ 75
December Purchases 10 @ $18 = $ 180
Total $ 255
FIFO Perpetual Journal Entry
In June, the Hat Company sold 20 hats for $25
each. The entry is as follows:
Accounts Receivable............... 500
Sales Revenue.................. 500
To recognize revenues from June sales.
FIFO Perpetual Journal Entry
In June, the Hat Company sold 20 hats for $25
each. The entry is as follows:
Accounts Receivable............... 500
Sales Revenue.................. 500
To recognize revenues from June sales.
Cost of Goods Sold................. 250
Inventory........................... 250
To recognize expenses from selling hats.
FIFO Periodic Inventory
Using FIFO - - - both perpetual and periodic
inventory systems result in the same results.
Purch. 10
July
Purch. 15
Feb
Sale 20
June
Beg. 10
Jan
LIFO Perpetual Inventory
Purchase Sale Balance `
Date Units Total Units Total Units Cost Total
Jan 1 10 $10 $100
Feb 15 $225 10 $10 $100
15 $15 $225
June 15 $225
5 $ 50 5 $10 $ 50
Dec 10 $180 5 $10 $ 50
10 $18 $180
LIFO Perpetual Inventory
Using LIFO - - - perpetual removes the latest
items received at the time of each sale.
Purch. 10
July
Purch. 15
Feb Sale 20
June
Beg. 10
Jan
LIFO Perpetual Journal Entry
In June, the Hat Company sold 20 hats for $25
each. The entry is as follows:
Accounts Receivable............... 500
Sales Revenue.................. 500
To recognize revenues from June sales.
LIFO Perpetual Journal Entry
In June, the Hat Company sold 20 hats for $25
each. The entry is as follows:
Accounts Receivable............... 500
Sales Revenue.................. 500
To recognize revenues from June sales.
Cost of Goods Sold................. 275
Inventory........................... 275
To recognize expenses from selling hats.
Inventory Costing - Periodic
1. Determine quantity of units of inventory
2. Apply unit costs to the quantities
3. Determine total cost of inventory
4. Determine cost of goods sold
Process can be complicated if units are purchased at
different times and at different prices!
LIFO Periodic
Cost of Goods Sold:
July Purchases 10 @ $18 = $ 180
February Purch 10 @ $15 = $ 150
Total $ 330
Ending Inventory:
Beginning Inventory 10 @ $10 = $ 100
February Purchases 5 @ $15 = $ 75
Total $ 175
LIFO Periodic Inventory
Using LIFO - - - periodic removes the latest
items received as of the end of the period.
Purch. 10
July Sale 20
June
Purch. 15
Feb
Beg. 10
Jan
Weighted-Average Perpetual
In June, the Hat Company sold 20 hats for $25
each. The entry is as follows:
Accounts Receivable............... 500
Sales Revenue.................. 500
To recognize revenues from June sales.
Weighted-Average Perpetual
In June, the Hat Company sold 20 hats for $25
each. The entry is as follows:
Accounts Receivable............... 500
Sales Revenue.................. 500
To recognize revenues from June sales.
Cost of Goods Sold................. 260
Inventory........................... 260
To recognize expenses from selling hats.
Weighted-Average 2007 Inventory
Purchase Sale Balance `
Date Units Total Units Total Units Cost Total
Jan 1 10 $10.00 $100
Feb 15 $225 25 $13.00 $325
June 20 $260 5 $13.00 $ 65
July 10 $180 15 $16.33 $245
Weighted Average
Cost of Goods Sold:
Units Sold 20 @ $13.00 = $ 260
Total $ 260
Ending Inventory:
Units Remaining 15 @ $16.33 = $ 245
Total $ 245
Weighted Average Inventory
Using Weighted Average - - - perpetual removes
units at the average cost of all goods on hand.
Purch. 10
July
Purch. 15
Feb Sale 20
June
Beg. 10
Jan
Question 1
Which inventory cost flow method produces
the highest net income in a period of rising
prices?
a. Weighted average cost
b.Lifo
c. Fifo
d.Specific Identification.
Question 1
Which inventory cost flow method produces
the highest net income in a period of rising
prices?
a. Weighted average cost
b.Lifo
c. Fifo
d.Specific Identification.
Question 2
Which inventory cost flow method produces
the lowest income taxes in a period of rising
prices?
a. Weighted average cost
b. Lifo
c. Fifo
d. Specific Identification.
Question 2
Which inventory cost flow method produces
the lowest income taxes in a period of rising
prices?
a. Weighted average cost
b. Lifo
c. Fifo
d. Specific Identification.
Comparison of Inventory Costing
Methods -- Perpetual
Weighted
FIFO LIFO Average
Ending
Inventory $255 $230 $245
Comparison of Inventory Costing
Methods -- Perpetual
Weighted
FIFO LIFO Average
Ending
Inventory $255 $230 $245
Cost of
Goods Sold $250 $275 $260
Income Statement Effects
The Lower of Cost or Market Basis
of Accounting for Inventories
When the value of inventory is lower
than its cost, the inventory is written
down to its market value by valuing the
inventory at the lower of cost or market
(LCM) in the period in which the price
decline occurs.
Lower of Cost or Market (LCM)
• departure from cost principle
• follows conservatism concept
• can be used only after one of the cost flow
methods ( Specific Identification FIFO,
LIFO, or Average Cost)
Market Is...
CURRENT REPLACEMENT
COST
57
How Much Inventory Should a
Company Have?
– Only enough for sales needs
– Excess inventory costs:
• storage costs
• interest costs
• obsolescence - technology, fashion
Inventory Turnover
Ratio =
An indication of how
quickly a company sells its
goods.
Higher is better.
Inventory Turnover
Ratio =
Cost of Goods Sold
Average Inventory
Days in Inventory =
An indication of how
quickly a company sells its
goods.
Lower is better.
Days in Inventory =
365 days
Inventory Turnover Ratio
Lifo Reserve And Its Importance For
Comparing Results Of Different Companies
• Accounting standards require firms using LIFO to
report the amount by which inventory would be
increased (or on occasion decreased) if the firm had
instead been using FIFO.
• This amount is referred to as the LIFO reserve.
Reporting the LIFO reserve enables analysts to
make adjustments to compare companies that use
different cost flow methods.
