WILEY

IFRS EDITION
Prepared by
Coby Harmon
University of California, Santa Barbara
6-1 Westmont College
 CHAPTER

6 Inventories
LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Discuss how to classify and determine inventory.

2. Explain the accounting for inventories and apply the inventory cost flow
methods.
3. Explain the financial effects of the inventory cost flow assumptions.
4. Explain the lower-of-cost-or-net realizable value basis of accounting for
inventories.
5. Indicate the effects of inventory errors on the financial statements.
6. Discuss the presentation and analysis of inventory.
6-2
 Classifying and Determining Inventory
Learning Objective 1
Discuss how to classify and
Classifying Inventory determine inventory.

Merchandising Manufacturing
Company Company

One Classification: Three Classifications:

 Inventory  Raw Materials

 Work in Process
• HELPFUL HINT
Regardless of the classification,  Finished Goods
companies report all inventories
under Current Assets on the
statement of financial position.

6-3 LO 1
 Determining Inventory Quantities

Physical Inventory taken for two reasons:

Perpetual System
1. Check accuracy of inventory records.

2. Determine amount of inventory lost due to wasted raw

materials, shoplifting, or employee theft.

Periodic System
1. Determine the inventory on hand.

2. Determine the cost of goods sold for the period.

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 Determining Inventory Quantities

DETERMINING OWNERSHIP OF GOODS

GOODS IN TRANSIT

 Purchased goods not yet received.

 Sold goods not yet delivered.

Goods in transit should be included in the inventory of the

company that has legal title to the goods. Legal title is
determined by the terms of sale.

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 DETERMINING OWNERSHIP OF GOODS

GOODS IN TRANSIT Illustration 6-2

Terms of sale

Ownership of the goods passes

to the buyer when the public
carrier accepts the goods from
the seller.

Ownership of the goods

remains with the seller until the
goods reach the buyer.

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 Classifying and Determining Inventory
Learning Objective 2
Explain the accounting for
Inventory is accounted for at cost. inventories and apply the
inventory cost flow methods.
 Cost includes all expenditures necessary
to acquire goods and place them in a condition ready for
sale.
 Unit costs are applied to quantities to compute the total cost
of the inventory and the cost of goods sold using the
following costing methods:
► Specific identification
► First-in, first-out (FIFO) Cost Flow
► Average-cost Assumptions

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 Inventory Costing

Illustration: Crivitz TV Company purchases three identical 50-

inch TVs on different dates at costs of £700, £750, and £800.
During the year Crivitz sold two sets at £1,200 each. These
facts are summarized below.

Illustration 6-3
Data for inventory costing example

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 Specific Identification

If Crivitz sold the TVs it purchased on February 3 and May 22,

then its cost of goods sold is £1,500 (£700 + £800), and its
ending inventory is £750.

Illustration 6-4
Specific identification method

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 Specific Identification

Actual physical flow costing method in which items still in

inventory are specifically costed to arrive at the total cost of
the ending inventory.

 Practice is relatively rare.

 Most companies make

assumptions (cost flow
assumptions) about which units
were sold.

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 Cost Flow Assumptions

There are two assumed cost flow methods:

1. First-in, first-out (FIFO)

2. Average-cost

Cost flow does not need be consistent with the physical

movement of the goods.

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 Cost Flow Assumptions

Data for Lin Electronics’ Astro condensers.

Illustration 6-5

(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold

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 Cost Flow Assumptions

FIRST-IN, FIRST-OUT (FIFO)

 Costs of the earliest goods purchased are the first to be
recognized in determining cost of goods sold.

 Often parallels actual physical flow of merchandise.

 Companies obtain the cost of the ending inventory by

taking the unit cost of the most recent purchase and
working backward until all units of inventory have been
costed.

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 FIRST-IN, FIRST-OUT (FIFO)

Illustration 6-6
Allocation of costs—FIFO method
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 FIRST-IN, FIRST-OUT (FIFO)

• HELPFUL HINT
Another way of thinking about
the calculation of FIFO ending
inventory is the LISH
assumption—last in still here.
Illustration 6-6
Allocation of costs—FIFO method

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 Cost Flow Assumptions

AVERAGE-COST
 Allocates cost of goods available for sale on the basis
of weighted-average unit cost incurred.

 Applies weighted-average unit cost to the units on

hand to determine cost of the ending inventory.

Illustration 6-8
Formula for weighted-average unit cost

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 AVERAGE-COST

Illustration 6-9
Allocation of costs—average-cost method

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 AVERAGE-COST

Illustration 6-11

Illustration 6-9
Allocation of costs—average-cost method

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 Financial Statement and Tax Effects of
Cost Flow Methods
Learning Objective 3
Explain the financial effects of
Either of the two cost flow assumptions the inventory cost flow
assumptions.
is acceptable for use. For example,
 adidas (DEU) and Lenovo (CHN) use the average-cost
method, whereas
 Syngenta Group (CHE) and Nokia (FIN) use FIFO.

A recent survey of IFRS companies, approximately

► 60% use the average-cost method,

► 40% use FIFO, and
► 23% use both for different parts of their inventory.
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 INCOME STATEMENT EFFECTS

Illustration 6-10
6-20 Comparative effects of cost flow methods LO 3
 Lower-of-Cost-or-Net Realizable Value
Learning Objective 4
Explain the lower-of-cost-or-net
When the value of inventory is lower realizable value
basis of accounting for
than its cost inventories.

 companies must “write down” the inventory to its net

realizable value.

Net realizable value: Amount that a company expects to

realize (receive from the sale of inventory).

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 Lower-of-Cost-or-Net Realizable Value

Illustration: Assume that Gao TV has the following lines of

merchandise with costs and market values as indicated.

Illustration 6-11
Computation of lower-of-cost-or-net realizable value

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 Income Statement Effects

Inventory errors affect the computation of cost of goods sold

and net income in two periods. Illustration 6-12
Formula for cost of goods sold

Illustration 6-13
Effects of inventory errors on current year’s income statement
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 Income Statement Effects Illustration 6-14
Effects of inventory errors on
two years’ income statements

2016 2017
Incorrect Correct Incorrect Correct
Sales € 80,000 € 80,000 € 90,000 € 90,000
Beginning inventory 20,000 20,000 12,000 15,000
Cost of goods purchased 40,000 40,000 68,000 68,000
Cost of goods available 60,000 60,000 80,000 83,000
Ending inventory 12,000 15,000 23,000 23,000
Cost of good sold 48,000 45,000 57,000 60,000
Gross profit 32,000 35,000 33,000 30,000
Operating expenses 10,000 10,000 20,000 20,000
Net income € 22,000 € 25,000 € 13,000 € 10,000

Combined income for (€3,000) €3,000

2-year period is correct. Net income Net income
understated overstated

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 Income Statement Effects

Question
Atlantis Company’s ending inventory is understated
NT$122,000. The effects of this error on the current year’s
cost of goods sold and net income, respectively, are:

a. understated, overstated.

b. overstated, understated.

c. overstated, overstated.

d. understated, understated.

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 Statement of Financial Position Effects

Effect of inventory errors on the statement of financial position

is determined by using the basic accounting equation: Assets
= Liabilities + Equity.

Errors in the ending inventory have the following effects.

Illustration 6-15
Effects of ending inventory errors on statement of financial position

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APPENDIX 6A Perpetual Inventory System
Learning Objective 7
Apply the inventory cost
Illustration 6A-1 flow methods to perpetual
Inventoriable units and costs inventory records.

Assuming the Perpetual Inventory System, compute Cost of Goods

Sold and Ending Inventory under FIFO and average-cost.
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 First-In-First-Out (FIFO)

Illustration 6A-2
Perpetual system—FIFO Cost of Goods Sold
Ending Inventory

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 Average-Cost

Illustration 6A-3
Perpetual system— Cost of Goods Sold Ending Inventory
average-cost method

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