Kế toán, kiểm toán - Chương 08: Valuation of inventories: A cost - Basis approach

C H A P T E R 8VALUATION OF INVENTORIES: A COST-BASIS APPROACHIntermediate Accounting13th EditionKieso, Weygandt, and Warfield Identify major classifications of inventory.Distinguish between perpetual and periodic inventory systems.Identify the effects of inventory errors on the financial statements.Understand the items to include as inventory cost.Describe and compare the cost flow assumptions used to account for inventories.Explain the significance and use of a LIFO reserve.Understand the effect of LIFO liquidations.Explain the dollar-value LIFO method.Identify the major advantages and disadvantages of LIFO.Understand why companies select given inventory methods.Learning ObjectivesInventoryIssuesPhysical GoodsIncluded inInventoryCosts Includedin InventoryCost Flow AssumptionsLIFO: Special IssuesClassificationCost flowControlBasic inventory valuationBasis for SelectionGoods in transitConsigned goodsSpecial sales agreementsInventory errorsProduct costsPeriod costsPurchase discountsSpecific identificationAverage costFIFOLIFOLIFO reserveLIFO liquidationDollar-value LIFOComparison of LIFO approachesAdvantages of LIFODisadvantages of LIFOSummary of inventory valuation methodsValuation of Inventories:Cost-Basis ApproachInventories are:items held for sale, orgoods to be used in the production of goods to be sold.Inventory IssuesLO 1 Identify major classifications of inventory.ClassificationMerchandiserManufacturerBusinesses with Inventory:orOne inventory accountPurchase goods ready for saleClassificationInventory IssuesLO 1 Identify major classifications of inventory.Illustration 8-1ClassificationInventory IssuesLO 1 Identify major classifications of inventory.Illustration 8-1Three accountsRaw materialsWork in processFinished goodsInventory Cost FlowInventory IssuesIllustration 8-2LO 1 Identify major classifications of inventory.Inventory Cost FlowInventory IssuesIllustration 8-3LO 1 Identify major classifications of inventory.Companies use one of two types of systems for maintaining inventory records — perpetual system or periodic system.Inventory Cost FlowLO 2 Distinguish between perpetual and periodic inventory systems.Perpetual System Purchases of merchandise are debited to Inventory.Freight-in is debited to Inventory. Purchase returns and allowances and purchase discounts are credited to Inventory.Cost of goods sold is debited and Inventory is credited for each sale.Subsidiary records show quantity and cost of each type of inventory on hand.The perpetual inventory system provides a continuous record of Inventory and Cost of Goods Sold.Inventory Cost FlowLO 2 Distinguish between perpetual and periodic inventory systems.Periodic System Purchases of merchandise are debited to Purchases.Ending Inventory determined by physical count.Calculation of Cost of Goods Sold:Beginning inventory $ 100,000Purchases, net 800,000Goods available for sale 900,000Ending inventory 125,000Cost of goods sold $ 775,000Inventory Cost FlowLO 2 Distinguish between perpetual and periodic inventory systems.Illustration: Fesmire Company had the following transactions during the current year.Record these transactions using the Perpetual and Periodic systems.Inventory Cost FlowLO 2 Distinguish between perpetual and periodic inventory systems.Illustration 8-4Illustration:Solution on notes pageInventory Cost FlowLO 2 Distinguish between perpetual and periodic inventory systems.Illustration: Assume that at the end of the reporting period, the perpetual inventory account reported an inventory balance of $4,000. However, a physical count indicates inventory of $3,800 is actually on hand. The entry to record the necessary write-down is as follows.Inventory Over and Short 200 Inventory 200Note: Inventory Over and Short adjusts Cost of Goods Sold. In practice, companies sometimes report Inventory Over and Short in the “Other revenues and gains” or “Other expenses and losses” section of the income statement.Inventory ControlInventory IssuesLO 2 Distinguish between perpetual and periodic inventory systems.All companies need periodic verification of the inventory records by actual count, weight, or measurement, with the counts compared with the detailed inventory records.Companies should take the physical inventory near the end of their fiscal year, to properly report inventory quantities in their annual accounting reports.Basic Issues in Inventory ValuationLO 2 Distinguish between perpetual and periodic inventory systems.ValuationCompanies must allocate the cost of all the goods available for sale (or use) between the goods that were sold or used and those that are still on hand.Illustration 8-5Basic Issues in Inventory ValuationLO 2 Distinguish between perpetual and periodic inventory systems.The physical goods (goods on hand, goods in transit, consigned goods, special sales agreements).The costs to include (product vs. period costs).The cost flow assumption (FIFO, LIFO, Average cost, Specific Identification, Retail, etc.).Valuation requires determiningA company should record purchases when it obtains legal title to the goods.Physical Goods Included in InventoryLO 2 Distinguish between perpetual and periodic inventory systems.Illustration 8-6Effect of Inventory ErrorsLO 3 Identify the effects of inventory errors on the financial statements.Ending Inventory MisstatedThe effect of an error on net income in one year (2009) will be counterbalanced in the next (2010), however the income statement will be misstated for both years.Illustration 8-7Effect of Inventory ErrorsIllustration: Jay Weiseman Corp. understates its ending inventory by $10,000 in 2009; all other items are correctly stated.Illustration 8-8LO 3Effect of Inventory ErrorsLO 3 Identify the effects of inventory errors on the financial statements.Purchases and Inventory MisstatedThe understatement does not affect cost of goods sold and net income because the errors offset one another.Illustration 8-9Costs Included in InventoryLO 4 Understand the items to include as inventory cost.Product Costs - costs directly connected with bringing the goods to the buyer’s place of business and converting such goods to a salable condition.Period Costs – generally selling, general, and administrative expenses.Purchase Discounts – Gross vs. Net Method Costs Included in InventoryLO 4 Understand the items to include as inventory cost.Treatment of Purchase DiscountsIllustration 8-11* $4,000 x 2% = $80*** $10,000 x 98% = $9,800**Solution on notes pageAnswer: Method adopted should be one that most clearly reflects periodic income.Cost Flow Assumption Adopted does not need to equal Physical Movement of GoodsFIFOWhich Cost Flow Assumption to Adopt?LIFOAverage CostSpecific IdentificationLO 5 Describe and compare the cost flow assumptions used to account for inventories.Young & Crazy Company makes the following purchases:One item on 2/2/11 for $10One item on 2/15/11 for $15One item on 2/25/11 for $20Young & Crazy Company sells one item on 2/28/11 for $90. What would be the balance of ending inventory and cost of goods sold for the month ended Feb. 2011, assuming the company used the FIFO, LIFO, Average Cost, and Specific Identification cost flow assumptions? Assume a tax rate of 30%.ExampleCost Flow AssumptionsLO 5 Describe and compare the cost flow assumptions used to account for inventories.Purchase on 2/2/07 for $10Purchase on 2/15/07 for $15Purchase on 2/25/07 for $20Inventory Balance = $ 45Young & Crazy CompanyIncome StatementFor the Month of Feb. 2007 Sales $ 90 Cost of goods sold 0 Gross profit 90 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 57 Taxes 17 Net Income $ 40Cost Flow Assumptions“First-In-First-Out (FIFO)”LO 5 Describe and compare the cost flow assumptions used to account for inventories.Purchase on 2/2/07 for $10Purchase on 2/15/07 for $15Purchase on 2/25/07 for $20Cost Flow AssumptionsInventory Balance = $ 35Young & Crazy CompanyIncome StatementFor the Month of Feb. 2007 Sales $ 90 Cost of goods sold 10 Gross profit 80 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 47 Taxes 14 Net Income $ 33“First-In-First-Out (FIFO)”LO 5 Describe and compare the cost flow assumptions used to account for inventories.Purchase on 2/2/07 for $10Purchase on 2/15/07 for $15Purchase on 2/25/07 for $20Inventory Balance = $ 45Young & Crazy CompanyIncome StatementFor the Month of Feb. 2007 Sales $ 90 Cost of goods sold 0 Gross profit 90 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 57 Taxes 17 Net Income $ 40Cost Flow Assumptions“Last-In-First-Out (LIFO)”LO 5 Describe and compare the cost flow assumptions used to account for inventories.Purchase on 2/2/07 for $10Purchase on 2/15/07 for $15Cost Flow AssumptionsInventory Balance = $ 25Purchase on 2/25/07 for $20Young & Crazy CompanyIncome StatementFor the Month of Feb. 2007 Sales $ 90 Cost of goods sold 20 Gross profit 70 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 37 Taxes 11 Net Income $ 26“Last-In-First-Out (LIFO)”LO 5 Describe and compare the cost flow assumptions used to account for inventories.Purchase on 2/2/07 for $10Purchase on 2/15/07 for $15Purchase on 2/25/07 for $20Inventory Balance = $ 45Young & Crazy CompanyIncome StatementFor the Month of Feb. 2007 Sales $ 90 Cost of goods sold 0 Gross profit 90 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 57 Taxes 17 Net Income $ 40Cost Flow Assumptions“Average Cost”LO 5 Describe and compare the cost flow assumptions used to account for inventories.Purchase on 2/2/07 for $10Purchase on 2/15/07 for $15Purchase on 2/25/07 for $20Inventory Balance = $ 30Cost Flow AssumptionsYoung & Crazy CompanyIncome StatementFor the Month of Feb. 2007 Sales $ 90 Cost of goods sold 15 Gross profit 75 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 42 Taxes 12 Net Income $ 30“Average Cost”LO 5 Describe and compare the cost flow assumptions used to account for inventories.Purchase on 2/2/07 for $10Purchase on 2/15/07 for $15Purchase on 2/25/07 for $20Inventory Balance = $ 45Young & Crazy CompanyIncome StatementFor the Month of Feb. 2007 Sales $ 90 Cost of goods sold 0 Gross profit 90 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 57 Taxes 17 Net Income $ 40Cost Flow Assumptions“Specific Identification”LO 5 Describe and compare the cost flow assumptions used to account for inventories.Purchase on 2/2/07 for $10Purchase on 2/15/07 for $15Purchase on 2/25/07 for $20Inventory Balance = $ 45Young & Crazy CompanyIncome StatementFor the Month of Feb. 2007 Sales $ 90 Cost of goods sold 0 Gross profit 90 Expenses: Administrative 14 Selling 12 Interest 7 Total expenses 33 Income before tax 57 Taxes 17 Net Income $ 40Cost Flow Assumptions“Specific Identification”Depends which one is soldLO 5 Describe and compare the cost flow assumptions used to account for inventories.Financial Statement Summary Inventory Balance302535Cost Flow AssumptionsLO 5 Describe and compare the cost flow assumptions used to account for inventories.Cost Flow AssumptionsLO 5Illustration: Call-Mart Inc. had the following transactions in its first month of operations.Beginning inventory (2,000 x $4) $ 8,000Purchases: 6,000 x $4.40 26,400 2,000 x 4.75 9,500Goods available for sale $43,900 Calculate Goods Available for SaleSpecific IdentificationIllustration: Assume that 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 8-12Solution on notes pageAverage CostLO 5 Describe and compare the cost flow assumptions used to account for inventories.Solution on notes pageIllustration 8-13Weighted-AverageAverage CostLO 5 Describe and compare the cost flow assumptions used to account for inventories.Solution on notes pageIllustration 8-14In this method, Call-Mart computes a new average unit cost each time it makes a purchase.Moving-AverageFirst-In, First-Out (FIFO)LO 5 Describe and compare the cost flow assumptions used to account for inventories.Solution on notes pageIllustration 8-15Periodic MethodDetermine cost of ending inventory by taking the cost of the most recent purchase and working back until it accounts for all units in the inventory.First-In, First-Out (FIFO)LO 5 Describe and compare the cost flow assumptions used to account for inventories.Solution on notes pageIllustration 8-16Perpetual MethodIn 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.Last-In, First-Out (LIFO)LO 5 Describe and compare the cost flow assumptions used to account for inventories.Solution on notes pageIllustration 8-17Periodic MethodThe cost of the total quantity sold or issued during the month comes from the most recent purchases.Last-In, First-Out (LIFO)LO 5 Describe and compare the cost flow assumptions used to account for inventories.Solution on notes pageIllustration 8-18Perpetual MethodThe LIFO method results in different ending inventory and cost of goods sold amounts than the amounts calculated under the periodic method.Many companies use LIFO for tax and external financial reporting purposes FIFO, average cost, or standard cost system for internal reporting purposes.Reasons:Special Issues Related to LIFOLO 6 Explain the significance and use of a LIFO reserve.LIFO ReservePricing decisionsRecord keeping easierProfit-sharing or bonus arrangementsLIFO troublesome for interim periodsSpecial Issues Related to LIFOLO 6 Explain the significance and use of a LIFO reserve.LIFO Reserve is the difference between the inventory method used for internal reporting purposes and LIFO. Example:FIFO value per books $160,000LIFO value 145,000LIFO Reserve $ 15,000Cost of goods sold 15,000 Allowance to reduce inventory to LIFO 15,000Journal entry to reduce inventory to LIFO:Companies should disclose either the LIFO reserve or the replacement cost of the inventory.Older, low cost inventory is sold resulting in a lower cost of goods sold, higher net income, and higher taxes. Special Issues Related to LIFOLO 7 Understand the effect of LIFO liquidations.LIFO LiquidationIllustration: Basler Co. has 30,000 pounds of steel in its inventory on December 31, 2010, with cost determined on a specific goods LIFO approach.Illustration: At the end of 2011, only 6,000 pounds of steel remained in inventory.Special Issues Related to LIFOLO 7 Understand the effect of LIFO liquidations.LIFO LiquidationIllustration 8-21Changes in a pool are measured in terms of total dollar value, not physical quantity.Advantage:Broader range of goods in pool.Permits replacement of goods that are similar.Helps protect LIFO layers from erosion.Special Issues Related to LIFOLO 8 Explain the dollar-value LIFO method.Dollar-Value LIFOSpecial Issues Related to LIFOLO 8 Explain the dollar-value LIFO method.Exercise 8-26 (partial): The following information relates to the Choctaw Company.Use the dollar-value LIFO method to compute the ending inventory for 2007 through 2009. Dollar-Value LIFOSpecial Issues Related to LIFOLO 8 Explain the dollar-value LIFO method.Exercise 8-26 SolutionSpecial Issues Related to LIFOLO 8 Explain the dollar-value LIFO method.Exercise 8-26 SolutionSpecial Issues Related to LIFOLO 8 Explain the dollar-value LIFO method.Exercise 8-26 SolutionSpecific-goods LIFO - costing goods on a unit basis is expensive and time consuming.Specific-goods Pooled LIFO approachreduces record keeping and clerical costs.more difficult to erode the layers.using quantities as measurement basis can lead to untimely LIFO liquidations.Dollar-value LIFO is used by most companies.Special Issues Related to LIFOLO 8 Explain the dollar-value LIFO method.Comparison of LIFO ApproachesMatchingTax Benefits/Improved Cash FlowFuture Earnings HedgeSpecial Issues Related to LIFOLO 9 Identify the major advantages and disadvantages of LIFO.AdvantagesReduced earningsInventory understatedPhysical flowInvoluntary Liquidation / Poor Buying HabitsDisadvantagesLIFO is generally preferred:if selling prices are increasing faster than costs andif a company has a fairly constant “base stock.”Basis for Selection of Inventory MethodLO 10 Understand why companies select given inventory methods.LIFO is not appropriate:if prices tend to lag behind costs, if specific identification traditionally used, and when unit costs tend to decrease as production increases.Copyright © 2009 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.Copyright