Kế toán, kiểm toán - Chapter 08: Inventories: Measurement

Inventories:MeasurementChapter 8Recording and Measuring InventoryMerchandise InventoryGoods acquired for resaleManufacturing InventoryRaw MaterialsWork-in-ProcessFinished GoodsTypes of InventoryManufacturing InventoriesRawMaterialsWork-in-ProcessFinishedGoodsCost of Goods SoldDirectLaborManufacturingOverhead$XX$XX$XX Raw materials purchased Direct labor incurred Manufacturing overhead incurred Raw materials used Direct labor applied Manufacturing overhead applied Work-in-process transferred to finished goods Finished goods soldInventory SystemsPerpetual Inventory SystemThe inventory account is continuously updated as purchases and sales are made.Periodic Inventory SystemThe inventory account is adjusted at the end of a reporting period.Two accounting systems are used to record transactions involving inventory:Periodic Inventory SystemThe periodic inventory system is not designed to track either the quantity or cost of merchandise inventory. Cost of goods sold is calculated, using the schedule below, after the physical inventory count at the end of the period.Comparison of Inventory SystemsWhat is Included in Inventory?The ProblemIn some situations the identification of items that should be included in inventory can be difficult. Consider, for example the following:Goods in TransitGoods on ConsignmentDepends on f.o.b. shipping terms.Expenditures Included in InventoryInvoice PriceFreight-in on Purchases+Purchase Returns and AllowancesPurchase DiscountsInventory Cost Flow AssumptionsSpecific identificationAverage costFirst-in, first-out (FIFO)Last-in, first-out (LIFO)First-In, First-Out (FIFO)The cost of the oldest inventory items are charged to COGS when goods are sold. The cost of the newest inventory items remain in ending inventory.The FIFO method assumes that items are sold in the chronological order of their acquisition.First-In, First-Out (FIFO)Even though the periodic and the perpetual approaches differ in the timing of adjustments to inventory . . .. . . COGS and Ending Inventory Cost are the same under both approaches.Last-In, First-Out (LIFO)The cost of the newest inventory items are charged to COGS when goods are sold. The cost of the oldest inventory items remain in inventory.The LIFO method assumes that the newest items are sold first, leaving the older units in inventory.Last-In, First-Out (LIFO)Unlike FIFO, using the LIFO method may result in COGS and Ending Inventory Cost that differ under the periodic and perpetual approaches. When Prices Are Rising . . . LIFOMatches high (newer) costs with current (higher) sales.Inventory is valued based on low (older) cost basis.Results in lower pre-tax income.FIFOMatches low (older) costs with current (higher) sales.Inventory is valued at approximate replacement cost.Results in higher pre-tax income.U. S. GAAP vs. IFRSLIFO is permitted and used by U.S. Companies.If used for income tax reporting, the company must use LIFO for financial reporting.Conformity with IAS No. 2 would cause many U.S. companies to lose a valuable tax shelter.LIFO is an important issue for U.S. multinational companies. Unless the U.S. Congress repeals the LIFO conformity rule, an inability to use LIFO under IFRS will impose a serious impediment to convergence.IAS No. 2, Inventories, does not permit the use of LIFO.Because of this restriction, many U.S. multinational companies use LIFO only for domestic inventories.Decision Makers’ PerspectiveFactors Influencing Method ChoiceHow are income taxes affected by inventory method choice?How closely do reportedcosts reflect actualflow of inventory?How well are costs matched againstrelated revenues?LIFO LiquidationLIFO inventory costs in the balance sheet are “out of date” because they reflect old purchase transactions.When prices rise . . .If inventory declines, these “out of date” costs may be charged to current earnings.This LIFOliquidation results in “paper profits.”Inventory Management Gross profit ratio =Gross profitNet salesInventory turnover ratio =Cost of goods soldAverage inventoryThe higher the ratio, the higher the markup a company is able to achieve on its products. (Beginning inventory + Ending inventory2Designed to evaluate a company’seffectiveness in managing itsinvestment in inventoryQuality of EarningsChanges in the ratios we discussed above often provide information about the quality of a company’s current period earnings. For example, a slowing turnover ratio combined with higher than normal inventory levels may indicate the potential for decreased production, obsolete inventory, or a need to decrease prices to sell inventory (which will then decrease gross profit ratios and net income).Many believe that manipulating income reduces earnings quality because it can mask permanent earnings. Inventory write-downs and changes in inventory method are two additional inventory-related techniques a company could use to manipulate earnings.Methods of Simplifying LIFOThe objectives of using LIFO inventory pools are to simplify recordkeeping by grouping inventory units into pools based on physical similarities of the individual units and to reduce the risk of LIFO layer liquidation. For example, a glass company might group its various grades of window glass into a single window pool. Other pools might be auto glass and sliding door glass. A lumber company might pool its inventory into hardwood, framing lumber, paneling, and so on. LIFO pools allow companies to account for a few inventory pools rather than every specific type of inventory separately.LIFO Inventory PoolsExampleThe replacement inventory differs from the old inventory on hand. We just create a new layer.Methods of Simplifying LIFODollar-Value LIFO (DVL)DVL inventory pools are viewed as layers of value, rather than layers of similar units.DVL simplifies LIFO recordkeeping.DVL minimizes the probability of layer liquidation.At the end of the period, we determine if a new inventory layer was added by comparing ending inventory dollar amount to beginning inventory dollar amount.Methods of Simplifying LIFODollar-Value LIFO (DVL)We need to determine if the increase in ending inventory over beginning inventory was due to a cost increase or an increase in inventory quantity.1a. Compute a Cost Index for the year.Methods of Simplifying LIFODollar-Value LIFO (DVL)1b. Deflate the ending inventory value using the cost index.1c. Compare ending inventory at base year cost to beginning inventory at base year cost.Methods of Simplifying LIFODollar-Value LIFO (DVL)Next, identify the layers in ending inventory and the years they were created.Sum all the layers to arrive at ending inventory at DVL cost.Convert each layer’s base year cost to layer year cost by multiplying times the cost index.End of Chapter 8