Kế toán, kiểm toán - Chapter 7: Merchandise inventory

2Chapter 7:Merchandise Inventory3Learning Objective 1List the four important issues that must be addressed when accounting for inventory, and briefly describe how inventory valuation affects earnings. 4Merchandise InventoryWhat is inventory?Items held for resale to customersWho has inventory?Wholesaler or RetailerMerchandise InventoryManufacturerRaw MaterialsWork in ProcessFinished Goods5The Relative Size of Inventories6Four Important Inventory IssuesAcquiring inventory: What costs to capitalize?Carrying Inventory: Perpetual vs. Periodic?Selling inventory: Which cost flow assumption?Ending inventory: Lower-of-cost-or-market valuation.7Figure 7-2 Accounting for Inventory: Four Important Issues8Items should be included in the company’s inventory if they are:a. being used in the production of income.b. held in anticipation of an increase in value.c. being held for sale.d. sold during the period.9Which one of the following companies would likely carry the largest percentage of inventory as compared to its other assets? a. Ernst and Young, CPAsb. Merrill Lynch investment brokersc. The Magic Kingdom as Disney Worldd. DJ’s Ford Dealership10Learning Objective 2Describe how to decide which costs to capitalize in the inventory account. 11Acquiring Inventory – What Costs to Capitalize?What items or units to include?General rule: Complete loss belongs to the companyAll rights and benefits belong to the companyOwnership is usually possession; however, there are exceptionsConsignment consignee takes physical possession but does not take ownershipGoods in transitFOB Shipping Point – seller is responsible for (owns) goods only until they are loaded on the common carrierFOB Destination – seller is responsible for goods until they arrive at the destination (buyer). 12What costs to attach?Which costs are included in inventory? General rule: all costs associated with manufacture, acquisition, storage or preparation of inventory including shipping to facility.Must be brought in a salable conditionFreight-in (transportation-in) adds to the cost of inventory.Allocation of overhead to inventory is subjective, requires expertise, and impacts important financial numbers and ratios.13Concept Practice 2 14Learning Objective 3Compare the perpetual method to the periodic method when accounting for inventory carried on the balance sheet. 15Carrying Inventory: Perpetual Method vs. Periodic MethodAdvances in data processing has made the continuous tracking of inventory possible for companies in terms of time and cost. This is the perpetual inventory methodInventory purchases go into the inventory accountSales increase cost of goods sold and decrease the inventoryDiscrepancies in computer counts and period end physical counts provide important inventory controls16Carrying Inventory: Perpetual Method vs. Periodic MethodCompanies that do not maintain a continuous record of inventory must take periodic counts of inventory. This allows these companies to calculate cost of goods sold periodically.This is the periodic inventory methodThe inventory account is adjusted during periodic physical counts of inventory.Inventory control issues will be ‘buried’ in cost of goods sold when counts are adjusted to the physical counts. 17Carrying Value: Perpetual Method.18Exercise E7-620142013Sales$1,821$1,670Cost of Goods Sold (COGS): BI$304$244 Purchases1,2761,183 GAS$1,580$1,427 Less: EI343304 COGS1,2371,123Gross Profit$584$54719E7-6Assume that counting errors caused the ending inventory (EI) in 2013 to be understated by $50 and the ending inventory in 2014 to be overstated by $50.a. Compute the impact of these errors on cost of goods sold for the year ended December 31, 2013 and on the inventory balance as of December 31, 2013.20E7-6a. Error in Ending Inventory in 2013: The $50 understated error in the Ending inventory means that the Ending Inventory should have been $304 + $50 = $354. This would change the Cost of goods sold to $1,427 - 354 $ = $1,073 which would then increase the Gross profit to $597 ($1,670 - $1,073). 21E7-6b. Compute the impact of these errors on cost of goods sold for the year ended December 31, 2014 and on the inventory balance as of December 31, 2014.c. What is the impact of these errors on cost of goods sold over the two-year period ended December 31, 2014?22E7-6b. Error in Ending Inventory in 2014: = The 2013 error in the Ending Inventory changes the Beginning Inventory in 2014 and the Goods Available for sale to $354 + $1,276 = $1,630. To calculate the Cost of Goods Sold the Ending Inventory for 2014 is deducted from the revised Goods Available for Sale: $1,630 – ($343 - $50) = $1,337. The gross profit would then be $1,821 - $1,337 = $484.23E7-6c. 2013 2014 Original COGS $1,123 $1,237Corrected COGS $1,073 $1,337 24Learning Objective 4Discuss specific identification, list the three commonly used assumptions for inventory flows, and describe the important economic trade-offs among them. 25Cost Flow AssumptionsGiven: BI + P (net) = EI + COGSManagement must decide how to assign costs of inflows [BI + P(net)] to EI and COGS?Methods:Specific identificationAverage for both COGS and EIFIFO - (first-in, first-out) for COGSand LISH (last-in, still here) for EILIFO - (last-in, first-out) for COGSand FISH (first-in, still here) for EI26Specific IdentificationIdentifying which specific inventory items have been sold and which remainPossible with :Infrequent salesLarge ticket items (jewelry, furniture, automobiles)27 Cost Flows Figure 7-5 Inventory flow assumption: average, FIFO, and LIFO28 Cost Flows - Average29 Cost Flows - FIFO30 Cost Flows - LIFO31Effects on Financials/TaxesIn an inflationary period (rising prices) which most periods are:FIFO has the highest inventory balance, lowest COGS, and highest incomeLIFO has the lowest inventory balance, highest COGS, and lowest incomeThis means that LIFO pays the least taxes32 Cost Flows – Effects on Financial StatementsFigure 7-6 Financial statement effects of the three inventory cost flow assumptions33 Cost Flows – Effects on Federal Income Taxes34Choosing an Inventory Cost Flow Assumption: Trade-OffsIncome and Asset MeasurementFIFO provides the best representation of the ending inventory balanceLIFO better matches recent revenues with expensesEconomic ConsequencesIncome Taxes and LiquidityBookkeeping CostsLIFO Liquidation and Inventory Purchasing PracticesDebt and Compensation PracticesThe Capital Market35The LIFO Reserve: A User PerspectiveThe LIFO reserve is the difference between the inventory value recorded at FIFO and LIFO for those organizations that use LIFO valuation. This can be used to:Revalue inventory for comparison purchasesCalculate additional potential tax liabilityRecalculate net income36During a period of rising prices and inventories, a company whose current ratio is dangerously close to the minimum specified by agreement with a major creditor would prefer which cost flow assumption?a. FIFOb. LIFOc. Averagingd. The company would be indifferent as to which cost flow assumption is adopted.37Learning Objective 5Explain the lower-of-cost-or-market rule and how it is applied to inventory accounting. 38Ending Inventory: Applying the Lower-of-Cost-or-Market RuleApplying the lower-of-cost-or-market rule to ending inventory is accomplished by comparing the cost allocated to ending inventory with the market value of the inventory. If the market value exceeds the cost, no adjustment is made and the inventory remains at cost. If the market value is less than the cost, the inventories are written down to market value with an adjusting journal entry.39The Lower-of-Cost-or-Market Rule and Hidden ReservesBased on conservatism, ending inventory is valued at cost or market value, whichever is lower.Recognizes price decreases immediatelyDefers price increase recognition until soldProblem: can create hidden reserves40Under the lower-of-cost-or-market rule, market is:a. the selling price of inventory items.b. the original cost paid for inventory.c. used to value inventory if it is less than its recorded cost.d. the amount of cash the company expects to collect from the sale of an inventory item.41If the market value of inventory is less than its cost, then application of the lower-of-cost-or-market rule would:a. increase earnings and decrease the current ratio.b. decrease earnings and increase the current ratio.c. decrease earnings and decrease the current ratio.d. cause no change to earnings or the current ratio.42Learning Objective 6Describe why the economic trade-offs faced by Japanese managers may be smaller than those faced by U.S. managers when considering different inventory flow assumptions. 43International Perspective: Japanese Business and Inventory AccountingJust-in-time (JIT) inventory systems, which reduce the costs of carrying large amounts of inventory without jeopardizing customer service, have long been a characteristic of this Japanese system and have given the Japanese a definite advantage when competing against U.S. industry. Japan has adopted international reporting standards (IFRS), which does not allow the use of LIFO.44Concept Practice 6 45Wiley © 2018