Kế toán, kiểm toán - Chapter 8: Inventory

CHAPTER 8:INVENTORY2Chapter 8: InventoryAfter studying this chapter, you should be able to:Understand inventory from a business perspective.Define inventory from an accounting perspective.Identify which inventory items should be included in ending inventory.Identify the effects of inventory errors on the financial statements and adjust for them.Determine the components of inventory cost.Distinguish between perpetual and periodic inventory systems and account for them.Identify and apply GAAP cost formula options and indicate when each cost formula is appropriate.Explain why inventory is measured at the lower of cost and market, and apply the lower of cost and net realizable value standard.Identify inventories that are or may be valued at amounts other than the lower of cost and net realizable value.Apply the gross profit method of estimating inventory.Identify how inventory should be presented and the type of inventory disclosures required by IFRS and ASPE.Explain how inventory analysis provides useful information and apply ratio analysis to inventory.Identify differences in accounting between IFRS and ASPE, and what changes are expected in the near future.3Inventory4Inventory ClassificationInventory is classified as a current assetA merchandising company:has one inventory account on the balance sheet called Merchandise Inventory; the cost of the inventory sold is transferred to Cost of Goods Sold (COGS) on the income statementA manufacturing company:will normally have three inventory accounts on the balance sheet: raw materials, work in process and finished goods; Cost of Goods Manufactured (COGM) is used by a manufacturer which is similar to the COGS 5Inventory Cost Flows Manufacturing Operations$$$COGM$$$ Raw MaterialsDirect LabourMfg. OverheadCOGS$$$Work in Process InventoryFinished GoodsCOGS6InventoryDefinition of Inventory:CPA Handbook Section 3031 under ASPE or IAS 2 under IFRS Inventories are “assets:held for sale in the ordinary course of business;in the process of production for such sale; orin the form of materials or supplies to be consumed in the production process or in the rendering of services.”7Items to Be Included in InventoryLegal title to goods generally determines items to be included in inventoryThe following goods are included in the seller’s inventory:Goods in transit (if seller has title during shipment, i.e., if shipped f.o.b. destination)Goods out on consignmentGoods sold under buyback agreementsGoods sold with high rates of return that cannot be estimated8Effect of Inventory ErrorsError in Effect on Income Effect on Balance End Inv. Statement Items Sheet Items Under- -COGS (over) -Retained Earnings (under)stated -Net Income (under) -Working Capital (under) -Current ratio (under)Over- -COGS (under) -Retained Earnings (over)stated -Net Income (over) -Working Capital (over) -Current ratio (over)9ExampleGiven for the year 2016: COGS = $1.4 million Retained Earnings (R/E) = $5.2 millionDecember 31st inventory errors both discovered after 2016 books were closed: 2015: inventory overstated by $110,000 2016: inventory overstated by $45,000Calculate correct 2016 COGS and R/E at Dec. 31, 201610ExampleCOGS (as originally stated in 2016) $1,400,000Add: December 31, 2016 over- statement error 45,000 1,445,000Less: December 31, 2015 over- statement error 110,000Corrected 2016 COGS $1,335,000Retained Earnings (2016 original) $5,200,000Less: correction for 2016 inventory 45,000Retained Earnings (2016 restated) $5,155,000Note: 2015 inventory error is self-corrected as it was discovered after the books for 2016 were closedCosts Included in InventoryInventory cost includes “all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition”These costs include: Product costs including invoice, freight, and other direct acquisition costsConversion costs which include direct labour and fixed and variable overheadPeriod costs (selling, general, and administrative) are not inventoriable costs12Costs Included in InventoryOther issues to consider: Purchases discounts: gross method vs. net methodVendor rebates: cash rebates related to inventory generally recorded as a reduction to the cost of inventory“Basket” purchases and joint product costs: total cost allocated to units based on relative sales value13Costs Included in InventoryInterest or borrowing costsUnder IFRS, interest costs are included as product costs if manufacturing of inventory takes a long time (otherwise, company has a choice whether to capitalize interest costs or not)Under ASPE, interest costs may be either capitalized or expensed, but policy must be disclosed. 14Purchase CommitmentsWhere a company commits to purchase inventory, but title has not passed to the buyerNon-cancellable purchase contracts are not recorded, but if material, they are disclosed in the notes to the financial statementsLoss provision is recognized on onerous contracts (even though no specific requirement under ASPE)Onerous contracts are contracts where unavoidable costs to complete the contract are higher than expected benefits 15Inventory Accounting SystemsAn accurate inventory accounting system is important for: ensuring availability of inventory itemspreventing excessive accumulation of inventory itemsJust-in-time (JIT) inventory order systems have helped reduce inventory levelsThe perpetual system maintains a continuous record of inventory changesThe periodic system updates inventory records in the ledger only periodically16Perpetual SystemPurchases of inventory and cost of inventory sold are recorded directly in the Inventory accountCost of freight, purchase returns and allowances, and purchase discounts are all recorded in the Inventory accountCost of Goods Sold (COGS) is debited and Inventory is credited when inventory is soldA subsidiary ledger is maintained for individual inventory items on handPeriodic inventory counts are still required to ensure reliabilityAny differences between the inventory balance and the physical count are captured in a separate account called Inventory Over and Short (or may be recorded as an adjustment to Cost of Goods Sold)17Periodic SystemInventory purchases are recorded as a debit to a Purchases accountCost of Goods Sold and Inventory accounts are not kept up to date The quantity and cost of inventory on hand is determined by taking a physical inventory countCost of Goods Sold is determined at the end of the period Under both periodic and perpetual inventory systems, physical counts of inventory are conducted at least once a year as there is the risk of loss and errors (e.g. waste, breakage, theft)Freight, purchase returns and allowances, and purchase discounts are recorded in separate accounts18Perpetual and Periodic Systems: ExampleFesmire Limited reports the following data: Beginning Inventory : 100 units at $6 Purchases: (all credit) 900 units at $6 Defective units (returned) 50 units at $6 Sales: (all credit) 600 units at $12 Ending Inventory: 350 units at $6Provide all journal entries under each system.19Perpetual System7,200 Sales(600 units x $12)7,2003,600Inventory(600 units x $6) 300 3003,600 Accounts Payable(900 units x $6)5,4005,400Accounts ReceivableAccounts Payable Inventory(50 units x $6)Cost of goods soldPurchase ReturnSaleInventoryPurchaseRecord Sales RevenueRecord Inventory ChangesTransaction20Periodic System 5,400 600 Purchases Inventory (beg.)3,6002,100 300Cost of goods soldInventory (end - count)Purchases ReturnsYear-End Adjusting Entry7,200 Sales(600 units x $12)7,200 Accounts Payable(900 units x $6)Accounts Payable Purch. Returns and Allowances 5,400 300300 5,400Accounts Receiv.No entrySalePurchasesPurchaseReturnRecord Sales RevenueRecord Inventory ChangesDate21Cost FormulasIFRS and ASPE recognize three acceptable cost formulas: 1. Specific identification 2. First-in, First-out (FIFO) 3. Weighted average cost22Cost FormulasThe ending inventory in units is the same in all three methods; the cost is differentThe cost of goods sold and the cost of ending inventory are differentThe cost of purchases is the same in all three methods23Specific IdentificationEach item sold and purchased is individually identifiedRequired for goods that are not ordinarily interchangeable; and that are produced and segregated for specific projectsAdvantages:Matches actual costs with revenueEnding inventory reported at specific costDisadvantages:May be costly to implement and maintainMay lead to income manipulation May be difficult to allocate certain costs (e.g., storage, shipping) to specific inventory items24Weighted Average CostJustification for using weighted average cost formula:Reasonable to cost inventory based on an average costCosts assigned closely follows the actual physical flowSimple to apply, objective, less subject to income manipulationEnding inventory cost on balance sheet is made up of average costsMoving-average cost formula refers to a weighted-average method used with perpetual records (both units and dollars)25First-In, First-Out (FIFO)Advantages:Attempts to approximate physical flow of goodsEnding inventory made up of most recent costs, therefore close to its replacement costDoes not permit manipulation of incomeDisadvantages:Current costs not matched to current revenues, as oldest cost of goods are used with current revenueWhen prices are changing rapidly, gross profit and net income are distorted 26Choice of Cost FormulaInventory standards limit the choice of cost formulaSpecific identification is required in some casesShould choose the best method that:1. best reflects the physical flow2. reflects the most recent costs in the inventory account, and3. use this method for all inventory assets with same characteristics27Cost FormulasLIFO is not acceptable because: LIFO does not represent actual inventory flows reliably Costs assigned to ending inventory (oldest costs) do not represent recent cost of inventory on hand Can distort reported income on the income statementLIFO has never been allowed by CRA28Cost Formulas : ExampleCall-Mart reports the following transactions for March:Date Purchases Sales Balance (units) Beginning (500 @$3.80) 500 2 1,500 units (@$4.00) 2,00015 6,000 units (@$4.40) 8,00019 Sold 4,000 units 4,00030 2,000 units (@$4.75) 6,000Determine the cost of goods sold and the cost of ending inventory, under each cost formula29Weighted-Average FormulaDate Purchases Unit Cost Purchase Cost March 1 500 units $3.80 $ 1,900March 2 1,500 units $4.00 $ 6,000 March 15 6,000 units $4.40 $26,400 March 30 2,000 units $4.75 $ 9,50010,000 units $43,800Unit Cost = $43,800  10,000 = $4.38 Cost of goods availableCost of goods soldEnding inventory$43,8004,000 X $4.38 = 17,5206,000 X $4.38 = $26,28030Moving-Average FormulaDate Purchases Unit Cost Purchase Cost On HandMarch 1 500 units $3.80 $ 1,900 $ 1,900March 2 1,500 units $4.00 $ 6,000 $ 7,900March 15 6,000 units $4.40 $26,400 $ 34,300Mar. 19 New Unit Cost calculated – to use for Cost of Goods Sold $34,300/8,000 units = $4.2875 and 4,000 @ $4.2875 = $17,150 March 19 4,000 units remaining 17,150 March 30 2,000 units $4.75 $ 9,500 26,650New Unit Cost calculated—to use as COGS for next sale and for inventory $26,650/6,000 units = $4.4417NOTE: With each new purchase, a new average unit cost is determined31First-In, First-Out FormulaDate Purchases Unit Cost Purchase Cost March 1 500 units $3.80 $ 1,900March 2 1,500 units $4.00 $ 6,000 March 15 6,000 units $4.40 $26,400 March 30 2,000 units $4.75 $ 9,500$43,800 - $27,100 = $16,7006,000 units2,000 @ $4.75 = $ 9,5004,000 @ $4.40 = 17,600 $27,100$43,800Ending inventoryCost of goods soldCost of goods available32Basic Valuation IssuesMost inventory is valued using a cost-based system at “lower of cost and net realizable value”Specialized inventory (e.g. biological assets, including plants and animals) may use a “net realizable value” model (or “fair value less cost to sell”)Under the typical cost-based system, ending inventory valuation requires answers to each of the following:Which physical goods should be included as part of inventory?What costs should be included as part of inventory cost?What cost formula should be adopted?Has there been an impairment in value of inventory items held?33Lower of Cost and NRVInventory is initially recorded at cost Inventory is valued at the lower of cost and net realizable value (LC&NRV)Net realizable value (NRV) is the estimated selling price less the estimated costs to complete and sell34Determining Lower of Cost and NRVItem Cost NRV LC&NRVSpinach $80,000 $ 120,000 $ 80,000Carrots 100,000 100,000 100,000Cut beans 50,000 40,000 40,000Peas 90,000 72,000 72,000Mixed vegetables 95,000 92,000 92,000Final inventory value $ 384,000Comparison of cost and NRV should be done on an item-by-item basisGrouping inventory for purposes of valuation is permitted only under certain circumstances35Recording the LC&NRVUnder the Direct Method: The Inventory account is recorded at its net realizable value at year end if the NRV is less than costLoss becomes part of cost of goods sold on the income statement36Recording Decline in NRV– Direct Method (Perpetual Inventory System)Inventory At Cost At NRV AdjustmentBeginning $65,000 $65,000 $-0-End of year $82,000 $70,000 $12,000Under the Direct method:Dr. Cost of Goods Sold 12,000 Cr. Inventory 12,00037Recording Cost vs. NRVUnder the Indirect (Allowance) Method:Inventory reported at cost with declines and recoveries recorded through an Allowance (valuation) account on the balance sheet; a Loss account is reported on the income statementRecovery of market value decline is recorded up to but not exceeding original cost38Recording Decline in NRV: Indirect Method (Perpetual Inventory System)Inventory At Cost At NR AdjustmentBeginning $65,000 $65,000 $-0- End of year $82,000 $70,000 $12,000 Under the Allowance method: Dr. Loss Due to Decline in NRV 12,000 Cr. Allowance to Reduce Inventory 12,00039Exceptions to the LC&NRV ModelInventories measured at Net Realizable Value if:Sale is assured, or there is active market and minimal risk of not completing the sale, and Costs of disposal can be estimatedInventories measured at Fair Value Less Cost to Sell includeInventories of commodity broker-tradersBiological assets and agricultural produce at point of harvestThere is no specific ASPE guidance on measurement of these assets40Gross Profit Method of Estimating InventoryGross profit method is used to estimate ending inventoryEstimates may be required in such situations: interim reporting, fire loss, testing reasonableness of cost from an actual inventory countMethod is based on the three assumptions:Beginning inventory + purchases = cost of goods available for saleGoods not sold are in ending inventoryCost of goods available for sale – cost of goods sold = ending inventory41Gross Profit Method: ExampleGiven:Beginning inventory (at cost): $ 60,000Purchases (at cost) : $ 200,000Sales (at selling price) : $ 280,000Gross profit percentage on sales: 30% Estimate the ending inventory using the gross profit method42Gross Profit Method: ExampleBeg. Inventory + Purchases – COGS = Estimated Ending Inventory Cost of goods sold = Sales x (1 - 0.3) = Sales x 70%$60,000 + $200,000 - ($280,000x0.7) = Ending Inventory$60,000 + $200,000 - ($196,000) = $64,00043Understanding MarkupsAssume markup on cost is 25%Cost + Gross Profit = Sales ==> C + 25%C = SalesCost of goods sold (1 + 25%) = SalesCost of goods sold = Sales x (1/1.25)Gross Profit = Sales x (.25/1.25) If Sales is $1, Gross profit % = $1 x (.25/1.25) = 20%Gross Profit % = Markup % / (1 + markup %)Assume you are given markup on cost What is gross profit on selling price?44Disclosure and PresentationExamples of required disclosures:Measurement policyTotal inventory, as well as inventory by classificationAmount of inventory recognized as expense on the income statement (usually reported as cost of goods sold)Any amount of inventory pledged as security for liabilitiesIFRS has more disclosure requirements than ASPE45Common ratios Inventory Turnover: Cost of Goods Sold Average Inventory Measures number of times on average inventory was sold during the period Average Days to Sell Inventory: 365 Inventory Turnover 46Comparison of IFRS and ASPEThe CPA Canada Handbook, Part II, Section 3031 Inventories is converged with IAS 2 inventories, so there are very few differences. Major differences between IFRS and ASPE relates to a specific international standard (IAS 41) covering biological assets and agricultural produce at the point of harvestASPE has no specific guidance in this area47Looking AheadNo major changes are expected in the standards48