Kế toán, kiểm toán - Chương 8: Valuation of inventories: A cost - Basis approach

C H A P T E R 8VALUATION OF INVENTORIES: A COST-BASIS APPROACHIntermediate AccountingIFRS 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 methods used to price inventories.Learning ObjectivesGoods in transitConsigned goodsSpecial sales agreementsInventory errorsInventory IssuesPhysical Goods Included in InventoryCost Included in InventoryCost Flow AssumptionsClassification Cost flowControlBasic inventory valuationProduct costsPeriod costsPurchase discountsSpecific identificationAverage costFIFOSummary analysisValuation 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.MerchandiserManufacturerBusinesses with InventoryorClassificationOne inventory account.Purchase goods in form ready for sale.ClassificationInventory IssuesLO 1 Identify major classifications of inventory.Illustration 8-1Three accountsRaw materialsWork in processFinished goodsClassificationInventory IssuesLO 1Illustration 8-1Inventory 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:Inventory 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 income and expense” 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.Inventory IssuesLO 2 Distinguish between perpetual and periodic inventory systems.Basic Issues in Inventory 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 (specific Identification, average cost, FIFO, 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 8-6Physical Goods Included in InventoryLO 3 Identify the effects of inventory errors on the financial statements.Effect of Inventory ErrorsThe effect of an error on net income in one year (2010) will be counterbalanced in the next (2011), however the income statement will be misstated for both years.Illustration 8-7Ending Inventory MisstatedEffect of Inventory ErrorsIllustration: Yei Chen Corp. understates its ending inventory by HK$10,000 in 2010; all other items are correctly stated.Illustration 8-8LO 3Physical Goods Included in InventoryLO 3 Identify the effects of inventory errors on the financial statements.Effect of Inventory ErrorsThe understatement does not affect cost of goods sold and net income because the errors offset one another.Illustration 8-9Purchases and Inventory MisstatedCosts 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.Treatment of 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**Method adopted should be one that most clearly reflects periodic income.Cost Flow Assumption Adopted does not need to equal Physical Movement of GoodsWhich Cost Flow Assumption to Adopt?Specific Identification --- Average Cost --- LIFOLO 5 Describe and compare the methods used to price 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 February 2011, assuming the company used the FIFO, Average Cost, and Specific Identification cost flow assumptions? Assume a tax rate of 30%.ExampleCost Flow AssumptionsLO 5 Describe and compare the methods used to price inventories.Purchase on 2/2/11 for $10Purchase on 2/15/11 for $15Purchase on 2/25/11 for $20Inventory Balance = $ 45Young & Crazy CompanyIncome StatementFor the Month of Feb. 2011 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 5Purchase on 2/2/11 for $10Purchase on 2/15/11 for $15Purchase on 2/25/11 for $20Cost Flow AssumptionsInventory Balance = $ 35Young & Crazy CompanyIncome StatementFor the Month of Feb. 2011 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 5Purchase on 2/2/11 for $10Purchase on 2/15/11 for $15Purchase on 2/25/11 for $20Inventory Balance = $ 45Young & Crazy CompanyIncome StatementFor the Month of Feb. 2011 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 5Purchase on 2/2/11 for $10Purchase on 2/15/11 for $15Purchase on 2/25/11 for $20Inventory Balance = $ 30Cost Flow AssumptionsYoung & Crazy CompanyIncome StatementFor the Month of Feb. 2011 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 5Purchase on 2/2/11 for $10Purchase on 2/15/11 for $15Purchase on 2/25/11 for $20Inventory Balance = $ 45Young & Crazy CompanyIncome StatementFor the Month of Feb. 2011 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 5Young & Crazy CompanyIncome StatementFor the Month of Feb. 2011 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 $ 40Depends which one is soldPurchase on 2/2/11 for $10Purchase on 2/15/11 for $15Purchase on 2/25/11 for $20Inventory Balance = $ 45Cost Flow Assumptions“Specific Identification”LO 5Financial Statement SummaryInventory Balance3035Cost Flow Assumptions LO 5Cost 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 8-12Average CostIllustration 8-13Weighted-AverageLO 5 Describe and compare the methods used to price inventories.Average CostIllustration 8-14In this method, Call-Mart computes a new average unit cost each time it makes a purchase.Moving-AverageLO 5 Describe and compare the methods used to price inventories.First-In, First-Out (FIFO)Illustration 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.LO 5 Describe and compare the methods used to price inventories.First-In, First-Out (FIFO)Illustration 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.LO 5 Describe and compare the methods used to price inventories.Inventory Valuation Methods - SummaryIllustration 8-17LO 5 Describe and compare the methods used to price inventories.Inventory Valuation Methods - SummaryIllustration 8-18Balances of Selected Items under Alternative Inventory Valuation MethodsLO 5 Describe and compare the methods used to price inventories.LO 6 Describe the LIFO cost flow assumption.Under IFRS, LIFO is not permitted for financial reporting purposes. Nonetheless, LIFO is permitted for financial reporting purposes in the United States, it is permitted for tax purposes in some countries, and its use can result in significant tax savings.LO 6Illustration: 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 SaleLast-In, First-Out (LIFO)Last-In, First-Out (LIFO)Illustration 8A-1Periodic MethodThe cost of the total quantity sold or issued during the month comes from the most recent purchases.LO 6 Describe the LIFO cost flow assumption.Last-In, First-Out (LIFO)Illustration 8A-2Perpetual MethodThe LIFO method results in different ending inventory and cost of goods sold amounts than the amounts calculated under the periodic method.LO 6 Describe the LIFO cost flow assumption.Illustration 8A-3Inventory Valuation Methods - SummaryNotice that gross profit and net income are lowest under LIFO, highest under FIFO, and somewhere in the middle under average cost.LO 6 Describe the LIFO cost flow assumption.Illustration 8A-4Inventory Valuation Methods - SummaryLIFO results in the highest cash balance at year-end (because taxes arelower). This example assumes that prices are rising. The opposite result occurs if prices are declining.LO 6 Describe the LIFO cost flow assumption.Many companies use LIFO for tax and external financial reporting purposes FIFO, average cost, or standard cost system for internal reporting purposes.Reasons:LIFO ReservePricing decisionsRecord keeping easierProfit-sharing or bonus arrangementsLIFO troublesome for interim periodsLO 7 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. Cost of goods sold 30,000 Allowance to reduce inventory to LIFO 30,000Journal entry to reduce inventory to LIFO:Illustration: Acme Boot Company uses the FIFO method for internalreporting purposes and LIFO for external reporting purposes. At January 1, 2011, the Allowance to Reduce Inventory to LIFO balance is $20,000. At December 31, 2011, the balance should be $50,000. As a result, Acme Boot realizes a LIFO effect and makes the following entry at year-end.LO 7 Explain the significance and use of a LIFO reserve.Older, low cost inventory is sold resulting in a lower cost of goods sold, higher net income, and higher taxes. LIFO LiquidationIllustration: Basler Co. has 30,000 pounds of steel in its inventory on December 31, 2011, with cost determined on a specific-goods LIFO approach.LO 8 Understand the effect of LIFO liquidations.Illustration: At the end of 2012, only 6,000 pounds of steel remained in inventory.LIFO LiquidationIllustration 8B-3Illustration 8B-2LO 8Changes 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.Dollar-Value LIFOLO 9 Explain the dollar-value LIFO method.Exercise 8-29 (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 LIFOSpecific-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.Comparison of LIFO ApproachesMatchingTax Benefits/Improved Cash FlowFuture Earnings HedgeAdvantagesReduced 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.”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.Basis for Selection of Inventory MethodCopyright © 2011 John Wiley & Sons, Inc. All rights reserved. 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