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REPORTING AND ANALYZING INVENTORY
LO 1: Discuss how to classify and determine inventory.
Inventory: “Assets a company intends to sell in the normal course of business, has in production for future sale, or uses currently in the production of goods to be sold.”
- Inventory --ON BALANCE SHEET: “represents the cost of inventory STILL ON HAND.”
- Cost of Goods Sold ---ON INCOME STATEMENT: “represents the cost of inventory SOLD DURING THE PERIOD.”
Merchandising companies have ONE type of inventory: Merchandise Inventory Manufacturing companies have THREE types of inventory:
**1. Raw Materials
- Work in Process
- Finished Goods**
DETERMINING INVENTORY QUANTITIES
Physical inventory is taken for 2 reasons: o Perpetual System
- Check accuracy of inventory records.
- Determine amount of inventory lost due to wasted raw materials, shoplifting, or employee theft.
o Periodic System
- Determine the inventory on hand.
- Determine the cost of goods sold for the period.
One challenge in determining inventory quantities is making sure a company owns the inventory. o Goods in transit : purchased goods not yet received and sold goods not yet delivered. FOB (Free on Board) Shipping Point : Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. If goods are in transit they are the BUYERS.
FOB (Free on Board) Destination: Ownership of the goods remains with the seller until the goods reach the buyer. If goods are in transit they are the SELLERS.
o Consigned Goods: Goods held for other parties to see if they can sell the goods for the other party. The company holding the goods charges a fee and does not take ownership of the goods. Consignor: goods shipped by the owner. Consignee: sell goods for the owner. ****** At end of the year GOODS NOT SOLD BELONG AS PART OF CONSIGNOR’S (OWNER’S) INVENTORY.
Ex: Auto Alex owns a used car lot. Nick has a used car that he wants to sell. He goes to Auto Alex and the dealer agrees to put Nick’s car on the lot for a fee. Auto Alex does not take ownership of the car.
Consignor: Nick (Car is INCLUDED in inventory.) Consignee: Auto Alex (Used car is NOT INCLUDED in inventory.)
2. FIRST-IN, FIRST-OUT (FIFO) (PERIODIC) Assumes OLDEST ITEMS SOLD FIRST (Ex: Grocery stores sell oldest fruit or dairy products like milk first before newest.) Costs of the earliest goods purchased are the first to be recognized in determining cost of goods sold. (Resembles the actual physical flow of merchandise) Companies determine the cost of the ending inventory by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed.
Ex)
Items SOLD in order acquired ….
- Beginning Inventory
- Jan. 6
- Jan. 24
NEWEST UNITS REMAIN IN ENDING INVENTORY.
Date Explanation Units Unit Cost Total Cost Jan. 1 Beginning Inventory 10 $ 10.00 $100. Jan.6 Purchase 8 $ 15.00 $120. Jan. 24 Purchase 20 $ 20.00 $400. Total 38 $620.
*Assume 23 units are in ending inventory at the end of January
Date Units Unit Cost Total Cost
Jan. 24 20 $ 20.00 $ 400.
Jan. 6 3 $ 15.00 $ 45.
Total 23 $445.
Step 1: Calculate Ending Inventory
ENDING INVENTORY = units on hand x unit cost
Cost of Goods Available for sale $ 620. Less: Ending Inventory $(445.00) Cost of Goods Sold $175.
Step 2: Calculate Cost of Goods Sold
3. LAST-IN, FIRST-OUT (LIFO) (PERIODIC) Assumes NEWEST ITEMS SOLD FIRST (Ex: When new technology items came out.) Costs of the latest goods purchased are the first to be recognized in determining cost of goods sold. Seldom coincides with actual physical flow of merchandise.
Ex)
Items SOLD from newest to oldest ….
- Jan. 24
- Jan. 6
- Beginning Inventory
OLDEST UNITS REMAIN IN ENDING INVENTORY.
4. WEIGHTED AVERAGE (PERIODIC) Allocates cost of goods available for sale on the basis of weighted-average unit cost incurred. Applies weighted-average unit cost to the units on hand to determine cost of the ending inventory.
Ex)
Date Explanation Units Unit Cost Total Cost Jan. 1 Beginning Inventory 10 $ 10.00 $100. Jan.6 Purchase 8 $ 15.00 $120. Jan. 24 Purchase 20 $ 20.00 $400. Total 38 $620.
*Assume 23 units are in ending inventory at the end of January
Date Units Unit Cost Total Cost Beg. Inv. 10 $ 10.00 $ 100. Jan. 6 8 $ 15.00 $ 120. Jan. 24 5 $ 20.00 $ 100.
Total 23 $320.
Step 1: Calculate Ending Inventory
ENDING INVENTORY = units on hand x unit cost
Cost of Goods Available for sale $ 620. Less: Ending Inventory $ (320.00) Cost of Goods Sold $300.
Step 2: Calculate Cost of Goods Sold
WEIGHTED AVERAGE COST PER UNIT = Total Cost of Inventory on Hand ÷ Number of Units on Hand
Date Explanation Units Unit Cost Total Cost
Jan. 1 Beginning Inventory 10 $ 10.00 $ 100.
Jan.6 Purchase 8 $ 15.00 $ 120.
Jan. 24 Purchase 20 $ 20.00 $ 400.
Total 38 $620.
*Assume 23 units are in ending inventory at the end of January
LO 3: Explain the statement presentation and analysis of inventory.
Inventory is classified in the BALANCE SHEET as a CURRENT ASSET immediately below receivables. In a multiple-step income statement, cost of goods sold is subtracted from net sales. There also should be disclosure of
- The major inventory classifications
- The basis of accounting (cost, or lower-of-cost-or-market)
- The cost method (FIFO, LIFO, or average-cost).
LOWER-OF-COST-OR-MARKET Applied to items in inventory after the company has used one of the cost flow methods ( specific identification, FIFO, LIFO, or average-cost) to determine cost. Companies can “write down” the inventory to its market value in the period in which the price decline occurs. Market value = Replacement Cost Example of conservatism. Inventory is valued at the LOWER of its COST or MARKET VALUE.
ANALYSIS
- Inventory Turnover Ratio
Average Inventory = (Inventory Beginning of Year + Inventory End of Year) ÷ 2 Used to measure a company’s ability to manage its inventory effectively.
A company that has an inventory turnover of 4 indicates that it sells and replaces their inventory 4 times per year.
- Days in Inventory
Indicates the average number of days’ inventory is held.
Shorter the number of days’ in inventory, the better, but it depends on industry. For example, grocery stores will have a much shorter amount of days then jewelry stores. A company has 100 days’ in inventory. Therefore, it takes it 100 days to purchase, sell, and replace their inventory.
- LIFO Reserve
The difference between inventories reported using LIFO and Inventory using FIFO. Enables analysts to make adjustments to compare companies that use different cost flow methods.
Inventory Assuming FIFO = Inventory Using LIFO + LIFO Reserve
LAST-IN, FIRST-OUT (LIFO) (PERPETUAL) The LATEST units purchased prior to each sale are allocated to cost of goods sold. The amounts for ending inventory and cost of goods sold are going to be different from the periodic inventory system because in a periodic system the latest units purchased during the period are allocated to cost of goods sold.
- What is the cost of goods sold using LIFO?
- What is the ending inventory using LIFO?
AVERAGE COST (PERPETUAL) Called the “moving-average method.” Compute a new average after each purchase.
Average Cost = Cost of Goods Available for Sale ÷ Units on Hand
The average cost is then applied to..
- The units sold to calculate cost of goods sold.
- The remaining units on hand to calculate ending inventory.
- What is the cost of goods sold using Average Cost?
- What is the ending inventory using Average Cost?
