FINANCIAL ACCOUNTING A USER PERSPECTIVE

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FINANCIAL ACCOUNTINGA USER PERSPECTIVE

• Hoskin Fizzell Davidson
• Second Canadian Edition

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Inventory

• Chapter Seven

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Inventory

• Any item purchased by a company for
• resale to customers, or
• use in the manufacture of items to be sold to
  customers

4
Inventory

• Asset has probable future value
• Ownership is evidenced by possession
• Cost of goods sold the expense when inventory is
  sold

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Valuation Criteria

• Historical Cost
• Inventory recorded at its cost on the date it was
  acquired
• Income recognized when inventory is sold

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Valuation Criteria

• Market Value
• Wholesale market
• Input or entry market
• Replacement cost
• Output or exit market
• Net realizable value (NRV)

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Valuation Criteria

• Canadian practice
• Historical cost
• Apply a lower of cost or market (LCM) rule at the
  end of the period
• Market is either replacement cost or net
  realizable value

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Acquisition Costs

• Inventory value
• Include all laid-down costs
• invoice price, plus duties, tariffs, freight and
  cartage costs
• Transportation in (freight in)
• may be assigned to inventory or treated as a
  period cost

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Manufacturing Company

• Raw materials purchased
• used to make new products
• Work-in-process inventory
• includes raw materials used, direct labour, and
  overhead costs
• Finished goods inventory
• transferred in costs of finished goods

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Manufacturing Cost Flows
A-Raw materials
A-Work-in-process
A-Finished goods
XX
XX
XX
Labour costs
YY
YY
Overhead
YY
SE-Cost of goods sold
YY
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Lower of Cost and Market

• Lower of cost or market for inventories, using
  either
• Direct method
• Ending inventory is reduced
• Allowance method
• Uses Loss Due to Market Decline of Inventory
  account

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Lower of Cost and Market

• Cost of beginning inventory
• Purchases
• Transportation in
• Goods available for sale
• Ending inventory
• Cost of goods sold

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Inventory Systems

• Perpetual Inventory System
• Periodic Inventory System

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Perpetual Inventory System

• Keeps track of units and/or costs on a continual
  basis
• When a unit is sold, it is immediately removed
  from the inventory account
• Inventory ending balance can be computed at any
  time

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Perpetual Inventory System

• Ending inventory balances and cost of goods sold
  accounts are always up to date
• Information is most timely for decision-making
  purposes

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Periodic Inventory System

• No entry to record the reduction in inventory at
  the time of sale
• Count inventory to determine quantity on hand and
  assign costs
• Cost of goods sold is calculated
• Information is not up to date during the period

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Costs and Benefits

• Perpetual system
• provides better information, but at higher cost
• can identify inventory shrinkage
• losses due to theft, damage or spoilage
• Counting inventory is necessary under both systems

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Cost Flow Assumptions

• Assumptions for cost flows, not physical flows of
  goods
• Methods
• Specific identification
• First-in, first-out (FIFO)
• Last-in, first-out (LIFO)
• Weighted average

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Cost Flow Assumptions

• Specific Identification
• Each unit of inventory is identifiable
• The cost of each unit is matched to the specific
  unit
• FIFO
• The first item purchased is the first item sold

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Cost Flow Assumptions

• LIFO
• The last item purchased is the first item sold
• Weighted Average
• The cost of the items is determined using a
  weighted average of the cost of the items
  purchased

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Teds Toasters, Inc.Inventory of toasters
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Teds Toasters, Inc.Sale Record
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First-In, First-Out (FIFO)
Ending inventory
Cost of goods sold
Purchases
First-in, first-out FIFO
Last-in, still-here LISH
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First-In, First-Out (FIFO)
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Last-In, First-Out (LIFO)
Cost of goods sold
Purchases
Last-in, first-out LIFO
Layer 3
Layer 2
Layer 1
Ending inventory
First-in, still-here FISH
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Last-In, First-Out (LIFO)
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Weighted Average
Cost of goods sold
Purchases
Weighted average
Ending inventory
Weighted average
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Weighted Average
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Financial Statement Results
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Cash Flow Assumption Choice

• All three assumptions are in accordance with GAAP
• GAAP
• select the method that represents the fairest
  match of costs with revenues regardless of the
  actual physical flow of inventory

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Cost Flow Assumptions and Changing Prices

• Rising prices
• LIFO lowest net income
• FIFO highest net income
• Deflation
• opposite to rising prices
• Stable prices
• same values for each assumption

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Inventory Estimation

• Cost-to-Sales Ratio
• Also called the gross margin estimation method
• Sales revenue x Normal cost-to-sales ratio Cost
  of goods sold

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Inventory Turnover
Cost of goods sold
Inventory turnover

Average Inventory
365
Days of inventory

Inventory Turnover
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Inventory Turnover
7,691,231
Inventory turnover


3.6
(2,050,703 2,270,909) / 2
365
Days of inventory

101.4 days

3.6
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Inventory Turnover
Inventory turnover
1999
3.6
1998
3.7
101.4 days
1999
Days of inventory
98.6 days
1998