Merchandising Operations and the MultipleStep Income Statement

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Chapter 6
REPORTING AND ANALYZING INVENTORY
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Chapter 6Reporting and Analyzing Inventory

• Explain the basis of accounting for inventories
  and apply the inventory cost flow methods under a
  periodic inventory system.
• Explain the financial statement and tax effects
  of each of the inventory cost flow assumptions.
• Explain the lower of cost or market basis of
  accounting for inventories.
• Describe the LIFO reserve and explain its
  importance for comparing results of different
  companies.

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Inventory-Merchandiser

• Consists of many different items
• Owned by the company
• In a form ready for sale to customers (no
  physical alteration)
• One inventory classification Merchandise
  Inventory

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Inventory - Manufacturing

• Finished goods inventory
• Work in process
• Raw materials
• Accounts worked with in ACC102

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Consigned Goods

• Goods of others you hold. You do not pay
  for the goods until they sell.
• The company does not take ownership.

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Inventory Costing - Periodic

• Determine quantity of units of inventory
• Apply unit costs to the quantities
• Determine total cost of inventory
• Determine cost of goods sold

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Illustrative Data Crivitz TV Co.
Purchases February 3 1 set
700 March 5 1 set 750 May 22 1 set
800 Sales June 1 2 sets 2,400
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Inventory Costing

• Specific Identification method
• Cost Flow Assumptions
• FIFO- First-in, First-Out- earliest goods
  purchased are the first to be sold
• LIFO- Last-in,First-Out- latest goods purchased
  are the first to be sold
• Average Cost Method- costs are charged on the
  basis of weighted average unit cost

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Specific Identification
An actual physical flow costing method in which
items still in inventory are specifically costed
to arrive at the total cost of ending inventory.
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The FIFO method assumes the
earliest goods purchased are the first to be sold.
FIFO
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The LIFO method assumes the last goods purchased
are the first to be sold.
LIFO
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The average cost method allocates the cost of
goods available for sale on the basis of
weight-average unit cost incurred.
Weighted Average
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Factors Used in Selecting an Inventory Cost Method

• Income statement effects
• Balance sheet effects
• Tax effects

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Balance Sheet Effects of Cost Flow Methods
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Income Statement Effects
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Income Statement Effects
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Income Statement Effects
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Income Statement Effects
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Income Statement Effects
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Income Statement Effects

• In periods of increasing prices
• FIFO reports the highest net income
• LIFO the lowest
• average cost falls in the middle.
• In periods of decreasing prices
• FIFO will report the lowest net income
• LIFO the highest
• average cost in the middle.

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Balance Sheet Effects

• In a period of increasing prices, costs
  allocated to ending inventory using
• FIFO will approximate current costs
• LIFO will be significantly understated

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Why Do Companies Use LIFO?

• During periods of rising prices,
• Higher cost of goods sold
• Lower net income

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Income Tax Effects
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Consistency
Whatever cost flow method a company chooses, it
must use it consistently OR Disclose the change
and its effects on net income in the financial
statement.
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Lower of Cost or Market Basis of Accounting for
Inventories

• When the value of inventory is lower than its
  cost, the inventory is written down to its market
  value by valuing the inventory at the lower of
  cost or market (LCM) in the period in which the
  price decline occurs.

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Lower of Cost or Market (LCM)

• Under LCM, market is defined as current
  replacement cost NOT selling price
• Departure from cost principle, but follows
  conservatism concept
• LCM applied after costing with one of methods
  (FIFO, LIFO, average, specific)
• Apply to individual items or major categories or
  total inventory

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LIFO RESERVE

• Accounting standards require firms using LIFO to
  report the amount by which inventory would be
  increased (or on occasion decreased) if the firm
  had instead been using FIFO.
• This amount is referred to as the LIFO reserve.
  Reporting the LIFO reserve enables analysts to
  make adjustments to compare companies that use
  different cost flow methods.