Inventory Valuation

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• Inventory Valuation
• Physical inventory flow

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Inventory Costing

• Changing Prices makes cost flow assumption
  necessary
• Method chosen affects Income Statement, Balance
  Sheet amount of Income Taxes paid
• Cost Flow Assumptions
• FIFO- First-in, First-Out- earliest goods
  purchased first to be sold
• LIFO- Last-in,First-Out- latest goods purchased
  the first to be sold
• Average Cost Method- costs are charged on the
  basis of weighted average unit cost-assumes goods
  available for sale are homogeneous

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Effect of Inventory Errors
Ending Effect on Effect on Inventory Income items Balance sheet items
Under- C\G\Sold (over) Stated Net income (under) Retained Earning (Under) Work Capital (under)
Over- C\G\Sold (Under) stated Net Income (Over) Retained Earning (Over) Work Capital (Over)
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Role of Inventory Accounting System

• Provide information for financial statements
• and tax returns
• Provide timely information on inventory
• quantities and costs to facilitate ordering
  and
• manufacturing decisions
• Provide necessary controls to protect inventories
  
• from theft and other misuse.

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Inventory Issues
WHAT TO INCLUDE? ---What inventories? ---What costs? WHAT COST FLOW? ---Assumption? ---FIFO ? LIFO? ---WA?? WHAT INVENTORY? method to use ---Periodic? ---Perpetual? BALANCE SHEET VALUATION? ---Cost of market? ---Measurement of Market
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WHOSE INVENTORIES?

• General RuleTitle to the merchandise provides
  evidence of ownership, and the owner includes the
  merchandise in his/her inventory.
• FOB Shipping Point buyers inventory from time of
  shipment.
• FOB Destination sellers inventory until receipt
  by buyer.

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Inventory Cost Flows
Merchandising Operation
Merchandizing Inventory
Purchases
C/G/Sold
Cost Of Goods Sold

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Inventory Cost Flows
Manufacturing Operation
Raw Material
Work in Progress Inventory
Finished goods
Labor

C/G/Mfd

Cost of Goods Sold
Manual Overhead

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The key difference between period perpetual
inventory is the point at which the cost of goods
sold is computed. With periodic, No attempt is
made on date of sale to record the cost of
merchandise sold
Periodic Inventory
A physical count of inventory is taken at end
of period to determine

• Cost of merchandise on hand
• Cost of goods sold.

Businesses that use the periodic method
generally do not have sophisticated computer
systems required to compute cost of goods sold
when sale is made.
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Inventory at the Commercial Companies

• Physical inventory count at the end of Prd.
• Beginning Inventory balance and the purchase
  transactions together show the goods which is
  available for sale.
• Inventory cost per unit depends on the way of
  physical flow, LIFO? FIFO? WA?

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Ex. Based on Periodic Inventory
Amount in units Cost/u Total cost
Beg. Balance 18u 10 180
Purch Oct. 11 10u 10.50 105
Purch Oct. 25 12u 11 132
Purch Oct. 30 10u 12 120
Total 50 units 537
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• Later the company sold 30 units as flows
• In October 03 ..8 units.
• in October 17.5 units.
• in October 28...17 units.
• In order to prepare Inventory valuation report we
  have to know what is the inventory valuation way
  which was used
• FIFO? LIFO? WA?

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First In First Out (FIFO)

• The total units sold is 30.
• The available goods are
• 10 units from Oct. 30 _at_ 12 120
• 10 units from Oct. 25 _at_ 11 110
• 20 units TOTAL.... 230
• Sold goods 537 - 230 307

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Last In First Out (LIFO)

• 18 units from the beg inv. _at_ 10 180
• 2 units from Oct.11 puch._at_ 10.50 21
• 20 units TOAL cost........ 201
• Cost of Sold goods 537 - 201 336

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Weight Average

• Cost of available goods for sale
• Amount of units available for sale
• 537/50U 10.74/unit
• The cost of ending inventory balance is
• 20unts_at_10.74 241.8

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Valuation of Perpetual Inventories

• It is a continuous inventory count for every
  single operation and its costs.
• it is widely used in the industrial firms,
  because the costs of inventory can be distributed
  over all the operations cost during the
  manufacturing and the production process. It is
  continuous.
• The cost flow of the row materials can be changed
  as soon as the inventory enter the production
  process.

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Ex. on Perpetual using FIFO
DATE DESCRIBTION PURCHASES PURCHASES PURCHASES SALES SALES SALES BALANCE BALANCE
DATE DESCRIBTION N units Unit Cost Total Cost N. Units Unit Cost Total Cost N. Units Total Cost
Oct. 01 Beg. Balance 18.00 10.00 180     0 18.00 180.00
Oct. 03 Sold 8 units     0 8.00 10.00 80.00 10.00 100.00
Oct. 11 Buy 10 units 10.00 10.50 105     - 20.00 205.00
Oct. 17 Sold 5 units     0 5.00 10.00 50.00 15.00 155.00
Oct. 25 Buy 12 units 12.00 11.00 132     - 27.00 287.00
Oct. 28 Sold 17 units     0 5.00 10.00 50.00 22.00 237.00
        0 10.00 10.50 105.00 12.00 132.00
        0 2.00 11.00 22.00 10.00 110.00
Oct. 30 Buy 10 units 10.00 12.00 120     - 20.00 230.00
                   
                   
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Ex. on Perpetual using LIFO
DATE DESCRIBTION PURCHASES PURCHASES PURCHASES SALES SALES SALES BALANCE BALANCE
DATE DESCRIBTION N/units Unit Cost Total Cost N. Units Unit Cost Total Cost N. Units Total Cost
Oct. 01 Beg. Balance 18.00 10.00 180     0 18.00 180.00
Oct. 03 Sold 8 units     0 8.00 10.00 80.00 10.00 100.00
Oct. 11 Buy 10 units 10.00 10.50 105     - 20.00 205.00
Oct. 17 Sold 5 units     0 5.00 10.50 52.50 15.00 152.50
Oct. 25 Buy 12 units 12.00 11.00 132     - 27.00 284.50
Oct. 28 Sold 17 units     0 12.00 11.00 132.00 15.00 152.50
        0 5.00 10.50 52.50 10.00 100.00
Oct. 30 Buy 10 units 10.00 12.00 120     - 20.00 220.00
                   
                   
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Ex. on Perpetual using WA
DATE DESCRIBTION PURCHASES PURCHASES PURCHASES SALES SALES SALES BALANCE BALANCE BALANCE
DATE DESCRIBTION N units Unit Cost Total Cost N. Units Unit Cost Total Cost N. Units Unit cost Total Cost
Oct. 01 Beg. Balance 18.00 10.00 180     0 18.00 10.00 180.00
Oct. 03 Sold 8 units     0 8.00 10.00 80.00 10.00 10.00 100.00
Oct. 11 Buy 10 units 10.00 10.50 105     - 20.00 10.25 205.00
Oct. 17 Sold 5 units     0 5.00 10.25 51.25 15.00 10.25 153.75
Oct. 25 Buy 12 units 12.00 11.00 132     - 27.00 10.5833 285.75
Oct. 28 Sold 17 units     0 17.00 10.5833 179.92 10.00 10.5833 105.83
Oct. 30 Buy 10 units 10.00 12.00 120     - 20.00 11.2915 225.83
                     
                     
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Calculate the total Marginunder Perpetual Inv.
Description FIFO WA LIFO
Sales - 500 - 500 - 500
Deduct the Cost of Sold Goods - 307 311.17 - 317
Margin of Total Profit - 193 188.83 183
Ending Env. Balance - 230 225.83 - 220
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Calculate the total Marginunder Periodical Inv.
Description FIFO WA LIFO
Sales -500 -500 -500
Beg. Invent. Period. -180 -180 -180
Purchases -357 -357 -357
Amount of Available goods for Sale -537 -537 -537
Deduct ending Inventory Period. -230 214.80 -201
Cost of Available goods for Sale -307 322.20 -336
Margin of Total Profit -193 -177.80 -164
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Sales Revenues - Under a Periodic System

• are recorded when earned-revenue recognition
  principle
• must be supported by a business document-written
  evidence
• ONLY 1 entry is made for each sale
• one to record sale

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Companies that use periodic inventory take a
physical count to...

• Compute the amount of goods sold
• Determine ending inventory.
• Companies that use perpetual inventory must take
  a physical count in order to check accuracy of
  Book Inventory to actual inventory.

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• Determining inventory quantities by counting,
  weighting or measuring each type of inventory.
• Determining ownership of goods, including goods
  in transit, consigned goods.
• Quantity of each kind of inventory is listed on
  inventory summary sheets where unit costs are
  applied.
• Do all goods in count belong to company? Does the
  company own goods not included in the count (in
  transit?)

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Income Statement Presentation

• company is the same whether a periodic or
  perpetual inventory system is used, except for
  the
• cost of goods sold section.

The income statement for a merchandising
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Comparison of Methods

• Sales 5,00 (all methods)
• Cost of goods available for sale 537 (all
  methods)

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Comparison of Methods

• Ending Inventory
• Specific identification 227.50
• FIFO 230
• LIFO 223.83
• Weighted-average 225

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Comparison of Methods

• Cost of Goods Sold
• Specific identification 227. 5
• FIFO 230
• LIFO 223.83
• Weighted-average 227.5

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Comparison of Methods

• Gross Profit (Net Sales - Cost of Goods Sold)
• Specific identification 227.5
• FIFO 230
• LIFO 223.83
• Weighted-average 225

When prices are rising LIFO produces the lowest
income and lowest income tax.
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Income Statement Effects

• In periods of increasing prices
• FIFO reports the highest net income
• LIFO the lowest - thereby lowering income taxes
• 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 understated

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The 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. (Market is current
  replacement cost)
• departure from cost principle
• follows conservatism concept
• can be used only after one of the cost flow
  methods
• ( Specific Identification FIFO, LIFO, or
  Average Cost)

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LIFO Reserve And Its Importance For Comparing
Results Of Different Companies

• 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.

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• 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.