Merchandise Inventory

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Chapter 6
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Merchandise Inventory

• Owned by the company
• In form ready to sale to customers in ordinary
  course of business

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Manufacturing Inventory

• 3 inventory accounts
• 1
• 2
• 3

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Raw Materials
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Work in Process
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Finished Goods Inventory
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Key difference between periodic and perpetual
inventory
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Companies that use perpetual inventory take a
physical count to...

• check the accuracy of their perpetual inventory
  records
• to determine the amount of inventory lost due to
• wasted raw materials
• shoplifting
• employee theft

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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
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Comparing Periodic and Perpetual Inventory
Systems
Item Sold
Inventory Purchased
End of Period
Perpetual
Perpetual
No Entry
Record Purchase of Inventory
Record Revenue and Cost of Goods Sold
End of Period
Inventory Purchased
Item Sold
Periodic
Record Purchase of Inventory
Record Revenue Only
Compute Cost of Goods Sold
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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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Goods in Transit

• These are goods on board a truck, train, ship,
  or plane at the end of the period.

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Goods in Transit

• Who includes these in inventory?
• Buyer?
• Seller?

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Shipping Terms

• FOB (free on board) ____________ - ownership of
  goods passes to buyer when public carrier accepts
  the goods from the seller
• FOB (free on board) ____________ - ownership of
  goods remains with the seller until the goods
  reach the buyer

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Ownership passes to owner here
FOB Shipping Point
Public Carrier Co
Seller
Buyer
Ownership passes to buyer here
FOB Destination Point
Public Carrier Co
Seller
Buyer
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Consigned Goods

• Goods of others you hold that you dont pay for
  until they sell
• The company does not take ownership.

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Specific Identification
Cost of goods sold 700 800
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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Whats Wrong with Specific Identification?
COST BENEFIT - EXPENSIVE TO SET-UP AND MAINTAIN
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Inventory Costing

• Specific Identification method
• Cost Flow Assumptions
• __________________________ - earliest goods
  purchased are the first to be sold
• __________________________ - latest goods
  purchased are the first to be sold
• __________________________ - costs are charged on
  the basis of weighted average unit cost

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The _____ method assumes the earliest goods
purchased are the first to be sold.
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The _____ method assumes the latest goods
purchased are the first to be sold.
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The ________________ method assumes that goods
available for sale are the same.The allocation
of the cost of goods available for sale is made
on the basis of the _____________________ unit
cost incurred.
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The average cost method assumes that goods
available for sale are homogeneous.
Illustration 6-10
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Factors Used in Selecting an Inventory Cost Method

• Income statement effects
• Balance sheet effects
• Tax effects

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Income Statement Effects

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

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Balance Sheet Effects

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

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Tax Effects

• Why do companies use LIFO?

• Higher cost of goods sold
• Lower net income

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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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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.

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Lower of Cost or Market (LCM)

• 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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Market Is...
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How Much Inventory Should a Company Have?

• Only enough for sales needs
• Excess inventory costs
• storage costs
• interest costs
• obsolescence - technology, fashion

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Inventory Turnover Ratio

• An indication of how quickly a company sells its
  goods.

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Inventory Turnover Ratio
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Days in Inventory
An indication of how quickly a company sells its
goods.
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Days in Inventory
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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.
• 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.

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