Chapter 7 Reporting and Interpreting Inventories and Cost

Chapter 7: Reporting and Interpreting Inventories and Cost of Goods Sold Learning Objective 1 Describe the issues in managing different types of inventory. 7 -1

Inventory Management Decisions The primary goals of inventory managers are to: 1. Maintain a sufficient quantity to meet customers’ needs 2. Ensure quality meets customers’ expectations and company standards 3. Minimize the costs of acquiring and carrying the inventory 7 -2

Types of Inventory Merchandisers. . . § Buy finished goods. § Sell finished goods. Manufacturers. . . § Buy raw materials. § Produce and sell finished goods. Merchandise inventory Completed products awaiting sale Materials waiting to be processed Partially complete products 7 -3 Raw Materials Work in Process Finished goods

Learning Objective 2 Explain how to report inventory and cost of goods sold. 7 -4

Balance Sheet and Income Statement Reporting 7 -5

Cost of Goods Sold Equation BI + P – CGS = EI American Eagle Outfitters’ beginning inventory was $4, 800. During the period, the company purchased inventory for $10, 200. The cost of goods sold for the period is $9, 000. Compute the ending inventory. 7 -6

Cost of Goods Sold Equation Beginning Inventory $4, 800 + Purchases $10, 000 Goods Available for Sale $15, 000 Ending Inventory $6, 000 (Balance Sheet) 7 -7 Still Here Sold Cost of Goods Sold $9, 000 (Income Statement)

Learning Objective 3 Compute costs using four inventory costing methods. 7 -8

Inventory Costing Methods Specific identification First-in, first-out (FIFO) Last-in, first-out (LIFO) Weighted average 7 -9

Inventory Costing Methods Consider the following information May 6 $95 cost May 5 $75 cost May 3 $70 cost Specific Identification This method individually identifies and records the cost of each item sold as part of cost of goods sold. If the items sold were identified as the ones that cost $70 and $95, the total cost of those items ($70 + 95 = $165) would be reported as Cost of Goods Sold. The cost of the remaining item ($75) would be reported as Inventory on the balance sheet at the end of the period. 7 -10

Inventory Costing Methods LIFO May 6 $95 cost Sold May 3 $70 cost Still there Sold May 5 $75 cost Weighted average May 6 $95 cost May 5 $75 cost May 3 $70 cost Still there FIFO $80 $240 = per unit 3 Sold Still there 7 -11

Inventory Costing Methods Summary Let’s consider a more complex example. 7 -12

Inventory Cost Flow Computations (10 units @ $10) + (5 units @ $8) 7 -13

Inventory Cost Flow Computations (10 units @ $10) + (25 units @ $8) 7 -14

Inventory Cost Flow Computations Weighted Average 7 -15 Weighted Average Cost = Cost of goods Available for Sale Number of Units Available for Sale Weighted Average Cost = $410 50 units = $8. 20 per unit

Inventory Cost Flow Computations 15 units @ $8. 20 35 units @ $8. 20 7 -16

Financial Statement Effects 7 -17

Financial Statement Effects 7 -18

Financial Statement Effects Advantages of Methods Weighted Average 7 -19 First-In, First-Out Last-In, First -Out

Tax Implications and Cash Flow Effects 7 -20

Learning Objective 4 Report inventory at the lower of cost or market. 7 -21

Lower of Cost or Market The value of inventory can fall below its recorded cost for two reasons: 1. it’s easily replaced by identical goods at a lower cost, or 2. it’s become outdated or damaged. When the value of inventory falls below its recorded cost, the amount recorded for inventory is written down to its lower market value. This is known as the lower of cost or market (LCM) rule. 7 -22

Lower of Cost or Market 1, 000 items @ $165 7 -23 1 Analyze 2 Record 1, 000 items @ $150 400 items @ $20

Learning Objective 5 Analyze and record inventory purchases, transportation, returns and allowances, and discounts. 7 -24

Recording Inventory Transactions We will now look at the accounting for purchases, transportation costs, purchase returns and allowances, and purchase discounts. We will record all inventoryrelated transactions in the Inventory account. 7 -25

Inventory Purchases American Eagle Outfitters purchases $10, 500 of vintage jeans on credit. 1 Analyze 2 Record 7 -26

Transportation Cost American Eagle pays $400 cash to a trucker who delivers the $10, 500 of vintage jeans to one of its stores. 1 Analyze 2 Record 7 -27

Purchase Returns and Allowances American Eagle returned some of the vintage jeans to the supplier and received a $500 reduction in the balance owed. 1 Analyze 2 Record 7 -28

Purchase Discounts American Eagle’s vintage jeans purchase for $10, 500 had terms of 2/10, n/30. Recall that American Eagle returned inventory costing $500 and received a $500 reduction in its Accounts Payable. American Eagle paid within the discount period. 1 Analyze 2 Record 7 -29

Summary of Inventory Transactions 7 -30

Learning Objective 6 Evaluate inventory management by computing and interpreting the inventory turnover ratio. 7 -31

Inventory Turnover Analysis 7 -32

Comparison to Benchmarks 7 -33

Supplement 7 B The Effects of Errors in Ending Inventory

The Effects of Errors in Ending Inventory Cost of Goods Sold Equation BI + P – CGS = EI Errors in Ending Inventory will affect the Balance Sheet and the Income Statement. Assume that Ending Inventory was overstated in 2009 by $10, 000 due to an error that was not discovered until 2010. 7 -35

The Effects of Errors in Ending Inventory Now let’s examine the effects of the 2009 Ending Inventory Error on 2010. Assume that Ending Inventory was overstated in 2009 by $10, 000 due to an error that was not discovered until 2010. 7 -36