Reporting and Analyzing Inventory Periodic Inventory System Basic

Reporting and Analyzing Inventory Periodic Inventory System

Basic Model Beginning inventory +Purchases =Cost of goods available for sale -Ending inventory Cost of goods sold xxx xxx xxx

What to include in inventory cost? • Cost to bring inventory to existing location and condition • Freight costs to get inventory on shelf • Insurance in transit prior to sale • Storage costs prior to sale • Taxes paid prior to sale

Taking a Physical Inventory • Periodic System Essential for determining EI and computing COGS • Perpetual System Control device; inventory is updated continually Useful for detecting inventory losses

Shipping Terms • FOB Destination Seller pays freight to destination If inventory in transit at year end, seller includes in seller’s inventory and records sale in next year • FOB Shipping Point (most common) Buyer pays freight If inventory in transit at year end, buyer records in buyer’s inventory and records purchase.

Title and Risk of Loss • FOB Shipping Point • FOB Destination Pass when seller places Pass when goods reach goods with carrier and their destination makes a reasonable contract for their shipment __________ Consigned goods—counted in inventory of the owner

Inventory Costing • Why does it matter? COGS and EI are very important in a merchandising firm. Income and inventory (CA) may differ materially depending upon costing method • When prices fluctuate, need to know which costs should be assigned to COGS, and which to EI • Deals with cost flow, not physical flow of goods • We will be using a periodic system—a perpetual inventory system will result in different results for LIFO and Average Cost • After inventory costing method, still would apply Lower of Cost or Market (LCM)

Methods • Specific Identification Cost flow=Physical Flow • Keep track of cost of each particular item sold, and cost of each item in ending inventory • Disadvantages: difficult to keep track of costs associated with each item and can result in income manipulation.

Cost Flow Assumptions • First-In First-Out (FIFO-LISH) • Like physical flow in most businesses • Earliest goods purchased are first to be sold and their unit costs will be part of COGS • Ending inventory cost will consist of most recently purchased goods (Last-In Still Here LISH).

Cost Flow Assumptions • Last-In First-Out (LIFO-FISH) • Latest goods purchased are first to be sold and their unit costs will be part of COGS • Ending Inventory cost will consist of earliest purchased goods (First-In Still Here or FISH)

Cost Flow Assumptions • Average cost • Unit cost=COGAFS/# of units available for sale • Apply unit cost to number sold to determine COGS; to EI to determine EI value • Book has you round to three decimal places and then to nearest whole number for COGS and Inventory values

Working Problems • What is the call of the question: EI or COGS, or both? • One alternative. Compute COGAFS. Then subtract EI (based on the cost flow assumption you are using, FIFO, LIFO or average cost) and the result is COGS. • Advantage: usually fewer goods in EI, than sold; only have to compute EI

Working Problems, cont’d • Another alternative. Calculate COGS using the cost flow assumption you are using. Subtract that from COGAFS to obtain EI • Example: Using FIFO, compute COGS by starting with BI, and work forward until you have costed all units sold. • Advantage: may be more intuitive (don’t have to think about which costs are in EI), but takes longer because usually more units to be costed in COGS than EI

Income Statement Effects • Rising prices FIFO results in highest NI (earlier, lower costs in COGS); LIFO results in lowest (most recent, higher costs in COGS); and weighted average is in the middle. • Decreasing prices FIFO results in lowest NI, LIFO results in highest and weighted average cost is in the middle.

Balance Sheet Effects • Rising prices FIFO results in EI value approximating current costs; LIFO understates current value of inventory because earlier, lower costs used • Decreasing prices FIFO results in EI value approximating current costs; LIFO overstates current value of inventory because earlier, higher costs used

LIFO Advantages When Prices Rising • LIFO reduces “inventory” or “phantom” profits • Produces lower net income, less tax • One problem—ending inventory understated in terms of current costs

Inventory Turnover Ratio • ITO=COGS/Avg. Inventory • Days’ sales in inv. =365/ITO • How efficient is the company in managing inventory?

Common Inventory Errors • Year 1 EI is overstated (OS) then COGS understated (US) NI OS RE OS • Year 2 Beginning inventory overstated COGS OS NI US RE is correct

In doubt about effect of inventory error? • Consider: BI + Net Cost of Purchases COGAFS -EI COGS Plug in numbers and see what happens.

Inventory Errors • Or consider the following chart (easiest method): BI O/S +Purchases O/S - EI O/S COGS O/S U/S

IFRS vs. US GAAP • IFRS does not allow LIFO • IFRS requires same cost flow assumption for similar goods; US GAAP does not • With LCM, IFRS defines market at NRV, US GAAP defines it essentially as replacement cost • Under IFRS, inventory write-downs may be reversed to the extent of recovery and not more than the write down