Chapter 8 Valuation of Inventories A Cost Basis Approach.docx

Chapter 8 Valuation of Inventories A Cost Basis Approach.docx

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Chapter8ValuationofInventoriesACostBasisApproach

Chapter8:

ValuationofInventories:

ACostBasisApproach

CourseObjectives:

∙ReviewtheAccountingCycleandFinancialStatements:

Chapters1-5√

∙IntroducetheConceptofthetimevalueofmoney:

Chapter6√

∙Discussaccountingfor:

oCash:

Chapter7√

oReceivables:

Chapter7√

oInventory:

Chapter8and9

1）InventoryClassificationandControl:

aClassification（seefinancialstatementpresentationinIllustration8-1,p369）:

i）Inventory:

goodsavailableforresale.（Formanufacturingcompany,inventoryincludes:

RawMaterials,Work-in-Process,andFinishedGoods.）

ii）MerchandisingCompany:

___________________goods/inventory___________________.（e.g.,Walmart,EddieBauer,etc.）

iii）ManufacturingCompany:

___________________goods/inventory____________________.（e.g.,Boeing,ExxonMobil,BMW,etc.）

iv）RawMaterialsInventory:

Itemsininventorythatwillbecomponentsofaproducedgood.

v）WorkinProcessInventory:

Partiallycompletedinventoryunitsattheendofanaccountingperiod（e.g.,atablewithoutlegs.）Includestotalcosttodate.Thatis,includedirectmaterial,directlabor,andfactoryoverhead（fixedandvariable）.

vi）FinishedGoodsInventory:

Amountofmanufacturedproductonhandthatawaitssaletocustomers.

bControl:

i）PerpetualSystem:

（1）Maintaincontinuousrecordofchangesininventory

（2）

（asaresultofeverything–e.g.,purchases,freight-in,purchasereturnsandallowances,andpurchasediscounts--directlyenteringInventoryaccount.）

（3）

（4）Maintainsubsidiaryledgershowingquantityandcostofeachtypeofinventoryonhand.Physicalcountcomparetoaccountingrecords.Determineshortagesoroveragesininventory.

Ifthephysicalinventoryislowerthantheinventoryaccount,thefollowingentryismade:

Ifthephysicalinventoryishigherthantheinventoryaccount,thefollowingentryismade:

Perpetualinventoryoverages/shortagesgenerallyrepresentamisstatementofCOGS.Thedifferenceistheresultofnormalandexpectedshrinkage,breakage,shoplifting,incorrectrecordkeeping,etc.InventoryOverandShortwouldthereforebeanadjustmenttoCOGS.Inpractice,theaccountInventoryOverandShortissometimesreportedin“Otherrevenuesandgains”or“Otherexpensesandlosses”sectionoftheincomestatement,dependingonitsbalance.

ii）PeriodicSystem:

（1）QuantityofInventoryonhandisdetermined______________________.

（2）Purchases:

（3）CostofGoodsAvailableforSales=BeginningInventory+Purchases.

（4）CostofGoodsSold=CostofGoodsAvailableforSale–EndingInventory.（Note:

COGSisaresidualamountdependentuponaphysicalcountofendinginventory.）

（5）PhysicalInventoryCount:

Requiredunderperiodicsystem（alsoperformedunderperpetualsystem.）

Shouldbetakenasclosetoendoffiscalyearaspossible.（Ifnotpossible,itisacceptabletousephysicalinventoriestakenclosetoyear-endandkeepdetailedinventoryrecordstoreconciletoyear-end.）

（6）

Therearenoaccountingrecordsavailableagainstwhichtocomparethephysicalcount.Thus,inventoryoveragesandshortagesareburiedinCOGS.

iii）ComparisonofJournalEntriesforeachmethod:

Periodic

Perpetual

Topurchaseinventoryitem:

Topurchaseinventoryitem:

Tomakeareturn:

Tomakeareturn:

Torecordasale:

（1entry）

Torecordasale:

（2entries）

Endoftheyear:

Endoftheyear:

Additionalaccounts:

2）BasicIssuesinInventoryValuation:

aFormulas:

bValuationofinventoriescanbecomplexprocessthatrequiresdetermining:

（Eachoftheitemslistedbelowisdiscussedinmoredetailinthefollowingsections.）

i）Physicalgoodsincludedininventory:

（1）GoodsinTransit.

（2）ConsignedGoods.

（3）SpecialSalesAgreement.

ii）Costofgoodsininventory:

（1）Productvs.Periodcosts.

（2）Treatmentofpurchasediscounts.

iii）Costflowassumptionadopted:

（1）Specificidentification.

（2）Averagecost.

（3）FIFO.

（4）LIFO.

（5）Retail.

3）PhysicalGoodsIncludedinInventory:

（MakesureyouunderstandeachoftheseitemsfromtheviewofthesellerANDthebuyer.）

aGoodsinTransit:

Goodstowhichlegaltitlehaspassedshouldberecordedaspurchasesofthefiscalperiodonbuyer’sbooks.

i）FOBShippingPoint:

Example:

12/31FOBShippingPoint,you（thebuyer）havenotreceivedgoodsthathavebeen

deliveredtocommoncarrier:

___________________________________________________

ii）FOBDestination:

Example:

12/31FOBDestination,you（thebuyer）havenotreceivedgoodsthathavebeendeliveredtocommoncarrier:

__________________________________________________________________________

iii）Example（BriefExercise8-3,page400）:

MayberryCompanytookaphysicalinventoryonDecember31anddeterminedthatgoodscosting$200,000wereonhand.Notincludedinthephysicalcountwere$15,000ofgoodspurchasedfromTaylorCorporation,f.o.b.shippingpoint,and$22,000ofgoodssoldtoMountPilotCompanyfor$30,000,f.o.b.destination.BoththeTaylorpurchaseandtheMountPilotsalewereintransitatyear-end.WhatamountshouldMayberryreportasitsDecember31inventory?

bConsignedGoods:

i）Theowner（consignor）transfersphysicalgoodstoagent（consignee）forpurposesofsellingwithoutgivingupownership.

___________________________________________________________________________

ii）Whenconsigneesellsgoods,therevenue,lessasellingcommissionandexpensesincurredinaccomplishingsale,isremittedtoconsignor.

cSpecialSalesAgreements:

Seetextpages374to375.

i）SaleswithBuybackAgreement:

ii）SaleswithHighRatesofReturn:

iii）SalesonInstallment:

dIfweareholdinggoodsthatcustomerhaspurchasedandwillpickupathis/herconvenience,thesegoodsareNOTincludedinourinventory.

HOMEWORK:

YoushouldnowbeabletoworkE8-1,E8-2,andP8-1.

eEffectofInventoryErrors:

i）EndingInventoryMisstated:

Whatwouldhappenifbeginninginventoryandpurchasesarerecordedcorrectly,butsomeitemsarenotincludedinendinginventory?

SeeIllustration8-6includedonpage375andIllustration8-7intextonpage376.

Inthissituation,wewouldhavethefollowingeffectsonthefinancialstatementsattheendoftheperiod.

Note:

U=understated,O=overstated,NE=noeffect

BI

Sales

BeginningRE

+Purchases

-COGS

+NI

=GAS

=GrossProfit

+Investments

-EI

-Otherexpenses

-W/D

=COGS

=NetIncome

=EndingRE

BalanceSheet

IncomeStatement

Inventory（Assets）

Costofgoodssold

Retainedearnings

Netincome

ii）Thinkofothersituationswhereotheritemsaremisstated.HowdothesesituationsaffecttheB/SandI/S?

Forexample,ifendinginventoryisoverstated,thereverseoftheabovesituationoccurs.

Yr1

Yr2

Yr1

Yr2

Yr1

Yr2

BI

Sales

BeginningRE

+Purchases

-COGS

+NI

=GAS

=GrossProfit

+Investments

-EI

-Otherexpenses

-W/D

=COGS

=NetIncome

=EndingRE

iii）PurchasesandInventoryMisstated:

Supposegoodsarenotrecordedaspurchasesandnotincludedinendinginventory.（Notenetincomeisnotaffectedb/cpurchasesandendinginventoryarebothunderstatedbythesameamounttheerrortherebyoffsettingitselfincostofgoodssold.）

BI

Sales

BeginningRE

+Purchases

-COGS

+NI

=GAS

=GrossProfit

+Investments

-EI

-Otherexpenses

-W/D

=COGS

=NetIncome

=EndingRE

BalanceSheet

IncomeStatement

Inventory

Costofgoodssold

Retainedearnings

Netincome

Accountspayable

Purchases

iv）Thinkofothersituationswhereotheritemsaremisstated.HowdothesesituationsaffecttheB/SandI/S?

Forexample,ifbothpurchases（onaccount）andendinginventoryareoverstated,thentheeffectsonthebalancesheetareexactlythereverse:

InventoryandA/Pareoverstated.COGSandnetincomearenotaffectedb/ctheerrorsoffsetoneanother.

v）

Example:

Thecompanyusestheperiodicsystem.Apurchaseofmerchandiseonaccountfor$1,000in2005wasnotrecordeduntil2006,althoughthemerchandisewasincludedin2005endinginventory.

EntryNOTmade:

2005

2006

BeginningInventory

NE

+Purchases

O$1,000

=GAS

O$1,000

-EI

NE

=COGS

O$1,000

Sales

NE

-COGS

O$1,000

=GP

U$1,000

-Otherexp

NE

=NI

U$1,000

ASSETS

NE（EIisok）

LIABILITIES

NE

Owners’EQUITY

NE

BeginningOE（yr1）

BeginningA/P（yr1）

+NetIncome（yr2）

A/P（yr2）

EndingOE

EndA/P

vi）Example:

Acompanyusingaperpetualsystemfailedtorecordasaleof$1,000onaccountin2005.Mark-uponcostis100%.

Error–EntryNotMade:

Assets:

Income:

Example（BriefExercise8-4,page400）:

GavinBryarsEnterprisesreportedcostofgoodssoldfor2007of$1,400,000andretainedearningsof$5,200,000atDecember31,2007.GavinBryarslaterdiscoveredthatitsendinginventoriesatDecember31,2006and2007,wereoverstatedby$110,000and$45,000,respectively.Determinethecorrectedamountsfor2007costofgoodssoldandDecember31,2007,retainedearnings.

Costofgoodssoldasreported$1,400,000

12/31/07retainedearningsasreported$5,200,000

‘06

‘07

‘06

‘07

‘06

‘07

BI

Sales

BeginningRE

+Purchases

-COGS

+NI

=GAS

=GrossProfit

+Investments

-EI

-Otherexpenses

-W/D

=COGS

=NetIncome

=EndingRE

HOMEWORK:

YoushouldnowbeabletoworkE8-10andE8-12.

4）CostsInclu