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ACCT 1115 Lecture Notes 7 (CH 7)

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27 views33 pages

ACCT 1115 Lecture Notes 7 (CH 7)

Uploaded by

amorursabia
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 7

Inventory
Learning Objectives
– Discuss the importance of inventory to a
company’s overall success.
– Distinguish between the different inventory
classifications and determine which goods
should be included in a company’s
inventory.
– Explain the differences between perpetual
inventory systems and periodic inventory
systems

2
Learning Objectives
– Explain why cost formulas are necessary and
calculate the cost of goods sold and ending
inventory under the specific identification,
weighted-average, and first-in, first-out cost
formulas under a perpetual inventory system.
–– Describe management’s responsibility for
Internal control measures related to inventory.
–– Calculate the inventory turnover ratio and the
days to sell inventory ratio and explain how they
can be interpreted by users.
3
Inventory
• Any item purchased by a company for:
• Resale to customers, or
• Use in the manufacture of a product to be sold
to customers
• Companies that sell finished goods inventory
are known as merchandisers or retailers
• Companies that make products are known as
manufacturers

4
Significance of Inventory
• For retailers and manufacturers, inventory is a
significant current asset and the largest asset to
be converted into cash within the next year

5
Significance of Inventory

• Management’s objective is to sell inventory at a


higher price than it was purchased for. This
involves:
• Selecting appropriate suppliers
• Determining necessary inventory levels &
avoiding stock outs
• Pricing for profit
• Protecting inventory from damage and loss due
to theft

6
Inventory Classifications
• A manufacturer’s inventory may consist of:
• Raw materials
• Work-in-process
• Finished goods

• A merchandiser’s and retailer’s inventory


consists of finished goods that have been
purchased for resale

7
Inventory Ownership

• A key factor in determining inventory


ownership is who has title to the goods.
Considerations in determining ownership
include:
• FOB shipping point – buyer owns the inventory
when it leaves the seller’s premises
• FOB destination – buyer owns the inventory
when it arrives at the buyer’s premises
• Consignment arrangements - consignor vs
consignee
8
Inventory Systems
• A company begins its accounting period with
the inventory from the previous period. This is
known as the company’s opening or beginning
inventory.
• The cost of the opening inventory plus the cost
of purchases is known at the Cost of goods
available for sale or COGAS
• Therefore:
• COGAS = Beginning Inventory + Purchases
9
Periodic Inventory System
• Inventory purchases recorded in a Purchases
account
• No entry to record the reduction in inventory at
the time of sale
• Requires regular inventory counts and does
NOT provide management with up to date
information regarding inventory quantities or
costs

10
Periodic Inventory System
• End of the period:
• Count inventory to determine quantity on hand
and assign costs
• Calculate cost of goods sold

11
Periodic Inventory System

Beginning Inventory (last period’s ending inventory)


+ Purchases (based on invoices during the
period)
= Cost of Goods available
for Sale
- Ending Inventory (based on a physical count)
(COGS: goods that are not on
= Cost of Goods Sold hand are assumed to have been
sold)

12
Perpetual Inventory System

• Continual tracking of units and/or costs


• Inventory and COGS is updated after every
transaction
• A unit sold is immediately removed from the
inventory account
• Ending inventory and cost of goods sold are up-
to-date

13
Perpetual Inventory System

Beginning Inventory (last period’s ending inventory)


+ Purchases (based on invoices during the
period)
= Cost of Goods Available
(updated after each sale)
for Sale
- Cost of Goods Sold (ending inventory that should be
= Ending Inventory on hand)
-Actual Ending Inventory (actual ending inventory on hand)

Shrinkage / Theft

14
Key Distinctions between Inventory Systems

15
Advantages of Each Type of System

Advantages of Each Type of Inventory System 16


Choosing an Inventory System
Considerations for management when choosing a
perpetual or periodic inventory system:
• Importance of complete, timely inventory
information, and
• Identification of inventory shrinkage
versus
• The cost of purchasing and maintaining the
inventory system

17
Inventory Costs

Items Included in the “Cost” of Inventory 18


Cost Formulas
• Cost formulas are necessary because inventory
purchase costs change
• COGAS is the same regardless of cost formula
used
• The three cost formulas result in different
allocations of COGAS between ending inventory
and COGS

19
Cost Formulas
• Specific Identification
• Specific costs are allocated to the cost of good
sold
• Weighted average
• The cost of the items is determined using a
weighted average of the cost of the items
purchased
• First-in, first-out (FIFO)
• The first item purchased is the first item sold

20
Amon Ltd. – Example Inventory Data

Data for Additional Cost Formula Example 21


Specific Identification: Illustration
Assume that on the Sept 15 sale, 4 units were
from beginning inventory and 5 units were from
the Sept 5 purchase.
COGS = (4 units × $65) + (5 units × $74)
= $260 + $370 = $630
Or
= (1 unit × $65) + (5 units × $74) + (6 units × $81)
= $65 + $370 + $486 = $921

22
Weighted Average

Weighted-Average Cost Formula Illustration


23
First-in, First-out (FIFO)

24
Additional First-In, First-Out Cost Formula Illustration
Comparison of Cost Formulas

Comparative Results Across Cost Formulas 25


Choosing the Appropriate Cost Formula

Cost Formula Decision Tree 26


Inventory Valuation

• Inventory is recorded at its cost on the date of


acquisition
• Inventory is carried on the statement of
financial position at lower of cost or NRV

27
Inventory Valuation
• NRV = Expected Selling Price – Estimated Costs
to Make Sale
• If the NRV is lower than the inventory’s cost,
the inventory must be written down, the entry
is:
Dr. Cost of Goods Sold
Cr. Inventory

28
Application of Cost or NRV

29
Application of the Lower of Cost and NRV
Gross Margin

• Gross Margin = Sales Revenue – COGS


• Gross Margin Ratio= Gross Margin / Sales
Revenue
• Used to analyze a company’s performance over
time
• Also used as a comparative against other
companies or industry standards

30
Internal Controls & Inventory

• Safekeeping the inventory


• Management is responsible for ensuring that
internal controls are in place to safeguard the
inventory
• Physical controls
• Separation of duties
• Regular inventory counts

31
Internal Controls & Inventory

• Cost of inventory storage and insurance


• Cost of handling
• Risk of Obsolescence
• Auditors play an important role

32
Inventory Ratios
This ratio tells the user how fast inventory is sold
or how long it is held before it is sold.

Inventory turnover =

Days to Sell Inventory =

33

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