Inventories
CHAPTER 6
Control of Inventory
Two primary objectives of control over inventory
are:
1. Safeguarding the inventory from damage or
theft.
2. Reporting inventory in the financial
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Safeguarding Inventory
The Purchase Order authorizes the purchase of the
inventory from an approved vendor.
LO 1
The Receiving Report establishes an initial record of the receipt of the inventory.
Recording inventory using a perpetual inventory system is also an effective means of control. The amount of
inventory is always available in the Subsidiary
Controls for safeguarding inventory should include
security measures to prevent damage and customer or employee theft. Some examples of security measures include:
Safeguarding Inventory
1.
Storing inventory in areas that are restricted
to only authorized employees.
2.
Locking high-priced inventory in cabinets.
3.
Using two-way mirrors, cameras, security tags,
and guards.
Reporting Inventory
A Physical Inventory or count of inventory
should be taken near year-end to make sure that
the quantity of inventory reported in the financial
statements is accurate.
Describe three inventory cost flow assumptions and how they impact the income statement and
Under the First-in, First-out (FIFO) Inventory Cost Flow
Method, the first units purchased are assumed to be sold first and the ending inventory is made up of the most recent purchases.
This method is used for Perishable items.
Under Last-in, First-out (LIFO) Inventory Cost Flow Method, the last units purchased are assumed to be sold first and the ending inventory is made up of the first units purchased.
This method is used for hardware stores. Customers buy newest first.
Under the Average Inventory Cost Flow Method, the cost of the
units sold and in ending inventory is an average of the purchase costs.
This method is used for mines, gas, stone, dirt.
• Under the Specific Identification Inventory Cost Flow Method, the unit sold is identified with a specific purchase.
Inventory Costing Methods
For
purposes of illustration, the data for Item 127B
are used, as shown below. We will examine the
__________________________________ first.
LO 3
Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and
LO 3
LO 3
Average Cost Method
When the average cost method is used in a
perpetual system, an average unit cost for each
item is computed each time a purchase is made.
This unit cost is then used to determine the cost
of each sale until another purchase is made and a
new average is computed. This averaging
technique is called a moving average.
The physical count on January 31 shows that 150 units are on hand. (Conclusion: 130 units were sold.) What is the cost of the ending inventory?
First-In, First-Out Method
Beginning inventory and purchases of Item 127B in January are as follows:
Determine the cost of inventory under the periodic inventory system, using the FIFO, LIFO, and average
LO 4
Last-In, First-Out Method
Using the last-in, first-out method, the cost of the ending inventory on January 31 is determined as follows:
Beginning inventory and purchases of Item 127B in January are as follows:
The weighted average unit cost is determined as follows:
LO 4
Average Cost Method
Average Unit Cost =
Units Available for Sale
Average Unit Cost =
Average Unit Cost = $21 per unit
Beginning inventory and purchases of Item 127B in January are as follows:
The physical count on January 31 shows that 150 units are on hand.
(Conclusion: 130 units were sold.) What is the cost of the ending inventory?
Total cost of Units Available for Sale
LO 5
Comparing Inventory Cost Methods
Using the Periodic inventory system illustration with
sales of $3,900 (130 units x $30), the differences in
ending inventory, cost of merchandise sold, and
gross profit illustrated below
.
LO 6
Reporting Merchandise Inventory
Cost is the primary basis for valuing and reporting
inventories in the Financial Statements. However, inventory may be valued at other than cost in the
following cases:
The cost of replacing items in inventory is Below
the recorded cost.
The inventory cannot be sold at normal prices due to
imperfections, style changes, or other causes.
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Valuation at Lower of Cost or Market
Cost and replacement cost can be determined for:
Each item in the inventory.
Each major class or category of inventory.
Total inventory as a whole.
LO 6
Market, as used in Lower-of-cost-or-market
metnod, is the cost to replace the merchandise on
Valuation at Net Realizable Value
Merchandise that is out of date, spoiled, or damaged
should be written down to its Net Realizable Value. This is the estimated selling price less any direct costs of disposal, such as sales commissions or special
advertising.
Assume the following data about an item of damaged merchandise:
Original cost $1,000
Estimated selling price 800
Selling expenses 150
Merchandise Inventory on the Balance Sheet
Merchandise inventory is usually presented in the
Current Assets section of the balance sheet, following Receivables.
The method of determining the Cost of the inventory (FIFO, LIFO, or weighted average) and the method of
valuing the inventory (cost or the lower of cost or
Inventory Errors
Some reasons that inventory errors may occur
include:
Physical inventory on hand was miscounted.
Costs were incorrectly assigned to inventory.
Inventory in transit was incorrectly included or
excluded from inventory.
Inventory Errors
Inventory errors often arise from Consigned Inventory.
Manufacturers sometimes ship merchandise to retailers who act as the manufacturer’s agent.
LO 6
The manufacturer, called the Consignor retains title until the goods are sold. Such merchandise is said to be shipped on consignment to the retailer, called the
Inventory Turnover
Inventory Turnover measures the relationship
between cost of merchandise sold and the amount
of inventory carried during the period. It is
calculated as follows:
Inventory Turnover = Cost of Merchandise Sold
Describe and illustrate the inventory turnover and the number of days’ sales in inventory in analyzing the efficiency and effectiveness of inventory
management.
Inventory Turnover
Inventory turnover for Best Buy is shown
below (in millions).
Inventory Turnover
The Number of days’ sales in inventory measures
the length of time it takes to acquire, sell, and replace the inventory. It is computed as follows:
Number of Days’ Sales in Inventory
Average Inventory =
LO 7
Inventory Turnover
LO 7
