Intermediate Accounting IFRS 3rd Edition Textbook PDF

Prepared by Coby Harmon University of California, Santa Barbara Westmont College 8-1  Valuation of CHAPTER 8 Inventories: A Cost- Basis Approach LEARNING OBJECTIVES After studying this chapter, you should...

Prepared by Coby Harmon University of California, Santa Barbara Westmont College 8-1  Valuation of CHAPTER 8 Inventories: A Cost- Basis Approach LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Describe inventory 3. Compare the cost flow classifications and different assumptions used to account inventory systems. for inventories. 2. Identify the goods and costs 4. Determine the effects of included in inventory. inventory errors on the financial statements. 8-2  PREVIEW OF CHAPTER 8 Intermediate Accounting IFRS 3rd Edition Kieso Weygandt Warfield 8-3  LEARNING OBJECTIVE 1 Inventory Issues Describe inventory classifications and different inventory systems. Classification Inventories are asset:  items held for sale in the ordinary course of business, or  goods to be used in the production of goods to be sold. Businesses with Inventory Merchandising or Manufacturing Company Company 8-4 LO 1  Classification ILLUSTRATION 8.1  One inventory account.  Purchase merchandise in a form ready for sale. 8-5 LO 1  Classification ILLUSTRATION 8.1 Three accounts  Raw Materials  Work in Process  Finished Goods 8-6 LO 1  ILLUSTRATION 8.2 Flow of Costs through Manufacturing and Merchandising Companies 8-7 LO 1  Inventory Issues Inventory Cost Flow ILLUSTRATION 8.3 Two types of systems for maintaining inventory records — perpetual system or periodic system. 8-8 LO 1  Inventory Cost Flow Perpetual System 1. Purchases of merchandise are debited to Inventory. 2. Freight-in is debited to Inventory. Purchase returns and allowances and purchase discounts are credited to Inventory. 3. Cost of goods sold is debited and Inventory is credited for each sale. 4. Subsidiary records show quantity and cost of each type of inventory on hand. The perpetual inventory system provides a continuous record of the balance in both the Inventory and Cost of Goods Sold accounts. 8-9 LO 1  Inventory Cost Flow Periodic System 1. Purchases of merchandise are debited to Purchases. 2. Ending Inventory determined by physical count. 3. Calculation of Cost of Goods Sold: Beginning inventory $ 100,000 Purchases, net + 800,000 Goods available for sale 900,000 Ending inventory - 125,000 Cost of goods sold $ 775,000 8-10 LO 1  Inventory Cost Flow Comparing Perpetual and Periodic Systems Illustration: Fesmire Company had the following transactions during the current year. Record these transactions using the Perpetual and Periodic systems. 8-11 LO 1  Inventory Cost Flow ILLUSTRATION 8.4 Comparative Entries— Perpetual vs. Periodic 8-12 LO 1  Inventory Cost Flow Illustration: Assume that at the end of the reporting period, the perpetual inventory account reported an inventory balance of $4,000. However, a physical count indicates inventory of $3,800 is actually on hand. The entry to record the necessary write-down is as follows. Inventory Over and Short 200 Inventory 200 Note: Inventory Over and Short adjusts Cost of Goods Sold. In practice, companies sometimes report Inventory Over and Short in the “Other income and expense” section of the income statement. 8-13 LO 1  Inventory Issues Inventory Control All companies need periodic verification of the inventory records  by actual count, weight, or measurement, with  counts compared with detailed inventory records. Companies should take the physical inventory  near the end of their fiscal year,  to properly report inventory quantities in their annual accounting reports. 8-14 LO 1  Inventory Issues Determining Cost of Goods Sold Companies must allocate the cost of all the goods available for sale (or use) between the goods that were sold or used and those that are still on hand. ILLUSTRATION 8.5 Computation of Cost of Goods Sold 8-15 LO 1  LEARNING OBJECTIVE 2 Goods and Costs Identify the goods and costs included in inventory. Included an Inventory Goods Included in Inventory A company recognizes inventory and accounts payable at the time it controls the asset. Passage of title is often used to determine control because the rights and obligations are established legally. 8-16 LO 2  Goods Included In Inventory Goods in Transit Example: LG (KOR) determines ownership by applying the “passage of title” rule.  If a supplier ships goods to LG f.o.b. shipping point, title passes to LG when the supplier delivers the goods to the common carrier, who acts as an agent for LG.  If the supplier ships the goods f.o.b. destination, title passes to LG only when it receives the goods from the common carrier. “Shipping point” and “destination” are often designated by a particular location, for example, f.o.b. Seoul. 8-17 LO 2  Goods Included In Inventory Consigned Goods Example: Williams Art Gallery (the consignor) ships various art merchandise to Sotheby’s Holdings (USA) (the consignee), who acts as Williams’ agent in selling the consigned goods.  Sotheby’s agrees to accept the goods without any liability, except to exercise due care and reasonable protection from loss or damage, until it sells the goods to a third party.  When Sotheby’s sells the goods, it remits the revenue, less a selling commission and expenses incurred, to Williams. Goods out on consignment remain the property of the consignor (Williams). 8-18 LO 2  Goods Included In Inventory Sales with Repurchase Agreements Example: Hill Enterprises transfers (“sells”) inventory to Chase, Inc. and simultaneously agrees to repurchase this merchandise at a specified price over a specified period of time. Chase then uses the inventory as collateral and borrows against it.  Essence of transaction is that Hill Enterprises is financing its inventory—and retains control of the inventory—even though it transferred to Chase technical legal title to the merchandise.  Often described in practice as a “parking transaction.”  Hill should report the inventory and related liability on its books. 8-19 LO 2  Goods Included In Inventory Sales with Rights of Return Example: Quality Publishing Company sells textbooks to Campus Bookstores with an agreement that Campus may return for full credit any books not sold. Quality Publishing should recognize a) Revenue from the textbooks sold that it expects will not be returned. b) A refund liability for the estimated books to be returned. c) An asset for the books estimated to be returned which reduces the cost of goods sold. If Quality Publishing is unable to estimate the level of returns, it should not report any revenue until the returns become predictive. 8-20 LO 2  Costs Included In Inventory Product Costs Costs directly connected with bringing the goods to the buyer’s place of business and converting such goods to a salable condition. Cost of purchase includes all of: 1. The purchase price. 2. Import duties and other taxes. 3. Transportation costs. 4. Handling costs directly related to the acquisition of the goods. 8-21 LO 2  Costs Included In Inventory Period Costs Costs that are indirectly related to the acquisition or production of goods. Period costs such as  selling expenses and,  general and administrative expenses are not included as part of inventory cost. 8-22 LO 2  Costs Included In Inventory Treatment of Purchase Discounts Purchase or trade discounts are reductions in the selling prices granted to customers. IASB requires these discounts to be recorded as a reduction from the cost of inventories. 8-23 LO 2  Treatment of Purchase Discounts ** * ILLUSTRATION 8.6 * $4,000 x 2% = $80 ** $10,000 x 98% = $9,800 Entries under Gross and Net Methods 8-24 LO 2  LEARNING OBJECTIVE 3 Which Cost Flow Compare the cost flow assumptions used to account Assumptions to for inventories. Adopt? Cost Flow Methods  Specific Identification or  Two cost flow assumptions ► First-in, First-out (FIFO) or ► Average Cost 8-25 LO 3  Cost Flow Methods To illustrate the cost flow methods, assume that Call-Mart SpA had the following transactions in its first month of operations. Calculate Goods Available for Sale Beginning inventory (2,000 x €4) € 8,000 Purchases: 6,000 x €4.40 26,400 2,000 x €4.75 9,500 Goods available for sale €43,900 8-26 LO 3  Cost Flow Methods Specific Identification  Method may be used only in instances where it is practical to separate physically the different purchases made. Cost of goods sold includes costs of the specific items sold.  Used when handling a relatively small number of costly, easily distinguishable items.  Matches actual costs against actual revenue.  Cost flow matches the physical flow of the goods.  May allow a company to manipulate net income. 8-27 LO 3  Specific Identification Illustration: Call-Mart Inc.’s 6,000 units of inventory consists of 1,000 units from the March 2 purchase, 3,000 from the March 15 purchase, and 2,000 from the March 30 purchase. Compute the amount of ending inventory and cost of goods sold. ILLUSTRATION 8.7 8-28 LO 3  Cost Flow Methods Average-Cost  Prices items in the inventory on the basis of the average cost of all similar goods available during the period.  Not as subject to income manipulation.  Measuring a specific physical flow of inventory is often impossible. 8-29 LO 3  Average-Cost ILLUSTRATION 8.8 Weighted-Average Method Weighted-Average Method—Periodic Inventory 8-30 LO 3  Average-Cost ILLUSTRATION 8.9 Moving-Average Method Moving-Average Method— Perpetual Inventory In this method, Call-Mart computes a new average unit cost each time it makes a purchase. 8-31 LO 3  Cost Flow Methods First-In, First-Out (FIFO)  Assumes goods are used in the order in which they are purchased.  Approximates the physical flow of goods.  Ending inventory is close to current cost.  Fails to match current costs against current revenues on the income statement. 8-32 LO 3  First-In, First-Out (FIFO) Periodic Inventory System ILLUSTRATION 8.10 FIFO Method—Periodic Inventory Determine cost of ending inventory by taking the cost of the most recent purchase and working back until it accounts for all units in the inventory. 8-33 LO 3  First-In, First-Out (FIFO) Perpetual Inventory System ILLUSTRATION 8.11 FIFO Method— Perpetual Inventory In all cases where FIFO is used, the inventory and cost of goods sold would be the same at the end of the month whether a perpetual or periodic system is used. 8-34 LO 3  Inventory Valuation Methods—Summary Comparison assumes periodic inventory procedures and the following selected data. 8-35 LO 3  Inventory Valuation Methods—Summary ILLUSTRATION 8.12 Comparative Results of Average-Cost and FIFO Methods 8-36 LO 3  Inventory Valuation Methods—Summary When prices are rising, average-cost results in the higher cash balance at year-end (because taxes are lower). ILLUSTRATION 8.13 Balances of Selected Items under Alternative Inventory Valuation Methods 8-37 LO 3  LEARNING OBJECTIVE 4 Effect of Inventory Errors Determine the effects of inventory errors on the financial statements. Ending Inventory Misstated ILLUSTRATION 8.14 Financial Statement Effects of Misstated Ending Inventory The effect of an error on net income in one year will be counterbalanced in the next, however the income statement will be misstated for both years. 8-38 LO 4  Ending Inventory Misstated Illustration: Yei Chen Ltd. understates its ending inventory by HK$10,000 in 2019; all other items are correctly stated. ILLUSTRATION 8.15 Effect of Ending Inventory Error on Two Periods 8-39 LO 4  Effect of Inventory Errors ILLUSTRATION 8.16 Purchases and Inventory Financial Statement Effects of Misstated Misstated Purchases and Inventory The understatement does not affect cost of goods sold and net income because the errors offset one another. Inventory and purchases should be misstated with the same value and both overstated/understated 8-40 THIS IS THE FINAL SLIDE TO REVISE , THE REST IS NOT INCLUDED LO 4  APPENDIX 8A LIFO Cost Flow Assumption LEARNING OBJECTIVE 5 Describe the LIFO cost flow assumption. Under IFRS, LIFO is not permitted for financial reporting purposes. Nonetheless, LIFO is permitted for financial reporting purposes in the United States, it is permitted for tax purposes in some countries, and its use can result in significant tax savings. In this appendix, we provide an expanded discussion of LIFO inventory procedures. 8-41 LO 5  Last-In, First-Out (LIFO) Recall that Call-Mart Inc. had the following transactions in its first month of operations. 8-42 LO 5  Last-In, First-Out (LIFO) ILLUSTRATION 8A.1 Periodic Inventory System LIFO Method—Periodic Inventory The cost of the total quantity sold or issued during the month comes from the most recent purchases. 8-43 LO 5  Last-In, First-Out (LIFO) ILLUSTRATION 8A.2 Perpetual Inventory System LIFO Method—Perpetual Inventory LIFO results in different ending inventory and cost of goods sold amounts than the amounts calculated under the periodic method. 8-44 LO 5  Inventory Valuation Methods—Summary Comparison assumes periodic inventory procedures and the following selected data. 8-45 LO 5  Inventory Valuation Methods—Summary ILLUSTRATION 8A.3 Comparative Results of Notice that gross profit and net income are lowest Average-Cost and FIFO and LIFO Methods under LIFO, highest under FIFO, and somewhere in the middle under average-cost. 8-46 LO 5  Inventory Valuation Methods—Summary ILLUSTRATION 8A.4 Balances of Selected LIFO results in the highest cash balance at year-end Items under Alternative Inventory Valuation (because taxes are lower). This example assumes that Methods prices are rising. The opposite result occurs if prices are declining. 8-47 LO 5  COPYRIGHT Copyright © 2018 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. 8-48