Intermediate Accounting PDF

INTERMEDIATE ACCOUNTING Jae-Young Kim 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...

INTERMEDIATE ACCOUNTING Jae-Young Kim 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  Inventory Issues 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  Classifying and Determining Inventory Classifying Inventory Merchandising Manufacturing Company Company One Classification: Three Classifications:  Inventory  Raw Materials Example: Watermelon  Work in Process  Finished Goods Example: Hyundai Motors 6-5 LO 1  Manufacturing Operations - Inventory Finished 8-6 Raw Materials Work in process Goods  Inventory Issues Inventory Cost Flow ILLUSTRATION 8.3 Two types of systems for maintaining inventory records — perpetual system or periodic system. 8-7 LO 1  Inventory System - Control 1. The perpetual inventory system maintains a continuous updates inventory changes. 2. The periodic inventory system updates inventory records ONLY periodically. 8-8 LO 1  Inventory System – Example 1 Example Beginning Inventory: 50 units @ $5/unit = $250. Purchase: 800 units @ $5/unit = $4,000 Sell: 750 units @ $12/ unit (Assume credit sales) Then what is the Ending Inventory? 8-9 LO 1  Inventory system - Perpetual (Example 1 cont’d) CONTINUOUS UPDATE OF INVENTORY Beginning Inventory: 50 units @ $5/unit = $250. Purchase: 800 units @ $5/unit = $4,000  Inventory 4,000 / Cash 4,000 Sell: 750 units @ $12/ unit (Assume credit sales)  Record Sale: A/R 9,000 / Sales 9,000 (750x$12 =9,000)  Update Inventory: COGS 3,750 / Inventory 3,750 ( 750x $5=3750) Then what is the Ending Inventory? 100 units (50+800-750) @$5 /unit = $500 (Check whether physical count and ending inventory matches) 8-10 LO 1  Inventory system - Periodic (Example 1 cont’d) DETERMINE INVENTORY AT THE END OF A PERIOD Beginning Inventory: 50 units @ $5/unit = $250. Purchase: 800 units @ $5/unit = $4,000  Purchases 4,000 / Cash 4,000 Sell: 750 units @ $12/ unit (Assume credit sales)  Record Sale: A/R 9,000 / Sales 9,000 (750x$12 =9,000)  No entry for the COGS ( We will figure out later.....) Ending inventory: A physical count shows $500 inventory on hand  $250 + $4,000 – X = $500 so X is the COGS = 3,750  COGS 3,750 Inventory 250 Purchase 4,000 8-11 LO 1  Inventory Cost Flow – Example 2 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. 8-12 LO 1  Inventory Cost Flow – Example 2 cont’d 8-13 LO 1  Inventory Cost Flow - Summary Perpetual System Periodic System Update Inventory -continuously Update Inventory - END of period Purchases are debited to Purchases are debited to Purchase account Inventory account Freight-in , Purchase returns and Freight-in , Purchase returns allowances and purchase discounts and allowances and purchase are reflected in their respective discounts are reflected in account. Inventory account. COGS is calculated ONLY periodically: For each sale journalize: Goods-Available-for-Sale* COGS xxx / Inventory xxx - Ending Inventory COGS Goods Available for Sale = Beginning Inventory + Purchase 8-14 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. 8-15 LO 1 Cost to be Included an Inventory: (1) Freight cost 1. F.O.B (free on board) shipping point (Freight-In)  Buyer’s cost ( Treated as Inventory) 2. F.O.B (free on board) destination (Freight-out) Seller’s cost (Treated as operating expense) Inventory Value = Purchase costs + All relevant expenses 8-16 LO 2 Freight Costs (2 of 5) Ownership of the goods Ownership of the goods passes to the buyer when the remains with the seller until public carrier accepts the the goods reach the buyer. goods from the seller. Copyright © 2019 John Wiley & Sons, Inc. 17  Freight cost cont’d- Title ( ownership ) issues 1. F.O.B (free on board) shipping point  Title of the goods passes from the seller to the buyer at the point of shipping 2. F.O.B (free on board) destination  Title of the goods passes from the seller to the buyer at the destination 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. 8-18 LO 2 Cost to be Included an Inventory: (2) Purchase Discount 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. 8-19 LO 2  Purchase Discounts - Example Example: 2/10, n/30 Gross vs Net method Similar to Cash discounts in Chapter 7, but now you should approach this from a Buyer’s perspective 8-20 LO 2  Purchase Discounts - Treatment ** * ILLUSTRATION 8.6 * $4,000 x 2% = $80 Entries under Gross and ** $10,000 x 98% = $9,800 Net Methods 8-21 LO 2  Which Cost Flow Assumptions to Adopt? Likelihood of purchase cost to change is high. And in practice, it is unlikely to follow exactly which items are sold. Therefore, we need cost flow assumptions. Cost flow assumptions need not to be consistent with the physical flow of goods. Cost Flow assumptions are: 1. Specific Identification 2. First-in, First-out (FIFO) Last-in, First-out (LIFO) – Not allowed in IFRS but allowed in GAAP 3. Average Cost 8-22 LO 3  Which Cost Flow Assumptions to Adopt? Under IFRS, LIFO is not permitted for financial reporting purpose. Nonetheless, LIFO is permitted for financial reporting purpose in the US. It is permitted for tax purposes in some countries, and its use can result in significant tax savings. 8-23 LO 3  Example: Periodic vs Perpetual JYK sells watermellons:  Beginning Inventory: 15 units @$20 each  Jan10 purchased: 20 units @ $21 each  March10 sold: 10 units  May15 purchased: 30 units @ $22 each  July10 sold: 20 units  Sept 3 purchased: 10 units @ $23 each  Year end December 31. Calculate ending inventory and COGS under: 1. FIFO – Perpetual 2. FIFO – Periodic 3. LIFO – Perpetual 4. LIFO- Periodic 8-24 LO 3  Example: Periodic vs Perpetual Goods Available for Sale 15 @ $20 = $300 20 @ $21 = $420 30 @ $22 = $660 10 @ $23 = $230 ----------------------- $1610 8-25 LO 3  Example: FIFO - Perpetual Sale on March 10, 10 units sold from BI batch @ $20 each Sales on July 10, 20 units sold from BI batch ( 5 units @ $20) and Jan 10 purchase batch (15 units @ $21) Total COGS = $200 + $100 + $315= $615 Ending Inventory = January 10 5 units @$21= 105 May 15 30 units @$22 = 660 Sept 3 10 units @$23 = 230 ----------------------------- $995 8-26 LO 3  Example: FIFO - Periodic Total sale of 30 units: Start with the oldest inventory ( Sell water-mellon that was bought first) to calculate the COGS 15 units from BI batch: = $300 15 units from Jan 10 batch: = $315 ----------------- = $615 Ending Inventory = January 10 5 units @$21= 105 May 15 30 units @$22 = 660 Sept 3 10 units @$23 = 230 ----------------------------- $995 8-27 LO 3  Example: LIFO - Perpetual Sale on March 10, 10 units sold from Jan 10 batch @ $21 each : $210 Sales on July 10, 20 units sold from May 15 batch : $440 Total COGS = $210 + $440 = $650 Ending Inventory = Beginning Inventory 15 units @$20 = $300 January 10 10 units @$21= $210 May 15 10 units @$22 = $220 Sept 3 10 units @$23 = $230 ----------------------------- $960 8-28 LO 3  Example: LIFO - Periodic Total sale of 30 units: Start with the latest purchase to calculate the COGS 10 units from Sept 3 batch: = $230 15 units from May15 batch: = $440 ----------------- = $670 Ending Inventory = Beginning Inv 15 units @$20= 300 Jan 10 20 units @$21 = 420 May 15 10 units @$22 = 220 ----------------------------- $940 8-29 LO 3  Example 2: 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 8-30 LO 3  Example 2 : 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. 8-31 LO 3  Example 2-1. 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 8-32 LO 3  Example 2-2. 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. 8-33 LO 3  2. 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. 8-34 LO 3  2. 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. 8-35 LO 3  Example 2-3. 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. 8-36 LO 3  3. Average-Cost ILLUSTRATION 8.8 Weighted-Average Method Weighted-Average Method—Periodic Inventory 8-37 LO 3 Summary Example: Inventory Valuation Methods Comparison assumes periodic inventory procedures and the following selected data. 8-38 LO 3  Inventory Valuation Methods—Summary ILLUSTRATION 8.12 Comparative Results of Average-Cost and FIFO Methods 8-39 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 8-40 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. 8-41 LO 4  Effect of Inventory Errors Purchases and Inventory Misstated ILLUSTRATION 8.16 Financial Statement Effects of Misstated Purchases and Inventory The understatement does not affect cost of goods sold and net income because the errors offset one another. 8-42 LO 4  Effects of Inventory Errors COGS Net Income Retained Earnings Inventory Error effect effect effect Beg Understate Understate Overstate Overstate Inventory Overstate Overstate Understate Understate Ending Understate Overstate Understate Understate Inventory Overstate Understate Overstate Overstate 8-43 LO 3  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 8-44 LO 4  Statement Presentation and Analysis Inventory is classified in the statement of financial position as a current asset. In an income statement cost of goods sold is subtracted from sales. 8-45 LO 3  Analysis Inventory turnover: Measures the number of times on average the inventory is sold during the period. Its purpose is to measure the liquidity of the inventory. Cost of Goods Sold (COGS)  Average Inventory = Inventory Turnover 365 Inventory turnover in days = 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 8-46 LO 3  Working Capital and Current Ratio When analyzing a company’s liquidity, the current and non- current classification is useful. Liquidity refers to ability to pay maturing obligations and meet unexpected needs for cash. Working Capital = Current Asset – Current Liabilities Current Ratio = Current Asset / Current Liabilities. Sometimes can be referred to as the working capital ratio 8-47 LO 1  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