Financial Accounting

IFRS 4th Edition

Weygandt ● Kimmel ● Kieso

Chapter 6

Inventories
Chapter Outline:
Learning Objectives
LO 1 Discuss how to classify and determine inventory.
LO 2 Apply inventory cost flow methods and discuss
their financial effects.
LO 3 Indicate the effects of inventory errors on the
financial statements.
LO 4 Explain the statement presentation and analysis of
inventory.

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Learning Objective 1
Discuss How to Classify and Determine
Inventory

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Classifying and Determining Inventory
Merchandising Manufacturing
Company Company
One Classification: Three Classifications:
• Merchandise • Raw Materials
Inventory • Work in Process
• Finished Goods

Helpful Hint
Regardless of the classification, companies report all inventories
under Current Assets on the statement of financial position.
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Determining Inventory Quantities
Physical Inventory taken for two reasons:
Perpetual System
1. Check accuracy of inventory records.
2. Determine amount of inventory lost due to wasted
raw materials, shoplifting, or employee theft.
Periodic System
1. Determine the inventory on hand.
2. Determine the cost of goods sold for the period.

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Taking a Physical Inventory
Involves counting, weighing, or measuring each kind
of inventory on hand.
Taken,
• when the business is closed or business is slow
• at the end of the accounting period

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Determining Ownership of Goods (1 of 5)
Goods In Transit
• Purchased goods not yet received
• Sold goods not yet delivered
Goods in transit should be included in the inventory of
the company that has legal title to the goods.
Legal title is determined by the terms of sale.

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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.

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Determining Ownership of Goods (3 of 5)
Review Question
Goods in transit should be included in the inventory of
the buyer when the:
a. public carrier accepts the goods from the seller.
b. goods reach the buyer.
c. terms of sale are FOB destination.
d. terms of sale are FOB shipping point.

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Determining Ownership of Goods (4 of 5)
Review Question
Goods in transit should be included in the inventory of
the buyer when the:
a. public carrier accepts the goods from the seller.
b. goods reach the buyer.
c. terms of sale are FOB destination.
d. terms of sale are FOB shipping point.

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Determining Ownership of Goods (5 of 5)
Consigned Goods
To hold the goods of other parties and try to sell the
goods for them for a fee, but without taking ownership of
the goods.
Many car, boat, and antique dealers sell goods on
consignment. Why?

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Do It! 1: Rules of Ownership (1 of 2)
Deng Imports completed its inventory count. It arrived at a total
inventory value of ¥200,000. You have been given the
information listed below. Discuss how this information affects the
reported cost of inventory.
1. Deng included in the inventory goods held on consignment for
Falls Co., costing ¥15,000.
2. The company did not include in the count purchased goods of
¥10,000, which were in transit (terms: F O B shipping point).
3. The company did not include in the count inventory that had
been sold with a cost of ¥12,000, which was in transit (terms:
F O B shipping point).

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Do It! 1: Rules of Ownership (2 of 2)
Solution
1. Goods of ¥15,000 held on consignment should be deducted
from the inventory count.
2. The goods of ¥10,000 purchased F O B shipping point should be
added to the inventory count.
3. Item 3 was treated correctly

Inventory should be ¥195,000

(¥200,000 − ¥15,000 + ¥10,000)

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Learning Objective 2
Apply Inventory Cost Flow Methods
and Discuss Their Financial Effects

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Inventory Methods and Financial Effects
Inventory is accounted for at cost.
• Cost includes all expenditures necessary to acquire
goods and place them in a condition ready for sale
• Unit costs are applied to quantities to determine the
total cost of inventory and cost of goods sold using
the following costing methods:
§ Specific identification
§ Cost flow assumptions (First-in first-out and
Average-cost)

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Specific Identification (1 of 3)
Illustration: Crivitz TV Company purchases three identical 50-
inch TVs on different dates at costs of £720, £750, and £800.
During the year Crivitz sold two sets at £1,200 each. These
facts are summarized below.
Purchases
February 3 1 TV at £720
March 5 1 TV at £750
May 22 1 TV at £800
Sales
June 1 2 TVs for £2,400 (£1,200 × 2)

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Specific Identification (2 of 3)
If Crivitz sold the TVs it purchased on February 3 and May 22,
then its cost of goods sold is £1,520 (£720 + £800), and its
ending inventory is £750.
Cost of Goods Sold
Ending Inventory
£720
£750
£1,520

£800

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Specific Identification (3 of 3)
Costing method in which items still in inventory are
specifically costed to arrive at the total cost of the ending
inventory.
• Practice is relatively rare
• Most companies make assumptions (cost flow
assumptions) about which units were sold

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Cost Flow Assumptions (1 of 6)
There are two assumed cost flow methods:
1. First-in, first-out (FIFO)
2. Average-cost
Cost flow does not need be consistent with the physical
movement of the goods.

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Cost Flow Assumptions (2 of 6)
Illustration: Data for Lin Electronics’ Astro condensers.

Date Explanation Units Unit Cost Total Cost

Jan. 1 Beginning inventory 10 HK$100 HK$1,000
Apr. 15 Purchase 20 110 2,200
Aug. 24 Purchase 30 120 3,600
Nov. 27 Purchase 40 130 5,200
Total units available for sale 100 HK$12,000
Units in ending inventory (45)
Units sold 55
(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold

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Cost Flow Assumptions (3 of 6)
First-In, First-Out (FIFO)
• Costs of earliest goods purchased are first to be
recognized in determining cost of goods sold
• Often parallels actual physical flow of merchandise
• Companies determine cost of ending inventory by
taking unit cost of most recent purchase and working
backward until all units of inventory have been costed

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First-In, First-Out (FIFO) (1 of 2)
COST OF GOODS AVAILABLE FOR SALE
Date Explanation Units Unit Cost Total Cost
Jan. 1 Beginning inventory 10 HK$100 HK$1,000
Apr. 15 Purchase 20 110 2,200
Aug. 24 Purchase 30 120 3,600
Nov. 27 Purchase 40 130 5,200
Total 100 HK$12,000

STEP 1: ENDING INVENTORY STEP 2: COST OF GOODS SOLD

Unit Total
Date Units Cost Cost
Nov. 27 40 HK$130 HK$5,200 Cost of goods available for sale HK$12,000
Aug. 24 5 120 600 Less : Ending inventory 5,800
Total 45 HK$5,800 Cost of goods sold HK$ 6,200

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Cost Flow Assumptions (4 of 6)
Average-Cost
• Allocates cost of goods available for sale on basis of
weighted-average unit cost incurred
• Applies weighted-average unit cost to units on hand
to determine cost of ending inventory

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Average-Cost (1 of 2)
COST OF GOODS AVAILABLE FOR SALE
Date Explanation Units Unit Cost Total Cost
Jan. 1 Beginning inventory 10 HK$100 HK$1,000
Apr. 15 Purchase 20 110 2,200
Aug. 24 Purchase 30 120 3,600
Nov. 27 Purchase 40 130 5,200
Total 100 HK$12,000

STEP 1: ENDING INVENTORY STEP 2: COST OF GOODS SOLD

Unit Total
Units Cost Cost
HK$12,000 ÷ 100 = HK$120 Cost of goods available for sale HK$12,000
Cost of goods sold 5,400
45 HK$120 HK$5,400 Less : Ending inventory HK$ 6,600

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Financial Statement and Tax Effects
of Cost Flow Methods
Either of the two cost flow assumptions is acceptable for
use.
• Lenovo (CHN) uses the average-cost method
• Yingli Solar (CHN) uses average-costing for key raw
materials and FIFO for the remainder of its inventories

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Income Statement Effects
Lin Electronics
Condensed Income Statements
FIFO Average-Cost
Sales revenue HK$11,500 HK$11,500
Beginning inventory 1,000 1,000
Purchases 11,000 11,000
Cost of goods available for sale 12,000 12,000
Ending inventory 5,800 5,400
Cost of goods sold 6,200 6,600
Gross profit 5,300 4,900
Operating expenses 2,000 2,000
Income before income taxes 3,300 2,900
Income tax expense (30%) 990 870
Net income HK$ 2,310 HK$ 2,030

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Statement of Financial Position Effects (1 of 2)
• A major advantage of the FIFO method is that in a
period of inflation, costs allocated to ending
inventory will approximate their current cost
• A shortcoming of the average-cost method is that in a
period of inflation, costs allocated to ending
inventory may be understated in terms of current
cost

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Tax Effects
• Both inventory and net income are higher when
companies use FIFO in a period of inflation
• Average-cost results in lower income taxes (because
of lower net income) during times of rising prices

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Using Inventory Cost Flow Methods
Consistently
• Method should be used consistently, enhances
comparability
• Although consistency is preferred, a company may
change its inventory costing method
§ Should disclose the change and its effect on net
income

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Cost Flow Assumptions (5 of 6)
Review Question
The cost flow method that often parallels the actual
physical flow of merchandise is the:
a. FIFO method
b. LIFO method
c. average cost method
d. gross profit method

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Cost Flow Assumptions (6 of 6)
Review Question
The cost flow method that often parallels the actual
physical flow of merchandise is the:
a. FIFO method
b. LIFO method
c. average cost method
d. gross profit method

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DO IT! 2: Cost Flow Methods
The accounting records of Shumway Implements show the
following data.
Beginning inventory 4,000 units at € 3
Purchases 6,000 units at € 4
Sales 7,000 units at €12
Determine the cost of goods sold during the period under a
periodic inventory system using (a) the FIFO method, and (b)
the average-cost method.

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DO IT! 2: FIFO Method
Determine cost of goods sold under a periodic inventory.

COST OF GOODS AVAILABLE FOR SALE

Date Explanation Units Unit Cost Total Cost
Beginning inventory 4,000 €3 €12,000
Purchase 6,000 4 24,000
Total 10,000 €36,000

STEP 1: ENDING INVENTORY STEP 2: COST OF GOODS SOLD

Unit Total Cost of goods available for sale €36,000
Units Cost Cost Less : Ending inventory 12,000
3,000 €4 €12,000 Cost of goods sold € 24,000

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DO IT! 2: Average-Cost
Determine cost of goods sold under a periodic inventory.

COST OF GOODS AVAILABLE FOR SALE

Date Explanation Units Unit Cost Total Cost
Beginning inventory 4,000 €3.00 €12,000
Purchase 6,000 4.00 24,000
Total 10,000 €3.60 €36,000
Average Cost Per Unit

STEP 1: ENDING INVENTORY STEP 2: COST OF GOODS SOLD

Unit Total Cost of goods available for sale €36,000
Units Cost Cost Less : Ending inventory 10,800
3,000 €3.60 €10,800 Cost of goods sold € 25,200

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Learning Objective 3
Indicate the Effects of Inventory Errors
on the Financial Statements

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Learning Objective 4
Explain the Statement Presentation
and Analysis of Inventory

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Statement Presentation and Analysis (1 of 2)
Presentation
Statement of Financial Position - Inventory classified as
current asset.
Income Statement - Cost of goods sold subtracted from
sales.
There also should be disclosure of
1. major inventory classifications
2. basis of accounting (cost or LCNRV)
3. costing method (FIFO, or average-cost)
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Lower-of-Cost-or-Net Realizable Value (1 of 2)
When the value of inventory is lower than its cost
• Companies must “write down” inventory to its net
realizable value
• Net realizable value: Amount that company expects
to realize (receive from the sale of inventory)
• Example of conservatism

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Lower-of-Cost-or-Net Realizable Value (2 of 2)
Illustration: Assume that Gao TVs has the following lines of
merchandise with costs and net realizable values as indicated.
Net
Cost Realizable Lower-of-Cost-or-Net
Units per Unit Value per Unit Realizable Value
Flat-screen TVs 100 NT$600 NT$550 NT$ 55,000 (NT$550 x 100)
Satellite radios 500 90 104 45,000 (NT$90 x 500)
DVD recorders 850 50 48 40,800 (NT$48 x 850)
DVDs 3,000 5 6 15,000 (NT$5 x 3,000)
Total inventory NT$155,800

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Statement Presentation and Analysis (2 of 2)
Analysis
Inventory management is a double-edged sword
1. High Inventory Levels - may incur high carrying
costs (e.g., investment, storage, insurance,
obsolescence, and damage).
2. Low Inventory Levels – may lead to stock-outs and
lost sales.

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Analysis (1 of 2)
Inventory turnover measures the number of times on
average the inventory is sold during the period.
Cost of Goods Sold
Inventory
=
Turnover Average Inventory

Days in inventory measures the average number of

days inventory is held.
Days in Year (365)
Days in
=
Inventory Inventory Turnover
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Analysis (2 of 2)
Illustration: Esprit Holdings (HKG) reported in a recent annual
report a beginning inventory of HK$3,209 million, an ending
inventory of HK$3,254 million, and cost of goods sold for the year
ended of HK$12,071 million. Illustration 6.16 shows the inventory
turnover formula and computation for Esprit Holdings.

Cost of
÷ Average Inventory = Inventory Turnover
Goods Sold
HK$3,209 + HK$3,254
HK$12,071 ÷ = 3.7 Times
2

365 ÷ 3.7 = 98.6 Days

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DO IT! 4: LCNRV and Inventory Turnover
Poon Heaters sells three different types of home heating stoves
(gas, wood, and pellet). The cost and net realizable value of its
inventory of stoves are as follows.
Cost Net Realizable Value
Gas NT$ 84,000 NT$ 79,000
Wood 250,000 280,000
Pellet 112,000 101,000
Determine the value of the company’s inventory under the lower-
of-cost-or-net realizable value approach.
Solution: The lowest value for each inventory type is gas
NT$79,000, wood NT$250,000, and pellet NT$101,000. The total
inventory value is the sum of these amounts, NT$430,000.
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DO IT! 4: Inventory Turnover (1 of 2)
Early in 2020, Westmoreland Company switched to a just-in-time
inventory system. Its sales revenue, cost of goods sold, and
inventory amounts for 2019 and 2020 are shown below.
2019 2020
Sales revenue NT$2,000,000 NT$1,800,000
Cost of goods sold 1,000,000 910,000
Beginning inventory 290,000 210,000
Ending inventory 210,000 50,000
Determine the inventory turnover and days in inventory for 2019
and 2020.

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DO IT! 4: Inventory Turnover (2 of 2)
2019 2020
Sales revenue NT$2,000,000 NT$1,800,000
Cost of goods sold 1,000,000 910,000
Beginning inventory 290,000 210,000
Ending inventory 210,000 50,000

2019 2020
Inventory
turnover NT$1,000,000 NT$910,000 =7
=4
(NT$290,000 + NT$210,000)/2 (NT$210,000 + NT$50,000)/2
Days in 365 ÷ 4 = 91.3 Days 365 ÷ 7 = 52.1 Days
inventory

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