Chapter 8 Valuation of Inventories A Cost Basis Approach.docx
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Chapter8ValuationofInventoriesACostBasisApproach
Chapter8:
ValuationofInventories:
ACostBasisApproach
CourseObjectives:
∙ReviewtheAccountingCycleandFinancialStatements:
Chapters1-5√
∙IntroducetheConceptofthetimevalueofmoney:
Chapter6√
∙Discussaccountingfor:
oCash:
Chapter7√
oReceivables:
Chapter7√
oInventory:
Chapter8and9
1)InventoryClassificationandControl:
aClassification(seefinancialstatementpresentationinIllustration8-1,p369):
i)Inventory:
goodsavailableforresale.(Formanufacturingcompany,inventoryincludes:
RawMaterials,Work-in-Process,andFinishedGoods.)
ii)MerchandisingCompany:
___________________goods/inventory___________________.(e.g.,Walmart,EddieBauer,etc.)
iii)ManufacturingCompany:
___________________goods/inventory____________________.(e.g.,Boeing,ExxonMobil,BMW,etc.)
iv)RawMaterialsInventory:
Itemsininventorythatwillbecomponentsofaproducedgood.
v)WorkinProcessInventory:
Partiallycompletedinventoryunitsattheendofanaccountingperiod(e.g.,atablewithoutlegs.)Includestotalcosttodate.Thatis,includedirectmaterial,directlabor,andfactoryoverhead(fixedandvariable).
vi)FinishedGoodsInventory:
Amountofmanufacturedproductonhandthatawaitssaletocustomers.
bControl:
i)PerpetualSystem:
(1)Maintaincontinuousrecordofchangesininventory
(2)
(asaresultofeverything–e.g.,purchases,freight-in,purchasereturnsandallowances,andpurchasediscounts--directlyenteringInventoryaccount.)
(3)
(4)Maintainsubsidiaryledgershowingquantityandcostofeachtypeofinventoryonhand.Physicalcountcomparetoaccountingrecords.Determineshortagesoroveragesininventory.
Ifthephysicalinventoryislowerthantheinventoryaccount,thefollowingentryismade:
Ifthephysicalinventoryishigherthantheinventoryaccount,thefollowingentryismade:
Perpetualinventoryoverages/shortagesgenerallyrepresentamisstatementofCOGS.Thedifferenceistheresultofnormalandexpectedshrinkage,breakage,shoplifting,incorrectrecordkeeping,etc.InventoryOverandShortwouldthereforebeanadjustmenttoCOGS.Inpractice,theaccountInventoryOverandShortissometimesreportedin“Otherrevenuesandgains”or“Otherexpensesandlosses”sectionoftheincomestatement,dependingonitsbalance.
ii)PeriodicSystem:
(1)QuantityofInventoryonhandisdetermined______________________.
(2)Purchases:
(3)CostofGoodsAvailableforSales=BeginningInventory+Purchases.
(4)CostofGoodsSold=CostofGoodsAvailableforSale–EndingInventory.(Note:
COGSisaresidualamountdependentuponaphysicalcountofendinginventory.)
(5)PhysicalInventoryCount:
Requiredunderperiodicsystem(alsoperformedunderperpetualsystem.)
Shouldbetakenasclosetoendoffiscalyearaspossible.(Ifnotpossible,itisacceptabletousephysicalinventoriestakenclosetoyear-endandkeepdetailedinventoryrecordstoreconciletoyear-end.)
(6)
Therearenoaccountingrecordsavailableagainstwhichtocomparethephysicalcount.Thus,inventoryoveragesandshortagesareburiedinCOGS.
iii)ComparisonofJournalEntriesforeachmethod:
Periodic
Perpetual
Topurchaseinventoryitem:
Topurchaseinventoryitem:
Tomakeareturn:
Tomakeareturn:
Torecordasale:
(1entry)
Torecordasale:
(2entries)
Endoftheyear:
Endoftheyear:
Additionalaccounts:
2)BasicIssuesinInventoryValuation:
aFormulas:
bValuationofinventoriescanbecomplexprocessthatrequiresdetermining:
(Eachoftheitemslistedbelowisdiscussedinmoredetailinthefollowingsections.)
i)Physicalgoodsincludedininventory:
(1)GoodsinTransit.
(2)ConsignedGoods.
(3)SpecialSalesAgreement.
ii)Costofgoodsininventory:
(1)Productvs.Periodcosts.
(2)Treatmentofpurchasediscounts.
iii)Costflowassumptionadopted:
(1)Specificidentification.
(2)Averagecost.
(3)FIFO.
(4)LIFO.
(5)Retail.
3)PhysicalGoodsIncludedinInventory:
(MakesureyouunderstandeachoftheseitemsfromtheviewofthesellerANDthebuyer.)
aGoodsinTransit:
Goodstowhichlegaltitlehaspassedshouldberecordedaspurchasesofthefiscalperiodonbuyer’sbooks.
i)FOBShippingPoint:
Example:
12/31FOBShippingPoint,you(thebuyer)havenotreceivedgoodsthathavebeen
deliveredtocommoncarrier:
___________________________________________________
ii)FOBDestination:
Example:
12/31FOBDestination,you(thebuyer)havenotreceivedgoodsthathavebeendeliveredtocommoncarrier:
__________________________________________________________________________
iii)Example(BriefExercise8-3,page400):
MayberryCompanytookaphysicalinventoryonDecember31anddeterminedthatgoodscosting$200,000wereonhand.Notincludedinthephysicalcountwere$15,000ofgoodspurchasedfromTaylorCorporation,f.o.b.shippingpoint,and$22,000ofgoodssoldtoMountPilotCompanyfor$30,000,f.o.b.destination.BoththeTaylorpurchaseandtheMountPilotsalewereintransitatyear-end.WhatamountshouldMayberryreportasitsDecember31inventory?
bConsignedGoods:
i)Theowner(consignor)transfersphysicalgoodstoagent(consignee)forpurposesofsellingwithoutgivingupownership.
___________________________________________________________________________
ii)Whenconsigneesellsgoods,therevenue,lessasellingcommissionandexpensesincurredinaccomplishingsale,isremittedtoconsignor.
cSpecialSalesAgreements:
Seetextpages374to375.
i)SaleswithBuybackAgreement:
ii)SaleswithHighRatesofReturn:
iii)SalesonInstallment:
dIfweareholdinggoodsthatcustomerhaspurchasedandwillpickupathis/herconvenience,thesegoodsareNOTincludedinourinventory.
HOMEWORK:
YoushouldnowbeabletoworkE8-1,E8-2,andP8-1.
eEffectofInventoryErrors:
i)EndingInventoryMisstated:
Whatwouldhappenifbeginninginventoryandpurchasesarerecordedcorrectly,butsomeitemsarenotincludedinendinginventory?
SeeIllustration8-6includedonpage375andIllustration8-7intextonpage376.
Inthissituation,wewouldhavethefollowingeffectsonthefinancialstatementsattheendoftheperiod.
Note:
U=understated,O=overstated,NE=noeffect
BI
Sales
BeginningRE
+Purchases
-COGS
+NI
=GAS
=GrossProfit
+Investments
-EI
-Otherexpenses
-W/D
=COGS
=NetIncome
=EndingRE
BalanceSheet
IncomeStatement
Inventory(Assets)
Costofgoodssold
Retainedearnings
Netincome
ii)Thinkofothersituationswhereotheritemsaremisstated.HowdothesesituationsaffecttheB/SandI/S?
Forexample,ifendinginventoryisoverstated,thereverseoftheabovesituationoccurs.
Yr1
Yr2
Yr1
Yr2
Yr1
Yr2
BI
Sales
BeginningRE
+Purchases
-COGS
+NI
=GAS
=GrossProfit
+Investments
-EI
-Otherexpenses
-W/D
=COGS
=NetIncome
=EndingRE
iii)PurchasesandInventoryMisstated:
Supposegoodsarenotrecordedaspurchasesandnotincludedinendinginventory.(Notenetincomeisnotaffectedb/cpurchasesandendinginventoryarebothunderstatedbythesameamounttheerrortherebyoffsettingitselfincostofgoodssold.)
BI
Sales
BeginningRE
+Purchases
-COGS
+NI
=GAS
=GrossProfit
+Investments
-EI
-Otherexpenses
-W/D
=COGS
=NetIncome
=EndingRE
BalanceSheet
IncomeStatement
Inventory
Costofgoodssold
Retainedearnings
Netincome
Accountspayable
Purchases
iv)Thinkofothersituationswhereotheritemsaremisstated.HowdothesesituationsaffecttheB/SandI/S?
Forexample,ifbothpurchases(onaccount)andendinginventoryareoverstated,thentheeffectsonthebalancesheetareexactlythereverse:
InventoryandA/Pareoverstated.COGSandnetincomearenotaffectedb/ctheerrorsoffsetoneanother.
v)
Example:
Thecompanyusestheperiodicsystem.Apurchaseofmerchandiseonaccountfor$1,000in2005wasnotrecordeduntil2006,althoughthemerchandisewasincludedin2005endinginventory.
EntryNOTmade:
2005
2006
BeginningInventory
NE
+Purchases
O$1,000
=GAS
O$1,000
-EI
NE
=COGS
O$1,000
Sales
NE
-COGS
O$1,000
=GP
U$1,000
-Otherexp
NE
=NI
U$1,000
ASSETS
NE(EIisok)
LIABILITIES
NE
Owners’EQUITY
NE
BeginningOE(yr1)
BeginningA/P(yr1)
+NetIncome(yr2)
A/P(yr2)
EndingOE
EndA/P
vi)Example:
Acompanyusingaperpetualsystemfailedtorecordasaleof$1,000onaccountin2005.Mark-uponcostis100%.
Error–EntryNotMade:
Assets:
Income:
Example(BriefExercise8-4,page400):
GavinBryarsEnterprisesreportedcostofgoodssoldfor2007of$1,400,000andretainedearningsof$5,200,000atDecember31,2007.GavinBryarslaterdiscoveredthatitsendinginventoriesatDecember31,2006and2007,wereoverstatedby$110,000and$45,000,respectively.Determinethecorrectedamountsfor2007costofgoodssoldandDecember31,2007,retainedearnings.
Costofgoodssoldasreported$1,400,000
12/31/07retainedearningsasreported$5,200,000
‘06
‘07
‘06
‘07
‘06
‘07
BI
Sales
BeginningRE
+Purchases
-COGS
+NI
=GAS
=GrossProfit
+Investments
-EI
-Otherexpenses
-W/D
=COGS
=NetIncome
=EndingRE
HOMEWORK:
YoushouldnowbeabletoworkE8-10andE8-12.
4)CostsInclu