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I need your assistance with my discussion, this is due 5/4/16, 150 word minimum

Discussion Topic

Companies can determine the effect of ending inventory errors on the balance sheet by using the basic accounting equation: Assets = Liabilities + Owner?s Equity. How would the over or understatement of inventory impact assets, liability and owner?s equity.

6-1 6 Inventories Learning Objectives 1 2 Apply inventory cost flow methods and discuss their financial effects. 3 Indicate the effects of inventory errors on the financial statements. 4 6-2 Discuss how to classify and determine inventory. Explain the statement presentation and analysis of inventory. LEARNING OBJECTIVE 1 Discuss how to classify and determine inventory. Classifying Inventory Manufacturing Company Merchandising Company One Classification: Inventory Helpful Hint Regardless of the classification, companies report all inventories under Current Assets on the balance sheet. 6-3 Three Classifications: Raw Materials Work in Process Finished Goods LO 1 6-4 LO 1 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. 6-5 LO 1 Determining Inventory Quantities TAKING A PHYSICAL INVENTORY Involves counting, weighing, or measuring each kind of inventory on hand. Companies often \"take inventory\" when the business is closed or business is slow. 6-6 at the end of the accounting period. LO 1 6-7 LO 1 Determining Inventory Quantities DETERMINING OWNERSHIP OF GOODS 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. 6-8 LO 1 Determining Ownership of Goods GOODS IN TRANSIT Illustration 6-2 Terms of sale Ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. Ownership of the goods remains with the seller until the goods reach the buyer. 6-9 LO 1 Determining Ownership of Goods 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. 6-10 LO 1 Determining Ownership of Goods 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? 6-11 LO 1 6-12 LO 1 DO IT! 1 Rules of Ownership Hasbeen Company 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. Hasbeen 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: FOB 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: FOB shipping point). Solution 1. Goods of $15,000 held on consignment should be deducted from the inventory count. 2. The goods of $10,000 purchased FOB shipping point should be added to the inventory count. 3. Item 3 was treated correctly. 6-13 Inventory should be $195,000 ($200,000 - $15,000 + $10,000). LO 1 LEARNING OBJECTIVE 2 Apply inventory cost flow methods and discuss their 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 compute the total cost of the inventory and the cost of goods sold using the following costing methods: First-in, first-out (FIFO) Last-in, first-out (LIFO) 6-14 Specific identification Average-cost Cost Flow Assumptions LO 2 Inventory Costing Illustration: Crivitz TV Company purchases three identical 50inch TVs on different dates at costs of $700, $750, and $800. During the year Crivitz sold two sets at $1,200 each. These facts are summarized below. Illustration 6-3 Data for inventory costing example 6-15 LO 2 Specific Identification If Crivitz sold the TVs it purchased on February 3 and May 22, then its cost of goods sold is $1,500 ($700 + $800), and its ending inventory is $750. 6-16 Illustration 6-4 LO 2 Specific Identification Actual physical flow 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. 6-17 LO 2 Cost Flow Assumptions Cost flow assumptions DO NOT need to be consistent with the physical movement of the goods Illustration 6-12 Use of cost flow methods in major U.S. companies 6-18 LO 2 Cost Flow Assumptions Illustration: Data for Houston Electronics' Astro condensers. Illustration 6-5 (Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold 6-19 LO 2 Cost Flow Assumptions FIRST-IN, FIRST-OUT (FIFO) Costs of the earliest goods purchased are the first to be recognized in determining cost of goods sold. Often parallels actual physical flow of merchandise. Companies determine the cost of the ending inventory by taking the unit cost of the most recent purchase and working backward until all units of inventory have been costed. 6-20 LO 2 FIRST-IN, FIRST-OUT (FIFO) Illustration 6-6 6-21 LO 2 FIRST-IN, FIRST-OUT (FIFO) Illustration 6-6 6-22 Helpful Hint Another way of thinking about the calculation of FIFO ending inventory is the LISH assumptionlast in still here. LO 2 Cost Flow Assumptions LAST-IN, FIRST-OUT (LIFO) Costs of the latest goods purchased are the first to be recognized in determining cost of goods sold. Seldom coincides with actual physical flow of merchandise. 6-23 Exceptions include goods stored in piles, such as coal or hay. LO 2 LAST-IN, FIRST-OUT (LIFO) Illustration 6-8 6-24 LO 2 LAST-IN, FIRST-OUT (LIFO) Illustration 6-8 6-25 Helpful Hint Another way of thinking about the calculation of LIFO ending inventory is the FISH assumptionfirst in still here. LO 2 Cost Flow Assumptions AVERAGE-COST Allocates cost of goods available for sale on the basis of weighted-average unit cost incurred. Applies weighted-average unit cost to the units on hand to determine cost of the ending inventory. 6-26 LO 2 AVERAGE-COST Illustration 6-11 6-27 LO 2 AVERAGE-COST Illustration 6-11 6-28 LO 2 Inventory Costing Financial Statement and Tax Effects of Cost Flow Methods Each of the three cost flow methods is acceptable for use. Campbell Soup Company, Krogers, and Walgreen Drugs use LIFO for part or all of their inventory. Bristol-Myers Squibb, Starbucks, and Motorola use the averagecost method. 6-29 Reebok International Ltd. and Wendy's International currently use the FIFO method. Stanley Black & Decker Manufacturing Company uses LIFO for domestic inventories and FIFO for foreign inventories. LO 2 Financial Statement and Tax Effects INCOME STATEMENT EFFECTS 6-30 Illustration 6-13 Comparative effects of cost flow methods LO 2 Financial Statement and Tax Effects BALANCE SHEET EFFECTS A major advantage of the FIFO method is that in a period of inflation, the costs allocated to ending inventory will approximate their current cost. A major shortcoming of the LIFO method is that in a period of inflation, the costs allocated to ending inventory may be significantly understated in terms of current cost. 6-31 LO 2 Financial Statement and Tax Effects TAX EFFECTS Both inventory and net income are higher when companies use FIFO in a period of inflation. LIFO results in the lowest income taxes (because of lower net income) during times of rising prices. Helpful Hint A tax rule, often referred to as the LIFO conformity rule, requires that if companies use LIFO for tax purposes they must also use it for financial reporting purposes. 6-32 LO 2 Inventory Costing Using Cost Flow Methods Consistently Method should be used consistently, enhances comparability. Although consistency is preferred, a company may change its inventory costing method. Illustration 6-14 Disclosure of change in cost flow method 6-33 LO 2 Cost Flow Assumptions 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. 6-34 LO 2 Cost Flow Assumptions Question In a period of inflation, the cost flow method that results in the lowest income taxes is the: a. FIFO method. b. LIFO method. c. average cost method. d. gross profit method. 6-35 LO 2 6-36 LO 2 DO IT! 2 6-37 Cost Flow Methods LO 2 LEARNING OBJECTIVE 3 Indicate the effects of inventory errors on the financial statements. Common Cause: Not properly recognizing the transfer of legal title to goods in transit. 6-38 Failure to count or price inventory correctly. Errors affect both the income statement and balance sheet. LO 3 Income Statement Effects Inventory errors affect the computation of cost of goods sold and net income in two periods. Illustration 6-15 Illustration 6-16 6-39 LO 3 Income Statement Effects Inventory errors affect the computation of cost of goods sold and net income in two periods. Over the two years, the total net income is correct because the errors offset each other. 6-40 An error in ending inventory of the current period will have a reverse effect on net income of the next accounting period. Ending inventory depends entirely on the accuracy of taking and costing the inventory. LO 3 Income Statement Effects 2016 Correct Incorrect Sales $ 80,000 $ 80,000 Illustration 6-17 Effects of inventory errors on two years' income statements 2017 Incorrect Correct $ 90,000 $ 90,000 Beginning inventory 20,000 20,000 12,000 15,000 Cost of goods purchased 40,000 40,000 68,000 68,000 Cost of goods available 60,000 60,000 80,000 83,000 Ending inventory 12,000 15,000 23,000 23,000 Cost of good sold 48,000 45,000 57,000 60,000 Gross profit 32,000 35,000 33,000 30,000 Operating expenses 10,000 10,000 20,000 20,000 Net income Combined income for 2-year period is correct. 6-41 $ 22,000 $ 25,000 ($3,000) Net Income understated $ 13,000 $ 10,000 $3,000 Net Income overstated LO 3 Income Statement Effects Question Understating ending inventory will overstate: a. assets. b. cost of goods sold. c. net income. d. owners' equity 6-42 LO 3 Balance Sheet Effects Effect of inventory errors on the balance sheet is determined by using the basic accounting equation: Assets = Liabilities + Owners' Equity. Errors in the ending inventory have the following effects. Illustration 6-18 Effects of ending inventory errors on balance sheet 6-43 LO 3 DO IT! 3 Inventory Errors Visual Company overstated its 2016 ending inventory by $22,000. Determine the impact this error has on ending inventory, cost of goods sold, and owners' equity in 2016 and 2017. Solution 2016 2017 Ending inventory $22,000 overstated No effect Cost of goods sold $22,000 understated $22,000 overstated Owners' equity $22,000 overstated No effect 6-44 LO 3 LEARNING OBJECTIVE 4 Explain the statement presentation and analysis of inventory. Presentation Balance Sheet - Inventory classified as current asset. Income Statement - Cost of goods sold is subtracted from sales. There also should be disclosure of the 1) major inventory classifications, 2) basis of accounting (cost or LCM), and 3) costing method (FIFO, LIFO, or average-cost). 6-45 LO 4 Lower-of-Cost-or-Net Realizable Value When the value of inventory is lower than its cost Net realizable value: Amount that a company expects to realize (receive from the sale of inventory). 6-46 Companies must \"write down\" the inventory to its net realizable value. Example of conservatism. LO 4 Lower-of-Cost-or-Net Realizable Value Illustration: Assume that Ken Tuckie TV has the following lines of merchandise with costs and market values as indicated. Illustration 6-20 Computation of lower-ofcost-or-net realizable value 6-47 LO 4 Statement Presentation and Analysis 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. 6-48 LO 4 Analysis Inventory turnover measures the number of times on average the inventory is sold during the period. Inventory Turnover = Cost of Goods Sold Average Inventory Days in inventory measures the average number of days inventory is held. Days in Inventory 6-49 = Days in Year (365) Inventory Turnover LO 4 Analysis Illustration: Wal-Mart reported in its 2014 annual report a beginning inventory of $43,803 million, an ending inventory of $44,858 million, and cost of goods sold for the year ended January 31, 2014, of $358,069 million. The inventory turnover formula and computation for Wal-Mart are shown below. Illustration 6-21 Days in Inventory: Inventory turnover of 8.1 times divided into 365 is approximately 45.1 days. This is the approximate time that it takes a company to sell the inventory. 6-50 LO 4 6-51 LO 4 DO IT! 4 LCNRV and Inventory Turnover Tracy Company 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 $ 84,000 $ 79,000 Wood 250,000 280,000 Pellet 112,000 101,000 Determine the value of the company's inventory under the lowerof-cost-or-net realizable value approach. Solution 6-52 Lowest value for each inventory type is gas $79,000, wood $250,000, and pellet $101,000. The total inventory value is the sum of these amounts, $430,000. LO 4 LEARNING OBJECTIVE 5 Illustration APPENDIX 6A: Apply the inventory cost flow methods to perpetual inventory records. Illustration 6A-1 Inventoriable units and costs Assuming the Perpetual Inventory System, compute Cost of Goods Sold and Ending Inventory under FIFO, LIFO, and average-cost. 6-53 LO 5 First-In, First-Out (FIFO) Perpetual Inventory System Cost of Goods Sold 6-54 Illustration 6A-2 Ending Inventory LO 5 Last-In, First-Out (LIFO) Perpetual Inventory System Cost of Goods Sold 6-55 Illustration 6A-3 Ending Inventory LO 5 Average-Cost Moving Average Method Cost of Goods Sold 6-56 Illustration 6A-4 Ending Inventory LO 5 LEARNING OBJECTIVE 6 APPENDIX 6B: Describe the two methods of estimating inventories. Gross Profit Method A method of estimating the cost of ending inventory by applying a gross profit rate to net sales. A company needs to know its net sales, cost of goods available for sale, and gross profit rate. 6-57 Illustration 6B-1 Gross profit method formulas LO 6 Gross Profit Method Illustration: Kishwaukee Company records show net sales of $200,000, beginning inventory $40,000, and cost of goods purchased $120,000. In the preceding year, the company realized a 30% gross profit rate. It expects to earn the same rate this year. Compute the estimated cost of the ending inventory at January 31 under the gross profit method. Illustration 6B-1 Illustration 6B-2 Example of gross profit method 6-58 Retail Inventory Method Retail companies establish a relationship between cost and sales price. Company applies cost-to-retail percentage to ending inventory at retail prices to determine inventory at cost. 6-59 Illustration 6B-3 Retail inventory method formulas LO 6 Retail Inventory Method Illustration: It is not necessary to take a physical inventory to determine the estimated cost of goods on hand at any given time. Illustration 6B-4 The major disadvantage of the retail method is that it is an averaging technique. It may produce an incorrect inventory valuation if the mix of the ending inventory is not representative of the mix in the goods available for sale. 6-60 LO 6 A Look at IFRS LEARNING OBJECTIVE 7 Compare the accounting for inventories under GAAP and IFRS. Relevant Facts Similarities IFRS and GAAP account for inventory acquisitions at historical cost and value inventory at the lower-of-cost-or-net-realizable value subsequent to acquisition. Who owns the goodsgoods in transit or consigned goodsas well as the costs to include in inventory are essentially accounted for the same under IFRS and GAAP. 6-61 LO 7 A Look at IFRS Relevant Facts Differences The requirements for accounting for and reporting inventories are more principles-based under IFRS. That is, GAAP provides more detailed guidelines in inventory accounting. A major difference between IFRS and GAAP relates to the LIFO cost flow assumption. GAAP permits the use of LIFO for inventory valuation. IFRS prohibits its use. FIFO and average-cost are the only two acceptable cost flow assumptions permitted under IFRS. Both sets of standards permit specific identification where appropriate. 6-62 LO 7 A Look at IFRS Looking to the Future One convergence issue that will be difficult to resolve relates to the use of the LIFO cost flow assumption. As indicated, IFRS specifically prohibits its use. Conversely, the LIFO cost flow assumption is widely used in the United States because of its favorable tax advantages. In addition, many argue that LIFO from a financial reporting point of view provides a better matching of current costs against revenue and, therefore, enables companies to compute a more realistic income. 6-63 LO 7 A Look at IFRS IFRS Self-Test Questions Which of the following should not be included in the inventory of a company using IFRS? a) Goods held on consignment from another company. b) Goods shipped on consignment to another company. c) Goods in transit from another company shipped FOB shipping point. d) None of the above. 6-64 LO 7 A Look at IFRS IFRS Self-Test Questions Which method of inventory costing is prohibited under IFRS? a) Specific identification. b) FIFO. c) LIFO. d) Average-cost. 6-65 LO 7 Copyright \"Copyright 2015 John Wiley & Sons, Inc. All rights reserved. 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