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Focus on: Inventories—Module 10

INVENTORIES

Goods in Transit

Abnormal costs expensed in current period instead of being included in inventory:

Idle facility expense
Wasted materials in production
Double freight when items returned and redelivered

Cost of Goods Sold (COGS)

Beginning inventory

+ Net purchases

= Cost of goods available for sale

– Ending inventory

= Cost of goods sold (COGS)

Inventory Errors

Periodic versus Perpetual

	Periodic	Perpetual
Buy merchandise	Purchases	Inventory
	Accounts payable	Accounts payable
Sell merchandise	Accounts receivable	Accounts receivable
	Sales	Sales
		COGS sold (COGS)
		Inventory
Record COGS	Ending inventory (count)
	COGS (plug)
	Purchases (net amount)
	Beginning inventory (balance)

First in, first out (FIFO)—Same under either method

Last in, first out (LIFO)—Different amounts for periodic and perpetual

Average—Different amounts for periodic and perpetual

Periodic—Weighted average

Inventory Valuation Methods

FIFO Application—Valuing Cost Of Sales and Ending Inventory

The earliest purchased goods are assumed to be sold first

Cost of sales and ending inventory values are identical under perpetual and periodic methods

Example: Beginning inventory = 0; Ending Inventory = 15,000

Calculate the value of ending inventory and cost of sales:

Ending inventory = 15,000 units (given) = November 13,500 units × $6.50 + July 1,500 units × $6.00 = $96,750 (ending inventory consists of the latest purchased units).

Cost of sales: Total available – Ending inventory = $293,750 − 96,750 = $197,000

LIFO Application—Valuing Cost of Sales and Ending Inventory Using the Periodic Method

The earliest purchased goods are assumed to be sold last

Cost of sales and ending inventory values are different under perpetual and periodic methods

Example of periodic method: Beginning inventory = 0; Ending Inventory = 15,000

Calculate the value of ending inventory and cost of sales:

Ending inventory = 15,000 units (given) = January 10,000 units × $5.00 + April 1,500 units × $5.50 = $58,250 (ending inventory consists of earliest purchased units)

Cost of sales: Total available – Ending inventory = $293,750 − 58,250 = $235,500

Applying LIFO Layers

Step 1. Determine ending quantity.

Step 2. Compare to previous period’s ending quantity.

Step 3. Increases—Add new layer.

Step 4. Small decreases (less than most recent layer)—Reduce most recent layer.

Step 5. Large decreases (more than most recent layer)—Eliminate most recent layer or layers and decrease next most recent layer.

Step 6. Apply appropriate unit price to each layer.

For each layer:

Inventory quantity × Price per unit = Inventory value

Application of LIFO

Dollar-Value LIFO

Less cumbersome than LIFO for inventory consisting of many items

Combines inventory into pools

Increases in some items within a pool offset decreases in others

Applying Dollar-Value LIFO

Step 1. Determine ending inventory at current year’s prices

Step 2. Divide by current price level index to convert to base-year prices

Step 3. Compare to previous period’s ending inventory at base-year prices

Step 4. Increases—Add new layer at base-year prices

Step 5. Small decreases (less than most recent layer)—Reduce most recent layer

Step 6. Large decreases (more than most recent layer)—Eliminate most recent layer or layers and decrease next most recent layer

Step 7. Apply appropriate unit price to each layer

For each layer:

Application of Dollar-Value LIFO

Dollar-Value LIFO—Calculating a Price Level Index

Simplified LIFO—Company uses a published index

Lower of Cost or Market

Gross Profit Method for Estimating Inventory

Conventional Retail (Lower of Cost or Market)

IFRS: Inventory

LIFO not permissible
Lower of cost or net realizable value (LCNRV) on item-by-item basis
Biological assets carried at fair value less costs to sell at the point of harvest

LONG-TERM CONSTRUCTION CONTRACTS

Percentage of Completion

Use when:

Estimates of costs are reasonably dependable
Estimates of progress toward completion

Reporting profit

Recognized proportionately during contract
Added to construction in process

Balance sheet amount

Current asset—Excess of costs and estimated profits over billings
Current liability—Excess of billings over costs and estimated profits

Calculating profit

Step 1. Total profit

Contract price		xxx
Total estimated cost
Cost incurred to date (1)	xxx
Estimated cost to complete	+ xxx
Total estimated cost (2)		− xxx
Total estimated profit (3)		= xxx

Step 2. % of completion (Cost-to-cost method)

Costs incurred to date (1) ÷ Total estimated cost (2) = % of completion (4)

Step 3. Profit to date

% of completion (4) × Total estimated profit (3) = Estimated profit to date (5)

Step 4. Current period’s profit

Estimated profit to date (5) – Profit previously recognized = Current period’s profit

Recognizing Losses

When loss expected:

Estimated loss	xxx
+ Profit recognized to date	xxx
= Amount of loss to recognize	xxx

Completed Contract

Income statement amount

Profit recognized in period of completion
Loss recognized in earliest period estimable