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ADMS 3585 (22)
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Chapter 8

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Department
Administrative Studies
Course
ADMS 3585
Professor
Liona Lai
Semester
Fall

Description
CHAPTER 8: INVENTORY Inventory Categories Merchandise inventory - ready for sale units that are unsold at the end of the fiscal period raw materials inventory - costs assigned to goods and materials on hand, but not yet placed into production work-in-process inventory - cost of the raw material on which production has been started but not completed, plus the direct labour cost applied specifically to this material, and an applicable share of manufacturing overhead costs finished goods inventory - reporting of the costs associated with the completed but unsold units at the end of the fiscal period cost of goods available for sale or use - total of (1) the cost of goods on hand at the beginning of the period + (2) the cost of the goods acquired or produced during the period cost of goods sold - difference between those available for sale during the period and those on hand at the end of the period COGS = beginning inventory + purchases – ending inventory Gross profit or net income = sales – COGS Reporting Ending Inventory 1. Determine inventory that should be included 2. Cost that should be included in inventory 3. Cost formula 4. Test for impairment Ending Inventory Effect on current year Effect on next year COGS Overstated Understated Net income Understated Overstated Understated Retained earnings Understated No effect Working capital Understated No effect Current ratio Understated No effect COGS Understated Overstated Net income Overstated Understated Retained earnings Overstated No effect Overstated Working capital Overstated No effect Current ratio Overstated No effect Correcting Inventory Errors Assume 2014 ending inventory is understated by $10,000 Error discovered before 2014 books are closed: Inventory 10,000 Cost of goods sold 10,000 Error discovered in 2015: Inventory 10,000 Retained Earnings 10,000 Error discovered in 2015 after 2015 books are closed: No journal entry, but comparative statements must use corrected figures for presentation purposes Example: 2014 - COGS = $1,400,000 R/E = $5,200,000 st December 31 inventory errors both discovered after 2014 books were closed: 2013: ending inventory overstated by $110,000 2014: ending inventory overstated by $45,000 2014 COGS = 2013 ending inventory + 2014 purchases - 2014 ending inventory over by 110,000 over by 45,000 = over by 65,000 (110,000 – 45,000) = 1,335,000 (1,400,000 – 65,000) Net income and retained earnings will be overstated by 45,000. 2014 Retained Earnings should be 5,155,000. Since the 2014 books have already been closed, journal entry to correct overstatement would be: Retained Earnings 45,000 Inventory 45,000 Inventories - “assets” o Held for sale in the ordinary course of business (finished goods) o In the process of production for such sale (work-in-process) o In the form of materials or supplies to be consumed in the production process or in the rendering of services (raw materials) - Represent a future benefit, which the entity has control over or access to - Recognition is through transaction arising from an inventory purchase and risks and rewards of ownership have passed to the purchaser Physical Goods Included in Inventory - generally determined by legal title to goods - purchase commitments should not be included, but should be disclosed if material Items included in seller’s inventory:  Goods in transit o FOB shipping point  legal title passes to the buyer when seller delivers the goods to the common carrier o FOB destination  legal title passes when the goods reach destination  Goods out on consignment o Possession is with consignee but legal title held by consignor  Goods sold under buyback agreements  Goods sold with high rates of return that cannot be estimated Inventory Cost - all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition o product costs  invoice, freight, and other direct acquisition costs; borrowing cost (interest expense) o conversion costs  direct labour and fixed and variable overhead (must always report actual costs but may use standard costs if they approximate actual costs) - does not include period costs (selling, general, and administrative) - purchase discounts - vendor rebates - “basket” purchases and joint product costs Purchase Discounts Assume Company A purchases goods for $10,000 with terms 2/10, net 30. Company A pays for $4,000 of this amount within the discount period and the rest after the discount period. Gross Method Net Method Purchase: Purchase: Purchases 10,000 Purchases 9,800 A/P 10,000 A/P 9,800 Payment w/in discount period: Payment w/in discount period: A/P 4,000 A/P 3,920 Purchase Discounts 80 Cash 3,920 Cash 3,920 Payment after discount period Payment after discount period A/P 5,880 A/P 6,000 Purchase Discounts Lost 120 Cash 6,000 Cash 6,000 E8-3 March 10 purchases = 25,000, 3/10 n/60 discount until march 20 11 purchases = 26,575, 1/15 n/30 discount until march 26 19 paid (25,000 x 97%) = 24,250 24 purchases = 11,500, 3/10 n/30 discount until april 3 a) net method March 10 Purchases 24,250 A/P 24,250 March 11 Purchases 26,309 A/P 26,309 March 19 A/P 24,250 Cash 24,250 March 24 Purchases 11,155 A/P 11,155 b) no purchase or payment transactions as at march 31 March 31 Purchase Discounts Lost 266 A/P 266 c) gross method March 10 Purchases 25,000 A/P 25,000 March 11 Purchases 26,575 A/P 26,575 March 19 A/P 25,000 Cash 24,250 Purchase Discounts 750 March 24 Purchases 11,500 A/P 11,500 d) no additional entries as at march 31 under the gross method e) net method is more theoretically correct and has faithful representation compared to gross method. Also, discounts lost can be tracked for a more effective cash management. However, gross method is more cost-effective. Vendor Rebates - cash rebates related to inventory generally recorded as a reduction to the cost of inventory - record as reduction to inventory if: o non-discretionary on part of supplier o probable and amount reasonably estimated BE8-6 a) volume rebate from Traders can only be accrued if (1) the rebate is non-discretionary on the part of Traders and (2) the receipt of the rebate is probable and its value can be reasonably estimated. b) Amount of rebate to be accrued at June 30, 2014 Current units on hand 3,000 Estimated number of units to be purchased 3,000 Less: number of units (3,500) Units that will qualify for rebate 2,500 Rebate = 2,500 x $0.25 = 625 Jun 30/14 rebate receivable 625 Inventory 625 c) Unit cost of wood frames Current inventory on hand (3,000 x $2.50) 7,500 Add: Estimated inventory to be purchased 7,500 Less: Rebate to be received (625) Total cost of inventory 14,375 Unit cost = 14,375/(3,000 + 3,000) = $2.40 per unit Basket Purchases and Joint Product Costs - total costs allocated to units based on relative sales value BE8-8 Group # of CDs price per CD total price % share cost allocated cost/unit 1 100 5 500 5 5% x 7,500 = $375 $3.75 2 800 10 8,000 80 80% x 7,500 = $6,000 $7.50 3 100 15 1,500 15 15% x 7,500 = $1,125 $11.25 total 1,000 10,000 100 $7,500 Inventory Accounting System Accurate inventory accounting system is important for:  ensuring availability of inventory items  preventing excessive accumulation of inventory items just-in-time (JIT) inventory order systems - helped reduce inventory levels (minimize storage costs) - only purchase inventory when needed - made to order; Dell, car manufacturers (customized) perpetual system - maintains a continuous record of inventory changes - costly to implement but gives up-to-date information at any given time periodic system - updates inventory records in the ledger only periodically - recommended for smaller businesses perpetual system periodic system Purchases, cost of freight, purchase returns, discountsPurchases, cost of freight, purchase returns, discounts are all directly debited to the Inventory account are debited to their respective accounts COGS and Inventory accounts are up to date COGS and Inventory accounts are updated after the physical inventory count Physical count is still required periodically to ensureCOGS is a residual amount physical stock = accounting stock COGS = beg. inventory + purchases – end. inventory BE8-3 Beginning inventory = 50 x $100 = $5,000 Sept purchase = 200 x $100 = $20,000 (AP) Sept purchase returns = 6 x $100 = $600 credit Sept sales = 150 x $200 = $30,000 (AR) Perpetual system: Purchase Inventory 20,000 A/P 20,000 Purchase returns A/P 600 Inventory 600 Sales A/R 30,000 Sales revenue 30,000 COGS (150 x $100) 15,000 Inventory 15,000 Periodic System: Purchase Purchases 20,000 A/P 20,000 Purchase returns A/P 600 Purchase returns 600 Sales A/R 30,000 Sales revenue 30,000 Month-end adj = ending inventory – beginning inventory = (94 – 50) x $100 = $4,400 COGS = 5,000 + (20,000 – 600) – 9,400 = 15,000 Month-end adj Inventory 4,400 Purchase returns 600 COGS 15,000 Purchases
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