Valuation
Valuation of
of Inventories:
Inventories:
A
A Cost-Basis
Cost-Basis Approach
Approach

Chapter

8
Intermediate Accounting
12th Edition
Kieso, Weygandt, and Warfield

Chapter
8-1

Prepared by Coby Harmon, University of California, Santa Barbara


Learning
Learning Objectives
Objectives
1.

Identify major classifications of inventory.

2.


Identify the major advantages and disadvantages of LIFO.

10.

Understand why companies select given inventory methods.

Chapter
8-2


Valuation
Valuation of
of Inventories:
Inventories:
Cost-basis
Cost-basis Approach
Approach
Inventory
Classification
and Control
Classification
Control
Basic
inventory
valuation
issues

Chapter
8-3


LIFO:
Special
Issues
LIFO reserve
LIFO
liquidation
Dollar-value
LIFO
Comparison of
LIFO
approaches
Advantages of
LIFO
Disadvantages
of LIFO

Basis for
Selection
Summary of
inventory
valuation
methods


Inventory
Inventory Classification
Classification and
and Systems
Systems
Classification

8-5

Balance Sheet (in thousands)
Current assets
Cash
Marketable securities
Accounts receivable
Merchandise inventory
Prepaids
Total current assets
Investments:
Invesment in ABC bonds
Investment in UC Inc.
Notes receivable
Land held for speculation
Sinking fund
Pension fund

$ 285,000
530,000
149,000
777,000
33,000
1,774,000
321,657
253,980
150,000
550,000
225,000
653,798

8-7

Illustration 8-2

LO 1 Identify major classifications of inventory.


Inventory
Inventory Classification
Classification and
and Systems
Systems
Control
Two systems for maintaining inventory records:
Perpetual system
Periodic system

Chapter
8-8

LO 2 Distinguish between perpetual and periodic inventory systems.


Inventory
Inventory Classification
Classification and
and Systems
Systems
Perpetual System
Features:


Purchases of merchandise are debited to Purchases.

2. Ending Inventory determined by physical count.
3. Calculation of Cost of Goods Sold:

Beginning inventory
$ 100,000
Purchases, net

Chapter
8-10

800,000
Goods available for sale

LO 2 Distinguish between perpetual and periodic inventory systems.


Inventory
Inventory Classification
Classification and
and Systems
Systems
Perpetual System

vs.

Periodic System



6,300

|

3. Sale of 600 untis at $14:

|
|

Accounts receivable
Sales
Cost of goods sold
Inventory

8,400

|

8,400
4,200

|

8,400

|

4,200


Inventory Valuation
Valuation
Valuation of Inventories
Requires the following:
The physical goods (goods on hand, goods in transit,
consigned goods, special sales agreements).
The costs to include (product vs. period costs).
The cost flow assumption (FIFO, LIFO, Average cost,
Specific Identification, Retail, etc.).

Chapter
8-12

LO 2 Distinguish between perpetual and periodic inventory systems.


Physical
Physical Goods
Goods Included
Included in
in Inventory
Inventory
Physical Goods
A company should record purchases when it
obtains legal title to the goods.
Special Consideration:
Goods in Transit (FOB shipping point, FOB destination)
Consigned goods
Sales with buyback agreement
Sales with high rates of return

Errors
Purchases and Inventory Understated

Illustration 8-8

The understatement does not affect cost of goods sold and net
income because the errors offset one another.

Chapter
8-15

LO 3 Identify the effects of inventory errors on the financial statements.


Costs
Costs Included
Included in
in Inventory
Inventory
Product Costs - costs directly connected with
bringing the goods to the buyer’s place of
business and converting such goods to a salable
condition.
Period Costs – generally selling, general, and
administrative expenses.
Purchase Discounts – Gross vs. Net Method

Chapter
8-16


Purchases
Accounts payable

19,600
19,600

|

Invoices of $15,000 are paid within discount period:
|

Accounts payable
Purchase discounts
Cash

15,000

|

300
14,700

|

Accounts payable
Cash

14,700
14,700




What
What Cost
Cost Flow
Flow Assumption
Assumption to
to Adopt?
Adopt?
FIFO

LIFO

Cost Flow Assumption Adopted
does not need to equal

Physical Movement of Goods

Average Cost

Specific Identification

Answer: Method adopted should be one
that most clearly reflects periodic income.
Chapter
8-18

LO 5 Describe and compare the cost flow assumptions
used to account for inventories.




Cost
Cost Flow
Flow Assumptions
Assumptions
“First-In-First-Out (FIFO)”
Inventory
Balance = $ 45
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-20

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax

2/2/07 for $10
Chapter
8-21

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

$ 90
10
80
14
12
7
33
47
14
$ 33


Total expenses
Income before tax
Taxes
Net Income

$ 90
0
90
14
12
7
33
57
17
$ 40

LO 5 Describe and compare the cost flow assumptions
used to account for inventories.


Cost
Cost Flow
Flow Assumptions
Assumptions
“Last-In-First-Out (LIFO)”
Inventory
Balance = $ 25
Purchase on
2/25/07 for $20
Purchase on

$ 26

LO 5 Describe and compare the cost flow assumptions
used to account for inventories.


Cost
Cost Flow
Flow Assumptions
Assumptions
“Average Cost”
Inventory
Balance = $ 45
Purchase on
2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-24

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative

2/25/07 for $20
Purchase on
2/15/07 for $15
Purchase on
2/2/07 for $10
Chapter
8-25

Young & Crazy Company
Income Statement
For the Month of Feb. 2007
Sales
Cost of goods sold
Gross profit
Expenses:
Administrative
Selling
Interest
Total expenses
Income before tax
Taxes
Net Income

$ 90
15
75
14
12
7
33