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Lecture 12
Inventory Accounting
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Key Issues in Inventory Accounting
Inventory tracking systems
Inventory Valuation methods

Changes in inventory value
Costs included in inventory
Inventory related ratios
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Goals of Todays Class
Perpetual vs. periodic inventory
Accounting for use of inventory
FIFO
LIFO
LIFO Reserve
LIFO Liquidation
Weighted Average Cost
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Accounting for Acquisition
What we have seen so far:

Inventory XXX
Cash (or Accounts Payable) XXX

Accounting for Use of Inventory
What we have seen so far:

Cost of Goods Sold XXX
Inventory XXX

Issue: What number to assign to XXX ?
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Issues:
Since historical cost is used as the basis for
valuing inventories, then identical goods
purchased at different times may have
different values associated with them.
How do you decide between how much to
allocate for COGS and how much to
inventory?
There is also a timing issue as to when
inventory use should be recorded.
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Accounting for Use of Inventory
Perpetual vs. Periodic Inventory
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Timing: When should the Cost of Goods Sold be Recorded?
The Perpetual Method:

Both purchases and sales (use) of inventory are recorded as they occur.

Both the inventory account balance and the cost of goods sold (COGS)
account balance are always up to date, reporting the cost of inventories on
hand and the cost of goods sold to date, respectively.


The Periodic Method:

Purchases are recorded as they occur, but COGS are recorded only at the
end of the period (as an adjusting entry).

Thus, the inventory account balance and the COGS account balance are
only up to date at the end of the period, after the adjusting entry, to record
COGS, has been recorded and posted.

For financial reporting, most firms use the periodic method.
Perpetual Inventory System
This is what we been using so far.
Inventory is purchased:
Inventory XXX
A/P (or Cash) XXX
Inventory is sold:
A/R (or Cash) XXX
Revenue XXX
COGS XXX
Inventory XXX

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Under the periodic inventory method


Inventory
Purchases
Beg. Bal.
COGS
End Bal.
Cost of
goods
available
for sale
While, in general, the quantity of goods sold and the quantity of goods held
in the ending inventory are known, the cost of goods sold and the cost of
the ending inventory must be determined
Beg. Bal.
+ Purchases
= Available for Sale
End Bal
= COGS
In practice, however,
purchases are recorded
in a separate account
Perpetual vs. Periodic
Purchase:
Inventory 20
A/P 20
Sale:
COGS 15
Inventory 15

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Beginning inventory is $10. Purchase $20. Sell $15.
Perpetual Periodic
Purchase:
Purchases 20
A/P 20
Sale:
No entry
(Revenue still recorded)
Adjustment:
Inv. (Ending) 15
COGS 15
Purchases 20
Inv. (Beginning) 10


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Inventory Valuation Methods
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If there are identical items included in
goods available for sale that were
purchased at different costs, then we need
to answer the following questions:

1) Which costs are to be associated with
the ending inventory and which are to be
associated with the goods sold?

2) How does the answer to the above affect
financial reporting?

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How is the cost of goods sold to be determined?
How is the cost of the goods remaining after the sale to be
determined?
Three methods:

1. First-in, first-out (FIFO)
2. Last-in, first-out (LIFO)
3. Weighted average

FIFO is the most common inventory
valuation method in the US.
LIFO is prohibited under IFRS.

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FIFO
The cost of goods sold is derived using relatively
older costs.

The cost of the remaining inventory is the cost
of inventory acquired later in the period and,
therefore, more current relative to the end of the
period (the date of the financial reports).

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Example
Date Transaction Quantity Cost/unit Selling Price/unit

Year 1
1/1/1 Beginning Inv. 100 0.20
12/30/1 Purchase 100 0.45
12/31/1 Sale 70 0.70

Year 2
3/1/2 Purchase 20 0.50
12/2/2 Sale 130 0.80
12/31/2 Purchase 40 0.60

Year 3
12/30/3 Purchase 20 0.65
12/31/3 Sale 20 0.90
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FIFO
Cost of Goods Sold Cost of Ending
Inventory
Year 1
Year 2
Year 3
70 x .20 = 14

30 x .20 = 6

100 x .45 = 45

130 51
20 x .50 = 10
30 x .20 = 6

100 x .45 = 45

130 51

20 x .50 = 10

40 x .60 = 24

60 34

40 x .60 = 24

20 x .65 = 13

60 37

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FIFO
Thus, using FIFO, the reported income would
be:

Year 1 Year 2 Year 3
Sales Revenue 49 104 18
COGS (14) (51) (10)
Income 35 53 8
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LIFO
The cost of goods sold is derived using relatively
newer costs.

The cost of the remaining inventory is the cost
of inventory acquired earlier in the period and,
therefore, less current relative to the end of the
period (the date of the financial reports).
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Example
Date Transaction Quantity Cost/unit Selling Price/unit

Year 1
1/1/1 Beginning Inv. 100 0.20
12/30/1 Purchase 100 0.45
12/31/1 Sale 70 0.70

Year 2
3/1/2 Purchase 20 0.50
12/2/2 Sale 130 0.80
12/31/2 Purchase 40 0.60

Year 3
12/30/3 Purchase 20 0.65
12/31/3 Sale 20 0.90
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LIFO
Cost of Goods sold Cost of Ending
inventory
Year 1
Year 2
Year 3
70 x .45 = 31.50
40 x .60 = 24.00
20 x .50 = 10.00
30 x .45 = 13.50
40 x .20 = 8.00
130 55.50
20 x .65 = 13.00 60 x .20 = 12.00
100 x .20 = 20.00
30 x .45 = 13.50

130 33.50
60 x .20 = 12.00
(Periodic)
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LIFO
Cost of Goods sold Cost of Ending
inventory
Year 1
Year 2
Year 3
70 x .45 = 31.50
20 x .50 = 10.00
30 x .45 = 13.50
80 x .20 = 16.00
130 39.50
20 x .65 = 13.00
Same as Year 2
100 x .20 = 20.00
30 x .45 = 13.50

130 33.50
20 x .20 = 4.00
(Perpetual)
40 x .60 = 24.00
60 28.00
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With increasing costs (over time) and with inventory levels not
declining, the LIFO cost of goods sold will always exceed the
FIFO cost of goods sold.
Newer, higher costs are being allocated to COGS first under LIFO
Older, lower costs are being allocated to COGS first under FIFO
In this scenario the value of ending inventory under FIFO exceeds LIFO
Year 1 Year 2 Year 3
Sales Revenue 49 104 18
COGS (31.5) (55.5) (13)
Income 17.5 48.5 5
LIFO
Using LIFO (periodic), the reported income
would be:

LIFO Reserve
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LIFO Reserve is the difference between the FIFO and
the LIFO inventory
= FIFO Inventory LIFO Inventory

The change in the LIFO Reserve over any period is
equal to the difference between the FIFO and LIFO
COGS for that period.
LIFO Reserve = LIFO COGS FIFO COGS

Firms that use LIFO are required to disclose LIFO
reserve
LIFO reserve can be used to analyze the effect on
financial statements had the firm used FIFO


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Comparing the LIFO and FIFO Cost Flow Assumptions:
Total lifetime income must be the same under both LIFO and FIFO,
but, with inflation, NI
FIFO
> NI
LIFO
in almost every year.
Inventory (FIFO) - LIFO Reserve = Inventory (LIFO)
Beg. Bal 20.00 (From Periodic Example) Beg. Bal 20.00
+Purchases 45.00 +Purchases 45.00
- COGS 14.00 +Diff. in COGS 17.50 - COGS 31.50
=Yr1 Inv. 51.00 =LIFO Res. 17.50 =Yr1 Inv. 33.50
+Purchases 34.00 +Purchases 34.00
- COGS 51.00 +Diff. in COGS 4.50 - COGS 55.50
=Yr2 Inv. 34.00 =LIFO Res. 22.00 =Yr2 Inv. 12.00
+Purchases 13.00 +Purchases 13.00
- COGS 10.00 +Diff. in COGS 3.00 - COGS 13.00
=Yr3 Inv. 37.00 =LIFO Res. 25.00 =Yr3 Inv. 12.00
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To compare firms that use different methods, compute
financial statements of a LIFO firm as if it used FIFO for all
of its inventories

LIFO Reserve
The difference between a companys inventory valued at
LIFO and what it would be under FIFO
Represents the cumulative effect on COGS and Gross
Profit over the time that the company has been applying
LIFO

Change in LIFO Reserve represents the effect on COGS
and Gross Profit for a given year
Adjusting from LIFO to FIFO
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FIFO Inventory = LIFO Inventory + LIFO Reserve
Adjusting from LIFO to FIFO
FIFO COGS = LIFO COGS - LIFO Reserve
FIFO Gross Profit = LIFO Gross Profit + LIFO Reserve
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Lets consider what would happen if, in year 3, the firm were to
liquidate all of its inventory without buying anything more:
In this case, the FIFO cost of goods sold is greater than the LIFO cost of goods
sold exactly the opposite of what we saw earlier. And, the LIFO/FIFO
difference has been eliminated. WHY?
Over the life of the firm, the aggregate cost of goods available is fixed. Thus, over
the life of the firm, aggregate cost of goods sold is fixed (equal to the cost of
goods available) without regard for the inventory method used.
This illustrates that differences among the methods of accounting for
inventory will effect the timing of when the expense is to be recognized but
will not effect the aggregate amount.
Inventory - FIFO
37.00
37.00
0
Yr3
LIFO Reserve
25.00
25.00
0
Inventory - LIFO
12.00
12.00
0
Yr3
COGS COGS
LIFO Liquidation
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LIFO liquidation results when there is a decline in
inventory quantities.

Decline in inventories under LIFO results in older costs
being matched with current sales dollar.

This can results in inflated or illusory profits margins

LIFO liquidation profit is calculated as (current cost-
LIFO layer cost)*Quantity liquidated.

When LIFO liquidation profits are material, the SEC
requires that its income effect be reported.
LIFO Liquidation
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Consider a firm that had following layers in its LIFO inventory at the end of
year 2

LIFO Liquidation
Year of acquisition Units Cost per unit
1 100 $1
2 50 $2
Assume: (i) that cost per unit during year 3 is $3 per unit, (ii) firm
purchases 50 units during the year, (iii) firm sells 125 units during year 3.
This implies that firm needs to liquidate its older inventories by 75 units
(=125-50)
COGS (under LIFO) during year 3 = 50*3 + 50*2 +25*1 = 275
COGS based on current cost = 125*3 = 375

Gain in pre-tax income due to LIFO liquidation =

COGS based on current cost - COGS (under LIFO)
375 - 275 = 100

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Sharp increases in profit can result when old LIFO "layers"
are liquidated. Example: LIFO has been used for the past 5
years
Year 1 100 @ $20 = $2,000
Year 2 100 @ $20
+ 10 @ $22 = $2,220
Ending inventory: Year 3 100 @ $20
+ 10 @ $22
+ 10 @ $23 = $2,450
Year 4 100 @ $20 (from Year 1)
+ 10 @ $22 (from Year 2)
+ 10 @ $23 (from Year 3)
+ 20 @ $25 = $2,950
More on LIFO Layers & Liquidation
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In year 5, the cost of one unit of inventory is $30 and the sales price is
$60.

1) What is gross profit if during year 5 we first buy 50 units and then sell
140 units?

COGS = (50*$30) + (20*$25) + (10*$23) + (10*$22) + (50*$20)
=$3,450
Gross profit = Revenues COGS
= (140 * $60) 3,450 = $4,950


2) What is gross profit if during year 5 we do not buy any more units
and sell 140 units?

COGS = (20*$25) + (10*$23) + (10*$22) + (100*$20) = $2,950
Gross profit = Revenues COGS
= (140 * $60) 2,950 = $5,450
More on LIFO Layers & Liquidation
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Big Oil's Accounting Methods Fuel Criticism LIFO Leaves the Likes
of Exxon With Big Balance-Sheet Reserves as Gas-Pump Prices Slam
Drivers
By DAVID REILLY, Wall Street Journal

A string of record profits at Exxon Mobil Corp. has drawn howls from
some politicians, but earnings at the world's largest oil company
are, by at least one measure, understated. Like many U.S. oil
companies, Exxon uses an accounting method to value its
inventory that has the effect of raising the company's costs when
the price of oil is rising. Those higher costs lower net profit and
trim Exxon's tax bill.

In 2005, for example, the accounting method lifted Exxon's costs by $5.6
billion. If Exxon hadn't used this approach, a back-of-the-envelope
calculation shows its net profit could have neared $40 billion rather than
the $36.1 billion it reported.

There is nothing improper or even unusual about the method, known as
last-in, first-out -- or LIFO. Companies have used it since the 1930s, and
LIFO is permitted for both financial-reporting and tax purposes. But the
run-up in oil prices, which leads to higher LIFO-related costs, is fueling
debate within tax circles over its use. And lawmakers have tried to do away
with the accounting approach to increase the flow of revenue to the
government.
Inventories. Crude oil, products and merchandise inventories are carried at the lower of
current market value or cost (generally determined under the last-in, first-out method
LIFO). Inventory costs include expenditures and other charges (including depreciation)
directly and indirectly incurred in bringing the inventory to its existing condition and
location. Selling expenses and general and administrative expenses are reported as
period costs and excluded from inventory cost. Inventories of materials and supplies are
valued at cost or less.
..
.
.
In 2005, 2004 and 2003, net income included gains of $215 million, $227 million and
$255 million, respectively, attributable to the combined effects of LIFO inventory
accumulations and draw-downs. The aggregate replacement cost of inventories was
estimated to exceed their LIFO carrying values by $15.4 billion and $9.8 billion at
December 31, 2005, and 2004, respectively.
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ExxonMobil Example
Information from Notes from 10-K
Holding Gain
Gain on LIFO
liquidation
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COGS is calculated using a weighted
average of prior inventory costs.
It is a combination of FIFO and LIFO
After FIFO this is the next most common
inventory valuation method in the US.
Weighted Average Cost
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Example
Date Transaction Quantity Cost/unit Selling Price/unit

Year 1
1/1/1 Beginning Inv. 100 0.20
12/30/1 Purchase 100 0.45
12/31/1 Sale 70 0.70

Year 2
3/1/2 Purchase 20 0.50
12/2/2 Sale 130 0.80
12/31/2 Purchase 40 0.60

Year 3
12/30/3 Purchase 20 0.65
12/31/3 Sale 20 0.90
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Weighted Average
Cost of Goods Available
Weighted Average
Cost of Goods Sold
Weighted Average
Cost of Ending
Inventory

Year 1
Year 2
Year 3
(.20*100 + .45 *100)
200 = .325
70 x .325 = 22.75
130 x .325 = 42.25
(.325*130 + .50 *20
+.60*40) 190 = .4013

130 x .4013 = 52.17 60 x .4013 = 24.08
(.4013*60 + .65*20)
80 = .4635
20 x .4635 = 9.27 60 x .4635 = 27.81
Weighted Average Cost
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Year 1 Year 2 Year 3
Sales Revenue 49 104 18
COGS (22.75) (52.17) (9.27)
Income 26.25 51.83 8.73
Weighted Average Cost
Using Weighted Average Cost, the reported
income would be:

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For financial reporting purposes, firms may freely
choose any of the inventory methods weve
discussed. In fact, they can choose one method for
some inventories and another method for other
inventories.
If you were a manager, faced with rising costs
for the goods that your firm is selling, which
inventory method would you choose? Why?
If you were an investor or creditor, what
inventory method would you prefer that the
firm use?
For tax purposes (i.e. to compute taxable income)
in the United States, a firm may choose LIFO if
and only if it also uses LIFO for financial
reporting.
Financial Reporting vs. Tax Reporting
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Next class
More Inventory!
Lecture 13

Inventory Accounting for
Snap-On Tools
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Key Issues in Inventory Accounting
Inventory tracking systems
Inventory Valuation methods

Changes in inventory value
Costs included in inventory
Inventory related ratios
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Goals of Todays Class
Recap of Inventory Accounting
Practice Problem

Lower of Cost or Market Principle

What costs are to be included as inventory?

Case Study: Snap-On Tools

Inventory Ratios
RECAP
Cost of Beginning Inventory
+ Cost of Acquisitions
= Cost of Ending Inventory
+ Cost of Goods Sold/Used

Since historical cost is used as the basis for
valuing inventories, then identical goods
purchased at different times may have
different values associated with them.

Cost of Goods Available for Sale
Questions:
How is the cost of goods sold to be
determined?
How is the cost of the goods remaining
after the sale to be determined?

Methods for inventory valuation:
1. First-in, first-out (FIFO)
2. Last-in, first-out (LIFO)
3. Weighted average
Alternative Cost Flow Assumptions
FIFO
The cost of goods sold is derived using relatively
older costs.

The inventory costs are those which were
incurred later in the period and, therefore, are
more current relative to the end of the period
(the date of the financial reports).

This is the most common method in the U.S.


LIFO
The cost of goods sold is derived using relatively
newer costs.

The inventory costs are those which were
incurred earlier in the period and, therefore, are
stale relative to the end of the period (the date
of the financial reports).

LIFO can be used for tax purposes if and only if
LIFO is used for financial reporting purposes

COGS is calculated using a weighted
average of prior inventory costs.

It is a combination of FIFO and LIFO

After FIFO this is the next most common
inventory valuation method in the US.
Weighted Average Cost
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Practice
1. Compute the units in ending inventory.

Beginning Inventory: 200 units @ $16
Purchases: 600 units @ $17
800 units @ $20
Sales: 1,530 units @ $50
Ending Units = 200 + 600 + 800 1530 = 70 units

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Practice
2. Using FIFO, find Ending Inventory, COGS and Gross
Profit.

Ending Inventory: 70 units @ $20 = $1,400

COGS: (200 units @ $16) + (600 units @ $17) + (730 units @
$20) = $28,000

Gross Profit: Sales COGS = (1,530 units @ $50) 28,000 =
$48,500
Beginning Inventory: 200 units @ $16
Purchases: 600 units @ $17
800 units @ $20
Sales: 1,530 units @ $50
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Practice
3. Using LIFO, find Ending Inventory, COGS and Gross
Profit.

Ending Inventory: 70 units @ $16 = $1,120

COGS: (800 units @ $20) + (600 units @ $17) + (130 units @
$16) = $28,280

Gross Profit: Sales COGS = (1,530 units @ $50) 28,280 =
$48,220
Beginning Inventory: 200 units @ $16
Purchases: 600 units @ $17
800 units @ $20
Sales: 1,530 units @ $50
Practice
4. Using Weighted Average, find Ending Inventory, COGS
and Gross Profit.

Cost of Goods Available for Sale =
(200 * $16) + (600 * $17) + (800 * $20) = $29,400
# of Units Available for Sale = 200 + 600 + 800 = 1600
Weighted Average Cost per Unit = $18.375

Ending Inventory: (70 units) @ $18.375 = $1,286.25
COGS: (1,530 units @ $18.375) = $ 28,113.75
Gross Profit: Sales - COGS = (1,530 units* $50) - $28,113.75 =
$48,386.25
Beginning Inventory: 200 units @ $16
Purchases: 600 units @ $17
800 units @ $20
Sales: 1,530 units @ $50
Lower of Cost or Market
Principle
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The Lower of Cost or Market (LCM)
Requirement
If the current replacement cost of the inventory
is less than its historical cost, then the firm must
adjust the carrying value of the inventory from
historical cost to the lower market value.
Market typically means replacement cost, but
cannot exceed net realizable value (NRV)
NRV: selling price less selling costs

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Example
On December 31, ABC Company, using the FIFO
method, determined that the cost of its inventory
was $40,000. However, the current
replacement cost of those goods was $35,000.
In order to adjust the carrying value of its
inventory to the current market value
(replacement cost), ABC must make the
following entry:

Loss on Inventory Revaluation 5000
Inventory 5000
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Example
July 20, 2013:
Microsoft shares plunge over 11% after Microsoft Surface RT inventory
write-down, earnings shortfall

Shares of Microsoft plunged 11.4% on Friday, closing down $4.04 to $31.40. For Microsoft,
it was the sharpest one-day decline of the company's shares in 11 years and came after the
company reported its quarterly earnings. Yes, Microsoft earned nearly $5 billion for the
three month period, but a $900 million write-off of Microsoft Surface RT tablets held in
inventory rattled investors along with a gigantic 16 cents a share earnings shortfall for the
quarter. The Redmond based software giant reported 59 cents a share in earnings while
Wall Street's consensus was for 75 cents.



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The Lower of Cost or Market (LCM)
Requirement
However, if market values subsequently rise, the
firm CAN NOT adjust the carrying value of the
inventory upward (i.e. recognize a gain)

Conservatism principle (Lecture 2)
Recognize losses when anticipated but recognize gains only
when realized
i.e. recognize gains only when inventory sold
What costs are included in
inventory?
Purchase Returns, Allowances,
and Discounts
The other side of sales returns and
allowances.
Example:
Buy $120 of inventory, terms 2/10, n/30.
Return $20 worth of inventory on day 5.
Pay off balance on day 10.

Purchase Returns, Allowances,
and Discounts
Perpetual
Buy:
Inventory 120
A/P 120
Return:
A/P 20
Inventory 20
Pay:
A/P 100
Inventory 2
Cash 98

Periodic
Buy:
Purchases 120
A/P 120
Return:
A/P 20
Purchase Returns 20
Pay:
A/P 100
Purch. Discount 2
Cash 98

Purchase Returns, Allowances,
and Discounts
Periodic Cost of Goods Sold:
Beginning Inventory 200
+Purchases (gross) 120
-Purchase Returns 20
-Purchase Discounts 2
=Net Purchases 98
Goods Available for Sale 298
-Ending Inventory 150
=Cost of Goods Sold 148

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Manufacturing Inventory Costs
Manufacturing firms have 3 categories of
inventory:
1. Raw Materials
2. Work in Process
3. Finished Goods

Inventory costs include expenditures and other
charges (including depreciation) directly
incurred in bringing the inventory to its
sellable condition and location.



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Manufacturing Inventory Costs
1. Costs incurred in the manufacturing process, to produce goods for
resale, are capitalized as a cost of Work-in-Process Inventory
when they are incurred. These costs include:
Raw material expense
Direct Labor Expense
Depreciation of manufacturing-related equipments
Utilities expense related to manufacturing

2. Subsequently, those costs are transferred to the Finished Goods
inventory as production is completed and the goods become
available for sale.

3. It is only when the goods are sold and delivered to the customer
that the costs of producing them are expensed as a part of Cost of
Goods Sold.
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Manufacturing Inventory Costs
Harley Inc. manufactures and sells motorbikes. There are no
motorbikes at the start of the fiscal period on hand. During the
period they incurred the following costs:
Raw materials used $10,000
Wages for production staff $ 5,000
Wages for sales staff $ 4,000
Depreciation for Production PPE $ 2,500
Depreciation for Delivery PPE $ 1,000
All raw materials were purchased in prior periods and wages are yet
to be paid.
During the period, Harley Inc. produced 20 motorbikes with a cost
of $14,000. Some motorbikes are yet to be finished.
15 motorbikes were sold during the period
For each cost decide whether it should be capitalized or not and
record the events that occurred in the period.

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Harley completed
20 bikes with cost of
$14000 ($700 ea)
Harley sold 15 bikes
(cost $700 ea)
Case Study

Inventory Accounting for
Snap-On Tools



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Snap-Ons Financial Statements
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Snap-Ons Financial Statements
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Snap-Ons Financial Statements
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Snap-Ons Financial Statements
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FIFO Inventory = LIFO Inventory + LIFO Reserve
Adjusting from LIFO to FIFO
FIFO COGS = LIFO COGS - LIFO Reserve
FIFO Gross Profit = LIFO Gross Profit + LIFO Reserve
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Parsing Snap-Ons Financial
Statements
Snap-On uses LIFO
What is Snap-Ons LIFO reserve
What is the change in LIFO reserve

FIFO X = LIFO
X = LIFO Reserve
81.8
-14.0
Q1: What would the cost of goods sold have been in fiscal
year 2003 if Snap-On Tools had always used FIFO to
account for its inventory?
1,268.5
- (-14.0)
1,282.5
FIFO COGS = LIFO COGS - LIFO Reserve
Q2: What would the net earnings have been in fiscal year
2003 if Snap-On Tools had always used FIFO? Assume a
tax rate of 35%.
78.7
+ (-14.0)
69.6
FIFO Gross Profit = LIFO Gross Profit + LIFO Reserve
x (1-0.35)
Q3: Assume a tax rate of 35%. Determine the tax savings
from using LIFO rather than FIFO for:
a) fiscal year 2003.
b) for the life of the firm up to and including 2003.
a) LIFO Reserve = LIFO COGS FIFO COGS
-14.0 x 35% = -4.9 (Note that this is a cost!!)
b) LIFO Reserve = (LIFO COGS FIFO COGS)
81.8 x 35% = 28.63
Q4: Suppose that Snap-On Tools had always used the
FIFO basis. Under this assumption, by how much would
the firms 2003 Retained Earnings balance increase or
decrease? Assume that the tax rate of 35% is applicable
over the firms entire life.
LIFO Reserve = (LIFO COGS FIFO COGS)
= 81.8 higher cumulative pre-tax income
multiply by (1 - 35%)
= 53.17 higher cumulative net income
Inventory 81.8
Retained Earnings 53.17
Income Tax Payable 28.63
Q5: Current cost approximates the value of the inventory
on the FIFO basis. Why?
Because the more recent purchases (which are more
representative of the current cost) are what is reflected
in the ending inventory balance under FIFO.
83
When prices are INCREASING
FIFO
Highest ending inventory
Lowest cost of goods sold
Highest gross profit
LIFO
Lowest ending inventory
Highest cost of goods sold
Lowest gross profit
Weighted-Average
Results fall between
the extremes of FIFO
and LIFO
When prices are DECREASING
FIFO
Lowest ending inventory
Highest cost of goods sold
Lowest gross profit
LIFO
Highest ending inventory
Lowest cost of goods sold
Highest gross profit
Weighted-Average
Results fall between
the extremes of FIFO
and LIFO
FIFO
Better approximates Inventory:
Balance Sheet most correct
LIFO
Better approximates COGS:
Income Statement most
correct
Summary of Valuation Effects
Inventory Ratios
Gross Profit = Sales COGS
Gross Profit % = Gross Profit/Sales
Inventory Turnover = COGS/Avg. Inv
Days in Inventory = 365/Inv. Turnover
Inventory Ratios
Whole Foods (2013, in millions)
Gross Profit = 12,917 8,288 = 4,629
Gross Profit % = 4,629/12,917 = 35.8%
Inventory Turnover = 8,288/394 = 21.0
Days in Inventory = 365/21 = 17.4
Kroger (2013, in millions)
Gross Profit = 36,139 26,645 = 9,494
Gross Profit % = 9,494/36,139 = 26.3%
Inventory Turnover = 26,645/2,326 = 11.5
Next Class
Property, Plant & Equipment (PP&E)