Ending Inventory Considerations

• The 100 units from April 25 and January 1 are considered for ending inventory.
• LIFO (Last-In-First-Out) method starts with the last purchase first.
  • Results in increased cost of goods sold and decreased ending inventory.
  • Key advantage: favorable for tax reporting purposes due to increased expenses.
    • Decreasing net income leads to lower taxes due.

Weighted Average Cost Method

• Important to compute the weighted average unit cost.
• Formula for weighted average cost:
  • Weighted Average Cost per Unit =
    rac{ ext{Cost of Goods Available for Sale} }{ ext{Number of Units Available for Sale} }
• Example:
  • Cost of goods available for sale = 10,000
  • Number of units available for sale = 1,000
  • rac{10,000}{1,000} = 10 ext{ per unit}
• Multiply weighted average unit cost by cost of goods sold and unsold units to find totals for cost of goods sold and ending inventory.
• The totals should equal the cost of goods available for sale.

Comparison of Inventory Methods

• Differences between LIFO and FIFO methods:
  • LIFO:
    • Highest expense recognized.
    • Lowest asset reported, i.e., lowest ending inventory value.
  • FIFO:
    • Closest resemblance to actual physical flow of inventory.
    • Highest amount of assets (ending inventory) and lowest expenses.
• LIFO conformity rule:
  • If a company uses LIFO for tax reporting, it must also use LIFO for financial reporting.
• Example of Kroger:
  • Uses FIFO for inventory tracking but reports finances under LIFO.
  • Uses LIFO reserve to reconcile FIFO and LIFO values.

Inventory Systems

• Two primary inventory systems: perpetual and periodic.
• Perpetual Inventory System:
  • Continuously records inventory purchases and sales.
  • Managers require accurate records for decision-making on purchases, pricing, and employee management.
  • Enhanced by technological advancements, cost-effective, and preferred by most companies.
• Periodic Inventory System:
  • Does not keep continuous records; calculates inventory balance at the end of the period.
  • Relies on physical inventory counts, making it less common in practice.

Differences in Methods under FIFO and LIFO

• FIFO produces same amount of cost of goods sold and ending inventory regardless of the recording system used.
• LIFO requires adjusting entries to convert FIFO records at year-end to report LIFO amounts correctly.

Inventory Transaction Recording Examples

• Example of Mario’s Game Shop (FIFO approach):
  • Beginning inventory: 100 units
  • Purchased: 900 units
  • Sold: 800 units
• Purchase: Inventory purchase of $2,700 on account.
  • Increase Inventory: debit inventory $2,700.
  • Increase Liabilities: credit accounts payable $2,700.
• Sale: Sold inventory of 300 units for $4,500.
  • Recognize sale: debit accounts receivable $4,500, credit sales revenue $4,500.
  • Recognize cost: debit cost of goods sold, credit inventory (based on cost calculations).

Profit Calculation

• Gross Profit = Revenue - Cost of Goods Sold
• Example: Revenue of $4,500, Cost of Goods Sold = $2,500.
• Gross Profit = $4,500 - $2,500 = $2,000.

Inventory Account T-accounts

• Debits increase inventory (purchases), while credits decrease inventory (sales).
• Ending inventory should be reflected as a debit balance in T-account.

Shift to LIFO Method and Adjustments

• To report under LIFO, need year-end adjusting entry.
• LIFO adjustment involves:
  • Debiting cost of goods sold (increasing expense by the difference).
  • Crediting inventory (decreasing inventory by the same amount).

Additional Inventory Transactions

• Freight Charges:
  • Freight on incoming shipments increases inventory.
  • Freight on outgoing shipments is an operational expense.
• Purchase Discounts:
  • Discounts reduce purchase costs, decreasing cost of goods sold.
• Purchase Returns:
  • Returning items reduces inventory and accounts payable.

FOB Shipping Terms

• Important in recognizing when ownership transfers:
  • FOB Shipping Point: title passes when goods are shipped.
  • FOB Destination: title passes when goods reach the buyer’s location.

Inventory Analysis Comparing Companies

• Inventory Turnover Ratio: Shows times inventory is sold during a period.
  • Formula: Inventory Turnover = Cost of Goods Sold / Average Inventory
  • Interpretation: Higher ratio indicates quicker sales.
• Days in Inventory: Indicates the average number of days inventory is held.
  • Formula: Days in Inventory = 365 / Inventory Turnover Ratio
• Best Buy vs. Tiffany’s:
  • Best Buy: Higher turnover (about 6.3) and lower days in inventory.
  • Tiffany’s: Lower turnover (about 0.7) due to nature of luxury goods.
• Gross Profit Ratio: Indicates profitability.
  • Formula: Gross Profit Ratio = Gross Profit / Net Sales
  • Example Comparison: Best Buy (23%) vs. Tiffany’s (62%).

Conclusion

• Both inventory management and transaction recognition are crucial for effective financial reporting.
• Understanding these concepts helps provide insights into a company's operational efficiency and profitability.