Notes on Inventory Costing

Chapter 6: Inventory Costing

Learning Objective 6

• Demonstrate the presentation and analysis of inventory.

Classifying and Reporting Inventory

• Dependence on Type of Company:
  • Merchandiser:
  • Buys its inventory.
  • Only one classification used for inventory.
  • Manufacturer:
  • Produces its inventory.
  • Classified into three categories:
    • Raw Materials: Basic materials that have not yet been processed.
    • Work in Process (WIP): Costs for partially finished goods that are still in production.
    • Finished Goods: Completed products ready for sale.
• Asset Classification:
  • Typically recorded as a Current Asset on the balance sheet.
  • Can be classified as a Non-current Asset if it will not be sold within one year.

Analysis of Inventory

• Balancing Competing Objectives:
  • Excessive Inventory:
  • Leads to high carrying costs (costs associated with storing and managing inventory).
  • Insufficient Inventory:
  • May result in lost sales opportunities.
• Ratios for Inventory Analysis:
  • Used to determine if a company has too much or too little inventory:
  • Inventory Turnover Ratio
  • Days Sales in Inventory

Inventory Turnover Ratio

• Formula:
  • \text{Inventory Turnover Ratio} = \frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}
• Interpretation:
  • Represents the number of times inventory "turns over" during a given period.
  • A higher turnover indicates more efficient sales made from inventory.
• Average Inventory Calculation:
  • Typically calculated as the average of beginning and ending inventories for the period in consideration.

Days Sales in Inventory

• Formula:
  • \text{Days Sales in Inventory} = \frac{\text{Days in Year}}{\text{Inventory Turnover}}
• Interpretation:
  • Indicates the average number of days that inventory is held before it is sold.
  • Useful for comparisons over multiple years and against industry averages.