ADM1340 Ch6-Inventory

École de gestion TELFER

• School of Management

• Linked with Leadership

Chapter 6: Inventory

• Author: Shujun Ding, Ph.D.

Study Objectives

• Inventory Quantities: Describe the steps in determining inventory quantities.

• Cost Determination Methods: Apply methods like specific identification, FIFO, and average under a perpetual inventory system.

• Financial Statement Effects: Explain the effects of inventory cost determination methods.

• Presentation of Inventory: Demonstrate the presentation and analysis of inventory.

• Inventory Cost Formulas: Apply FIFO and average under a periodic inventory system (Appendix 6A).

Determining Inventory Quantities

• Physical Inventory Count: Necessary for both periodic and perpetual systems at the end of the period.

  • Checks accuracy of perpetual inventory records.

  • Determines inventory lost to shrinkage or theft.

Taking Inventory

• Importance of a good internal control system for accurate counts:

  • Employees counting inventory should not have custody or record-keeping duties.

  • Establish validity through counters and conduct a second count by another individual or auditor.

  • Use pre-numbered tags.

Ownership of Goods

• Considerations: Ownership must be determined during the inventory process.

• Goods in Transit: Determine legal title to inventory in transit.

  • Only include in inventory if the company has legal title.

Freight and Shipping Concepts

• Shipping Terms: FOB shipping point vs. FOB destination.

• Consigned Goods: Ownership remains with the consignor, not the consignee.

• Goods on Approval: Customers do not own goods until they are accepted.

Inventory Cost Determination Methods

• After counting quantities, apply unit costs to determine total inventory cost.

• Inventory units can be purchased at different prices; decision is required on which costs to use.

Specific Identification

• Characteristics: Tracks physical flow of goods, used in perpetual systems.

  • Applicable only when actual costs can be determined and items are easily distinguishable.

  • Useful for specific projects/productions.

Cost Formulas

• Cost formulas assume a flow of costs that may differ from physical flow.

  • FIFO (First-in, First-out): Oldest costs are recognized first.

  • Average: Cost determined using moving average of purchases.

FIFO Method

• Merchandise inventory recorded at most recent costs in current assets section of the financial position.

• Cost of goods sold recorded as an expense at oldest inventory cost on income statement.

• Ending inventory and COGS are consistent for periodic and perpetual systems.

Perpetual System Inventory Costing - FIFO

• Example Table: Records for purchases, COGS, and inventory balance.

Average Method

• Use when physical flow cannot be measured. Calculate a new weighted average after each purchase.

Cost Determination Method Considerations

• Choose a method that:

  • Represents physical flow of goods.

  • Reports ending inventory at recent costs.

  • Consistency in methods for similar inventory.

Advantages of Cost Determination Methods

• Specific Identification: Matches costs with revenues, tracks physical flow accurately.

• FIFO: Ending inventory reflects current costs, approximates retailer physical flow.

• Average: Smooths price changes by assigning the same average cost to all units.

Financial Statement Effects (Rising Prices)

• Income Statement: COGS dynamics with varying methods—Specific Identification (variable), FIFO (lowest), Average (highest).

• Statement of Financial Position: Report effects on cash, ending inventory, and retained earnings.

Lower of Cost and Net Realizable Value (LCNRV)

• Rule: Inventory is written down if net realizable value is less than cost.

• Application: Applies to individual items, reducing inventory accordingly, may reverse write-downs if conditions change.

Reporting Inventory

• Statement of Financial Position must reflect:

  • Lower of cost and NRV.

  • Notes include total inventory, COGS, determination methods, and amount of write-downs.

Inventory Management Ratios

• Methods to determine appropriate inventory levels:

  • Inventory Turnover Ratio: Measures sales frequency.

  • Days in Inventory Ratio: Indicates average days inventory held.

• Higher turnover and lower days in inventory are favorable.

Periodic Inventory Systems

• Both FIFO and Average can be used; allocations are made at the end of the period.

Example Periodic Systems

• Include tables for FIFO and Average calculations with respective steps for cost of goods available and sold.

Specific Identification Method Case Study

• Identifies cost of each sold item for unique inventory like art, luxury cars, etc.

Moving Average Method Example

• Calculation examples to show how unit costs are determined under this method.