Inventories

Why is Inventory Control

Important?

Inventory is a significant asset and for many companies the largest asset.

Inventory is central to the main activity of merchandising and manufacturing companies.

Mistakes in determining inventory cost can cause critical errors in financial statements.

Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.

Receiving

report

Purchase

order

Invoice

AGREE

JOURNAL

Description Nov. 9

Post.

Ref. Date

Inventory 1 222 00

Accounts Payable--XYZ Co. 1 222 00 Purchased merchandise on

account.

LIABILITIES

OWNER’S

EQUITY

REVENUES

ASSETS

COSTS &

EXPENSES

Effect of Inventory Errors on

Financial Statements

Merchandise

Inventory

Cost of

Merchandise Sold

If merchandise inventory is . . . . . . .

Cost of merchandise sold is . . . . . .

Gross profit and net income are . . .

Ending owner’s equity is . . . . . . . . .

overstated

understated

overstated

overstated

Net Income

If merchandise inventory is . . . . . . .

Cost of merchandise sold is . . . . . .

Gross profit and net income are . . .

Ending owner’s equity is . . . . . . . . .

understated

overstated

understated

understated

Effect of Inventory Errors on

Financial Statements

Purchased

goods

Sold

goods

Inventory Cost Flow

Assumptions

Purchased

goods

Sold

goods

Inventory Cost Flow

Assumptions

Purchased

goods Sold

goods

Inventory Cost Flow

Assumptions

Inventory Costing Methods

40%

30%

20%

10%

0%

43%

34%

19%

4%

Fifo Lifo Average Other

Perpetual Inventory Costs

Inventory cost data to demonstrate

FIFO and LIFO Perpetual Systems

Cost of

Mdse. Sold

Item 127B Units Cost Price

Jan. 1 Inventory 10 $20

4 Sale 7 $30

10 Purchase 8 21

22 Sale 4 31

28 Sale 2 32

30 Purchase 10 22

FIFO ( Cost Accounting)

• FIFO is most useable technique of valuation of material issue in manufacturing and trading industries.

• It means First in, First Out.

• We will send that material for production first which we bought first.

• We also record the cost of issue on this basis.

• Closing stock's value in store will be the purchase value of material which we purchased at the end.

• This system of valuation of cost is very useful where there is the trend of decreasing prices, because we will charge high cost to the units which we bought earlier to new.

• But this method is not useful in the trend of increasing prices.

Merits of FIFO Method

• This method is very logical because material should be issued first which we bought first.

• Because we issue the material at its purchase price, so closing stock can be calculated correctly.

• Closing stock's cost automatically shows the market price.

Demerits of FIFO Method

• In case, there is fluctuation in prices, we can not calculate correct cost of material issued.

• We also can not compare on job's cost with other job's cost in case prices are fluctuating.

• This is not good method in inflation.

Item 127B

FIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

The firm begins the year with 10

units of Item 127B on hand at a

total cost of $200.

Inventory cost data to demonstrate

FIFO and LIFO Perpetual Systems

Cost of

Mdse. Sold

Item 127B Units Cost Price

Jan. 1 Inventory 10 $20

4 Sale 7 $30

10 Purchase 8 21

22 Sale 4 31

28 Sale 2 32

30 Purchase 10 22

FIFO Perpetual Inventory Account

On January 4, 7 units of Item

127B are sold at $30 each.

Item 127B

FIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

The sale of 7 units leaves a

balance of 3 units.

Jan. 1 10 20 200

4 7 20 140 3 20 60

Jan. 1 10 20 200

On January 4, 7 units of Item

127B are sold at $30 each.

Inventory cost data to demonstrate

FIFO and LIFO Perpetual Systems

Cost of

Mdse. Sold

Item 127B Units Cost Price

Jan. 1 Inventory 10 $20

4 Sale 7 $30

10 Purchase 8 21

22 Sale 4 31

28 Sale 2 32

30 Purchase 10 22

FIFO Perpetual Inventory Account

On January 10, the firm purchased

eight units at $21 each.

Item 127B

FIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 3 20 60

8 21 168

On January 10, the firm

purchased eight units at $21 each.

Because the purchase price of $21 is

different than the cost of the previous 3

units on hand, the inventory balance of

11 units is accounted for separately.

Inventory cost data to demonstrate

FIFO and LIFO Perpetual Systems

Cost of

Mdse. Sold

Item 127B Units Cost Price

Jan. 1 Inventory 10 $20

4 Sale 7 $30

10 Purchase 8 21

22 Sale 4 31

28 Sale 2 32

30 Purchase 10 22

FIFO Perpetual Inventory Account

On January 22, the firm sold

four units for $31 each.

Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 3 20 60

8 21 168

FIFO Perpetual Inventory Account

22 3 20 60

1 21 21 7 21 147

Of the four units sold, three are

from the first units in (fifo) at a

cost of $20.

On January 22, the

firm sold four units

for $31 each.

FIFO Perpetual Inventory Account

On January 28, the firm

sold two units at $32.

Inventory cost data to demonstrate

FIFO and LIFO Perpetual Systems

Cost of

Mdse. Sold

Item 127B Units Cost Price

Jan. 1 Inventory 10 $20

4 Sale 7 $30

10 Purchase 8 21

22 Sale 4 31

28 Sale 2 32

30 Purchase 10 22

Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 3 20 60

8 21 168

FIFO Perpetual Inventory Account

22 3 20 60

1 21 21 7 21 147

28 2 21 42 5 21 105

On January 28, the firm

sold two units at $32.

FIFO Perpetual Inventory Account

On January 30, purchased ten additional

units of Item 127B at $22 each.

Inventory cost data to demonstrate

FIFO and LIFO Perpetual Systems

Cost of

Mdse. Sold

Item 127B Units Cost Price

Jan. 1 Inventory 10 $20

4 Sale 7 $30

10 Purchase 8 21

22 Sale 4 31

28 Sale 2 32

30 Purchase 10 22

Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 3 20 60

8 21 168

FIFO Perpetual Inventory Account

22 3 20 60

1 21 21 7 21 147

28 2 21 42 5 21 105

30 10 22 220 5 21 105

10 22 220

Totals 18 $388 13 $263 15 $325

On January 30, purchased

ten additional units of Item

127B at $22 each.

What is LIFO

• In this method of valuation of inventory, we calculate the inventory issue cost by reverse order.

• It means that we charge old quantities price first for issue of material and then new prices will be charged.

• It is just opposite of FIFO. It is most suitable in inflation of prices.

• In other words, LIFO is last-in, first-out, meaning that the most recently purchased items are recorded as issued for production first from store.

• If LIFO is used for calculating the cost of goods sold and closing stock, then it will calculated for calculating correct gross and net profit.

• At that time, we take last (latest) purchase price for sold material first time.

Item 127B

LIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

The firm begins the year with

10 units of Item 127B on

hand at a total cost of $200.

Item 127B

LIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

4 7 20 140 3 20 60

On January 4, the firm sold

7 units at $30 each.

Item 127B

LIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 3 20 60

8 21 168

On January 10, the

firm purchased eight

units at $21 each.

Note that a new

layer is formed.

Item 127B

LIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 3 20 60

8 21 168

On January 22, the

firm sells four

units at $31 each.

22 4 21 84 3 20 60

4 21 84

Of the 4 units sold, all come

from the most recent purchase

at a cost of $21 each.

Item 127B

LIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 3 20 60

8 21 168

On January 28, sold

two units at $32 each.

22 4 21 84 3 20 60

4 21 84

28 2 21 42 3 20 60

2 21 42

Item 127B

LIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 3 20 60

8 21 168

On January 30, purchase

10 units at $22 each.

22 4 21 84 3 20 60

4 21 84

28 2 21 42 3 20 60

2 21 42

30 10 22 220 3 20 60

2 21 42

10 22 220

Item 127B

LIFO Perpetual Inventory Account

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost

Jan. 1 10 20 200

4 7 20 140 3 20 60

10 8 21 168 3 20 60

8 21 168

22 4 21 84 3 20 60

4 21 84

28 2 21 42 3 20 60

2 21 42

30 10 22 220 3 20 60

2 21 42

10 22 220

Totals 18 $388 13 $266 15 $322

Fifo

Periodic

Jan. 1 Beginning

Inventory 200 units @ $9

Mar. 10 Purchase 300 units @ $10

400 units @ $11 Sept. 21 Purchase

100 units @ $12 Nov. 18 Purchase

1,000 units available

for sale during

year

Fifo Periodic

Fifo Periodic

200 units @ $9

300 units @ $10

400 units @ $11

100 units @ $12

1,000 units available

for sale during

year

$10,400

= $1,800 Jan. 1

= 3,000 Mar. 10

= 4,400 Sept. 21

= 1,200 Nov. 18

Cost of merchandise

available for sale

Fifo Periodic

A physical count on

December 31 reveals that

700 of the 1,000 units

have been sold.

Using fifo, the first units

purchased are theoretically the

first units sold. We begin the

count with January 1.

Fifo Periodic

200 units @ $9

300 units @ $10

400 units @ $11

100 units @ $12

1,000 units available

for sale during

year

$10,400

= $1,800 Jan. 1

= 3,000 Mar. 10

= 4,400 Sept. 21

= 1,200 Nov. 18

Sold these 200

Sold these 300

Sold 200 of these 200 units @ $11

= $ 0 Jan. 1

= 0 Mar. 10

= 2,200 Sept. 21

$ 3,400

Ending inventory

Cost of merchandise available for

sale $10,400

Less ending inventory 3,400

Cost of merchandise sold $ 7,000

Fifo Periodic

Jan. 1

200 units at $9

Summary of Fifo Periodic

Mar. 10

300 units at $10

Sep. 21

400 units at $11

Nov. 18

100 units at $12

$1,800

$3,000

$4,400

$1,200

Purchases

Merchandise Available for Sale

$1,800

$3,000

$2,200

Cost of Merchandise

Sold

200 units at $9

$10,400 $2,200

$1,200

$7,000

Merchandise Inventory

$3,400

300 units at $10

200 units at $11

200 units at $11

100 units at $12 1,000 units

700 units

300 units

Lifo

Periodic

Jan. 1 Beginning

Inventory 200 units @ $9

Mar. 10 Purchase 300 units @ $10

400 units @ $11 Sept. 21 Purchase

100 units @ $12 Nov. 18 Purchase

1,000 units available

for sale during

year

Lifo Periodic

Using lifo, the most recent batch

purchased is considered the first

batch of merchandise sold.

Jan. 1 Beginning

Inventory 200 units @ $9

Mar. 10 Purchase 300 units @ $10

400 units @ $11 Sept. 21 Purchase

100 units @ $12 Nov. 18 Purchase

1,000 units available

for sale during

year

Lifo Periodic

Assume again that

700 units were sold

during the year.

200 units @ $9

300 units @ $10

400 units @ $11

100 units @ $12

1,000 units available

for sale during

year

Lifo Periodic

Sold these 100

Sold these 400

Sold 200 of these 100 units @ $10

= $1,800 Jan. 1

= 3,000 Mar. 10

= 4,400 Sept. 21

= 1,200 Nov. 18

$10,400

0

0

1,000

Ending Inventory

$2,800

Cost of merchandise available for

sale $10,400

Less ending inventory 2,800

Cost of merchandise sold $ 7,600

Lifo Periodic

Jan. 1

200 units at $9

Summary of Lifo Periodic

Mar. 10

300 units at $10

Sep. 21

400 units at $11

Nov. 18

100 units at $12

$1,800

$3,000

$4,400

$1,200

$1,800

$1,000

Cost of Merchandise

Sold

200 units at $9

$10,400

$4,400

$1,200

$2,800

$7,600

100 units at $10

200 units at $10

400 units at $11

100 units at $12

$2,000

700 units

1,000 units

300 units

Purchases

Merchandise Available for Sale

$1,800

Cost of Merchandise Sold

Jan. 1 Beginning

Inventory 200 units @ $9

Mar. 10 Purchase 300 units @ $10

400 units @ $11 Sept. 21 Purchase

100 units @ $12 Nov. 18 Purchase

1,000 units available

for sale during

year

The average cost

periodic method is based

on the average cost of

identical units.

Average Cost Periodic

Average Cost Periodic

200 units @ $9 = $ 1,800

1,000 units available

for sale during

year

300 units @ $10 = $ 3,000

400 units @ $11 = $ 4,400

100 units @ $11 = $ 1,200

$10,400 Cost of merchandise available for sale

Cost of Merchandise

Available for Sale

Units Available for Sale

During Year

= Average Unit Cost

$10,400

1,000 Units = $10.40 per Unit

Average Cost Periodic

Cost of merchandise available for sale $10,400

Less ending inventory ($10.40 x 300) 3,120

Cost of merchandise sold $ 7,280

To verify this

amount, multiply

700 units sold

times $10.40 to get

the same $7,280.

Average Cost Periodic

$ 3,800

2,700

4,650

3,920

Total $15,520 $15,472 $15,070

Valuation of Inventory at

Lower-of-Cost-or-Market

A 400 $10.25 $ 9.50 $ 4,100 $ 3,800

B 120 22.50 24.10 2,700 2,892

C 600 8.00 7.75 4,800 4,650

D 280 14.00 14.75 3,920 4,130

Unit Unit

Inventory Cost Market Total Total Lower

Item Quantity Price Price Cost Market C or M

The market decline based on individual items

($15,520 – $15,070) = $450

Assets

Current assets:

Cash $ 19 400 00

Accounts receivable $80 000 00

Less allowance for

doubtful accounts 3 000 00 77 000 00

Merchandise inventory

at lower of cost (first-in,

first-out method) or market 216 300 00

Metro-Arts Balance Sheet December 31, 2007

Presentation of Merchandise Inventory

on the Balance Sheet

The End