7 Inventories.

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7

InventoriesInventories


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1. Describe the importance of control over inventory.

2. Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet.

After studying this chapter, you should be able to:


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3. Determine the cost of inventory under the perpetual system, using the FIFO, LIFO, and average cost methods.


4. Determine the cost of inventory under the periodic system, using the FIFO, LIFO, and average cost methods.5. Compare and contrast the use of the three inventory costing methods.


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6. Describe and illustrate the reporting of merchandise inventory in the financial statement.


7. Estimate the cost of inventory using the retail method and the gross profit method.


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Describe the importance of control over inventory.

Objective 1Objective 1

7-1


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7-1

Two primary objectives of control over inventory are:1) Safeguarding the inventory, and

2) Properly reporting it in the financial statements.


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7-1

Controls over inventory include developing and using security measures to prevent

inventory damage or customer or employee theft.


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7-1

To ensure the accuracy of the amount of inventory reported in

the financial statements, a merchandising business should

take a physical inventory.


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Describe three inventory cost flow assumptions and how they

impact the income statement and balance sheet.


7-2


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1010

7-2Inventory Costing Methods


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7-2

(Continued)


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7-2

(Continued)


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(Concluded)


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400

300

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371

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130

FIFO LIFO Average cost

Inventory Costing Methods 7-2

Number of firms (> $1B Sales)


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7-2-Example Exercise 7-1

The three identical units of Item QBM are purchased during February, as shown below.

Feb. 8 Purchase 1 $ 4515 Purchase 1 4826 Purchase 1 51

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Item QBM Units Cost

Assume that one unit is sold on February 27 for $70.

Determine the gross profit for February and ending inventory on February 28 using (a) first-in, first-out (FIFO); (b) last-in, first-out (LIFO); and (c) average cost methods.

Total 3 $144 Average cost per unit $48 ($144 ÷ 3 units)


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Follow My Example 7-1

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7-2

For Practice: PE 7-1A, PE 7-1B

Gross Profit Ending Inventory

(a) First-in, first-out (FIFO): $25 ($70 – $45) $99 ($48 – $51)

(b) Last-in, first-out (LIFO): $19 ($70 – $51) $93 ($45 + $48)

(c) Average cost: $22 ($70 – $48) $96 ($48 x 2)

$144/3 units


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Determine the cost of inventory under the perpetual

inventory system, using FIFO, LIFO, and average

cost methods.


7-3


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On January 1, the firm had 100 units of Item 127B that cost $20 per unit.

7-3FIFO Perpetual

Item 127B Units Cost

Jan. 1 Inventory 100$20


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1919

7-3FIFO Perpetual

On January 4, the firm sold 70 units of 127B at $30 each.



4 Sale 70


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7-3FIFO Perpetual

On January 22, the firm sold twenty units at $30.

4 Accounts Receivable 2 100 00Sales 2 100 00

4 Cost of Merchandise Sold 1 400 00Merchandise Inventory 1 400 00


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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

4 70 20 1,400 30 20 600

7-3FIFO Perpetual

Jan. 1 100 20 2,000


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2222

On January 10, the firm purchased 80 units at $21 each.

7-3FIFO Perpetual



4 Sale 70

10 Purchase 80 21


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10 Merchandise Inventory 1 680 00Accounts Payable 1 680 00


7-3FIFO Perpetual


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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

10 80 21 1,680 30 20 60080 21 1,680

7-3FIFO Perpetual


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On January 22, the firm sold 40 units for $30 each.

7-3FIFO Perpetual



4 Sale 70

10 Purchase 80 2122 Sale 40


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7-3FIFO Perpetual



22 Cost of Merchandise Sold 810 00Merchandise Inventory 810 00


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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

10 80 21 1,680 30 20 60080 21 1,680

22 30 20 60010 21 210 70 21 1,470

7-3FIFO Perpetual

Of the forty sold, thirty are considered to be from those acquired at $20 each. The other ten are

considered to be from the January 10 purchase.


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On January 28, the firm sold 20 units at $30 each.

7-3FIFO Perpetual



4 Sale 70


28 Sale 20 28


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7-3FIFO Perpetual

28 Accounts Receivable 600 00Sales 600 00




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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

10 80 21 1,680 30 20 60080 21 1,680

22 30 20 60010 21 210 70 21 1,470

28 20 21 420 50 21 1,050

7-3FIFO Perpetual


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4 Sale 70


28 Sale 20

30 Purchase 100 22

7-3FIFO Perpetual

On January 30, purchased ten additional units of Item 127B at $22 each.


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On January 30, purchased ten additional units of Item 127B at $22 each.

7-3FIFO Perpetual



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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

10 80 21 1,680 30 20 60080 21 1,680

22 30 20 60010 21 210 70 21 1,470

28 20 21 420 50 21 1,05030 100 22 2,200 50 21 1,050

100 222,200

7-3FIFO Perpetual


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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

10 80 21 1,680 30 20 60080 21 1,680

22 30 20 60010 21 210 70 21 1,470

28 20 21 420 50 21 1,05030 100 22 2,200 50 21 1,050

100 222,200

7-3FIFO Perpetual

Cost of merchandise sold for January is $2,630.


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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

10 80 21 1,680 30 20 60080 21 1,680

22 30 20 60010 21 210 70 21 1,470

28 20 21 420 50 21 1,05030 100 22 2,200 50 21 1,050

100 222,200

7-3FIFO Perpetual

January 31, inventory is $3,250 ($1,050 + $2,200)

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7-3-

Example Exercise 7-2

Beginning inventory, purchases, and sales for Item ER27 are as follows:

Nov. 1 Inventory 40 units at $55 Sale 32 units

11 Purchase 60 units at $721 Sale 45 units

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Assuming a perpetual inventory system and the first-in, first-out (FIFO) method, determine (a) the cost of the merchandise sold for the November 21 sale and (b) the inventory on November 30.


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a) Cost of merchandise sold: 8 units @ $5 $4037 units @ $7 25945 units $299

b) Inventory, November 30:

$161 = (23 units x $7)


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On January 1, the firm had 100 units of Item 127B that cost $20 per unit.

7-3LIFO Perpetual




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7-3LIFO Perpetual




4 Sale 70


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7-3LIFO Perpetual



4 Cost of Merchandise Sold 1 400 00Merchandise Inventory 1 400 00


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Item 127B



4 70 20 1,400 30 20 600

7-3LIFO Perpetual

Jan. 1 100 20 2,000


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7-3LIFO Perpetual



4 Sale 70

10 Purchase 80 21


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7-3LIFO Perpetual


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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

10 80 21 1,680 30 20 60080 21 1,680

7-3LIFO Perpetual


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4545


7-3LIFO Perpetual



4 Sale 70



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7-3LIFO Perpetual





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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

10 80 21 1,680 30 20 60080 21 1,680

22 40 21 840 30 20 60040 21 840

7-3LIFO Perpetual

All of the 40 sold are considered to be from the January 10 purchase.


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7-3LIFO Perpetual

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4 Sale 70


28 Sale 20


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7-3LIFO Perpetual

28 Accounts Receivable 600 00Sales 600 00




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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

28 20 21 420 30 20 60020 21 420

7-3LIFO Perpetual

22 40 21 840 30 20 60040 21 840

10 80 21 1,680 30 20 60080 21 1,680

All of the 20 sold are considered to be from the January 22 purchase.


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4 Sale 70


28 Sale 20

30 Purchase 100 22

7-3LIFO Perpetual

On January 30, the firm purchased one hundred additional units of Item 127B at $22 each.


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On January 30, the firm purchased one hundred additional units of Item 127B at $22 each.

7-3LIFO Perpetual



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7-3LIFO Perpetual

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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

28 20 21 420 30 20 60020 21 420

7-3LIFO Perpetual

22 40 21 840 30 20 60040 21 840

10 80 21 1,680 30 20 60080 21 1,680

30 100 22 2,200 30 20 60020 21 420

100 22 2,200


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7-3LIFO Perpetual

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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

28 20 21 420 30 20 60020 21 420

7-3LIFO Perpetual

22 40 21 840 30 20 60040 21 840

10 80 21 1,680 30 20 60080 21 1,680

30 100 22 2,200 30 20 60020 21 420

100 22 2,200Cost of merchandise sold $2,660Cost of merchandise sold $2,660


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7-3LIFO Perpetual

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Item 127B



Jan. 1 100 20 2,0004 70 20 1,400 30 20 600

28 20 21 420 30 20 60020 21 420

7-3LIFO Perpetual

22 40 21 840 30 20 60040 21 840

10 80 21 1,680 30 20 60080 21 1,680

30 100 22 2,200 30 20 60020 21 420

100 22 2,200

January 31, inventory….. $3,220January 31, inventory….. $3,220


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7-3-


Beginning inventory, purchases, and sales for Item ER27 are as follows:

Nov. 1 Inventory 40 units at $55 Sale 32 units

11 Purchase 60 units at $721 Sale 45 units

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Assuming a perpetual inventory system and the last-in, first-out (LIFO) method, determine (a) the cost of the merchandise sold for the November 21 sale and (b) the inventory on November 30.


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a) Cost of merchandise sold: $315 = (45 units x $7)

b) Inventory, November 30:

8 units @ $5 $ 4015 units @ $7 10523 $145


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Determine the cost of inventory under the periodic inventory

system, using FIFO, LIFO, and average cost methods.

Objective 4Objective 47-4


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Using FIFO, the earliest batch purchased is

considered the first batch of merchandise sold. The

physical flow does not have to match the

accounting method chosen.

7-4FIFO Periodic


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= $2,000

= 1,680

= 2,200

Cost of merchandise available for sale

7-4FIFO Periodic

100 units @ $20100 units @ $20

80 units @ $2180 units @ $21

100 units @ $22100 units @ $22

280 units available for sale during year

Jan. 1

Jan. 10

Jan. 30

$5,880


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7-4FIFO Periodic

The physical count on January 31 shows that 150 units are on hand (conclusion: 130 units were

sold). What is the cost of the ending inventory?

= $ 0

= 1,050

= 2,200

100 units @ $20100 units @ $20

80 units @ $2180 units @ $21

100 units @ $22100 units @ $22

Jan. 1

Jan. 10

Jan. 30

Sold these

Sold 30 of these

50 units @ $2150 units @ $21

100 units @ $22100 units @ $22

Ending inventory

$3,250


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7-4FIFO Periodic

Now we can calculate the cost of goods sold as follows:

Beginning inventory, January 1 (Slide 60) $2,000Purchases ($1,680 + $2,200) 3,880Cost of merchandise available for sale $5,880Ending inventory, January 31(Slide 61) 3,250Cost of merchandise sold $2,630

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Using LIFO, the most recent batch purchased is considered the first batch of

merchandise sold. The actual flow of goods does not have to be LIFO. For example, a

store selling fresh fish would want to sell the oldest fish first (which is FIFO) even though

LIFO is used for accounting purposes.

7-4LIFO Periodic


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7-4LIFO Periodic

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= $2,000

= 1,680

= 2,200

Cost of merchandise available for sale

100 units @ $20100 units @ $20

80 units @ $2180 units @ $21

100 units @ $22100 units @ $22

280 units available for sale during year

Jan. 1

Jan. 10

Jan. 30

$5,880


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7-4LIFO Periodic

Assume again that the physical count on January 31 is 150 units (and that 130 units were sold).

What is the cost of the ending inventory?

= $2,000

= 1, 680

= 2,200

100 units @ $20100 units @ $20

80 units @ $2180 units @ $21

100 units @ $22100 units @ $22

Jan. 1

Jan. 10

Jan. 30 Sold these

Sold 30 of these50 units @ $2150 units @ $21

= 0

= 1,050

Ending inventory

$3,050


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7-4LIFO Periodic




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The weighted average unit cost method is based on the average cost of identical units. The total

cost of merchandise available for sale is divided by the related

number of units of that item.

7-4Average Cost


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7-4Average Cost

$5,880

= $2,000

= 1,680

= 2,200

100 units @ $20100 units @ $20

80 units @ $2180 units @ $21

100 units @ $22100 units @ $22

280

Jan. 1

Jan. 10

Jan. 30

Average unit cost: $5,880 ÷ 280 = $21Cost of merchandise sold: 130 units at $21 = $2,730Ending merchandise inventory: 150 units at $21= $3,150 68

100 units @ $22100 units @ $22


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7-4



Average Cost


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7-4-


The units of an item available for sale during the year were as follows:

Jan. 1 Inventory 6 units @ $50 $ 300Mar. 20 Purchase 14 units @ $55 770Oct. 30 Purchase 20 units @ $62 1,240 Available for sale 40 units $2,310

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There are 16 units of the item in the physical inventory at December 31. The periodic inventory system is used. Determine the inventory cost by (a) the first-in, first-out (FIFO) method, (b) the last-in, first-out (LIFO) method, and (c) the average cost method.


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7-4


a) First-in, first-out (FIFO) method: $992 (16 units x $62)

b) Last-in, first-out (LIFO) method: $850 (6 units x $50) + (10 units x $55)

c) Average method: $924 (16 units x $57.75) where average cost = $57.75 ($2,310 ÷ 40 units)


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Compare and contrast the use of the three inventory

costing methods.


7-5


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7-5Partial Income Statements

Net sales $3,900Cost of merchandise sold:

Beginning inventory $2,000Purchases 3,880Merchandise available for sale $5,880Less ending inventory 3,250 Cost of merchandise sold 2,630

Gross profit $1,270

First-In, First-Out


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Gross profit $1,170

Average Cost


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Gross profit $1,070

Last-In, First-Out


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7-5Recap

Weighted FIFO LIFO Average

Ending inventory $3,250 $3,150 $3,050

Cost of merchandise sold $2,630 $2,730 $2,830

Gross profit $1,270 $1,170 $1,070


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Describe and illustrate the reporting of merchandise inventory in the financial

statements.


7-6


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7-6

If the cost of replacing an item in inventory is lower than the original purchase cost, the lower-of-cost-or-market (LCM) method is

used to value the inventory.

Lower-of-Cost-or-Market Method


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7-6

Market, as used in lower of cost or market, is the

cost to replace the merchandise on the

inventory date.


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7-6

Cost and replacement cost can be determined for—1) each item in the inventory,2) major classes or categories of

inventory, or3) the inventory as a whole.


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8181

7-6Determining Inventory at Lower-of-Cost-or-Market Method


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7-6

Merchandise that is out of date, spoiled, or damaged should be

written down to its net realizable value. This is the estimated

selling price less any direct cost of disposal, such as sales

commissions.


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7-6Merchandise Inventory on the Balance Sheet

Merchandise inventory is usually presented in the Current Assets

section of the balance sheet, following receivables.


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7-6

Both the method of determining the cost of inventory (FIFO, LIFO,

or weighted average) should be shown.


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7-6-


On the basis of the following data, determine the value of the inventory at the lower of cost or market. Apply lower of cost or market to each inventory item as shown in Exhibit 7.

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Inventory Unit UnitCommodity Quantity Cost Price Market PriceC17Y 10 $ 39 $40B563 7 110 98


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86For Practice: PE 7-5A, PE 7-5B

Unit Unit Lower ofCommodity Qty Cost Price Market Price Cost Market C or M

C17Y 10 $ 39 $40 $ 390 $ 400 $ 390B563 7 110 98 770 686 686Total $1,160 $1,086 $1,076

7-6-


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7-6-


Zula Repair Shop incorrectly counted its December 31, 2008 inventory as $250,000 instead of the correct amount of $220,000. Indicate the effect of the misstatement on Zula’s December 31, 2008 balance sheet and income statement for the year ended December 31, 2008.

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7-6-

Amount of Misstatement Overstatement (Understatement)

Balance Sheet:Merchandise inventory overstated $30,000Current assets overstated 30,000Total assets overstated 30,000Owner’s equity overstated 30,000

Income Statement:Cost of merchandise sold understated $(30,000)Gross profit overstated 30,000Net income overstated 30,000


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Estimate the cost of inventory, using the retail

method and the gross profit method.


7-7


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The retail inventory method of estimating inventory cost is based on

the relationship of the cost of merchandise available for sale to the retail price of the same merchandise.

7-7Retail Inventory Method


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7-7Determining Inventory by the Retail Method


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7-7


A business using the retail method of inventory costing determines that merchandise inventory at retail is $900,000. If the ratio of cost to retail price is 70%, what is the amount of inventory to be reported on the financial statements?

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$630,000 ($900,000 x 70%)



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The gross profit method uses the estimated gross profit for the

period to estimate the inventory at the end of the period.

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7-7Gross Profit Method


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7-7Estimating Inventory by Gross Profit Method


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The gross profit method is useful for estimating inventories for monthly or

quarterly financial statements in a periodic inventory system.

7-7


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7-7


Based on the following data, estimate the cost of ending merchandise inventory:

Sales (net) $1,250,000Estimated gross profit rate 40%

Beginning merchandise inventory $100,000Purchases (net) 800,000Merchandise available for sale $900,000

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7-7

Merchandise available for sale $900,000Less cost of merchandise sold [$1,250,000 x (100% – 40%)] 750,000Estimated ending merchandise inventory $150,000


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7-7

Inventory turnover measures the relationship between the volume of

goods (merchandise) sold and the amount of inventory carried during the period.

Inventory turnover = Cost of merchandise soldAverage inventory


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9999

SUPERVALU ZaleCost of merchandise sold $16,681,472,000 $1,157,226,000Inventories:

Beginning of year $1,078,343,000 $826,824,000End of year $1,032,034,000 $853,580,000Average $1,055,188,500 $840,202,000

Inventory turnoverInventory turnover 15.8 times15.8 times 1.4 times1.4 times

7-7


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7-7

Generally, the larger the inventory turnover, the more

efficient and effective the management of inventory.


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The number of days’ sales in inventory is a rough measure of the

length of time it takes to acquire, sell, and replace the inventory.

7-7

Average inventoryAverage daily cost of

merchandise sold

Number of days’ sales in inventory =


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102102

Average daily cost of merchandise sold: $16,681,472,000/365 $45,702,663 $1,157,226,000/365 $3,170,482Average inventory $1,055,188,500 $840,202,000

SUPERVALU Zale

Number of days’ salesNumber of days’ sales in inventoryin inventory 23.1 days23.1 days 265.0 days265.0 days

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7 Inventories.

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