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![Page 1: Merchandise Inventory and Cost of Sales C H A P T E R 7 Electronic Presentations in Microsoft® PowerPoint®](https://reader038.fdocuments.in/reader038/viewer/2022110320/56649cc55503460f9498f66f/html5/thumbnails/1.jpg)
Merchandise Inventory and Cost of Sales
C H A P T E R 7C H A P T E R 7
Electronic Presentations in Microsoft® PowerPoint®
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1. Identify the components and costs included in merchandise inventory.
2. Calculate the cost of goods sold and merchandise inventory using specific identification, moving weighted average, FIFO, and LIFO-perpetual.
3. Analyze the effects of the costing methods on financial reporting.
Learning ObjectivesLearning Objectives
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4. Calculate the lower of cost or market value of inventory.
5. Analyze the effects of inventory errors on current and future financial statements-perpetual.
6. Apply both the gross profit and retail methods to estimate inventory.
Learning ObjectivesLearning Objectives
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7. Calculate cost of goods sold and merchandise inventory using specific identification, weighted average, FIFO, and LIFO-periodic. (Appendix 7A).
8. Analyze the effects of inventory errors on current and future financial statements-periodic. (Appendix 7A).
9. Assess inventory management using both merchandise turnover and days’ sales in inventory. (Appendix 7B)
Learning ObjectivesLearning Objectives
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Accounting for inventory requires several decisions which include: Items to include in cost. Inventory System.
Perpetual or Periodic Costing Method.
FIFO, LIFO, Moving Weighted Average, Specific ID Use of estimates.
Gross profit method, Retail inventory method
Assigning Costs to InventoryAssigning Costs to Inventory
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Inventory includes all goods owned by a company and held for sale.
Items requiring special attention: Goods in Transit Goods on consignment Obsolete or damaged goods
Items in Merchandise InventoryItems in Merchandise Inventory
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All expenditures necessary to bring an item to a saleable condition and location. This includes:
Invoice price less discounts Import dutiesTransportation-inStorage Insurance
Costs of Merchandise InventoryCosts of Merchandise Inventory
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Management must decide on method of determining unit cost.
This will affect both the income statement and the balance sheet.
Methods:1. Specific Identification2. FIFO3. LIFO4. Average Cost
Assigning Costs to InventoryAssigning Costs to Inventory
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MerchandiseAvailable
for Sale
Net Costof Purchases
Cost ofGoods Sold
BeginningInventory
EndingInventory
Balance SheetBalance Sheet Income StatementIncome Statement
Merchandising Cost Flows
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FIFO47%
Other4%
Average Cost45%
LIFO4%
Use of Inventory Methods in Use of Inventory Methods in PracticePractice
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This method is used when items: Are unique. Can be directly identified with a specific
purchase and its invoice.
Examples: Automobiles, art custom furniture.
Specific IdentificationSpecific Identification
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Specific Identification — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 8 91$ 728$ 2 91$ 182$
12 106$ 1,272$ 3 106$ 318$
5 500$ 2 91$ 182$ 3 106$ 318$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,800$ 8/28 2 91$ 182$ 3 106$ 318$
12 115$ 1,380$ 8 115$ 920$ Totals 45 4,800$ 34 3,562$ 11 1,238$
Specific Identificaton Computations - Perpetual Inventory System
The opening inventory consists of 10 units @ $91/unit.
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Specific Identification — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 8 91$ 728$ 2 91$ 182$
12 106$ 1,272$ 3 106$ 318$
5 500$ 2 91$ 182$ 3 106$ 318$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,800$ 8/28 2 91$ 182$ 3 106$ 318$
12 115$ 1,380$ 8 115$ 920$ Totals 45 4,800$ 34 3,562$ 11 1,238$
Specific Identificaton Computations - Perpetual Inventory System
This results in two layers of inventory.
Additional units are purchased @ $106/unit.
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Specific Identification — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 8 91$ 728$ 2 91$ 182$
12 106$ 1,272$ 3 106$ 318$
5 500$ 2 91$ 182$ 3 106$ 318$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,800$ 8/28 2 91$ 182$ 3 106$ 318$
12 115$ 1,380$ 8 115$ 920$ Totals 45 4,800$ 34 3,562$ 11 1,238$
Specific Identificaton Computations - Perpetual Inventory System
On August 14, 20 units are sold. Eight of these units came from the opening inventory and the remaining 12
units came from the August 3 purchase.
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Specific Identification — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 8 91$ 728$ 2 91$ 182$
12 106$ 1,272$ 3 106$ 318$
5 500$ 2 91$ 182$ 3 106$ 318$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,800$ 8/28 2 91$ 182$ 3 106$ 318$
12 115$ 1,380$ 8 115$ 920$ Totals 45 4,800$ 34 3,562$ 11 1,238$
Specific Identificaton Computations - Perpetual Inventory System
This leaves 2 units remaining from the original inventory and 3 units remaining
from the August 3 purchase.
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Under this method, the cost of all units are averaged together.
Cost of goods available for sale
Number of units available for sale
Average cost per unit
=
Moving Weighted Average MethodMoving Weighted Average Method
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Moving Weighted Average - Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 8/3 15 106$ 1,590$ 25 100$ 2,500$
8/14 20 100$ 2,000$ 5 100$ 500$
8/17 20 115$ 2,300$ 25 112$ 2,800$
8/28 14 112$ 1,568$ 11 112$ 1,232$
Totals 45 4,800$ 34 3,568$ 11 1,232$
Moving Weighted Average Computations - Perpetual Inventory System
The opening inventory consists of 10 units @ $91/unit.
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Moving Weighted Average- Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 8/3 15 106$ 1,590$ 25 100$ 2,500$
8/14 20 100$ 2,000$ 5 100$ 500$
8/17 20 115$ 2,300$ 25 112$ 2,800$
8/28 14 112$ 1,568$ 11 112$ 1,232$
Totals 45 4,800$ 34 3,568$ 11 1,232$
Moving Weighted Average Computations - Perpetual Inventory System
Additional units are purchased @ $106/unit. This results in an average cost of
$100/unit.
(10 x $91) + (15 x $106) 25 units
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Moving Weighted Average- Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 8/3 15 106$ 1,590$ 25 100$ 2,500$
8/14 20 100$ 2,000$ 5 100$ 500$
8/17 20 115$ 2,300$ 25 112$ 2,800$
8/28 14 112$ 1,568$ 11 112$ 1,232$
Totals 45 4,800$ 34 3,568$ 11 1,232$
Moving Weighted Average Computations - Perpetual Inventory System
These 20 units are sold at the average cost of $100/unit.
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Moving Weighted Average- Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 8/3 15 106$ 1,590$ 25 100$ 2,500$
8/14 20 100$ 2,000$ 5 100$ 500$
8/17 20 115$ 2,300$ 25 112$ 2,800$
8/28 14 112$ 1,568$ 11 112$ 1,232$
Totals 45 4,800$ 34 3,568$ 11 1,232$
Moving Weighted Average Computations - Perpetual Inventory System
This leaves 5 units remaining at an average cost of $100/unit.
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Mini-QuizMini-QuizA company that uses a perpetual inventory system made the following cash purchases and sales:
Jan. 1-Purchased 100 units at $10 per unit.
Feb. 5-Purchased 60 units at $12 per unit.
Mar.16-Sold for cash 40 units for $16 per unit.
Prepare journal entries to record the sale assuming a Moving Weighted Average system is used.
Cash 640 Sales (40x16) 640
Cost of goods sold 430 Inventory 430(100x10 + 60x12)/160 x 40
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Based on the assumption that the items are sold in the order acquired.
When a sale occurs: The earliest units purchased are
charged to Cost of Goods Sold. The cost of the most recent purchases
remain in inventory.
First-In, First-Out (FIFO)First-In, First-Out (FIFO)
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FIFO — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 10 91$ 910$
10 106$ 1,060$ 5 106$ 530$ 5 106$ 530$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,830$ 8/28 5 106$ 530$
9 115$ 1,035$ 11 115$ 1,265$ Totals 45 4,800$ 34 3,535$ 11 1,265$
FIFO Computations - Perpetual Inventory System
The opening inventory consists of 10 units @ $91/unit.
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FIFO — Example
Additional units re purchased @ $106/unit.
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 10 91$ 910$
10 106$ 1,060$ 5 106$ 530$ 5 106$ 530$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,830$ 8/28 5 106$ 530$
9 115$ 1,035$ 11 115$ 1,265$ Totals 45 4,800$ 34 3,535$ 11 1,265$
FIFO Computations - Perpetual Inventory System
This results in two layers of inventory.
Additional units are purchased @ $106/unit.
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FIFO — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 10 91$ 910$
10 106$ 1,060$ 5 106$ 530$ 5 106$ 530$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,830$ 8/28 5 106$ 530$
9 115$ 1,035$ 11 115$ 1,265$ Totals 45 4,800$ 34 3,535$ 11 1,265$
FIFO Computations - Perpetual Inventory System
Under FIFO, units are assumed to be sold in the order acquired. Therefore, of the 20 units sold on August 14, the first 10 units come
from beginning inventory. Therefore, those 10 units are removed from the inventory record based on the cost of those units of $91.
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FIFO — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 10 91$ 910$
10 106$ 1,060$ 5 106$ 530$ 5 106$ 530$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,830$ 8/28 5 106$ 530$
9 115$ 1,035$ 11 115$ 1,265$ Totals 45 4,800$ 34 3,535$ 11 1,265$
FIFO Computations - Perpetual Inventory System
The remaining 10 units sold on August 14th come from the next purchase, made on August 3rd. Therefore, these units are removed
from the inventory record based on their cost of $106.
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FIFO — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 10 91$ 910$
10 106$ 1,060$ 5 106$ 530$ 5 106$ 530$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,830$ 8/28 5 106$ 530$
9 115$ 1,035$ 11 115$ 1,265$ Totals 45 4,800$ 34 3,535$ 11 1,265$
FIFO Computations - Perpetual Inventory System
The ending inventory consists of the 5 remaining units from the August 3 purchase.
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Mini-QuizMini-Quiz
A company that uses a perpetual inventory system made the following cash purchases and sales:
Jan. 1-Purchased 100 units at $10 per unit.
Feb. 5-Purchased 60 units at $12 per unit.
Mar.16-Sold for cash 40 units for $16 per unit.
Prepare journal entries to record the sale assuming a FIFO system is used.
Cash 640 Sales (40x16) 640
Cost of goods sold 400 Inventory (40x10) 400
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Based on the assumption that the most recently purchased items are sold first.
When a sale occurs: The latest units purchased are charged to
Cost of Goods Sold. The cost of the earliest purchases remain
in inventory.
Last-In, First-Out (LIFO)Last-In, First-Out (LIFO)
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LIFO — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 15 106$ 1,590$
5 91$ 455$ 5 91$ 455$ 5 91$ 455$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,755$ 8/28 14 115$ 1,610$ 5 91$
Totals 45 4,800$ 34 3,655$ 11 1,145$
LIFO Computations - Perpetual Inventory System
The opening inventory consists of 10 units @ $91/unit.
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LIFO — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 15 106$ 1,590$
5 91$ 455$ 5 91$ 455$ 5 91$ 455$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,755$ 8/28 14 115$ 1,610$ 5 91$
Totals 45 4,800$ 34 3,655$ 11 1,145$
LIFO Computations - Perpetual Inventory System
Additional units are purchased @ $106/unit.
This results in two layers of inventory.
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LIFO — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 15 106$ 1,590$
5 91$ 455$ 5 91$ 455$ 5 91$ 455$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,755$ 8/28 14 115$ 1,610$ 5 91$
Totals 45 4,800$ 34 3,655$ 11 1,145$
LIFO Computations - Perpetual Inventory System
Of the 20 units sold, these units are assumed to be sold
first.
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LIFO — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 15 106$ 1,590$
5 91$ 455$ 5 91$ 455$ 5 91$ 455$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,755$ 8/28 14 115$ 1,610$ 5 91$
Totals 45 4,800$ 34 3,655$ 11 1,145$
LIFO Computations - Perpetual Inventory System
Once the latest units purchased are sold, units are sold from the
previous purchase.
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LIFO — Example
Purchases Sales BalanceDate Units Cost Total Units Cost Total Units Cost Total
8/1 10 91$ 910$ 10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 15 106$ 1,590$
5 91$ 455$ 5 91$ 455$ 5 91$ 455$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,755$ 8/28 14 115$ 1,610$ 5 91$
Totals 45 4,800$ 34 3,655$ 11 1,145$
LIFO Computations - Perpetual Inventory System
This leaves 5 units remaining from the first purchase.
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Mini-QuizMini-Quiz
A company that uses a perpetual inventory system made the following cash purchases and sales:
Jan. 1-Purchased 100 units at $10 per unit.
Feb. 5-Purchased 60 units at $12 per unit.
Mar.16-Sold for cash 40 units for $16 per unit.
Prepare journal entries to record the sale assuming a LIFO system is used.
Cash 640 Sales (40x16) 640
Cost of goods sold 480 Inventory (40x12) 480
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Because prices change, the choice of an inventory method is important.
Units Specific
Identification
Moving Weighted Average FIFO LIFO
Cost of Goods Sold 34 3,562$ 3,568$ 3,535$ 3,655$
Ending Inventory 11 1,238$ 1,232$ 1,265$ 1,145$
Goods Available for Sale 45 4,800$ 4,800$ 4,800$ 4,800$
Financial ReportingFinancial Reporting
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Advantages of Each Method
First-In, First-Out
First-In, First-Out
Ending inventory approximates
current replacement cost.
Ending inventory approximates
current replacement cost.
Weighted Average
Weighted Average
Smoothes out purchase price
changes.
Smoothes out purchase price
changes.
Last-In, First-Out
Last-In, First-Out
Better matches current costs in
cost of goods sold with revenues.
Better matches current costs in
cost of goods sold with revenues.
Financial ReportingFinancial Reporting
First-In, First-Out
First-In, First-Out
Ending inventory approximates
current replacement cost.
Ending inventory approximates
current replacement cost.
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A company is required to use the same accounting methods from period to period (consistency principle).
A change is only acceptable when it improves financial reporting.
The costing method used must be disclosed in the notes to the financial statements (full-disclosure principle).
Financial ReportingFinancial Reporting
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Inventory must be reported at market value when market is lower than cost (conservatism principle).
Market may be defined as: Net realizable value Current replacement cost
Lower of Cost or MarketLower of Cost or Market
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May be applied in one of three ways:
1. Separately to each item.
2. To major categories of items.
3. To the inventory as a whole.
Lower of Cost or MarketLower of Cost or Market
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Errors in the computation of or physical count of inventory will cause a misstatement of:
Cost of goods sold Gross profit Net income Current assets Owner’s equity
Inventory ErrorsInventory Errors
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Inventory Errors- Effects on the Inventory Errors- Effects on the Income StatementIncome Statement
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Inventory Errors- Effects on the Inventory Errors- Effects on the Balance SheetBalance Sheet
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Ending inventory is estimated by applying gross profit ratio to net sales.
It is used: when inventory has been destroyed, lost, or
stolen. for testing the reasonableness of the
physical inventory count.
Gross Profit MethodGross Profit Method
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Occasionally used for interim period reporting.
Information required:1. Beginning inventory at cost and retail.
2. Net purchases at cost and retail.
3. Net sales.
Retail Inventory MethodRetail Inventory Method
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Q Describe how management’s decisions can affect the determination of the cost of inventory.
A Choice of method –FIFO,LIFO, Moving weighted average, Specific item.
Choice of application of LCM -separate item, categories, whole inventory. Definition of market.
Choice of periodic or perpetual system.
Items to include in cost. Other.
ReviewReview
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The periodic system also uses FIFO, LIFO, specific identification, and weighted average methods to assign costs to inventory and cost of goods sold.
The results may be the same or different under both systems.
Periodic System-Appendix 7APeriodic System-Appendix 7A
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Applied in same manner as periodic system.
Yields same results as perpetual system since units are specifically identified.
Specific Identification- Appendix 7ASpecific Identification- Appendix 7A
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Steps:
1. Calculate weighted average unit cost.
(# units beg. Inv. X unit cost) + (#units purchased x unit cost) # units available for sale
= weighted average unit cost
2. Use weighted average unit cost to assign costs to cost of goods sold and ending inventory.
Weighted Average-Appendix 7AWeighted Average-Appendix 7A
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Yields same results as perpetual system since most recent purchases are in ending inventory under both systems.
FIFO-Appendix 7AFIFO-Appendix 7A
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Yields different results than perpetual system since:
LIFO periodic assigns costs at the end of period.
LIFO perpetual assigns most recent costs to cost of goods sold.
LIFO-Appendix 7ALIFO-Appendix 7A
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An error in the ending inventory affects the assets, net income, and owner’s equity of that period.
The ending inventory of one period becomes the opening inventory of the next period. The cost of goods sold and net income of the next period are affected as well.
Inventory Errors in a Periodic Inventory Errors in a Periodic System-Appendix 7ASystem-Appendix 7A
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Inventory ratios may be used to assess:
1. Short-term liquidity.
2. Inventory management.
Ratios-Appendix 7BRatios-Appendix 7B
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Merchandise Turnover Ratio Measures how many times a company
turns its inventory over each period. The ratio will vary from industry to
industry. Merchandise turnover cost of goods sold
average inventory
Ratios-Appendix 7BRatios-Appendix 7B
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Days’ Sales in Inventory Used to estimate how many days it will take to
convert inventory to cash or receivables. Used to assess if inventory levels can meet sales
demand.
Days’ sales in inventory = Ending inventory x 365
Cost of goods sold
Ratios-Appendix 7BRatios-Appendix 7B
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End of ChapterEnd of Chapter