© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-1

55 Reporting and Analyzing Inventories

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-2

Assigning Costs to InventoryInventory Inventory

affects . . . affects . . .

The matching The matching principle requires principle requires matching cost of matching cost of sales with sales.sales with sales.

Balance Balance SheetSheet

Balance Balance SheetSheet

Income Income StatementStatement

Income Income StatementStatement

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-3

Assigning Costs to Inventory

Accounting for inventory

requires several decisions . . .

Costing Method.Costing Method. FIFO, LIFO, Weighted Average, FIFO, LIFO, Weighted Average,

Specific IDSpecific ID

Inventory System.Inventory System. Perpetual or PeriodicPerpetual or Periodic

Items included in costs.Items included in costs.

Use of market or other estimates.Use of market or other estimates.

Costing Method.Costing Method. FIFO, LIFO, Weighted Average, FIFO, LIFO, Weighted Average,

Specific IDSpecific ID

Inventory System.Inventory System. Perpetual or PeriodicPerpetual or Periodic

Items included in costs.Items included in costs.

Use of market or other estimates.Use of market or other estimates.

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Slide 5-4

Assigning Costs to Inventory

Use of Inventory Methods in PracticeUse of Inventory Methods in Practice

Exh. 5.1

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Slide 5-5

Example Inventory Information

Exh. 5.2,3

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Slide 5-6

Perpetual Inventory

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Slide 5-7

Specific Identification

When units are When units are sold, the sold, the

specific costspecific cost of of the unit sold is the unit sold is

added to added to cost of cost of goods soldgoods sold..

When units are When units are sold, the sold, the

specific costspecific cost of of the unit sold is the unit sold is

added to added to cost of cost of goods soldgoods sold..

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-8

Specific Identification

The above purchases were made by The above purchases were made by Trekking in August. On August 14, Trekking in August. On August 14,

Trekking sold 8 bikes originally costing $91 Trekking sold 8 bikes originally costing $91 and 12 bikes originally costing $106.and 12 bikes originally costing $106.

The above purchases were made by The above purchases were made by Trekking in August. On August 14, Trekking in August. On August 14,

Trekking sold 8 bikes originally costing $91 Trekking sold 8 bikes originally costing $91 and 12 bikes originally costing $106.and 12 bikes originally costing $106.

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-9

The Cost of Goods Sold for the The Cost of Goods Sold for the August 14 sale is $2,000, leaving August 14 sale is $2,000, leaving

$500 and 5 units in inventory. $500 and 5 units in inventory.

The Cost of Goods Sold for the The Cost of Goods Sold for the August 14 sale is $2,000, leaving August 14 sale is $2,000, leaving

$500 and 5 units in inventory. $500 and 5 units in inventory.

Specific Identification

Exh. 5.4

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-10

Additional purchases were made on August 17 and 28. Additional purchases were made on August 17 and 28.

Cost of sales on August 31 were as follows: Cost of sales on August 31 were as follows:

2 @ $91, 3 @ $106, 15 @ $115, & 3 @ $119.2 @ $91, 3 @ $106, 15 @ $115, & 3 @ $119.

Additional purchases were made on August 17 and 28. Additional purchases were made on August 17 and 28.

Cost of sales on August 31 were as follows: Cost of sales on August 31 were as follows:

2 @ $91, 3 @ $106, 15 @ $115, & 3 @ $119.2 @ $91, 3 @ $106, 15 @ $115, & 3 @ $119.

Specific Identification

Exh. 5.4

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-11

Specific Identification

Cost of Goods Sold for August 31 = $2,582

Cost of Goods Sold for August 31 = $2,582

Exh. 5.4

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-12

Specific Identification

Balance Sheet Balance Sheet Inventory = $1,408Inventory = $1,408

Balance Sheet Balance Sheet Inventory = $1,408Inventory = $1,408

Income Statement Income Statement COGS = $4,582COGS = $4,582

Income Statement Income Statement COGS = $4,582COGS = $4,582

Exh. 5.4

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-13

First-In, First-Out (FIFO)

Cost of Cost of Goods SoldGoods Sold

Cost of Cost of Goods SoldGoods Sold

Ending Ending InventoryInventoryEnding Ending

InventoryInventory

Oldest Oldest CostsCosts

Oldest Oldest CostsCosts

Recent Recent CostsCosts

Recent Recent CostsCosts

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-14

First-In, First-Out (FIFO)

The above purchases were made by Trekking in The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes. August. On August 14, Trekking sold 20 bikes. The above purchases were made by Trekking in The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes. August. On August 14, Trekking sold 20 bikes.

Exh. 5.5

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-15

First-In, First-Out (FIFO)

The Cost of Goods Sold for the August 14 sale is The Cost of Goods Sold for the August 14 sale is $1,970, leaving $530 and 5 units in inventory. $1,970, leaving $530 and 5 units in inventory.

The Cost of Goods Sold for the August 14 sale is The Cost of Goods Sold for the August 14 sale is $1,970, leaving $530 and 5 units in inventory. $1,970, leaving $530 and 5 units in inventory.

Exh. 5.5

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-16

Additional purchases were made on August 17 Additional purchases were made on August 17 and August 28. On August 31, an additional 23 and August 28. On August 31, an additional 23

units were sold.units were sold.

Additional purchases were made on August 17 Additional purchases were made on August 17 and August 28. On August 31, an additional 23 and August 28. On August 31, an additional 23

units were sold.units were sold.

First-In, First-Out (FIFO)

Exh. 5.5

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-17

First-In, First-Out (FIFO)

Cost of Goods Sold for August 31 = Cost of Goods Sold for August 31 = ($530 + $2,070) = $2,600($530 + $2,070) = $2,600

Cost of Goods Sold for August 31 = Cost of Goods Sold for August 31 = ($530 + $2,070) = $2,600($530 + $2,070) = $2,600

Exh. 5.5

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-18

First-In, First-Out (FIFO)

Balance Sheet Balance Sheet Inventory = $1,420Inventory = $1,420

Balance Sheet Balance Sheet Inventory = $1,420Inventory = $1,420

Income StatementCOGS = $4,570

Income StatementCOGS = $4,570

Exh. 5.5

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-19

Last-In, First-Out (LIFO)

Recent Recent CostsCosts

Recent Recent CostsCosts

Cost of Goods Cost of Goods SoldSold

Cost of Goods Cost of Goods SoldSold

Oldest Oldest CostsCosts

Oldest Oldest CostsCosts

Ending Ending InventoryInventoryEnding Ending

InventoryInventory

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-20

The above purchases were made by Trekking in The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes. August. On August 14, Trekking sold 20 bikes. The above purchases were made by Trekking in The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes. August. On August 14, Trekking sold 20 bikes.

Last-In, First-Out (LIFO)

Exh. 5.6

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Slide 5-21

Last-In, First-Out (LIFO)

The Cost of Goods Sold for the August 14 The Cost of Goods Sold for the August 14 sale is ($1,590 + $455) $2,045, leaving sale is ($1,590 + $455) $2,045, leaving

$455 and 5 units in inventory. $455 and 5 units in inventory.

The Cost of Goods Sold for the August 14 The Cost of Goods Sold for the August 14 sale is ($1,590 + $455) $2,045, leaving sale is ($1,590 + $455) $2,045, leaving

$455 and 5 units in inventory. $455 and 5 units in inventory.

Exh. 5.6

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-22

Additional purchases were made on Additional purchases were made on August 17 and August 28. On August 31, August 17 and August 28. On August 31,

an additional 23 units were sold.an additional 23 units were sold.

Additional purchases were made on Additional purchases were made on August 17 and August 28. On August 31, August 17 and August 28. On August 31,

an additional 23 units were sold.an additional 23 units were sold.

Last-In, First-Out (LIFO)

Exh. 5.6

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-23

Last-In, First-Out (LIFO)

Cost of Goods Sold for August 31 = Cost of Goods Sold for August 31 = ($1,190 + $1,495) = $2,685($1,190 + $1,495) = $2,685

Cost of Goods Sold for August 31 = Cost of Goods Sold for August 31 = ($1,190 + $1,495) = $2,685($1,190 + $1,495) = $2,685

Exh. 5.6

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-24

Last-In, First-Out (LIFO)

Balance Sheet Balance Sheet Inventory = $1,260Inventory = $1,260

Balance Sheet Balance Sheet Inventory = $1,260Inventory = $1,260

Income Statement Income Statement COGS = $4,730COGS = $4,730

Income Statement Income Statement COGS = $4,730COGS = $4,730

Exh. 5.6

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-25

Weighted Average

When a unit is sold, the When a unit is sold, the average cost of each unitaverage cost of each unit in in inventory is assigned to cost inventory is assigned to cost

of goods sold. of goods sold.

When a unit is sold, the When a unit is sold, the average cost of each unitaverage cost of each unit in in inventory is assigned to cost inventory is assigned to cost

of goods sold. of goods sold.

Cost of Goods Cost of Goods Available for Available for

SaleSale

Units on hand Units on hand on the date of on the date of

salesale÷÷

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-26

The above purchases were made by Trekking in The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes. August. On August 14, Trekking sold 20 bikes. The above purchases were made by Trekking in The above purchases were made by Trekking in August. On August 14, Trekking sold 20 bikes. August. On August 14, Trekking sold 20 bikes.

Weighted Average

Exh. 5.7

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-27

The weighted average cost per unit is The weighted average cost per unit is computed prior to each sale.computed prior to each sale.

The weighted average cost per unit is The weighted average cost per unit is computed prior to each sale.computed prior to each sale.

Weighted Average

Cost of goods available for sale 2,500$ Total units in inventory 25 Weighted average cost per unit 100$

Cost of goods available for sale 2,500$ Total units in inventory 25 Weighted average cost per unit 100$

÷

Exh. 5.7

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-28

Additional purchases were made on Additional purchases were made on August 17 and August 28. On August 31, August 17 and August 28. On August 31,

an additional 23 units were sold.an additional 23 units were sold.

Additional purchases were made on Additional purchases were made on August 17 and August 28. On August 31, August 17 and August 28. On August 31,

an additional 23 units were sold.an additional 23 units were sold.

Weighted Average

Exh. 5.7

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-29

Weighted Average

Cost of goods available for sale 3,990$ Total units in inventory 35 Weighted average cost per unit 114$

Cost of goods available for sale 3,990$ Total units in inventory 35 Weighted average cost per unit 114$

÷

Purchase 8/1 10 Purchase 8/3 15 Sale 8/14 (20) Purchase 8/17 10 Purchase 8/28 20 Units available for sale 35

Purchase 8/1 10 Purchase 8/3 15 Sale 8/14 (20) Purchase 8/17 10 Purchase 8/28 20 Units available for sale 35

Exh. 5.7

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-30

Weighted Average

Balance Sheet Balance Sheet Inventory = $1,368Inventory = $1,368

Balance Sheet Balance Sheet Inventory = $1,368Inventory = $1,368

Income Statement Income Statement COGS = $4,622COGS = $4,622

Income Statement Income Statement COGS = $4,622COGS = $4,622

Exh. 5.7

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-31

Cost of Merchandise Inventory

Include all expenditures necessary to bring an Include all expenditures necessary to bring an item to a salable condition and location.item to a salable condition and location.

Include all expenditures necessary to bring an Include all expenditures necessary to bring an item to a salable condition and location.item to a salable condition and location.

Invoice PriceInvoice PriceInvoice PriceInvoice Price

Import DutiesImport DutiesImport DutiesImport Duties

Freight-inFreight-inFreight-inFreight-in

StorageStorageStorageStorage

InsuranceInsuranceInsuranceInsurance

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Slide 5-32

Financial ReportingBecause prices change, the choice of an Because prices change, the choice of an

inventory method is important.inventory method is important.Because prices change, the choice of an Because prices change, the choice of an

inventory method is important.inventory method is important.

Exh. 5.8

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-33

Financial Reporting

Advantages of Each MethodAdvantages of Each MethodAdvantages of Each MethodAdvantages of Each Method

Smooths out Smooths out price changes.price changes.Smooths out Smooths out

price changes.price changes.

Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with

revenues.revenues.

Better matches Better matches current costs in cost current costs in cost of goods sold with of goods sold with

revenues.revenues.

Ending inventory Ending inventory approximates approximates

current current replacement cost.replacement cost.

Ending inventory Ending inventory approximates approximates

current current replacement cost.replacement cost.

First-In, First-In, First-OutFirst-OutFirst-In, First-In, First-OutFirst-Out

Weighted Weighted AverageAverage

Weighted Weighted AverageAverage

Last-In, Last-In, First-OutFirst-OutLast-In, Last-In,

First-OutFirst-Out

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Slide 5-34

Tax Reporting

The Internal Revenue Service (IRS) identifies The Internal Revenue Service (IRS) identifies several acceptable methods for inventory several acceptable methods for inventory

costing for financial reporting and reporting costing for financial reporting and reporting taxable income.taxable income.

If LIFO is used for If LIFO is used for tax purposestax purposes, the IRS , the IRS requires it be used in financial statements.requires it be used in financial statements.

The Internal Revenue Service (IRS) identifies The Internal Revenue Service (IRS) identifies several acceptable methods for inventory several acceptable methods for inventory

costing for financial reporting and reporting costing for financial reporting and reporting taxable income.taxable income.

If LIFO is used for If LIFO is used for tax purposestax purposes, the IRS , the IRS requires it be used in financial statements.requires it be used in financial statements.

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-35

Consistency in Reporting

The consistency principle requires a company The consistency principle requires a company to use the same accounting methods period to use the same accounting methods period after period so that financial statements are after period so that financial statements are

comparable across periods.comparable across periods.

The consistency principle requires a company The consistency principle requires a company to use the same accounting methods period to use the same accounting methods period after period so that financial statements are after period so that financial statements are

comparable across periods.comparable across periods.

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-36

Errors in Reporting InventoryIncome Statement EffectsIncome Statement Effects

Exh. 5.10

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Slide 5-37

Errors in Reporting Inventory

Exh. 5.12

Balance Sheet EffectsBalance Sheet Effects

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-38

FOB Destination Point

Public Carrier

Seller Buyer

Items in Merchandise Inventory

Public Carrier

Seller Buyer

FOB Shipping Point

Ownership passes to the buyer here.

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-39

Items in Merchandise Inventory

Goods on ConsignmentGoods on Consignment Goods shipped by the owner (consignor) to another Goods shipped by the owner (consignor) to another

party (consignee).party (consignee). Merchandise is included in the inventory of the Merchandise is included in the inventory of the

consignor.consignor.

Goods Damaged or ObsoleteGoods Damaged or Obsolete Damaged or obsolete goods are not counted in Damaged or obsolete goods are not counted in

inventory.inventory. Cost should be reduced to Cost should be reduced to net realizable valuenet realizable value..

Goods on ConsignmentGoods on Consignment Goods shipped by the owner (consignor) to another Goods shipped by the owner (consignor) to another

party (consignee).party (consignee). Merchandise is included in the inventory of the Merchandise is included in the inventory of the

consignor.consignor.

Goods Damaged or ObsoleteGoods Damaged or Obsolete Damaged or obsolete goods are not counted in Damaged or obsolete goods are not counted in

inventory.inventory. Cost should be reduced to Cost should be reduced to net realizable valuenet realizable value..

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-40

Physical Count of Merchandise Inventory Most companies take a Most companies take a

physical countphysical count of of inventory at least once inventory at least once each year.each year.

When the When the physical physical count count does not match does not match the Merchandise the Merchandise Inventory account, an Inventory account, an adjustment must be adjustment must be made.made.

Most companies take a Most companies take a physical countphysical count of of inventory at least once inventory at least once each year.each year.

When the When the physical physical count count does not match does not match the Merchandise the Merchandise Inventory account, an Inventory account, an adjustment must be adjustment must be made.made.

Quantity ___

InventoryCount TagCountedby _______

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-41

Lower of Cost or Market

Inventory must be reported at market value Inventory must be reported at market value when when marketmarket is is lowerlower than cost.than cost.

Inventory must be reported at market value Inventory must be reported at market value when when marketmarket is is lowerlower than cost.than cost.

Can be applied Can be applied threethree ways: ways:(1)(1) separately to each separately to each

individual item.individual item.(2)(2) to major categories of to major categories of

assets.assets.(3)(3) to the whole inventory.to the whole inventory.

Can be applied Can be applied threethree ways: ways:(1)(1) separately to each separately to each

individual item.individual item.(2)(2) to major categories of to major categories of

assets.assets.(3)(3) to the whole inventory.to the whole inventory.

Defined as current Defined as current replacement costreplacement cost (not sales price).(not sales price).Consistent withConsistent with

the conservatismthe conservatismprinciple.principle.

Defined as current Defined as current replacement costreplacement cost (not sales price).(not sales price).Consistent withConsistent with

the conservatismthe conservatismprinciple.principle.

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-42

A motorsports retailer has the following items in inventory:A motorsports retailer has the following items in inventory:A motorsports retailer has the following items in inventory:A motorsports retailer has the following items in inventory:

Lower of Cost or Market

Exh. 5.14

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-43

Here is how to compute lower of cost or market for Here is how to compute lower of cost or market for individual inventory itemsindividual inventory items..

Here is how to compute lower of cost or market for Here is how to compute lower of cost or market for individual inventory itemsindividual inventory items..

Lower of Cost or Market

Exh. 5.14

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-44

Lower of Cost or Market

Here is how to compute lower of cost or market for Here is how to compute lower of cost or market for the two groups of inventory itemsthe two groups of inventory items..

Here is how to compute lower of cost or market for Here is how to compute lower of cost or market for the two groups of inventory itemsthe two groups of inventory items..

Exh. 5.14

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-45

Lower of Cost or Market

Here is how to compute lower of cost or market for Here is how to compute lower of cost or market for the entire inventorythe entire inventory..

Here is how to compute lower of cost or market for Here is how to compute lower of cost or market for the entire inventorythe entire inventory..

Exh. 5.14

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-46

Retail Inventory MethodOften used to estimate inventory for interim period reporting. Often used to estimate inventory for interim period reporting.

Needed Information includes:Needed Information includes:

Often used to estimate inventory for interim period reporting. Often used to estimate inventory for interim period reporting.

Needed Information includes:Needed Information includes:

Net purchases at Net purchases at cost and retailcost and retail

Net purchases at Net purchases at cost and retailcost and retail

Beginning Beginning inventory at cost inventory at cost

and retailand retail

Beginning Beginning inventory at cost inventory at cost

and retailand retailNet salesNet salesNet salesNet sales

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-47

Retail Inventory Method

Step 3Step 3 Cost to retail Cost to retail ratioratio

Cost to retail Cost to retail ratioratio

Ending Ending inventory at inventory at

retailretail

Ending Ending inventory at inventory at

retailretail

Estimated Estimated ending ending

inventory at inventory at costcost

Estimated Estimated ending ending

inventory at inventory at costcost

=×

Step 2Step 2Goods Goods

available for available for sale at retailsale at retail

Goods Goods available for available for sale at retailsale at retail

Goods Goods available for available for sale at costsale at cost

Goods Goods available for available for sale at costsale at cost

=÷ Cost to retail Cost to retail ratioratio

Cost to retail Cost to retail ratioratio

Step 1Step 1 Net sales at Net sales at retailretail

Net sales at Net sales at retailretail

Goods Goods available for available for sale at retailsale at retail

Goods Goods available for available for sale at retailsale at retail

– =Ending Ending

inventory at inventory at retailretail

Ending Ending inventory at inventory at

retailretail

Exh. 5.15

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-48

Retail Inventory Method

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-49

Retail Inventory Method

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-50

Retail Inventory Method

Exh. 5.16

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-51

Gross Profit Method Estimate ending inventory by applying the Estimate ending inventory by applying the

gross profit ratio to net sales (at retail).gross profit ratio to net sales (at retail). Useful when inventory has been Useful when inventory has been

destroyed, lost, or stolen.destroyed, lost, or stolen.

Estimate ending inventory by applying the Estimate ending inventory by applying the gross profit ratio to net sales (at retail).gross profit ratio to net sales (at retail).

Useful when inventory has been Useful when inventory has been destroyed, lost, or stolen.destroyed, lost, or stolen.

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-52

Gross Profit Method

Step 1Step 11.0 1.0 – – the the gross profit gross profit

ratioratio

1.0 1.0 – – the the gross profit gross profit

ratioratio

Net sales at Net sales at retailretail

Net sales at Net sales at retailretail × =

Estimated Estimated cost of cost of

goods soldgoods sold

Estimated Estimated cost of cost of

goods soldgoods sold

Step 2Step 2Estimated Estimated

cost of cost of goods soldgoods sold

Estimated Estimated cost of cost of

goods soldgoods sold

Goods Goods available for available for sale at costsale at cost

Goods Goods available for available for sale at costsale at cost

– =Estimated Estimated

ending ending inventory at inventory at

costcost

Estimated Estimated ending ending

inventory at inventory at costcost

Exh. 5.17

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-53

In March of 2002, Chemical Company’s In March of 2002, Chemical Company’s inventory was destroyed by fire. inventory was destroyed by fire.

Chemical’s normal gross profit ratio is 30% Chemical’s normal gross profit ratio is 30% of net sales. At the time of the fire, of net sales. At the time of the fire,

Chemical showed the following balances:Chemical showed the following balances:

In March of 2002, Chemical Company’s In March of 2002, Chemical Company’s inventory was destroyed by fire. inventory was destroyed by fire.

Chemical’s normal gross profit ratio is 30% Chemical’s normal gross profit ratio is 30% of net sales. At the time of the fire, of net sales. At the time of the fire,

Chemical showed the following balances:Chemical showed the following balances:

Gross Profit Method

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-54

Gross Profit Method

Sales 31,500$ Less: sales returns (1,500) Net sales 30,000 (100% - 30%) 70%Estimated cost of goods sold 21,000$

Sales 31,500$ Less: sales returns (1,500) Net sales 30,000 (100% - 30%) 70%Estimated cost of goods sold 21,000$

Step 1Step 1

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-55

Gross Profit Method

Goods Available for Sale: Inventory, 1/1/02 12,000$ Net cost of goods purchased 20,500 Goods available for sale 32,500 Less estimated cost of goods sold: Estimated cost of goods sold (21,000) Estimated March inventory loss 11,500$

Goods Available for Sale: Inventory, 1/1/02 12,000$ Net cost of goods purchased 20,500 Goods available for sale 32,500 Less estimated cost of goods sold: Estimated cost of goods sold (21,000) Estimated March inventory loss 11,500$

Step 2Step 2

Exh. 5.18

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-56

Inventory TurnoverShows how many times a company turns over its inventory Shows how many times a company turns over its inventory

during a period. Indicator of how well management is during a period. Indicator of how well management is controlling the amount of inventory available.controlling the amount of inventory available.

Shows how many times a company turns over its inventory Shows how many times a company turns over its inventory during a period. Indicator of how well management is during a period. Indicator of how well management is

controlling the amount of inventory available.controlling the amount of inventory available.

Inventory Inventory TurnoverTurnover ==

Cost of goods sold Cost of goods sold

Avg. inventoryAvg. inventory

Exh. 5.19

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-57

Days’ Sales in Inventory

Reveals how much inventory is available in Reveals how much inventory is available in terms of the number of days’ sales.terms of the number of days’ sales.

Reveals how much inventory is available in Reveals how much inventory is available in terms of the number of days’ sales.terms of the number of days’ sales.

Days' Sales in Days' Sales in InventoryInventory ==

Ending Inventory Ending Inventory

Cost of goods soldCost of goods sold ×× 365365

Exh. 5.20

© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin

Slide 5-58

End of Chapter 5