© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin2
Determining Inventory ItemsDetermining Inventory Items
Merchandise inventory includes all goods that a company owns and holds for sale, regardless of where the goods are located when inventory
is counted.
Items requiring special attention include:
Goods in Transit
Goods Damaged or
ObsoleteGoods on Consignment
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin3FOB Destination Point
Public Carrier
Seller Buyer
Goods in TransitGoods in Transit
Public Carrier
Seller Buyer
FOB Shipping Point
Ownership passes to the buyer here.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin4
Goods on ConsignmentGoods on Consignment
Merchandise is included in the inventory of the consignor, the owner of the inventory.
Consignor
Consignee
Thanks for selling my inventory in
your store.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin5
Goods Damaged or ObsoleteGoods Damaged or Obsolete
Damaged or obsolete goods are not counted in inventory.
Cost should be reduced to net realizable value.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin6
Determining Inventory CostsDetermining Inventory Costs
Invoice Cost
Include all expenditures necessary to bring an item to a salable condition and location.
Minus Discounts
Plus Import Duties
Plus Freight
Plus Storage
Plus Insurance
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin7
Internal Controls and Taking a Physical CountInternal Controls and Taking a Physical Count
Most companies take a physical count of inventory at least once each year.
When the physical count does not match the Merchandise Inventory account, an adjustment must be made.
Most companies take a physical count of inventory at least once each year.
When the physical count does not match the Merchandise Inventory account, an adjustment must be made.
InventoryCount Tag
Countedby _______
Quantity Counted ___
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin8
Learning objectiveLearning objective
Compute inventory in a perpetual system using the methods of specific identification, FIFO, LIFO, and weighted average.
Analyze the effects of inventory methods for both financial and tax reporting.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin9
Inventory Costing Under a Perpetual SystemInventory Costing Under a Perpetual System
Inventory 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., 2006McGraw-Hill/Irwin10
Inventory Costing Under a Perpetual SystemInventory Costing Under a Perpetual System
Accounting for inventory
requires several decisions . . .
Costing Method. Specific Identification, FIFO, LIFO, or
Weighted Average Inventory System.
Perpetual or Periodic Items included in inventory and
their costs. Use of market values or other
estimates.
Costing Method. Specific Identification, FIFO, LIFO, or
Weighted Average Inventory System.
Perpetual or Periodic Items included in inventory and
their costs. Use of market values or other
estimates.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin11
Frequency in Use of Inventory MethodsFrequency in Use of Inventory Methods
Exh. 6.1
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin12
Inventory Cost Flow AssumptionsInventory Cost Flow Assumptions
First-In, First-Out(FIFO)
Assumes costs flow in the order incurred.
Last-In, First-Out(LIFO)
Assumes costs flow in the reverse order incurred.
Weighted Average
Assumes costs flow at an average of the costs available.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin13
Inventory Costing IllustrationInventory Costing Illustration
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin14
Specific IdentificationSpecific Identification
When units are sold, the
specific cost of the unit
sold is added to cost of
goods sold.
When units are sold, the
specific cost of the unit
sold is added to cost of
goods sold.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin15
Specific IdentificationSpecific Identification
The above purchases were made by Trekking in August. On August 14, Trekking sold 8 bikes originally costing $91 and 12 bikes originally costing $106.
The above purchases were made by Trekking in August. On August 14, Trekking sold 8 bikes originally costing $91 and 12 bikes originally costing $106.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin16
The Cost of Goods Sold for the August 14 sale is $2,000.
After this sale, there are 5 units in inventory at $500:
2 @ $91 3 @ $106
The Cost of Goods Sold for the August 14 sale is $2,000.
After this sale, there are 5 units in inventory at $500:
2 @ $91 3 @ $106
Specific IdentificationSpecific Identification
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin17
Additional purchases were made on August 17 and 28.
The cost of items sold on August 31 were as follows: 2 @ $91
3 @ $10615 @ $115 3 @ $119
Additional purchases were made on August 17 and 28.
The cost of items sold on August 31 were as follows: 2 @ $91
3 @ $10615 @ $115 3 @ $119
Specific IdentificationSpecific Identification
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin18
Specific IdentificationSpecific Identification
Cost of Goods Sold for August 31 = $2,582
Cost of Goods Sold for August 31 = $2,582
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin19
Specific IdentificationSpecific Identification
After the August 31 sale, there are 12 units in inventory at $1,408:
5 @ $1157 @ $119
After the August 31 sale, there are 12 units in inventory at $1,408:
5 @ $1157 @ $119
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin20
Specific IdentificationSpecific Identification
Balance Sheet Inventory = $1,408
Balance Sheet Inventory = $1,408
Income Statement COGS = $4,582
Income Statement COGS = $4,582
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin21
Specific IdentificationSpecific Identification
Aug. 3 Merchandise inventory 1,590 Accounts payable 1,590
Aug. 14 Accounts receivable 2,600 Sales 2,600
Aug. 14 Cost of goods sold 2,000 Merchandise inventory 2,000
Aug. 17 Merchandise inventory 2,300 Accounts payable 2,300
Aug. 28 Merchandise inventory 1,190 Accounts payable 1,190
Aug. 31 Accounts receivable 3,450 Sales 3,450
Aug. 31 Cost of goods sold 2,582 Merchandise inventory 2,582
Here are the entries to record the purchases and sales entries for Trekking. The numbers in red are determined by
the cost flow assumption used.
All purchases and sales are
made on credit.
The selling price of
inventory was as follows:
8/14 $130 8/31 150
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin22
First-In, First-Out (FIFO)First-In, First-Out (FIFO)
Cost of Goods Sold
Cost of Goods Sold
Ending InventoryEnding
Inventory
Oldest Costs
Oldest Costs
Recent Costs
Recent Costs
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin23
First-In, First-Out (FIFO) First-In, First-Out (FIFO)
The above purchases were made by Trekking in August.
On August 14, Trekking sold 20 bikes.
The above purchases were made by Trekking in August.
On August 14, Trekking sold 20 bikes.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin24
First-In, First-Out (FIFO) First-In, First-Out (FIFO)
The Cost of Goods Sold for the August 14 sale is $1,970.
After this sale, there are 5 units in inventory at $530:
5 @ $106
The Cost of Goods Sold for the August 14 sale is $1,970.
After this sale, there are 5 units in inventory at $530:
5 @ $106
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin25
First-In, First-Out (FIFO) First-In, First-Out (FIFO)
Additional purchases were made on August 17 and 28.
Twenty-three bikes were sold on August 31.
Additional purchases were made on August 17 and 28.
Twenty-three bikes were sold on August 31.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin26
First-In, First-Out (FIFO) First-In, First-Out (FIFO)
Cost of Goods Sold for August 31 = $2,600
Cost of Goods Sold for August 31 = $2,600
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin27
First-In, First-Out (FIFO) First-In, First-Out (FIFO)
After the August 31 sale, there are 12 units in inventory at $1,420:
2 @ $11510 @ $119
After the August 31 sale, there are 12 units in inventory at $1,420:
2 @ $11510 @ $119
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin28
First-In, First-Out (FIFO) First-In, First-Out (FIFO)
Balance Sheet Inventory = $1,420
Balance Sheet Inventory = $1,420
Income Statement COGS = $4,570
Income Statement COGS = $4,570
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin29
First-In, First-Out (FIFO) First-In, First-Out (FIFO)
Aug. 3 Merchandise inventory 1,590 Accounts payable 1,590
Aug. 14 Accounts receivable 2,600 Sales 2,600
Aug. 14 Cost of goods sold 1,970 Merchandise inventory 1,970
Aug. 17 Merchandise inventory 2,300 Accounts payable 2,300
Aug. 28 Merchandise inventory 1,190 Accounts payable 1,190
Aug. 31 Accounts receivable 3,450 Sales 3,450
Aug. 31 Cost of goods sold 2,600 Merchandise inventory 2,600
Here are the entries to record the purchases and sales entries for Trekking. The numbers in red are determined by
the cost flow assumption used.
All purchases and sales are
made on credit.
The selling price of
inventory was as follows:
8/14 $130 8/31 150
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin30
Last-In, First-Out (LIFO)Last-In, First-Out (LIFO)
Cost of Goods Sold
Cost of Goods Sold
Ending InventoryEnding
Inventory
Recent Costs
Recent Costs
Oldest Costs
Oldest Costs
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin31
Last-In, First-Out (LIFO) Last-In, First-Out (LIFO)
The above purchases were made by Trekking in August.
On August 14, Trekking sold 20 bikes.
The above purchases were made by Trekking in August.
On August 14, Trekking sold 20 bikes.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin32
Last-In, First-Out (LIFO) Last-In, First-Out (LIFO)
The Cost of Goods Sold for the August 14 sale is $2,045.
After this sale, there are 5 units in inventory at $455:
5 @ $91
The Cost of Goods Sold for the August 14 sale is $2,045.
After this sale, there are 5 units in inventory at $455:
5 @ $91
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin33
Last-In, First-Out (LIFO) Last-In, First-Out (LIFO)
Additional purchases were made on August 17 and 28.
Twenty-three bikes were sold on August 31.
Additional purchases were made on August 17 and 28.
Twenty-three bikes were sold on August 31.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin34
Last-In, First-Out (LIFO) Last-In, First-Out (LIFO)
Cost of Goods Sold for August 31 = $2,685
Cost of Goods Sold for August 31 = $2,685
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin35
Last-In, First-Out (LIFO) Last-In, First-Out (LIFO)
After the August 31 sale, there are 12 units in inventory at $1,260:
5 @ $91 7 @ $115
After the August 31 sale, there are 12 units in inventory at $1,260:
5 @ $91 7 @ $115
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin36
Last-In, First-Out (LIFO) Last-In, First-Out (LIFO)
Balance Sheet Inventory = $1,260
Balance Sheet Inventory = $1,260
Income Statement COGS = $4,730
Income Statement COGS = $4,730
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin37
Last-In, First-Out (LIFO) Last-In, First-Out (LIFO)
Aug. 3 Merchandise inventory 1,590 Accounts payable 1,590
Aug. 14 Accounts receivable 2,600 Sales 2,600
Aug. 14 Cost of goods sold 2,045 Merchandise inventory 2,045
Aug. 17 Merchandise inventory 2,300 Accounts payable 2,300
Aug. 28 Merchandise inventory 1,190 Accounts payable 1,190
Aug. 31 Accounts receivable 3,450 Sales 3,450
Aug. 31 Cost of goods sold 2,685 Merchandise inventory 2,685
Here are the entries to record the purchases and sales entries for Trekking. The numbers in red are determined by
the cost flow assumption used.
All purchases and sales are
made on credit.
The selling price of
inventory was as follows:
8/14 $130 8/31 150
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin38
Weighted AverageWeighted Average
When a unit is sold, the average cost of each unit in inventory is assigned to
cost of goods sold.
When a unit is sold, the average cost of each unit in inventory is assigned to
cost of goods sold.
Cost of Goods Available for
Sale
Units on hand on the date of
sale÷
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin39
Weighted AverageWeighted Average
The above purchases were made by Trekking in August.
On August 14, Trekking sold 20 bikes.
The above purchases were made by Trekking in August.
On August 14, Trekking sold 20 bikes.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin40
Cost of goods available for sale 2,500$ 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$
÷
Weighted AverageWeighted Average
First, we need to compute the weighted average cost per unit of items in inventory.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin41
Weighted AverageWeighted Average
The Cost of Goods Sold for the August 14 sale is $2,000.
After this sale, there are 5 units in inventory at $500:
5 @ $100
The Cost of Goods Sold for the August 14 sale is $2,000.
After this sale, there are 5 units in inventory at $500:
5 @ $100
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin42
Weighted AverageWeighted Average
Additional purchases were made on August 17 and 28.
Twenty-three bikes were sold on August 31.
Additional purchases were made on August 17 and 28.
Twenty-three bikes were sold on August 31.
What is the weighted average cost per unit of items in inventory?
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin43
Weighted AverageWeighted Average
Cost of goods available for sale 3,990$ 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$
÷
UnitsInventory 8/14 5 Purchase 8/17 20 Purchase 8/28 10 Units available for sale 35
UnitsInventory 8/14 5 Purchase 8/17 20 Purchase 8/28 10 Units available for sale 35
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin44
Weighted AverageWeighted Average
Cost of Goods Sold for August 31 = $2,622
Cost of Goods Sold for August 31 = $2,622
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin45
Weighted AverageWeighted Average
After the August 31 sale, there are 12 units in inventory at $1,368:
12 @ $114
After the August 31 sale, there are 12 units in inventory at $1,368:
12 @ $114
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin46
Weighted AverageWeighted Average
Balance Sheet Inventory = $1,368
Balance Sheet Inventory = $1,368
Income Statement COGS = $4,622
Income Statement COGS = $4,622
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin47
Weighted AverageWeighted Average
Aug. 3 Merchandise inventory 1,590 Accounts payable 1,590
Aug. 14 Accounts receivable 2,600 Sales 2,600
Aug. 14 Cost of goods sold 2,000 Merchandise inventory 2,000
Aug. 17 Merchandise inventory 2,300 Accounts payable 2,300
Aug. 28 Merchandise inventory 1,190 Accounts payable 1,190
Aug. 31 Accounts receivable 3,450 Sales 3,450
Aug. 31 Cost of goods sold 2,622 Merchandise inventory 2,622
Here are the entries to record the purchases and sales entries for Trekking. The numbers in red are determined by
the cost flow assumption used.
All purchases and sales are
made on credit.
The selling price of
inventory was as follows:
8/14 $130 8/31 150
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin48
Financial Statement Effects of Costing MethodsFinancial Statement Effects of Costing Methods
Because prices change, inventory methods nearly always assign different cost amounts.
Because prices change, inventory methods nearly always assign different cost amounts.
Exh. 6.8
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin49
Financial Statement Effects of Costing MethodsFinancial Statement Effects of Costing Methods
Advantages of MethodsAdvantages of MethodsAdvantages of MethodsAdvantages of Methods
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
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin50
Tax Effects of Costing MethodsTax Effects of Costing Methods
The Internal Revenue Service (IRS) The Internal Revenue Service (IRS) identifies several acceptable methods for identifies several acceptable methods for
inventory costing for reporting taxable inventory costing for reporting taxable income.income.
The Internal Revenue Service (IRS) The Internal Revenue Service (IRS) identifies several acceptable methods for identifies several acceptable methods for
inventory costing for reporting taxable inventory costing for reporting taxable income.income.
If LIFO is used for If LIFO is used for tax tax purposespurposes, the IRS requires , the IRS requires
it be used in financial it be used in financial statements.statements.
If LIFO is used for If LIFO is used for tax tax purposespurposes, the IRS requires , the IRS requires
it be used in financial it be used in financial statements.statements.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin51
Consistency in Using Costing MethodsConsistency in Using Costing Methods
The The consistency principleconsistency principle requires a company to requires a company to use the same accounting methods period after use the same accounting methods period after
period so that financial statements are period so that financial statements are comparable across periods.comparable across periods.
The The consistency principleconsistency principle requires a company to requires a company to use the same accounting methods period after use the same accounting methods period after
period so that financial statements are period so that financial statements are comparable across periods.comparable across periods.
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin52
Lower of Cost or MarketLower 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 three ways:Can be applied three 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 three ways:Can be applied three 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., 2006McGraw-Hill/Irwin53
Lower of Cost or MarketLower of Cost or Market
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:
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin54
Lower of Cost or MarketLower of Cost or Market
Here is how to compute lower of cost or market Here is how to compute lower of cost or market for for individual inventory itemsindividual inventory items..
Here is how to compute lower of cost or market Here is how to compute lower of cost or market for for individual inventory itemsindividual inventory items..
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin55
Lower of Cost or MarketLower of Cost or Market
Here is how to compute lower of cost or market Here is how to compute lower of cost or market for for the two groups of inventory itemsthe two groups of inventory items..
Here is how to compute lower of cost or market Here is how to compute lower of cost or market for for the two groups of inventory itemsthe two groups of inventory items..
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin56
Lower of Cost or MarketLower of Cost or Market
Here is how to compute lower of cost or market Here is how to compute lower of cost or market for for the entire inventorythe entire inventory..
Here is how to compute lower of cost or market Here is how to compute lower of cost or market for for the entire inventorythe entire inventory..
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin57
Financial Statement Effects of Inventory ErrorsFinancial Statement Effects of Inventory Errors
Income Statement EffectsIncome Statement Effects
Exh. 6.10
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin58
Financial Statement Effects of Inventory ErrorsFinancial Statement Effects of Inventory Errors
Balance Sheet EffectsBalance Sheet Effects
Exh. 6.12
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin59
Inventory TurnoverInventory Turnover
Shows how many times a company turns over its Shows how many times a company turns over its inventory during a period. Indicator of how well inventory during a period. Indicator of how well
management is controlling the amount of inventory management is controlling the amount of inventory available.available.
Shows how many times a company turns over its Shows how many times a company turns over its inventory during a period. Indicator of how well inventory during a period. Indicator of how well
management is controlling the amount of inventory management is controlling the amount of inventory available.available.
Inventory Inventory TurnoverTurnover ==
Cost of goods sold Cost of goods sold
Avg. inventoryAvg. inventory
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin60
Days’ Sales in InventoryDays’ 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
© The McGraw-Hill Companies, Inc., 2006McGraw-Hill/Irwin61
Homework for chapter 6Homework for chapter 6
Ex 6-1, 6-3, 6-5, 6-8 Problem 6-1A
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