BY R A C H E L L E A G AT H A , C PA , M B A
Inventory
Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac
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.
Objectives
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.
6. Describe and illustrate the reporting of merchandise inventory in the financial statement.
Objectives
Describe the importance of control over inventory.
Objective 1
Objective 1
Two primary objectives of control over inventory are:
1)Safeguarding the inventory, and
2)Properly reporting it in the financial statements.
Controls over inventory include
developing and using security measures to
prevent inventory damage or customer or
employee theft.
To ensure the accuracy of the amount of inventory reported in the financial
statements, a merchandising business should take a physical inventory.
Describe three inventory cost flow
assumptions and how they impact the income statement and balance
sheet.
Objective 2
Objective 2
Inventory Costing Methods
FIFO LIFO WTD AVG
BEG INVENTORY 2,500.00$ 2,500.00$ 2,500.00$
PURCHASES + 2,031.25$ 2,031.25$ 2,031.25$
GOODS AVAILABLE 4,531.25$ 4,531.25$ 4,531.25$
ENDING INVENTORY - 687.50$ 625.00$ 647.32$
CGS = 3,843.75$ 3,906.25$ 3,883.93$
COMPARISON OF CGS PER INVENTORY METHOD
Three identical inventory items were purchases during July:
Units CostJuly 6 Purchase 1 115$
19 Purchase 1 118$ 24 Purchase 1 121$
Total 3 354$
Average Cost 118.00$ ($354/3)
Assume one unit is sold on July 28th for $150.
Determine gross profit for July under the three methods.
Gross Profit Ending Inventory CGS
FIFO $35 ($150 - $115) $239 ($118 + $121) 115$
LIFO $29 ($150 - $121) $233 ($115 + $118) 121$
Avg Cost $32 ($150 - $118) $236 ($118 × 2) 118$
Determine the cost of inventory under the perpetual inventory system, using FIFO, LIFO, and average
cost methods.
Objective 3
Objective 3
In FIFO, the cost in ending inventory are the newer costs and the cost of merchandise
sold has the older cost (First In – First out).
FIFO - cost inventory from the bottom up. Newest in is sitting
in inventory.
Date Units Cost SalesAug 8 15 34$ 510$ Aug 30 13 34$ 442$ Aug 30 7 38$ 266$
35 1,218$
FIFOCost of merchandise sold (August 30):
Units Cost SALES INV
Aug 1 Beg Inv 28 34$ (28) -
8 Sale 1515 Purchase 22 38$ (7) 15
30 Sale 20
FIFO Perpetual Inventory
Beg inv 28 Sales (35) (sold 28 out of beg inv and 7 out of purchases on 8/15)
Purch 22 End Inv 15 (Under FIFO cost from bottom)
FIFO End Inv Cost 570$ (15 units @ $38)
FIFO Perpetual Inventory
FIFO Perpetual Inventory
DATE QTYUNIT COST
TOTAL COST QTY
UNIT COST
TOTAL COST QTY
UNIT COST
TOTAL COST
Aug 1 28 34$ 952$
Aug 8 15 34$ 510$ 13 34$ 442$
Aug 15 22 38$ 836$ 13 34$ 442$ Aug 15 22 38$ 836$
Aug 30 13 34$ 442$ 7 38$ 266$ 15 38$ 570$
Aug 31 Balances 1,218$ 570$
PURCHASES COST MERCH SOLD INVENTORY
In LIFO, the cost in ending inventory are the older cost and the cost of merchandise
sold has the newer cost (Last In – First out).
LIFO - cost inventory from the top down. Oldest is sitting in
inventory.
LIFO Perpetual Inventory
Date Units Cost SalesAug 8 15 34$ 510$ Aug 30 20 38$ 760$
35 1,270$
LIFOCost of merchandise sold (August 30):
Units Cost SALES INV
Aug 1 Beg Inv 28 34$ (15) 13
8 Sale 1515 Purchase 22 38$ (20) 2
30 Sale 20
LIFO Perpetual Inventory
LIFO Perpetual Inventory
DATE QTYUNIT COST
TOTAL COST QTY
UNIT COST
TOTAL COST QTY
UNIT COST
TOTAL COST
Aug 1 28 34$ 952$
Aug 8 15 34$ 510$ 13 34$ 442$
Aug 15 22 38$ 836$ 13 34$ 442$ Aug 15 22 38$ 836$
Aug 30 20 38$ 760$ 13 34$ 442$ 2 38$ 76$
Aug 31 Balances 1,270$ 518$
PURCHASES COST MERCH SOLD INVENTORY
When the Average Cost Method is used with in a perpetual system, the average cost for each type of
item is computed each time a purchase is made
The Average Cost Method is rarely used in a perpetual system so it is
not illustrated.
1. Most companies will use a computerized system if they chose to do perpetual inventory as is it very time intensive manually.2. Computerized systems track all relevant information about each inventory item, such as description, quantity, cost, size, location.3. For every inventory transaction, there is an entry into the system. Companies will use bar codes, scanners, and other technology.
Computerized Perpetual Accounting Systems
4. A physical inventory is taken at the end of the year and compared to the system records.
Determine the cost of inventory under the periodic inventory
system, using FIFO, LIFO, and average cost
methods.
Objective 4
Objective 4
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.
FIFO Periodic
Beginning inventory, purchases, and sales for Item SJ68 units:
Units CostAug 1 Beg Inv 28 34$
8 Sale 1515 Purchase 22 38$ 30 Sale 20
Assume a periodic inventory system using FIFO.
Determine the cost of merch sold in August and the ending inventory balance.
FIFO Periodic
FIFO Periodic
Sales InvAug 1 28 @ 34$ 952$ (28) Aug 15 22 @ 38$ 836$ (7) 15 Available for Sale 50.0 1,788$ (35) 15
Sales 35
Ending Inventory 15 (15 units @ $38) 570$
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.
LIFO Periodic
LIFO Periodic
Beginning inventory, purchases, and sales for Item SJ68 units:
Units CostAug 1 Beg Inv 28 34$
8 Sale 1515 Purchase 22 38$ 30 Sale 20
Assume a periodic inventory system using LIFO.
Determine the cost of merch sold in August and the ending inventory balance.
LIFO Periodic
Sales InvAug 1 28 @ 34$ 952$ (13) 15 Aug 15 22 @ 38$ 836$ (22) - Available for Sale 50.0 1,788$ (35) 15
Sales 35
Ending Inventory 15 (15 units @ $34) 510$
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.
Average Cost
Average Cost - Periodic
Beginning inventory, purchases, and sales for Item SJ68 units:
Units Cost TotalAug 1 Beg Inv 28 34.00$ 952$
15 Purchase 22 38.00$ 836$ Available for Sale 50 1,788$
Assume a periodic inventory system using Avg Cost
Determine the cost of merch sold in August and the ending inventory balance.
Average Cost - Periodic
Units Cost TotalAug 1 Beg Inv 28 34.00$ 952$
15 Purchase 22 38.00$ 836$ Available for Sale 50 1,788$
Average Cost ($1,788/50) 36$
End Inventory Cost ($36 * 15) 540$
Average Cost - Periodic
Compare and contrast the use of the three inventory costing methods.
Objective 5
Objective 5
Beginning inventory, purchases, and sales for Item SJ68 units:
Units CostAug 1 Beg Inv 28 34$
8 Sale 1515 Purchase 22 38$ 30 Sale 20
Assume items were sold at $40/unitSales (35 units @ $40) 1,400$
Comparison of Methods
Comparison of Methods
Net sales 1,400$ Cost of merchandise sold:
Beginning inventory 952$ Purchases 836 Merchandise available for sale 1,788 Less ending inventory 570 Cost of merchandise sold 1,218
Gross profit 182$
FIFO
Comparison of Methods
Net sales 1,400$ Cost of merchandise sold:
Beginning inventory 952$ Purchases 836 Merchandise available for sale 1,788 Less ending inventory 510 Cost of merchandise sold 1,278
Gross profit 122$
LIFO
Comparison of Methods
Net sales 1,400$ Cost of merchandise sold:
Beginning inventory 952$ Purchases 836 Merchandise available for sale 1,788 Less ending inventory 540 Cost of merchandise sold 1,248
Gross profit 152$
AVERAGE COST
FIFO LIFO AVGNet sales 1,400$ 1,400$ 1,400$ Cost of merchandise sold:
Beginning inventory 952$ 952 952Purchases 836 836 836Merchandise available for sale 1,788 1,788 1,788 Less ending inventory 570 510 540 Cost of merchandise sold 1,218 1,278 1,248
Gross profit 182$ 122$ 152$
COMPARISON
Comparison of Methods
Note - with FIFO and rising costs:CMS is lower and ending inventory is higher
Note - with LIFO and rising costs:CMS is higher and ending inventory is lower
Note - Average cost falls between FIFO and LIFO
Describe and illustrate the reporting of merchandise
inventory in the financial statements.
Objective 6
Objective 6
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
Market, as used in lower of cost or
market, is the cost to replace the
merchandise on the inventory date.
Cost and replacement cost can be determined for—
1)each item in the inventory,
2)major classes or categories of inventory, or
3)the inventory as a whole.
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.
Merchandise Inventory on the Balance Sheet
Merchandise inventory is usually presented in the Current Assets section of
the balance sheet, following receivables.
The method of determining the cost of inventory (FIFO, LIFO, or
weighted average) should be shown.
Summary
Inventory and Controls
Inventory Costing Methods
Perpetual vs. Periodic
systems
Reporting of Inventory
Top Related