Chapter 5

Accounting for Inventories

Determining 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

C 1

FOB Destination Point

Public Carrier

Seller Buyer

Goods in Transit

Public Carrier

Seller Buyer

FOB Shipping Point

Ownership passes to the buyer here.

C 1

Goods 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.

C 1

Goods Damaged or Obsolete

Damaged or obsolete goods are not counted in inventory.

Cost should be reduced to net realizable value.

C 1

Determining Inventory Costs

Invoice Cost

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

Minus Discounts

and Allowances

Plus Import Duties Plus

Freight

Plus Storage

Plus Insurance

C 2

Internal 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 ___

C 2

Frequency in Use of Inventory Methods

Exh. 5.1

P1

Inventory 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.

P1

Specific 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.

P1

First-In, First-Out (FIFO)

Cost of Goods Sold

Cost of Goods Sold

Ending InventoryEnding

Inventory

Oldest Costs

Oldest Costs

Recent Costs

Recent Costs

P1

Last-In, First-Out (LIFO)

Cost of Goods Sold

Cost of Goods Sold

Ending InventoryEnding

Inventory

Recent Costs

Recent Costs

Oldest Costs

Oldest Costs

P1

Weighted 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÷

P1

Financial 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.

A1

Financial Statement Effects of Costing Methods

Advantages of MethodsAdvantages of MethodsAdvantages of MethodsAdvantages of Methods

Smoothes out Smoothes out price changes.price changes.Smoothes out Smoothes 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

A1

Tax Effects of Costing Methods

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

for inventory costing for reporting for inventory costing for reporting taxable income.taxable income.

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

for inventory costing for reporting for inventory costing for reporting taxable income.taxable 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.

A1

Consistency in Using Costing Methods

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

financial statements are comparable financial statements are comparable across periods.across periods.

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

financial statements are comparable financial statements are comparable across periods.across periods.

A1

Financial Statement Effects of Inventory Errors

Income Statement EffectsIncome Statement Effects

Exh. 5.10

A2

Financial Statement Effects of Inventory Errors

Balance Sheet EffectsBalance Sheet Effects

Exh. 5.12

A2

End of Chapter 5