chapterhorowitk/documents/chapter_13.pdf · chapter 13 author: larry larner created date: 6/19/2013...
TRANSCRIPT
Chapter
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13 Accounting for Merchandise Inventory
Learning Objective
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1
Explain the impact of merchandise inventory on the financial statements.
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Errors in inventory will cause errors on the: Income statement Statement of owner’s equity Balance sheet
Since this year’s ending inventory becomes next year’s beginning inventory, financial statements for the following year will also contain errors
Inventory Errors
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Effect Of Inventory Errors
INCOME STATEMENT 20-1 20-2 Sales 80 Cost of goods sold:
Beginning merch. inventory 20 Add purchases (net) 40
Cost of goods available for sale 60 Less ending merch. inventory
Let’s first look at the income statement with the ending inventory correctly stated at $20.
(20)
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INCOME STATEMENT 20-1 20-2 Sales 80 Cost of goods sold:
Beginning merch. inventory 20 Add purchases (net) 40 Cost of goods available for sale 60
Less ending merch. inventory (20) Cost of goods sold (40)
Gross profit 40 Operating expenses (10) Net income 30 Now let’s look at
the other financial statements.
Effect Of Inventory Errors
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STMT. OF OWNER’S EQUITY 20-1 20-2 Erv Bultman, capital, January 1 100 Net income Erv Bultman, capital, December 31
30 130
Current assets: Merchandise inventory
Owner’s equity: 20
Erv Bultman, capital
BALANCE SHEET (Partial)
130
Effect Of Inventory Errors
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INCOME STATEMENT 20-1 20-2 Sales 80 Cost of goods sold:
Beginning merch. inventory 20 Add purchases (net) 40 Cost of goods available for sale 60
Less ending merch. inventory (20) Cost of goods sold (40)
Gross profit 40 Operating expenses (10) Net income 30
80
20
20-1’s ending inventory becomes 20-2’s beginning
inventory.
Effect Of Inventory Errors
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INCOME STATEMENT 20-1 20-2 Sales 80 Cost of goods sold:
Beginning merch. inventory 20 Add purchases (net) 40 Cost of goods available for sale 60
Less ending merch. inventory (20) Cost of goods sold (40)
Gross profit 40 Operating expenses (10) Net income 30
80
20 40 60
(20) (40) 40
(10) 30
Effect Of Inventory Errors
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STMT. OF OWNER’S EQUITY 20-1 20-2 Erv Bultman, capital, January 1 100 Net income Erv Bultman, capital, December 31
30
Current assets: Merchandise inventory
Owner’s equity: 20
Erv Bultman, capital
BALANCE SHEET (Partial)
130
130 30
130 160
20
160
Effect Of Inventory Errors
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What would be the effect on the financial statements for 20-1 and 20-2 if the ending inventory was reported as $15 instead of $20?
Effect Of Inventory Errors
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Effect Of Inventory Errors
INCOME STATEMENT 20-1 20-2 Sales 80 Cost of goods sold:
Beginning merch. inventory 20 Add purchases (net) 40
Cost of goods available for sale 60 Less ending merch. inventory (15)
Cost of goods sold (45) Gross profit 35 Operating expenses (10) Net income 25
Understated ending inventory
results in understated net
income.
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Effect Of Inventory Errors
STMT. OF OWNER’S EQUITY 20-1 20-2 Erv Bultman, capital, January 1 100 Net income Erv Bultman, capital, December 31
25 125
BALANCE SHEET (Partial) Current assets:
Merchandise inventory Owner’s equity:
Erv Bultman, capital Understated net income results in understated
owner’s equity.
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effect Of Inventory Errors
STMT. OF OWNER’S EQUITY 20-1 20-2 Erv Bultman, capital, January 1 100 Net income Erv Bultman, capital, December 31
25 125
Current assets: Merchandise inventory
Owner’s equity: 15
Erv Bultman, capital
BALANCE SHEET (Partial)
125 Current assets and owner’s equity will
be understated.
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effect Of Inventory Errors
INCOME STATEMENT 20-1 20-2 Sales 80 Cost of goods sold:
Beginning merch. inventory 20 Add purchases (net) 40
Cost of goods available for sale 60 Less ending merch. inventory (15)
Cost of goods sold (45) Gross profit 35 Operating expenses (10) Net income 25
80
15 40 55 20
(35) 45
(10) 35
Understated beginning inventory results in
overstated net income.
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Effect Of Inventory Errors
STMT. OF OWNER’S EQUITY 20-1 20-2 Erv Bultman, capital, January 1 100 Net income Erv Bultman, capital, December 31
25
Current assets: Merchandise inventory
Owner’s equity: 15
Erv Bultman, capital
BALANCE SHEET (Partial)
125
125 35
125 160
Owner’s equity is correct by the end of 20-2.
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Effect Of Inventory Errors
STMT. OF OWNER’S EQUITY 20-1 20-2 Erv Bultman, capital, January 1 100 Net income Erv Bultman, capital, December 31
25
Current assets: Merchandise inventory
Owner’s equity: 15
Erv Bultman, capital
BALANCE SHEET (Partial)
125
125 35
125 160
20
160 Current assets and
owner’s equity will be correct by the end of 20-2.
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What would be the effect on the financial statements for 20-1 and 20-2 if the ending inventory was reported as $25 instead of $20?
Effect Of Inventory Errors
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Effect Of Inventory Errors
INCOME STATEMENT 20-1 20-2 Sales 80 Cost of goods sold:
Beginning merch. inventory 20 Add Purchases (net) 40 Cost of goods available for sale
60 Less ending merch. inventory (25)
Cost of goods sold (35) Gross profit 45 Operating expenses (10) Net income 35
Overstated ending inventory results in
overstated net income.
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effect Of Inventory Errors
STMT. OF OWNER’S EQUITY 20-1 20-2 Erv Bultman, capital, January 1 100 Net income Erv Bultman, capital, December 31
35 135
BALANCE SHEET (Partial) Current assets:
Merchandise inventory Owner’s equity:
Erv Bultman, capital Overstated net income results in overstated
owner’s equity.
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effect Of Inventory Errors
STMT. OF OWNER’S EQUITY 20-1 20-2 Erv Bultman, capital, January 1 100 Net income 35
135
Current assets: Merchandise inventory
Owner’s equity: 25
Erv Bultman, capital
BALANCE SHEET (Partial)
135 Current assets and
owner’s equity will be overstated.
Erv Bultman, capital, December 31
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effect Of Inventory Errors
INCOME STATEMENT 20-1 20-2 Sales 80 Cost of goods sold:
Beginning merch. inventory 20 Add purchases (net) 40 Cost of goods available for sale 60
Less ending merch. inventory (25) Cost of goods sold (35)
Gross profit 45 Operating expenses (10) Net income 35
80
25 40 65 20
(45) 35
(10) 25
Overstated beginning inventory results in
understated net income.
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effect Of Inventory Errors
STMT. OF OWNER’S EQUITY 20-1 20-2 Erv Bultman, capital, January 1 100 Net income Erv Bultman, capital, December 31
35
Current assets: Merchandise inventory
Owner’s equity: 25
Erv Bultman, capital
BALANCE SHEET (Partial)
135
135 25
135 160
Owner’s equity is correct by the end of 20-2.
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Effect Of Inventory Errors
STMT. OF OWNER’S EQUITY 20-1 20-2 Erv Bultman, capital, January 1 100 Net income Erv Bultman, capital, December 31
35
Current assets: Merchandise inventory
Owner’s equity: 25
Erv Bultman, capital
BALANCE SHEET (Partial)
135
135 25
135 160
20
160 Current assets and
owner’s equity will be correct by the end of
20-2.
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Your Perspective - Sales Associate
Learning Objective
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2
Describe the two principal systems of accounting for merchandise inventory—the periodic system and the perpetual system.
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PERIODIC INVENTORY SYSTEM Merchandise inventory account balance = most recent physical inventory Purchases account used for all merchandise purchases Current inventory and cost of goods sold are only computed at the end of the period
Types Of Inventory Systems
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PERPETUAL INVENTORY SYSTEM Merchandise inventory account reflects current inventory Purchases are debited to Merchandise Inventory and cost of goods sold are credited to Merchandise Inventory Generally, there is no need for end-of-year adjustments
Types Of Inventory Systems (cont.)
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EXAMPLE: Purchased merchandise on account, $100.
Comparing Entries For Periodic And Perpetual Inventory Systems
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DATE DESCRIPTION PR DEBIT CREDIT Purchases 1
2 3 4 5 6 7 8 9
10
Accounts Payable 100 00
Periodic System
The periodic system uses a purchases
account.
100 00
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DATE DESCRIPTION PR DEBIT CREDIT Merchandise Inventory 1
2 3 4 5 6 7 8 9
10
Accounts Payable
Perpetual System
The perpetual system records purchases directly in the merchandise inventory account.
100 00 100 00
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EXAMPLE: Paid freight charge, $30.
Comparing Entries For Periodic And Perpetual Inventory Systems
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DATE DESCRIPTION PR DEBIT CREDIT Freight-In 1
2 3 4 5 6 7 8 9
10
30 00 Cash 30 00
The periodic system separates freight charges into their own
account.
Periodic System
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DATE DESCRIPTION PR DEBIT CREDIT Merchandise Inventory 1
2 3 4 5 6 7 8 9
10
30 00 Cash 30 00
The perpetual system considers freight charges part of the cost of merchandise
and includes them in the inventory account.
Perpetual System
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EXAMPLE: Sold merchandise on account, $80. The cost of the merchandise was $50.
Comparing Entries For Periodic And Perpetual Inventory Systems
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DATE DESCRIPTION PR DEBIT CREDIT Accounts Receivable 1
2 3 4 5 6 7 8 9
10
80 00 Sales 80 00
The periodic system only records the selling price of merchandise sold. No attempt is made to reduce the inventory account for items sold.
Periodic System
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DATE DESCRIPTION PR DEBIT CREDIT Accounts Receivable 1
2 3 4 5 6 7 8 9
10
80 00 Sales 80 00
The perpetual system also records the selling price of merchandise
sold.
Perpetual System
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DATE DESCRIPTION PR DEBIT CREDIT Accounts Receivable 1
2 3 4 5 6 7 8 9
10
80 00 Sales 80 00
In addition, the perpetual system removes the cost of merchandise sold from
inventory.
Perpetual System
Cost of Goods Sold Merchandise Inventory
50 00 50 00
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EXAMPLE: Merchandise costing $10 was returned to the supplier.
Comparing Entries For Periodic And Perpetual Inventory Systems
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DATE DESCRIPTION PR DEBIT CREDIT Accounts Payable 1
2 3 4 5 6 7 8 9
10
10 00 Purchases Ret. and Allow. 10 00
The periodic system maintains a separate account for returns.
Periodic System
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DATE DESCRIPTION PR DEBIT CREDIT Accounts Payable 1
2 3 4 5 6 7 8 9
10
10 00 Merchandise Inventory 10 00
Since the merchandise was recorded in the inventory account when purchased, it
is removed from the account when returned.
Perpetual System
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EXAMPLE: Customers returned merchandise sold for $20. The cost of the merchandise was $15.
Comparing Entries For Periodic And Perpetual Inventory Systems
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DATE DESCRIPTION PR DEBIT CREDIT Sales Returns and Allowances 1
2 3 4 5 6 7 8 9
10
20 00 Accounts Receivable 20 00
The periodic system maintains a separate account for returns.
Periodic System
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DATE DESCRIPTION PR DEBIT CREDIT Sales Returns and Allowances 1
2 3 4 5 6 7 8 9
10
20 00 Accounts Receivable 20 00
The perpetual system records the returned sale.
Perpetual System
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DATE DESCRIPTION PR DEBIT CREDIT Sales Returns and Allowances 1
2 3 4 5 6 7 8 9
10
20 00 Accounts Receivable 20 00
Perpetual System
Merchandise Inventory 15 00 15 00 Cost of Goods Sold
It also must adjust the cost of goods sold and merchandise inventory
accounts.
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EXAMPLE: Paid for merchandise costing $100. The supplier granted a 2% discount for prompt payment.
Comparing Entries For Periodic And Perpetual Inventory Systems
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DATE DESCRIPTION PR DEBIT CREDIT Accounts Payable 1
2 3 4 5 6 7 8 9
10
Purchases Discounts 2 00
Discounts are recorded in a
separate account.
Periodic System
Cash 98 00
100 00
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DATE DESCRIPTION PR DEBIT CREDIT Accounts Payable 1
2 3 4 5 6 7 8 9
10
Merchandise Inventory
100 00
The perpetual system does not record discounts in a separate account. It
reduces Merchandise Inventory directly for the discount amount.
Perpetual System
Cash 2 00
98 00
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Entries for Periodic and Perpetual Inventory Systems
13-49
Learning Objective
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3
Compute the costs allocated to the ending inventory and cost of goods sold using different inventory methods.
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A Broader View
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Use of Inventory Methods
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Counting the goods on hand at the end of the period
Used in the PERIODIC system to allocate merchandise costs between sold and unsold goods In the PERPETUAL system, it is compared to the accounting records to determine if what is actually held agrees with what is reported in the accounting records
Taking A Physical Inventory
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Done after regular business hours The ideal time to count the goods is when the quantity on hand is at its lowest levels
A fiscal year that starts and ends when inventory is at its lowest level is known as natural business year
Taking A Physical Inventory (cont.)
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Two special situations: Goods held for sale on CONSIGNMENT
Goods held on consignment remain the property of the shipper (consignor)
Goods IN TRANSIT If goods are shipped FOB shipping point, the BUYER pays for shipping and goods belong to the buyer as soon as they are shipped If goods are shipped FOB destination, the seller pays for shipping and the goods belong to the seller until they are received by the buyer
Taking A Physical Inventory (cont.)
•
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EXAMPLE: A physical inventory found 50 bicycles (Model ZX007) on hand. All of this particular model were purchased for $60 each.
Computing The Cost Of Ending Inventory
Number of bikes on hand
× Cost per unit
= Ending inventory
50 $60 × = $3,000
Computing ending inventory is simple if all purchases were made at the same price.
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Computing The Cost Of Ending Inventory
• What if each time we restocked this bicycle the price had changed?
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500 Cost of these
200 sold?
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Computing The Cost Of Ending Inventory
• What if each time we restocked this bicycle the price had changed?
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500 Depends on
the inventory method used.
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Method #1 – Specific Identification Method Used when each unit of inventory can be specifically identified
Examples: cars, motorcycles, furniture, appliances, and fine jewelry
Practical only for businesses in which sales volume is relatively low and inventory unit value is relatively high
Inventory Methods
Let’s apply this method to the bicycle example.
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Computing The Cost Of Goods Sold • Inventory was maintained using the specific
identification method. The identity of the 200 bicycles sold is as follows: Units Unit Price Total Cost
On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500 30 of the beginning inventory were sold
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Computing The Cost Of Goods Sold
• Inventory was maintained using the specific identification method. The identity of the 200 bicycles sold is as follows: Units Unit Price Total Cost
On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500 50 from the 1st purchase
were sold
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Computing The Cost Of Goods Sold
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500 60 from the 2nd purchase
were sold
Inventory was maintained using the specific identification method. The identity of the 200 bicycles sold is as follows:
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Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500 60 from the 3rd purchase
were sold
Inventory was maintained using the specific identification method. The identity of the 200 bicycles sold is as follows:
Computing The Cost Of Goods Sold
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Units Unit Price Total Beginning inventory 30 $62 $ 1,860 1st purchase 50 2nd purchase 60 3rd purchase 60 Total 200
65 67 68
3,250 4,020 4,080
$13,210
Cost of goods (the 200 bicycles) sold
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Beginning inventory 10 $62 $ 620 1st purchase 10 2nd purchase 20 3rd purchase 10 Total 50
65 67 68
650 1,340
680 $3,290
This ending inventory will be reported on the income statement and the balance sheet.
Computing The Ending Inventory
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Method #2 – First-In, First-Out (FIFO) Method
Assumes that the first goods purchased were the first goods sold
Therefore, the latest goods purchased remain in inventory
Follows the natural flow of goods Especially true of grocery stores, fresh fruit stands, and computer software businesses
Inventory Methods
Let’s apply this method to the bicycle example.
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500
All of these were
assumed sold
Inventory was maintained using the FIFO method. The identity of the 200 bicycles sold is as follows:
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500
All of these were
assumed sold
Inventory was maintained using the FIFO method. The identity of the 200 bicycles sold is as follows:
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500
Inventory was maintained using the FIFO method. The identity of the 200 bicycles sold is as follows:
All of these were
assumed sold
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500
Inventory was maintained using the FIFO method. The identity of the 200 bicycles sold is as follows:
40 60 80
180 considered sold so far
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500
Inventory was maintained using the FIFO method. The identity of the 200 bicycles sold is as follows:
20 of these were
assumed sold
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Beginning inventory 40 $62 $2,480 1st purchase 60 2nd purchase 80 3rd purchase 20
65 67
3,900 5,360
The remaining units from the 3rd purchase are the 50 units
in ending inventory.
68 1,360
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Beginning inventory 40 $62 $ 2,480 1st purchase 60 2nd purchase 80 3rd purchase 20 Total 200
65 67 68
3,900 5,360 1,360
$13,100
Cost of goods (the 200 bicycles) sold
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Beginning inventory 0 $62 $ 0 1st purchase 0 2nd purchase 0 3rd purchase 50 Total 50
65 67 68
0 0
3,400 $3,400
This ending inventory will be reported on the income statement and the
balance sheet.
Computing The Ending Inventory
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Method #3 – Weighted-Average Method Computes an average cost per unit using the following formula:
Total cost of units available for sale divided by the units available for sale
Inventory Methods
Let’s apply this method to the bicycle example.
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Inventory was maintained using the weighted-average method.
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500 $16,500
250 = $66/unit
Computing The Average Cost Per Unit
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Weighted-Average Method
Cost of goods sold 200 units @ $66 = $13,200
Ending inventory 50 units @ $66 = 3,300
One of the advantages of the weighted-average
method is its simplicity.
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Method #4 – Last-In, First-Out (LIFO) Method
Assumes that the sales in the period were made from the most recently purchased goods
Therefore, the earliest goods purchased remain in inventory
The use of this method is justified because: The actual physical flow of goods in some businesses is actually last-in, first-out It matches the most current costs of items purchased against the current sales revenue
Inventory Methods
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500
Inventory was maintained using the LIFO method. The identity of the 200 bicycles sold is as follows:
All of these were assumed
sold
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500
Inventory was maintained using the LIFO method. The identity of the 200 bicycles sold is as follows:
All of these were assumed
sold
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500
Inventory was maintained using the LIFO method. The identity of the 200 bicycles sold is as follows:
70 80
150 considered sold so far
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Cost On hand at start of period 40 $62 $ 2,480 Purchased during period:
1st purchase 60 2nd purchase 80 3rd purchase 70
No. of units available for sale 250 On hand at end of period 50 No. of units sold during period 200
65 67 68
3,900 5,360 4,760
$16,500
Inventory was maintained using the LIFO method. The identity of the 200 bicycles sold is as follows:
50 of these were assumed
sold
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Beginning inventory 0 $62 $ 0 1st purchase 50 2nd purchase 80 3rd purchase 70
65 67
3,250 5,360
68 4,760 200 $13,370
Computing The Cost Of Goods Sold
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units Unit Price Total Beginning inventory 40 $62 $2,480 1st purchase 10 2nd purchase 0 3rd purchase 0 Total 50
65 67 68
650 0
$3,130
This ending inventory will be reported on the income statement
and the balance sheet.
0
Computing The Ending Inventory
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The assumed cost flows (FIFO, weighted-average, and LIFO) do not have to match the actual physical movement of goods Any one of the methods may be used under any set of physical flow conditions
Physical Flows And Cost Flows
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Sales Cost of goods sold:
Beg. inventory Purchases Goods avail. for sale
$18,000
$ 2,480 14,020
$16,500
Specific Identification FIFO
$18,000
14,020 $16,500
$ 2,480
Goods available for sale is the same for all four
methods!
Comparison of Inventory Methods
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$18,000
$ 2,480 14,020
$16,500
FIFO $18,000
14,020 $16,500
$ 2,480
Weighted-Average LIFO $18,000
$ 2,480 14,020
$16,500
Comparison of Inventory Methods
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Sales Cost of goods sold:
Beg. inventory Purchases Goods avail. for sale
$18,000
$ 2,480 14,020
$16,500
Specific Identification FIFO
$18,000
14,020 $16,500
$ 2,480
Less ending inventory
3,290 3,400
Cost of goods sold 13,210 13,100
Ending inventory and cost of goods sold differ with each
method.
Comparison of Inventory Methods
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
$18,000
$ 2,480 14,020
$16,500
FIFO $18,000
14,020 $16,500
$ 2,480
3,300 3,130 13,200 13,370
Weighted-Average LIFO $18,000
$ 2,480 14,020
$16,500 3,400
13,100
Comparison of Inventory Methods
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Sales Cost of goods sold: Beg. inventory Purchases Goods avail. for sale
$18,000
$ 2,480 14,020
$16,500
Specific Identification FIFO
$18,000
14,020 $16,500
$ 2,480
Less ending inventory
3,290 3,400
Cost of goods sold 13,210 13,100
Gross profit $ 4,790 $ 4,900
Comparison of Inventory Methods
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
$18,000
$ 2,480 14,020
$16,500
FIFO $18,000
14,020 $16,500
$ 2,480
3,300 3,130 13,200 13,370
$ 4,800 $ 4,630
Weighted-Average LIFO $18,000
$ 2,480 14,020
$16,500 3,400
13,100 $ 4,900
When prices are rising (as with the bicycles), FIFO results in the largest
gross profit.
Comparison of Inventory Methods
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
$18,000
$ 2,480 14,020
$16,500
FIFO $18,000
14,020 $16,500
$ 2,480
3,300 3,130 13,200 13,370
$ 4,800 $ 4,630
Weighted-Average LIFO $18,000
$ 2,480 14,020
$16,500 3,400
13,100 $ 4,900
LIFO results in the smallest gross profit, therefore creating the
smallest tax liability.
Comparison of Inventory Methods
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Merchandise Inventory is a controlling account
A subsidiary ledger is maintained with an account for each type of merchandise
Goods sold are usually assigned cost on either a FIFO, moving-average, or LIFO basis
The Perpetual Inventory System
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Let’s return to the example of the 200 bicycles sold.
Date
Total
Cost of Goods Sold
Units Cost/ Unit CGS
Jan. 1 (BI)
Cumulative CGS Units Unit
Cost/ Purchases
There were 40 bicycles in inventory at the beginning of
the year.
Perpetual Inventory Record: FIFO Method
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Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost
(1) 40 $62 $2,480
CGS Cumulative
Each of the 40 units were purchased at
$62.
Total
$2,480
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Date Purchases
Units Cost/ Unit Total
Cost of Goods Sold
Units Cost/ Unit CGS
Jan. 1 (BI)
Cumulative CGS
Feb. 15 30
The 30 bicycles sold came from the $62 bicycles in beginning
inventory.
$62
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Date Purchases
Units Cost/ Unit Total
Cost of Goods Sold
Units CGS Jan. 1 (BI)
Cumulative CGS
Feb. 15 30 $62 $1,860 $ 1,860
Unit Cost/
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost
(1) 40 $62 $2,480
CGS Cumulative
Total
$2,480
30 $62 $1,860 $ 1,860 (1) 10 $62 $ 620 $ 620
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Date Purchases
Units Cost/ Unit Total
Cost of Goods Sold
Units Cost/ Unit CGS
Jan. 1 (BI)
Cumulative CGS
Feb. 15 30 $62 $1,860 $ 1,860 Mar. 1
60 $65 $3,900
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost
(1) 40 $62 $2,480
CGS Cumulative
Total
$2,480
30 $62 $1,860 $ 1,860 (1) 10 $62 $ 620 $ 620 (1) 10 $62 $ 620 (2) 60 65 3,900 $4,520
Now there are two layers in inventory…10 bicycles from the beginning inventory and the
60 bicycles just purchased.
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Date Purchases
Units Cost/ Unit Total
Cost of Goods Sold
Units Cost/ Unit CGS
Jan. 1 (BI)
Cumulative CGS
Feb. 15 30 $62 $1,860 $ 1,860 Mar. 1
60 $65 $3,900 April 1
On April 1, 40 units were sold.
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost
(1) 40 $62 $2,480
CGS Cumulative
Total
$2,480
30 $62 $1,860 $ 1,860 (1) 10 $62 $ 620 $ 620 (1) 10 $62 $ 620 (2) 60 65 3,900 $4,520
FIFO assumes the first-in are the first sold….40 sold = 10 from the beginning
inventory and the 30 from the 3/1 purchase.
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Date Purchases
Units Cost/ Unit Total
Cost of Goods Sold
Units Cost/ Unit CGS
Jan. 1 (BI)
Cumulative CGS
Feb. 15 30 $62 $1,860 $ 1,860 Mar. 1
60 $65 $3,900 April 1 10 $62 $ 620
$ 4,430 30 65 1,950
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost
(1) 40 $62 $2,480
CGS Cumulative
Total
$2,480
30 $62 $1,860 $ 1,860 (1) 10 $62 $ 620 $ 620 (1) 10 $62 $ 620 (2) 60 65 3,900 $4,520
10 $62 $ 620 30 65 1,950 $ 4,430
(2) 30 $65 $1,950 $1,950
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Date Purchases
Units Cost/ Unit Total
Cost of Goods Sold
Units Cost/ Unit CGS
Jan. 1 (BI)
Cumulative CGS
Feb. 15 30 $62 $1,860 $ 1,860 Mar. 1
60 $65 $3,900 April 1 10 $62 $ 620
$ 4,430 30 65 1,950 May 15
80 $67 $5,360
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost
(1) 40 $62 $2,480
CGS Cumulative
Total
$2,480
30 $62 $1,860 $ 1,860 (1) 10 $62 $ 620 $ 620 (1) 10 $62 $ 620 (2) 60 65 3,900 $4,520
10 $62 $ 620 30 65 1,950 $ 4,430
(2) 30 $65 $1,950 $1,950
(2) 30 $65 $1,950 (3) 80 67 $5,360 $7,310
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Date Purchases
Units Cost/ Unit Total
Cost of Goods Sold
Units Cost/ Unit CGS
May 15
Cumulative CGS
80 $67 $5,360 June 30
On June 30, 90 units were sold.
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost CGS Cumulative
Total (2) 30 $65 $1,950 (3) 80 67 5,360 $7,310
90 bicycles sold = 30 (layer 2) + 60 (layer 3)
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Date Purchases
Units Cost/ Unit Total
Cost of Goods Sold
Units Cost/ Unit CGS
May 15
Cumulative CGS
80 $67 $5,360 June 30 30 $65 $1,950
60 67 4,020 $10,400
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost CGS Cumulative
Total (2) 30 $65 $1,950
80 67 5,360 $7,310 30 $65 $1,950
60 67 4,020 $10,400
(3) (3) 20 $67 $1,340
$1,340
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Date Purchases
Units Cost/ Unit Total
Cost of Goods Sold
Units Cost/ Unit CGS
May 15
Cumulative CGS
80 $67 $5,360 June 30 30 $65 $1,950
60 67 4,020 $10,400 Aug. 28
70 $68 $4,760
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost CGS Cumulative
Total (2) 30 $65 $1,950
80 67 5,360 $7,310 30 $65 $1,950
60 67 4,020 $10,400
(3) (3) 20 $67 $1,340
$1,340 (3) 20 $67 $1,340 (4) 70 68 4,760 $6,100
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Date Purchases
Units Cost/ Unit Total
Cost of Goods Sold
Units Cost/ Unit CGS
May 15
Cumulative CGS
80 $67 $5,360 June 30 30 $65 $1,950
60 67 4,020 $10,400 Aug. 28
70 $68 $4,760 Oct. 30
40 units were sold on Oct. 30.
Perpetual Inventory Record: FIFO Method
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Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost CGS Cumulative
Total (2) 30 $65 $1,950
80 67 5,360 $7,310 30 $65 $1,950
60 67 4,020 $10,400
(3) (3) 20 $67 $1,340
$1,340 (3) 20 $67 $1,340 (4) 70 68 4,760 $6,100
40 units sold =
20 (layer 3) + 20 (layer 4)
Perpetual Inventory Record: FIFO Method
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Let’s return to the example of the 200 bicycles sold.
Date Purchases
Units Cost/ Unit Total
Cost of Goods Sold
Units Cost/ Unit CGS
May 15
Cumulative CGS
80 $67 $5,360 June 30 30 $65 $1,950
60 67 4,020 $10,400 Aug. 28
70 $68 $4,760 Oct. 30 20 $67 $1,340
20 68 1,360 $13,100
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost CGS Cumulative
Total (2) 30 $65 $1,950
80 67 5,360 $7,310 30 $65 $1,950
60 67 4,020 $10,400
(3) (3) 20 $67 $1,340
$1,340 (3) 20 $67 $1,340 (4) 70 68 4,760 $6,100
20 $67 $1,340 20 68 1,360 $13,100
(4) 50 $68 $3,400
$3,400
Cost of goods sold for the year
Perpetual Inventory Record: FIFO Method
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Let’s return to the example of the 200 bicycles sold.
Units Cost/ Unit
Cost of Goods Sold
CGS
Inventory on Hand
Layer Units Unit Cost/ Layer
Cost CGS Cumulative
Total (2) 30 $65 $1,950
80 67 5,360 $7,310 30 $65 $1,950
60 67 4,020 $10,400
(3) (3) 20 $67 $1,340
$1,340 (3) 20 $67 $1,340 (4) 70 68 4,760 $6,100
20 $67 $1,340 20 68 1,360 $13,100
(4) 50 $68 $3,400
$3,400 Ending inventory
Perpetual Inventory Record: FIFO Method
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An asset that increases in value while being held…
No formal entry of the gain is made on the books until asset is sold
An asset that decreases in value while being held…
An entry is made to recognize the loss
We should never anticipate gains, but we should always anticipate and account for losses
Conservatism Principle
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Conservatism means that if the value of inventory declines while it is being held, the loss should be recognized in the period of the decline The purpose of the lower-of-cost-or-market method is to recognize such losses on the income statement and to report the lower inventory valuation on the balance sheet
Lower-of-cost-or-market Method
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“Cost” The dollar amount calculated using one of the four inventory costing methods
“Market” The cost to replace the inventory
Lower-of-cost-or-market Method (cont.)
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Lower-of-cost-or-market Method
Item Recorded
Purchase Cost End-of-Period Market Value
1
2
3
This company sells three products.
Lower-of-Cost-or-Market
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Item Recorded
Purchase Cost End-of-Period Market Value
1 $ 8,000
2
3
The inventory of product #1
cost $8,000.
Lower-of-Cost-or-Market
Lower-of-cost-or-market Method
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Item Recorded
Purchase Cost End-of-Period Market Value
1 $ 7,000
2
3 But the price has fallen;
it now could be replaced
for $7,000.
Lower-of-Cost-or-Market
$ 8,000
Lower-of-cost-or-market Method
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Item Recorded
Purchase Cost End-of-Period Market Value
1 $ 7,000
2
3
“Market” is the lowest.
Lower-of-Cost-or-Market $ 7,000 $ 8,000
Lower-of-cost-or-market Method
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Item Recorded
Purchase Cost End-of-Period Market Value
1 $ 7,000
Lower-of-Cost-or-Market $ 7,000
2 9,000 10,000 9,000
3 7,000 6,500 6,500 $24,000 $23,500 $22,500
There are two ways to calculate
the lower-of-cost-or-market.
$ 8,000
Lower-of-cost-or-market Method
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Item Recorded
Purchase Cost End-of-Period Market Value
1 $ 8,000 $ 7,000
Lower-of-Cost-or-Market $ 7,000
2 9,000 10,000 9,000
3 7,000 6,500 6,500 $24,000 $23,500 $22,500
#1 – Applied to Total Inventory
The lower of all items at their
cost or all items at their market value
Lower-of-cost-or-market Method
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Item Recorded
Purchase Cost End-of-Period Market Value
1 $ 8,000 $ 7,000
Lower-of-Cost-or-Market $ 7,000
2 9,000 10,000 9,000
3 7,000 6,500 6,500 $24,000 $23,500 $22,500
#2 – Applied to Each Item Each item is evaluated;
the lowest amount is selected for each item
Lower-of-cost-or-market Method
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Item Recorded
Purchase Cost End-of-Period Market Value
1 $ 8,000 $ 7,000
Lower-of-Cost-or-Market $ 7,000
2 9,000 10,000 9,000
3 7,000 6,500 6,500 $24,000 $23,500 $22,500
Let’s assume it was applied to the total inventory. A journal entry is needed to reduce Merchandise Inventory
to $23,500.
Lower-of-cost-or-market Method
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DATE DESCRIPTION PR DEBIT CREDIT 1 2 3 4 5 6 7 8 9
10
Loss on Write-Down of Inventory 500 Merchandise Inventory 500
To recognize loss in value of inventory held
Expense
General Journal
Learning Objective
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4
Estimate the ending inventory and cost of goods sold by using the gross profit and retail inventory methods.
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Estimating inventory is not a problem for businesses using the perpetual inventory method
Unverified amounts are generally reliable estimates and can be used for “interim” monthly or quarterly financial statements
Businesses using the periodic inventory method must use other methods to estimate ending inventory and cost of goods sold
Two generally accepted methods: Gross profit method Retail inventory method
Estimating Inventory
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A business’s normal gross profit (net sales – cost of goods sold) is used to estimate the cost of goods sold and ending inventory.
Gross Profit Method
3 STEPS
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Gross Profit Method (cont.)
Example:
Inventory, start of period $80,000 Net purchases, first month $70,000
$110,000 Net sales, first month Normal gross profit as a percentage of sales
40%
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Step #1: Compute the cost of goods available for sale.
Gross Profit Method (cont.)
Inventory, start of period $80,000 Net purchases, first month 70,000
Cost of goods avail. for sale $150,000
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Gross Profit Method (cont.)
Example:
Inventory, start of period Net purchases, first month Net sales, first month Normal gross profit as a percentage of sales
$80,000 $70,000
$110,000 40%
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Step #2: Estimate cost of goods sold by deducting the normal gross profit from net sales.
Gross Profit Method (cont.)
Net sales $110,000 Normal gross profit 44,000
$110,000 × 40%
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Gross Profit Method
Example: Inventory, start of period Net purchases, first month Net sales, first month Normal gross profit as a percentage of sales
$80,000 $70,000
$110,000 40%
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Step #3: Estimate the ending inventory by deducting cost of goods sold from the cost of goods available for sale.
Gross Profit Method (cont.)
Cost of goods available for sale $150,000 Estimated cost of goods sold 66,000 Estimated end-of-month inv. $ 84,000
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Used by many retail businesses. Requires keeping records of both the cost and selling (retail) prices of all goods purchased.
Retail Inventory Method
5 STEPS
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Inventory, start of period $ 60,000 $ 85,000 COST RETAIL
Net purchases during period 126,000 163,000 Goods available for sale $186,000 $248,000
Step #1: Compute the cost of goods available for sale at cost and retail.
Retail Inventory Method (cont.)
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Step #2: Compute the ending inventory at retail by subtracting sales at retail from goods available for sale at retail.
Retail Inventory Method (cont.)
Inventory, start of period $ 60,000 $ 85,000 COST RETAIL
Net purchases during period 126,000 163,000 Goods available for sale $186,000 $248,000 Less net sales for period 180,000 Inventory, end of period, at retail $ 68,000
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Step #3: Compute the cost-to-retail ratio by dividing the cost of goods available for sale by the retail value of the goods available for sale.
Retail Inventory Method (cont.)
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Retail Inventory Method (cont.)
Inventory, start of period $ 60,000 $ 85,000 COST RETAIL
Net purchases during period 126,000 163,000 Goods available for sale $186,000 $248,000 Less net sales for period 180,000 Inventory, end of period, at retail $ 68,000 Cost to Retail Ratio ($186,000 ÷ $248,000) 75%
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Step #4: Estimate the cost of the ending inventory by multiplying the ending inventory at retail by the cost-to-retail ratio.
Retail Inventory Method (cont.)
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Retail Inventory Method (cont.)
Inventory, start of period $ 60,000 $ 85,000 COST RETAIL
Net purchases during period 126,000 163,000 Goods available for sale $186,000 $248,000 Less net sales for period 180,000 Inventory, end of period, at retail $ 68,000 Cost to Retail Ratio ($186,000 ÷ $248,000) 75% Inventory, end of period,
$(51,000) at cost ($68,000 × 75%)
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Step #5: Estimate cost of goods sold by subtracting the estimated ending inventory from the cost of goods available for sale.
Retail Inventory Method (cont.)
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Retail Inventory Method (cont.)
Inventory, start of period $ 60,000 $ 85,000 COST RETAIL
Net purchases during period 126,000 163,000 Goods available for sale $186,000 $248,000 Less net sales for period 180,000 Inventory, end of period, at retail $ 68,000 Ratio ($186,000 ÷ $248,000) 75% Inventory, end of period,
$(51,000) at cost ($68,000 × 75%) Estimated cost of goods sold $135,000