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7

Inventories

Student Version

Describe the importance of control over inventory.

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Two primary objectives of control over inventory are:1. Safeguarding the inventory,

and2. Properly reporting it in the

financial statements.

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A physical inventory or count of inventory should be taken near year-end to make sure that the quantity of inventory reported in the financial statements is accurate.

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Describe the three inventory cost flow assumptions and how they impact the income statement and balance sheet.

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Under the first-in, first out (FIFO) inventory cost flow method, the first units purchased are assumed to be sold and the ending inventory is made up of the most recent purchases.

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Under the last-in, first out (LIFO) inventory cost flow method, the last units purchased are assumed to be sold first and the ending inventory is made up of the first units purchased.

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Under the average inventory cost flow method, the cost of the units sold and in ending inventory is an average of the purchase costs.

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Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and average cost methods.

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On January 1, the firm had 100 units of Item 127B that cost $20 per unit.

First-In, First-Out Method3

Item 127B

Units Cost

Jan. 1 Inventory 100

$20

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On January 4, the firm sold 70 units of 127B at $30 each.

Item 127B

Units Cost

Jan. 1 Inventory 100

$204 Sale 70

First-In, First-Out Method3

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3

Exhibit 3 Entries and Perpetual Inventory Account (FIFO)

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On January 10, the firm purchased 80 units at $21 each.

Item 127B

Units Cost

Jan. 1 Inventory 100

$204 Sale 70

10 Purchase 80 21

First-In, First-Out Method3

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Jan. 1

Date

3

Exhibit 3Entries and Perpetual Inventory Account (FIFO) (continued)

10 Merchandise Inventory 1,680 Accounts Payable 1,680

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On January 22, the firm sold 40 units for $30 each.

Item 127B

Units Cost

Jan. 1 Inventory 100

$204 Sale 70

10 Purchase 80 2122 Sale 40

First-In, First-Out Method3

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Jan. 1

Date

3Entries and Perpetual Inventory Account (FIFO) (continued)

Exhibit 3

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First-In, First-Out Method

On January 28, the firm sold 20 units at $30 each. Item 127B

Units Cost

Jan. 1 Inventory 100

$204 Sale 70

10 Purchase 80 2122 Sale 40

28 Sale 20

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Date

Jan. 1

3Exhibit 3

Entries and Perpetual Inventory Account (FIFO) (continued)

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Item 127B

Units Cost

Jan. 1 Inventory 100

$204 Sale 70

10 Purchase 80 2122 Sale 40

28 Sale 20

30 Purchase 100 22

On January 30, purchased one hundred additional units of Item 127B at $22 each.

First-In, First-Out Method3

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3

Exhibit 3Entries and Perpetual Inventory Account (FIFO) (continued)

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3

Cost of merchandise sold

January 31 inventory

Entries and Perpetual Inventory Account (FIFO) (concluded)

Exhibit 3

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On January 1, the firm had 100 units of Item 127B that cost $20 per unit.

Last-In, First-Out Method3

Item 127B

Units Cost

Jan. 1 Inventory 100

$20

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On January 4, the firm sold 70 units of 127B at $30 each.

Item 127B

Units Cost

Jan. 1 Inventory 100

$204 Sale 70

Last-In, First-Out Method3

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3

Exhibit 4 Entries and Perpetual Inventory Account (LIFO)

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Item 127B

Units Cost

Jan. 1 Inventory 100

$204 Sale 70

10 Purchase 80 21

Last-In, First-Out Method

On January 10, the firm purchased 80 units at $21 each.

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Date

Jan. 14

3

Exhibit 4Entries and Perpetual Inventory Account (LIFO) (continued)

10 Merchandise Inventory 1,680 Accounts Payable 1,680

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On January 22, the firm sold 40 units for $30 each.

Item 127B

Units Cost

Jan. 1 Inventory 100

$204 Sale 70

10 Purchase 80 2122 Sale 40

Last-In, First-Out Method3

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Date

Jan. 14

3

Exhibit 4Entries and Perpetual Inventory Account (LIFO) (continued)

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On January 28, the firm sold 20 units at $30 each. Item 127B

Units Cost

Jan. 1 Inventory 100

$204 Sale 70

10 Purchase 80 2122 Sale 40

28 Sale 20

Last-In, First-Out Method3

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3

Exhibit 4Entries and Perpetual Inventory Account (LIFO) (continued)

Jan. 14

Date

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Item 127B

Units Cost

Jan. 1 Inventory 100

$204 Sale 70

10 Purchase 80 2122 Sale 40

28 Sale 20

30 Purchase 100 22

Last-In, First-Out Method

On January 30, the firm purchased one hundred additional units of Item 127B at $22 each.

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Date

3Entries and Perpetual Inventory Account (LIFO) (continued)Exhibit 4

Jan. 14

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3Entries and Perpetual Inventory Account (LIFO) (concluded)Exhibit 4

Cost of Merchandise

Sold

January 31 Inventory

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Determine the cost of inventory under the periodic inventory system, using the FIFO, LIFO, and average cost methods.

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4

Exhibit 5 First-In, First-Out Flow of Costs

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Exhibit 5 Last-In, First-Out Flow of Costs

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The weighted average unit cost is determined as follows:

Average Unit Cost =

Total Cost of Units Available for SaleUnits Available for

Sale

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Compare and contrast the use of the three inventory costing methods.

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Partial Income Statements

Net sales $3,900Cost of merchandise sold:

Beginning inventory $2,000Purchases 3,880Merchandise available for sale $5,880Less ending inventory 3,250 Cost of merchandise sold 2,630

Gross profit $1,270

First-In, First-Out

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Partial Income Statements

Net sales $3,900Cost of merchandise sold:

Beginning inventory $2,000Purchases 3,880Merchandise available for sale $5,880Less ending inventory 3,150 Cost of merchandise sold 2,730

Gross profit $1,170

Average Cost

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Net sales $3,900Cost of merchandise sold:

Beginning inventory $2,000Purchases 3,880Merchandise available for sale $5,880Less ending inventory 3,050 Cost of merchandise sold 2,830

Gross profit $1,070

Last-In, First-Out

Partial Income Statements

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Describe and illustrate the reporting of merchandise inventory in the financial statements.

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Cost is the primary basis for valuing and reporting inventories in the financial statements. However, inventory may be valued at other than cost in the following cases:

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Cost

(continued)

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1. The cost of replacing items in inventory is below the recorded cost.

2. The inventory cannot be sold at normal prices due to imperfections, style changes, or other causes.

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Market, as used in lower of cost or market, is the cost to replace the merchandise on the inventory date.

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Market

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6Determining Inventory at Lower of Cost or Market

Exhibit 8

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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.

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Net Realizable Value

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