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8-1

INVENTORIES AND THE COST OF GOODS SOLD

Chapter

8

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8-2

InventoryInventory

Goods ownedand held for sale

to customers

Goods ownedand held for sale

to customers

Current asset

Current asset

Inventory DefinedInventory Defined

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8-3

INCOME STATEMENT

Revenue Cost of goods sold Gross profit Expenses Net income

As purchase cost (or manufacturing costs) are incurred

as goods are sold

BALANCE SHEET

Current assets: Inventory

$ $

$

The Flow of Inventory CostsThe Flow of Inventory Costs

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8-4

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Entry on Purchase Date

Inventory $$$$

Accounts Payable $$$$

Entry on Sale Date

Cost of Goods Sold $$$$

Inventory $$$$

In a perpetual inventory system, inventory entries parallel the flow of costs.

The Flow of Inventory CostsThe Flow of Inventory Costs

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8-5

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Entry on Sale Date

Cost of Goods Sold $$$$

Inventory $$$$

When identical units of inventory have different unit costs, a question naturally

arises as to which of these costs should be used in recording a sale of inventory.

Which Unit Did We Sell? Which Unit Did We Sell?

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8-6

A separate subsidiary account is maintained for each item in inventory.

A separate subsidiary account is maintained for each item in inventory.

How can we determine the unit cost for the Sept. 10 sale?

Item LL002 Primary supplier Electronic CityDescription Laser Light Secondary supplier Electric CompanyLocation Storeroom 2 Inventory level: Min: 25 Max: 200

Purchased Sold Balance

Date UnitsUnit Cost Total Units

Unit Cost

Cost of Goods Sold Units

Unit Cost Total

Sept. 5 100 30$ 3,000$ 100 30$ 3,000$ Sept. 9 75 50 3,750 100 30 3,000

75 50 3,750 Sept. 10 10 ? ? ? ? ?

? ? ?

Inventory Subsidiary LedgerInventory Subsidiary Ledger

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8-7

Specific identification

LIFO

Average cost

FIFO

We use one of these inventory valuation methods to determine cost of inventory sold.

Inventory Cost FlowsInventory Cost Flows

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8-8

Cost of Goods Available for SaleAug. 1 Beg. Inventory 10 units @ 91$ = 910$ Aug. 3 Purchased 15 units @ 106$ = 1,590$ Aug. 17 Purchased 20 units @ 115$ = 2,300$ Aug. 28 Purchased 10 units @ 119$ = 1,190$

Retail Sales of GoodsAug. 14 Sales 20 units @ 130$ = 2,600$ Aug. 31 Sales 23 units @ 150$ = 3,450$

The Bike Company (TBC)

Information for the Following Inventory Examples

Information for the Following Inventory Examples

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8-9

Specific Identification Specific Identification

When a unitis sold, the

specific cost of the unit sold is added to cost of

goods sold.

When a unitis sold, the

specific cost of the unit sold is added to cost of

goods sold.

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8-10

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$

On August 14, TBC sold 20 bikes for $130 each.

Nine bikes originally cost $91 and 11 bikes originally cost $106.

On August 14, TBC sold 20 bikes for $130 each.

Nine bikes originally cost $91 and 11 bikes originally cost $106.

Continue

Specific Identification Specific Identification

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8-11

The Cost of Goods Sold for the August 14 sale is $1,985, leaving $515 and 5 units in inventory.

The Cost of Goods Sold for the August 14 sale is $1,985, leaving $515 and 5 units in inventory.

Continue

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 9 @ 91$ = 819$

11 @ 106$ = 1,166$ 515$

Let’s look at the entries for the Aug. 14 sale.

Specific Identification Specific Identification

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8-12

Continue

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Aug. 14 Cash 2,600

Sales 2,600

14 Cost of Goods Sold 1,985

Inventory 1,985

RetailRetail

CostCost

A similar entry ismade after each sale.

A similar entry ismade after each sale.

Specific Identification Specific Identification

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8-13

Additional purchases were made on August 17 and 28.

Costs associated with sales on August 31 were as follows: 1 @ $91, 3 @ $106, 15 @ $115, & 4 @ $119.

Additional purchases were made on August 17 and 28.

Costs associated with sales on August 31 were as follows: 1 @ $91, 3 @ $106, 15 @ $115, & 4 @ $119.

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 9 @ 91$ = 819$

11 @ 106$ = 1,166$ 515$ Aug. 17 20 @ 115$ = 2,300$ 2,815$ Aug. 28 10 @ 119$ = 1,190$ 4,005$

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 9 @ 91$ = 819$

11 @ 106$ = 1,166$ 515$ Aug. 17 20 @ 115$ = 2,300$ 2,815$ Aug. 28 10 @ 119$ = 1,190$ 4,005$ Aug. 31 1 @ 91$ = 91$

3 @ 106$ = 318$

15 @ 115$ = 1,725$

4 @ 119$ = 476$ 1,395$

Continue

Specific Identification Specific Identification

Cost of Goods Sold for

August 31 = $2,610

Cost of Goods Sold for

August 31 = $2,610

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8-14

Balance Sheet

Inventory = $1,395

Income Statement

COGS = $4,595

1 @ 106$ = 106$ 5 @ 115$ = 575 6 @ 119$ = 714

End. Inv. 1,395$

Specific Identification Specific Identification

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 9 @ 91$ = 819$

11 @ 106$ = 1,166$ 515$ Aug. 17 20 @ 115$ = 2,300$ 2,815$ Aug. 28 10 @ 119$ = 1,190$ 4,005$ Aug. 31 1 @ 91$ = 91$

3 @ 106$ = 318$

15 @ 115$ = 1,725$

4 @ 119$ = 476$ 1,395$

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8-15

Since specific identification is so

easy, can’t we use it all the time?

Not really. Specific identification is hard to use

when we sell a lot of inventory that has lots of

different costs.

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8-16

Cost of Goods Available for

Sale

Units on hand on the date of

sale÷

Average-Cost MethodAverage-Cost Method

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.

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8-17

On August 14, TBC sold 20 bikes for $130 each. On August 14, TBC sold 20 bikes for $130 each.

Continue

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$

The average cost per unit must be computed prior

to each sale.

The average cost per unit must be computed prior

to each sale.

Average-Cost MethodAverage-Cost Method

$100 = $2,500 25$100 = $2,500 25

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8-18

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 20 @ 100$ = 2,000$ 500$

Continue

The average cost per unit is $100.

The average cost per unit is $100.

Let’s look at the entries for the Aug. 14 sale.

Average-Cost MethodAverage-Cost Method

$100 = $2,500 25$100 = $2,500 25

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8-19

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Aug. 14 Cash 2,600

Sales 2,600

14 Cost of Goods Sold 2,000

Inventory 2,000

Continue

RetailRetail

CostCost

A similar entry ismade after each sale.

A similar entry ismade after each sale.

Average-Cost MethodAverage-Cost Method

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8-20

Additional purchases were made on August 17 and August 28.

On August 31, an additional 23 units were sold.

Additional purchases were made on August 17 and August 28.

On August 31, an additional 23 units were sold.

Continue

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 20 @ 100$ = 2,000$ 500$ Aug. 17 20 @ 115$ = 2,300$ 2,800$ Aug. 28 10 @ 119$ = 1,190$ 3,990$

Average-Cost MethodAverage-Cost Method

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$114 = $3,990 35$114 = $3,990 35

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 20 @ 100$ = 2,000$ 500$ Aug. 17 20 @ 115$ = 2,300$ 2,800$ Aug. 28 10 @ 119$ = 1,190$ 3,990$

Total Purchases 55Less: Sales to Date -20Units on Hand 35

Average-Cost MethodAverage-Cost Method

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$114 = $3,990 35$114 = $3,990 35

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 20 @ 100$ = 2,000$ 500$ Aug. 17 20 @ 115$ = 2,300$ 2,800$ Aug. 28 10 @ 119$ = 1,190$ 3,990$ Aug. 31 23 @ 114$ = 2,622$ 1,368$

The average cost per unit is $114.

The average cost per unit is $114.

Average-Cost MethodAverage-Cost Method

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8-23

Income Statement

COGS = $4,622

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 20 @ 100$ = 2,000$ 500$ Aug. 17 20 @ 115$ = 2,300$ 2,800$ Aug. 28 10 @ 119$ = 1,190$ 3,990$ Aug. 31 23 @ 114$ = 2,622$ 1,368$

Balance Sheet

Inventory = $1,368

$114 × 12 = $1,368$114 × 12 = $1,368

Average-Cost MethodAverage-Cost Method

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Costs of Goods Sold

Costs of Goods Sold

Ending InventoryEnding

Inventory

Oldest Costs

Oldest Costs

Recent Costs

Recent Costs

First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)

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8-25

On August 14, TBC sold 20 bikes for $130 each. On August 14, TBC sold 20 bikes for $130 each.

Continue

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$

The Cost of Goods Sold for the August 14 sale is $1,970, leaving $530 and 5 units in inventory.

The Cost of Goods Sold for the August 14 sale is $1,970, leaving $530 and 5 units in inventory.

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 10 @ 91$ = 910$

10 @ 106$ = 1,060$ 530$

First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Aug. 14 Cash 2,600

Sales 2,600

14 Cost of Goods Sold 1,970

Inventory 1,970

RetailRetail

CostCost

ContinueA similar entry is

made after each sale.

A similar entry ismade after each sale.

First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)

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8-27

Additional purchases were made on Aug. 17 and Aug. 28.

On August 31, an additional 23 units were sold.

Additional purchases were made on Aug. 17 and Aug. 28.

On August 31, an additional 23 units were sold.

Continue

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 10 @ 91$ = 910$

10 @ 106$ = 1,060$ 530$ Aug. 17 20 @ 115$ = 2,300$ 2,830$ Aug. 28 10 @ 119$ = 1,190$ 4,020$

First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 10 @ 91$ = 910$

10 @ 106$ = 1,060$ 530$ Aug. 17 20 @ 115$ = 2,300$ 2,830$ Aug. 28 10 @ 119$ = 1,190$ 4,020$ Aug. 31 5 @ 106$ = 530$

18 @ 115$ = 2,070$ 1,420$

Cost of Goods Sold for August 31 = $2,600Cost of Goods Sold for August 31 = $2,600

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Balance Sheet

Inventory = $1,420

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 10 @ 91$ = 910$

10 @ 106$ = 1,060$ 530$ Aug. 17 20 @ 115$ = 2,300$ 2,830$ Aug. 28 10 @ 119$ = 1,190$ 4,020$ Aug. 31 5 @ 106$ = 530$

18 @ 115$ = 2,070$ 1,420$

Income Statement

COGS = $4,570

2 @ 115$ = 230$ 10 @ 119$ = 1,190

End. Inv. 1,420$

First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)

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Costs of Goods Sold

Costs of Goods Sold

Ending InventoryEnding

Inventory

Recent Costs

Recent Costs

Oldest Costs

Oldest Costs

Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

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8-30

On August 14, TBC sold 20 bikes for $130 each. On August 14, TBC sold 20 bikes for $130 each.

Continue

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$

Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 15 @ 106$ = 1,590$

5 @ 91$ = 455$ 455$

The Cost of Goods Sold for the August 14 sale is $2,045, leaving $455 and 5 units in inventory.

The Cost of Goods Sold for the August 14 sale is $2,045, leaving $455 and 5 units in inventory.

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8-31

GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Aug. 14 Cash 2,600

Sales 2,600

14 Cost of Goods Sold 2,045

Inventory 2,045

Continue

RetailRetail

CostCost

A similar entry ismade after each sale.

A similar entry ismade after each sale.

Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin

8-32

Continue

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 15 @ 106$ = 1,590$

5 @ 91$ = 455$ 455$ Aug. 17 20 @ 115$ = 2,300$ 2,755$ Aug. 28 10 @ 119$ = 1,190$ 3,945$

Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

Additional purchases were made on Aug. 17 and Aug. 28.

On Aug. 31, an additional 23 units were sold.

Additional purchases were made on Aug. 17 and Aug. 28.

On Aug. 31, an additional 23 units were sold.

© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin

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Continue

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 15 @ 106$ = 1,590$

5 @ 91$ = 455$ 455$ Aug. 17 20 @ 115$ = 2,300$ 2,755$ Aug. 28 10 @ 119$ = 1,190$ 3,945$

Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 15 @ 106$ = 1,590$

5 @ 91$ = 455$ 455$ Aug. 17 20 @ 115$ = 2,300$ 2,755$ Aug. 28 10 @ 119$ = 1,190$ 3,945$ Aug. 31 10 @ 119$ = 1,190$

13 @ 115$ = 1,495$ 1,260$

Cost of Goods Sold for August 31 = $2,685Cost of Goods Sold for August 31 = $2,685

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Date Purchases Cost of Goods SoldInventory Balance

Aug. 1 10 @ 91$ = 910$ 910$ Aug. 3 15 @ 106$ = 1,590$ 2,500$ Aug. 14 15 @ 106$ = 1,590$

5 @ 91$ = 455$ 455$ Aug. 17 20 @ 115$ = 2,300$ 2,755$ Aug. 28 10 @ 119$ = 1,190$ 3,945$ Aug. 31 10 @ 119$ = 1,190$

13 @ 115$ = 1,495$ 1,260$

Balance Sheet

Inventory = $1,260

Income Statement

COGS = $4,730

Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

5 @ 91$ = 455$ 7 @ 115$ = 805

End. Inv. 1,260$

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Inventory Valuation Methods: A SummaryCosts Allocated to:

Valuation Method

Cost of Goods Sold Inventory Comments

Specific Actual cost of Actual cost of units Parallels physical flow identification the units sold remaining Logical method when units

are uniqueMay be misleading for identical units

Average cost Number of units sold times the

Number of units on hand times the

Assigns all units the same average unit cost

average unit cost average unit cost Current costs are averaged in with older costs

First-in, First-out (FIFO)

Cost of earliest purchases on

Cost of most recently

Cost of goods sold is based on older costs

hand prior to the sale

purchased units Inventory valued at current costsMay overstate income during periods of rising prices; may increase income taxes due

Last-in, First-out (LIFO)

Cost of most recently

Cost of earliest purchases

Cost of goods sold shown at recent prices

purchased units (assumed still in inventory)

Inventory shown at old (and perhaps out of date) costsMost conservative method during periods of rising prices; often results in lower income taxes

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Once a company has adopted a particular

accounting method, it should follow that

method consistently, rather than switch methods from one year to the next.

The Principle of ConsistencyThe Principle of Consistency

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This inventory arrived just in time for us to use it in the manufacturing

process.

Just-In-Time (JIT) Inventory SystemsJust-In-Time (JIT) Inventory Systems

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Dec. 31 Cost of Goods Sold $$$$

Inventory $$$$

The primary reason for taking a physical inventory is to adjust the perpetual inventory records for

unrecorded shrinkage losses, such as theft, spoilage, or breakage.

The primary reason for taking a physical inventory is to adjust the perpetual inventory records for

unrecorded shrinkage losses, such as theft, spoilage, or breakage.

Taking a Physical InventoryTaking a Physical Inventory

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Reduces the value of the inventory.

Reduces the value of the inventory.ObsolescenceObsolescence

Adjust inventory value to the lower

of historical cost or current

replacement cost (market).

Adjust inventory value to the lower

of historical cost or current

replacement cost (market).

Lower of Cost or Market

(LCM)

Lower of Cost or Market

(LCM)

LCM and Other Write-Downsof Inventory

LCM and Other Write-Downsof Inventory

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Year End

A sale should be recorded when title to the merchandise passes to the

buyer.

A sale should be recorded when title to the merchandise passes to the

buyer.

F.O.B. shipping

point title passes to

buyer at the point of

shipment.

F.O.B. shipping

point title passes to

buyer at the point of

shipment.

F.O.B. destination point title passes to

buyer at the point of

destination.

F.O.B. destination point title passes to

buyer at the point of

destination.

Goods In TransitGoods In Transit

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Entry on Purchase Date

Purchases $$$$

Accounts Payable $$$$

In a periodic inventory system, inventory entries are as follows.

Note that an entry is not made to inventory.

Note that an entry is not made to inventory.

Periodic Inventory SystemsPeriodic Inventory Systems

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GENERAL JOURNAL

Date Account Titles and ExplanationPR Debit Credit

Entry on Sale Date

No entry to inventory.

Accounts Receivable $$$$

Sales $$$$

In a periodic inventory system, inventory entries are as follows.

Periodic Inventory SystemsPeriodic Inventory Systems

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The inventory on hand and the cost of goods

sold for the year are not

determined until year-end.

Periodic Inventory SystemsPeriodic Inventory Systems

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8-44

Specific identification

LIFO

Average cost

FIFO

We use one of these inventory valuation methods in a periodic inventory system.

Periodic Inventory SystemsPeriodic Inventory Systems

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8-45

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$

Ending Inventory 1,200 ?

Cost of Goods Sold 600 ?

Information for the Following Inventory Examples

Information for the Following Inventory Examples

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By reviewing actual purchase invoices,

Computers, Inc. determines that the 1,200 mouse pads on hand at year-end have

an actual total cost of $6,400.

Determine the cost of goods sold for the year.

Specific IdentificationSpecific Identification

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8-47

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$

Ending Inventory 1,200 6,400.00$

Cost of Goods Sold 600 3,325.00$

Cost of Goods Sold$9,725 - $6,400 = $3,325

Cost of Goods Sold$9,725 - $6,400 = $3,325

Specific IdentificationSpecific Identification

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Total Cost of Goods

Available for Sale

Total Number of Units

Available for Sale

÷

The average cost is calculated at year-

end as follows:

The average cost is calculated at year-

end as follows:

Average-Cost MethodAverage-Cost Method

© The McGraw-Hill Companies, Inc., 2005McGraw-Hill/Irwin

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Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$

Ending Inventory 1,200 ?

Cost of Goods Sold 600 ?

Avg. Cost $9,725 1,800 = $5.40278

Avg. Cost $9,725 1,800 = $5.40278

Average-Cost MethodAverage-Cost Method

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$

Ending Inventory 1,200 6,483.00$

Cost of Goods Sold 600 3,242.00$

Ending InventoryAvg. Cost $5.40278 1,200 =

$6,483

Ending InventoryAvg. Cost $5.40278 1,200 =

$6,483

Cost of Goods SoldAvg. Cost $5.40278 600 =

$3,242

Cost of Goods SoldAvg. Cost $5.40278 600 =

$3,242

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Costs of Goods Sold

Costs of Goods Sold

Ending InventoryEnding

Inventory

Oldest Costs

Oldest Costs

Recent Costs

Recent Costs

First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)

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Remember: Start with the 11/29

purchase and then add other purchases until you reach the number of units in ending inventory.

First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$

Ending Inventory 1,200 ?

Cost of Goods Sold 600 ?

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Date Beg. Inv. Purchases End. Inv.Cost of

Goods Sold

Nov. 29 150@$5.90 150@$5.90Units 150

Now, let’s complete the table.

Now, let’s complete the table.

First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)

Date Beg. Inv. Purchases End. Inv.Cost of

Goods Sold1,000@$5.25 600@$5.25

400@$5.25Jan. 3 300@$5.30 300@$5.30June 20 150@$5.60 150@$5.60Sept. 15 200@$5.80 200@$5.80Nov. 29 150@$5.90 150@$5.90Units 1,200 600

Now, we have allocated the cost to all 1,200 units

in ending inventory.

Date Beg. Inv. Purchases End. Inv.Cost of

Goods Sold1,000@$5.25 600@$5.25

400@$5.25Jan. 3 300@$5.30 300@$5.30June 20 150@$5.60 150@$5.60Sept. 15 200@$5.80 200@$5.80Nov. 29 150@$5.90 150@$5.90Units 1,200 600

Costs $6,575 $3,150

Cost of Goods Available for Sale $9,725

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Completing the table summarizes the

computations just made.

First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$

Ending Inventory 1,200 6,575.00$

Cost of Goods Sold 600 3,150.00$

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Costs of Goods Sold

Costs of Goods Sold

Ending InventoryEnding

Inventory

Recent Costs

Recent Costs

Oldest Costs

Oldest Costs

Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

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Remember: Start with beginning inventory and then add other purchases until you reach the number of

units in ending inventory.

Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$

Ending Inventory 1,200 ?

Cost of Goods Sold 600 ?

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Date Beg. Inv. Purchases End. Inv.Cost of

Goods Sold1,000@$5.25 1,000@$5.25

Units 1,000

Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

Date Beg. Inv. Purchases End. Inv.Cost of

Goods Sold1,000@$5.25 1,000@$5.25

Jan. 3 300@$5.30 200@$5.30100@$5.30

Units 1,200 100

Now, we have allocated the cost to all 1,200 units

in ending inventory.

Next, let’s complete the

table.

Next, let’s complete the

table.

Date Beg. Inv. Purchases End. Inv.Cost of

Goods Sold1,000@$5.25 1,000@$5.25

Jan. 3 300@$5.30 200@$5.30100@$5.30

June 20 150@$5.60 150@$5.60Sept. 15 200@$5.80 200@$5.80Nov. 29 150@$5.90 150@$5.90Units 1,200 600

Costs $6,310 $3,415

Cost of Goods Available for Sale $9,725

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Completing the table summarizes the

computations just made.

Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

Computers, Inc.Mouse Pad Inventory

Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods Available for Sale 1,800 9,725.00$

Ending Inventory 1,200 6,310.00$

Cost of Goods Sold 600 3,415.00$

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Errors in Measuring InventoryBeginning Inventory Ending Inventory

Effect on Income Statement Overstated Understated Overstated Understated

Goods Available for Sale + - NE NE

Cost of Goods Sold + - - +Gross Profit - + + -Net Income - + + -Effect on Balance Sheet

Ending Inventory NE NE + -Retained Earnings - + + -

An error in ending inventory in a year will result in the same error in the beginning inventory of the next year.

An error in ending inventory in a year will result in the same error in the beginning inventory of the next year.

Importance of an Accurate Valuation of Inventory

Importance of an Accurate Valuation of Inventory

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For interim financial statements, we may need to estimate ending inventory and cost of goods sold.

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Determine cost of goods available for sale.

Estimate cost of goods sold by multiplying the net sales by the cost ratio.

Deduct cost of goods sold from cost of goods available for sale to determine ending inventory.

Determine cost of goods available for sale.

Estimate cost of goods sold by multiplying the net sales by the cost ratio.

Deduct cost of goods sold from cost of goods available for sale to determine ending inventory.

The Gross Profit MethodThe Gross Profit Method

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In March of 2005, ChemCo’s inventory was destroyed by fire. ChemCo’s normal gross profit ratio is 30% of

net sales. At the time of the fire, ChemCo showed the following balances:

In March of 2005, ChemCo’s inventory was destroyed by fire. ChemCo’s normal gross profit ratio is 30% of

net sales. At the time of the fire, ChemCo showed the following balances:

Sales 31,500$ Sales returns 1,500 Beginning Inventory 12,000 Net cost of goods purchased 20,500

The Gross Profit MethodThe Gross Profit Method

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Goods Available for Sale: Beginning Inventory 12,000$ Net cost of goods purchased 20,500 Goods available for sale 32,500$ Less estimated cost of goods sold: Sales 31,500$ Less sales returns (1,500) Net sales 30,000$

Estimated cost of goods sold (21,000) Estimated March inventory loss 11,500$

Estimating Inventory The Gross Profit Method

The Gross Profit MethodThe Gross Profit Method

× 70%

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The Retail MethodThe Retail Method

The retail method of estimating inventory requires that management determine the value of ending

inventory at retail prices.

The retail method of estimating inventory requires that management determine the value of ending

inventory at retail prices.

Goods available for sale at cost 32,500$ Goods available for sale at retail 50,000 Physical count of ending inventory priced at retail 22,000

Information for ChemCoThe Retail Method

In March of 2005, ChemCo’s inventory was destroyed by fire. At the time of the fire, ChemCo’s

management collected the following information:

In March of 2005, ChemCo’s inventory was destroyed by fire. At the time of the fire, ChemCo’s

management collected the following information:

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The Retail MethodThe Retail Method

a Goods available for sale at cost 32,500$ b Goods available for sale at retail 50,000 c Cost ratio [a b] 65%d Physical count of ending inventory priced at retail 22,000 e Estimated ending inventory at cost [ c d] 14,300$

Estimating Inventory The Retail Method

ChemCo would follow the steps below to estimate their ending inventory using the retail

method.

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Measures how quickly a companysells its merchandise inventory.

Measures how quickly a companysells its merchandise inventory.

A ratio that is low compared to competitors suggests inefficient use of assets.

A ratio that is low compared to competitors suggests inefficient use of assets.

Inventory Turnover Rate =

Cost of Goods Sold Average Inventory

Average Inventory = (Beg. Inv. + End. Inv.) ÷ 2Average Inventory = (Beg. Inv. + End. Inv.) ÷ 2

Financial AnalysisFinancial Analysis

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Measures how many days on average it takes to sell its

inventory.

Measures how many days on average it takes to sell its

inventory.

Avg. Number of Days to

Sell Inventory =

Days in the Year Inventory Turnover

Financial AnalysisFinancial Analysis

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Remember that identical companies that use different

inventory methods (e.g., FIFO and LIFO) will have

different inventory turnover ratios.

Accounting Methods Can Affect Financial Ratios

Accounting Methods Can Affect Financial Ratios

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End of Chapter 8End of Chapter 8