Inventories and Cost of Sales

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Chapter 5

• Inventories and Cost of Sales
• NOTE Ignore Specific Identification Method

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Conceptual Chapter Objectives

• C1 Identify the items making up merchandise
  inventory.
• C2 Identify the costs of merchandise inventory.

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Analytical Chapter Objectives

• A1 Analyze the effects of inventory methods for
  both financial and tax reporting.
• A2 Analyze the effects of inventory errors on
  current and future financial statements.
• A3 Assess inventory management using both
  inventory turnover and days sales in inventory.
  SELF-STUDY

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Procedural Chapter Objectives

• P1 Compute inventory in a perpetual system using
  the methods of (specific identification), FIFO,
  LIFO, and weighted average.HW QS 1, 2 3
• P2 Compute the lower of cost or market amount of
  inventory.
• NOT COVERED
• P3 Appendix 5A Compute inventory in a periodic
  system using the methods of specific
  identification, FIFO, LIFO, and weighted average.
• P4 Appendix 5B Apply both the retail inventory
  and gross profit methods to estimate inventory.

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Determining Inventory Items
C 1
Merchandise inventory includes all goods that a
company owns and holds for sale, regardless of
where the goods are located when inventory is
counted.
Items requiring special attention include
Goods in Transit
Goods Damaged or Obsolete
Goods on Consignment
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Goods in Transit
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Determining Inventory Costs
C 2
Include all expenditures necessary to bring an
item to a salable condition and location.
Invoice Cost
Minus Discounts and Allowances
Plus Insurance
Plus Import Duties
Plus Storage
Plus Freight
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Practice Problems
Quick Study 10 Exercise 1 Quick Study
11Exercise 2
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Internal Controls and Taking a Physical Count
The Inventory account under a perpetual system is
updated for each purchase and sale, but events
(such as theft, loss, damage, and errors) can
cause the account balance to be different from
the actual inventory on hand.
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Internal Controls and Taking a Physical Count
C 2

• Most companies take a physical count of inventory
  at least once each year.
• When the physical count does not match the
  Merchandise Inventory account, an adjustment must
  be made gt Loss

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Internal Controls and Taking a Physical Count
Internal controls when taking a physical count of
inventory include a. Pre-numbered inventory
tickets each ticket must be accounted
for. b. Those responsible for inventory do not
count inventory. c. Counters confirm the
validity of inventory, including its
existence, amount and quality. d. A second count
is taken by a different counter. e. A
manager confirms that all inventories are
ticketed once, and only once.
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Inventory Costing Under a Perpetual System
P1
Accounting for inventory requires several
decisions . . .

• Costing Method
• Specific Identification, FIFO, LIFO, or Weighted
  Average
• Inventory System
• Perpetual or Periodic

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Frequency in Use of Inventory Methods
P1
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Inventory Cost Flow Assumptions
Physical flow and cost flow need not be the same.
First-In, First-Out(FIFO)
Assumes costs flow in the order incurred.
Last-In, First-Out(LIFO)
Assumes costs flow in the reverse order incurred.
Weighted Average
Assumes costs flow at an average of the costs
available.
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Inventory Costing Illustration
1. First-in, first-out (FIFO) As sales occur,
FIFO charges costs of the earliest units acquired
to cost of goods sold, leaving costs of most
recent purchases in inventory. 2. Last-in,
first-out (LIFO) As sales occur, LIFO charges
costs of the most recent purchase to cost of
goods sold, leaving costs of earliest purchases
in inventory. 3. Weighted averageAs sales
occur, weighted average computes the average cost
per unit of inventory at time of sale and charges
this cost per unit sold to cost of goods sold
leaving average cost per unit on hand in
inventory.
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P1 Illustrative Example (Exhibit 5.2 Pg. 199)
Three identical units of merchandise are
purchased separately at the following three dates
and costs May 1 1 Unit _at_ 45 May 3 1 Unit _at_
65 May 6 1 Unit _at_ 70 One (1) unit is then
sold on May 5 for 100. 1. What is the Cost of
Goods Sold and Gross Profit on Income
Statement using FIFO or LIFO or Avg. Cost? 2.
What is the Ending Inventory on Balance Sheet
using FIFO or LIFO or Avg. Cost?
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Inventory Costing Illustration
P1
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Specific IdentificationNOT COVERED
P1
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First-In, First-Out (FIFO)
P1
The above purchases were made in August. On
August 14, the company sold 20 bikes.
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First-In, First-Out (FIFO)
P1
The Cost of Goods Sold for the August 14 sale is
1,970. After this sale, there are five units
in inventory at 530 5 _at_ 106
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First-In, First-Out (FIFO)
P1
230 1190
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First-In, First-Out (FIFO)
P1
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First-In, First-Out (FIFO)
P1
Here are the entries to record the purchases and
sales entries. The numbers in red are determined
by the cost flow assumption used.
All purchases and sales are made on credit.The
selling price of inventory was as follows
8/14 130 8/31 150
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Last-In, First-Out (LIFO)
P1
The above purchases were made in August. On
August 14, the company sold 20 bikes.
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Last-In, First-Out (LIFO)
P1
The Cost of Goods Sold for the August 14 sale is
2,045. After this sale, there are five units
in inventory at 455 5 _at_ 91
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Last-In, First-Out (LIFO)
P1
455 7115
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Last-In, First-Out (LIFO)
P1
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Last-In, First-Out (LIFO)
P1
Here are the entries to record the purchases and
sales entries. The numbers in red are determined
by the cost flow assumption used.
All purchases and sales are made on credit.The
selling price of inventory was as follows
8/14 130 8/31 150
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Weighted Average
P1

• When a unit is sold, the average cost of each
  unit in inventory is assigned to cost of goods
  sold.

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Weighted Average
P1

First, we need to compute the weighted average
cost per unit of items in inventory.


The Cost of Goods Sold for the August 14 sale is
2,000. After this sale, there are five units in
inventory at 500
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Weighted Average
P1
Additional purchases were made on August 17 and
28. Twenty-three bikes were sold on August 31.
What is the weighted average cost per unit of
items in inventory?
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Weighted Average
P1
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Weighted Average
Ending inventory is comprised of 12 units _at_ an
average cost of 114 each or 1,368.
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Weighted Average


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Weighted Average
Here are the entries to record the purchases and
sales entries for Trekking. The numbers in red
are determined by the cost flow assumption used.
All purchases and sales are made on credit.The
selling price of inventory was as follows
8/14 130 8/31 150
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Financial Statement Effects of Costing Methods

• Because prices change, inventory methods nearly
  always assign different cost amounts.

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Financial Statement Effects of Costing Methods
Advantages of Methods
First-In, First-Out
Weighted Average
Last-In, First-Out
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Tax Effects of Costing Methods
A1

• The Internal Revenue Service (IRS) identifies
  several acceptable methods for inventory costing
  for reporting taxable income.

If LIFO is used for tax purposes, the IRS
requires it be used in financial statements.
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Consistency in Using Costing Methods
A1

• The consistency concept requires a company to use
  the same accounting methods period after period
  so that financial statements are comparable
  across periods.

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Merchandising Activities
C 1
Merchandising Companies
Manufacturer
Wholesaler
Retailer
Customer
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Lower of Cost or Market
P2

• Inventory must be reported at market value when
  market is lower than cost.

Can be applied three ways (1) separately to each
individual item. (2) to major categories of
assets. (3) to the whole inventory.
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Lower of Cost or Market
P2

• A motorsports retailer has the following items in
  inventory

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Lower of Cost or Market
P2

• Here is how to compute lower of cost or market
  for individual inventory items.

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Lower of Cost or Market
P2
Here is how to compute lower of cost or market
for the two groups of inventory items.
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Lower of Cost or Market
P2
Here is how to compute lower of cost or market
for the entire inventory.
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Exercise 7
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Financial Statement Effects of Inventory Errors
A2
Income Statement Effects
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Financial Statement Effects of Inventory Errors
A2
Balance Sheet Effects
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Inventory Turnover
A3

• Shows how many times a company turns over
  its inventory during a period. Indicator of how
  well management is controlling the amount of
  inventory available.

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Days Sales in Inventory
A3
Reveals how much inventory is available in terms
of the number of days sales.
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End of Chapter 5
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