Inventories
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess
© Copyright 2004 South-Western, a division
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Professor Emeritus of Accounting
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Objectives
Objectives
1. Summarize and provide examples of internal
After
After studying
control procedures studying this
that applythisto inventories.
2. Describe the chapter,
effect ofyou
chapter, should
inventory
you shoulderrors on the
be
financial statement.be able
able to:
to:
3. Describe the three inventory cost flow
assumptions and how they impact the income
statement and balance sheet.
4. Compute the cost of inventory under the
perpetual inventory system, using the
following cost methods: first-in, first-out; last-
in, first-out; average cost.
Objectives
Objectives
5. Compute the cost of inventory under the
periodic inventory system, using the
following costing methods: first-in, first-out;
last-in, first-out; average cost.
6. Compare and contrast the use of the three
inventory costing methods.
7. Compute the proper valuation of inventory at
other than cost, using the lower-of-cost-or-
market and net realization value concepts.
8. Prepare a balance sheet presentation of
merchandise inventory.
Objectives
Objectives
9. Estimate the cost of inventory, using the
retail method and the gross profit method.
10. Compute the interpret the inventory
turnover ratio and number of days’ sales in
inventory.
Why is Inventory Control Important?
Important
Inventory is a significant asset and for many
companies the largest asset.
Inventory is central to the main activity of
merchandising and manufacturing companies.
Mistakes in determining inventory cost can
cause critical errors in financial statements.
Inventory must be protected from external
risks ( such as fire and theft) and internal
fraud by employees.
Receiving Purchase
report AGREE order
AG
E
RE
RE
E Invoice
AG
JOURNAL
Post.
Date
Description
Ref.
Nov. 9 Inventory 1 222 00
Accounts Payable—XYZ Co. 1 222 00
Purchased merchandise on
account.
Effect
Effect of
of Inventory
Inventory Errors
Errors on
on
Financial
Financial Statements
Statements
LIABILITIES
IfIfmerchandise overstated
merchandiseinventory
inventoryisis..............
understated
Cost
Costof
ofmerchandise
merchandisesold
soldisis............ overstated
Gross
Grossprofit
profitand
andnet
netincome
incomeare are...... overstated
Total
Totalstockholders’
stockholders’equity
equityisis..........
Effect
Effect of
of Inventory
Inventory Errors
Errors on
on
Financial
Financial Statements
Statements
Sold
Sold
goods
goods
Inventory
Inventory Cost
Cost Flow
Flow Assumptions
Assumptions
Purchased
Purchased
goods
goods
Sold
Sold
goods
goods
Inventory
Inventory Cost
Cost Flow
Flow Assumptions
Assumptions
Sold
Purchased
Sold
Purchased
goods
goods
goods
goods
Inventory
Inventory Cost
Cost Flow
Flow Assumptions
Assumptions
Purchased
Purchased Sold
Sold
goods
goods goods
goods
Inventory
Inventory Costing
Costing Methods
Methods
43%
40%
34%
30%
19%
20%
10%
4%
0%
Fifo Lifo Average Other
Perpetual
Perpetual Inventory
Inventory Costs
Costs
Inventory
Inventorycost
costdata
datato
todemonstrate
demonstrate
FIFO
FIFOand
andLIFO
LIFOPerpetual
PerpetualSystems
Systems
Item
Item127B
127B Units
Units Cost
Cost Price
Price
Jan.
Jan. 11 Inventory
Inventory 10
10 $20
$20
4Cost
4 Saleof
Sale 77 $30
$30
10
10 Purchase
Mdse. Sold
Purchase 88 21
21
22
22 Sale
Sale 44 31
31
28
28 Sale
Sale 22 32
32
30
30 Purchase
Purchase 10
10 22
22
FIFO Perpetual Inventory Account
Item 127B
Inventory
Inventorycost
costdata
datato
todemonstrate
demonstrate
FIFO
FIFOand
andLIFO
LIFOPerpetual
PerpetualSystems
Systems
Item
Item127B
127B Units
Units Cost
Cost Price
Price
Jan.
Jan. 11 Inventory
Inventory 10
10 $20
$20
4Cost
4 Saleof
Sale 77 $30
$30
10
10 Purchase
Mdse. Sold
Purchase 88 21
21
22
22 Sale
Sale 44 31
31
28
28 Sale
Sale 22 32
32
30
30 Purchase
Purchase 10
10 22
22
On
On January
January 4,
4, 77 units
units of
of Item
Item
127B
127B are
are sold
sold at
at $30
$30 each.
each.
FIFO Perpetual Inventory Account
Item 127B
The
The sale
sale of
of 77 units
units leaves
leaves aa
balance
balance of of 33 units.
units.
On
On January
January 4,
4, 77 units
units of
of Item
Item
127B
127B are
are sold
sold at
at $30
$30 each.
each.
FIFO Perpetual Inventory Account
Inventory
Inventorycost
costdata
datato
todemonstrate
demonstrate
FIFO
FIFOand
andLIFO
LIFOPerpetual
PerpetualSystems
Systems
Item
Item127B
127B Units
Units Cost
Cost Price
Price
Jan.
Jan. 11 Inventory
Inventory 10
10 $20
$20
4Cost
4 Saleof
Sale 77 $30
$30
10
10 Purchase
Mdse. Sold
Purchase 88 21
21
22
22 Sale
Sale 44 31
31
28
28 Sale
Sale 22 32
32
30
30 Purchase
Purchase 10
10 22
22
On
On January
January 10,
10, the
the firm
firm purchased
purchased
eight
eight units
units at
at $21
$21 each.
each.
FIFO Perpetual Inventory Account
Item 127B
Inventory
Inventorycost
costdata
datato
todemonstrate
demonstrate
FIFO
FIFOand
andLIFO
LIFOPerpetual
PerpetualSystems
Systems
Item
Item127B
127B Units
Units Cost
Cost Price
Price
Jan.
Jan. 11 Inventory
Inventory 10
10 $20
$20
4Cost
4 Saleof
Sale 77 $30
$30
10
10 Purchase
Mdse. Sold
Purchase 88 21
21
22
22 Sale
Sale 44 31
31
28
28 Sale
Sale 22 32
32
30
30 Purchase
Purchase 10
10 22
22
On
On January
January 22,
22, the
the firm
firm sold
sold
four
four units
units for
for $31
$31 each.
each.
FIFO Perpetual Inventory Account
Item 127B
Inventory
Inventorycost
costdata
datato
todemonstrate
demonstrate
FIFO
FIFOand
andLIFO
LIFOPerpetual
PerpetualSystems
Systems
Item
Item127B
127B Units
Units Cost
Cost Price
Price
Jan.
Jan. 11 Inventory
Inventory 10
10 $20
$20
4Cost
4 Saleof
Sale 77 $30
$30
10
10 Purchase
Mdse. Sold
Purchase 88 21
21
22
22 Sale
Sale 44 31
31
28
28 Sale
Sale 22 32
32
30
30 Purchase
Purchase 10
10 22
22
On
On January
January 28,
28, the
the firm
firm
sold
sold two
two units
units at
at $32.
$32.
FIFO Perpetual Inventory Account
Item 127B
On
On January
January 28,
28, the
the firm
firm
sold
sold two
two units
units at
at $32.
$32.
FIFO Perpetual Inventory Account
Inventory
Inventorycost
costdata
datato
todemonstrate
demonstrate
FIFO
FIFOand
andLIFO
LIFOPerpetual
PerpetualSystems
Systems
Item
Item127B
127B Units
Units Cost
Cost Price
Price
Jan.
Jan. 11 Inventory
Inventory 10
10 $20
$20
4Cost
4 Saleof
Sale 77 $30
$30
10
10 Purchase
Mdse. Sold
Purchase 88 21
21
22
22 Sale
Sale 44 31
31
28
28 Sale
Sale 22 32
32
30
30 Purchase
Purchase 10
10 22
22
On
On January
January 30,
30, purchased
purchased ten
ten additional
additional
units
units of
of Item
Item 127B
127B at
at $22
$22 each.
each.
FIFO Perpetual Inventory Account
Item 127B
The
The firm
firm begins
begins thethe year
year with
with
10
10 units
units of of Item
Item 127B
127B onon
hand
hand atat aa total
total cost
cost of
of $200.
$200.
LIFO Perpetual Inventory Account
Item 127B
On
On January
January 4,4, the
the firm
firm sold
sold
77 units
units at
at $30
$30 each.
each.
LIFO Perpetual Inventory Account
Item 127B
On
On January
January 10,
10, the
the
firm
firm purchased
purchased eight
eight Note
Note that
that aa new
new
units layer
layer isis formed.
formed.
units at
at $21
$21 each.
each.
LIFO Perpetual Inventory Account
Item 127B
On
On January
January 28,
28, sold
sold
two
two units
units at
at $32
$32 each.
each.
LIFO Perpetual Inventory Account
Item 127B
Using
Using fifo,
fifo, the
the first
first units
units
purchased
purchased are are theoretically
theoretically thethe
first
first units
units sold.
sold. We We begin
begin the
the
count
count with
with January
January 1. 1.
Fifo
Fifo Periodic
Periodic
Soldunits
200 these@200
$9 = $1,800
$ 0 Jan. 1
Soldunits
300 these@300
$10 = 3,0000 Mar. 10
Sold
400
200 units
200 of
@these
$11 = 4,400
2,200 Sept. 21
Cost
Cost of
of merchandise
merchandise available
available for
for sale
sale $10,400
$10,400
Less
Less ending
ending inventory
inventory 3,400
3,400
Cost
Cost of
of merchandise
merchandise sold
sold $$ 7,000
7,000
Summary of Fifo Periodic
Cost of
Merchandise Merchandise
Available Sold
Purchases for Sale
$1,800 200 units at $9
Jan. 1
200 units at $9 $1,800
$3,000 300 units at $10
Mar. 10
300 units at $10 $3,000 200 units at $11
$2,200
Sep. 21
$7,000 700 units
400 units at $11 $4,400
Merchandise
Nov. 18
100 units at $12 $1,200 Inventory
$2,200 200 units at $11
1,000 units $10,400
$1,200 100 units at $12
Sold
100 200 of
300 units @these
$10 = 3,000
1,000 Mar. 10
400
Soldunits
these@400
$11 = 4,4000 Sept. 21
100
Soldunits
these@100
$12 = 1,2000 Nov. 18
1,000 units available $10,400
$2,800
for sale during
year Ending Inventory
Lifo
Lifo Periodic
Periodic
Cost
Cost of
of merchandise
merchandise available
available for
for sale
sale $10,400
$10,400
Less
Less ending
ending inventory
inventory 2,800
2,800
Cost
Cost of
of merchandise
merchandise sold
sold $$ 7,600
7,600
Summary
Summary of
of Lifo
Lifo Periodic
Periodic
Cost of
Merchandise Merchandise Sold
Available
Purchases for Sale $1,800 200 units at $9
$1,800
Jan. 1 $1,000 100 units at $10
200 units at $9 $1,800
$2,800 300 units
Mar. 10
300 units at $10 $3,000 Cost of
Merchandise
Sep. 21 Sold
400 units at $11 $4,400
$2,000 200 units at $10
Nov. 18
100 units at $12 $1,200
$4,400 400 units at $11
$10,400
= $10.40 per Unit
1,000 Units
Average
Average Cost
Cost Periodic
Periodic
Cost
Cost of
of merchandise
merchandise available
available for
for sale
sale $10,400
$10,400
Less
Less ending
ending inventory
inventory ($10.40
($10.40 xx 300)
300) 3,120
3,120
Cost
Cost of
of merchandise
merchandise sold
sold $$ 7,280
7,280
To verify this
amount, multiply
700 units sold
times $10.40 to get
the same $7,280.
Valuation of Inventory at
Lower-of-Cost-or-Market
Unit Unit
Inventory Cost Market Total Total Lower
Item Quantity Price Price Cost Market C or M
Step
Step 1:
1: Determine
Determine the the ratio
ratio of
of
cost
cost to
to the
the retail
retail price.
price.
Retail
Retail Inventory
Inventory Method
Method
Cost Retail
Merchandise inventory, Jan. 1 $19,400 $ 36,000
Purchases in January (net) 42,600 64,000
Merchandise available for sale $62,000 $100,000
Sales for January (net) 70,000
Merchandise inventory, January 31, at retail $ 30,000
Step
Step 2:
2: Determine
Determine the
the ending
ending
inventory
inventory at
at retail.
retail.
Retail
Retail Inventory
Inventory Method
Method
Cost Retail
Merchandise inventory, Jan. 1 $19,400 $ 36,000
Purchases in January (net) 42,600 64,000
Merchandise available for sale $62,000 $100,000
Sales for January (net) 70,000
Merchandise inventory, January 31, at retail $ 30,000
Merchandise inventory, January 31, at cost
($30,000 x 62%) $18,600
Step
Step 3:
3: Calculate
Calculate the
the estimated
estimated
inventory
inventory at
at cost.
cost.
Gross Profit Method of Estimating
Inventory Cost
1. A gross profit percentage rate is estimated based on previous
experience adjusted for known changes.
2. Estimated gross profit is calculated by multiplying the estimated
gross profit rate times the actual net sales.
3. Estimated cost of merchandise sold is calculated by subtracting
the gross profit from actual sales.
4. The cost of merchandise sold estimate is deducted from actual
merchandise available for sale to determine the estimated cost
of merchandise inventory.
Gross
Gross Profit
Profit Method
Method
Merchandise inventory, January 1 $ 57,000
Purchases in January (net) 180,000
Merchandise available for sale $237,000
Sales in January (net) $250,000
Less: Estimated gross profit
($250,000 x 30%) 75,000
Estimated cost of merchandise sold 175,000
Estimated merchandise inventory, January 31 $ 62,000
The
The gross
gross profit
profit method
method isis useful
useful for
for estimating
estimating
inventories
inventories for
for monthly
monthly oror quarterly
quarterly financial
financial
statements
statements in
in aa periodic
periodic inventory
inventory system.
system.
Inventory
Inventory Turnover
Turnover
SUPERVALU Zale
Cost of merchandise sold $15,620,127,000 $ 737,188,000
Inventories:
Beginning of year $1,115,529,000 $478,467,000
End of year 1,067,837,000 571,669,000
Total $2,183,366,000 $1,050,136,000
Average $1,091,683,000 $525,068,000
Inventory turnover 14.3 times 1.4 times
Use:
Use: Inventory
Inventory turnover
turnover measures
measures the
the relationship
relationship
between
between the
the volume
volume of
of goods
goods sold
sold and
and the
the
amount
amount of
of inventory
inventory carried
carried during
during the
the period.
period.
Number
Number of
of Days’
Days’ Sales
Sales in
in Inventory
Inventory
SUPERVALU Zale
Average daily cost of
merchandise sold:
$15,620,127,000/365 $42,794,868
$737,188,000/365 $2,019,693
Ending inventory $1,067,837,000 $571,669,000
Use:
Use: To
To assess
assess the
the efficiency
efficiency in
in the
the
management
management of of inventory
inventory
Chapter 8
The
The End
End