ACCT 201

5
Reporting and
Chapter

Analyzing Inventories
ACCT 201

UAA – ACCT 201

ACCT 201

Principles of Financial
Accounting
Dr. Fred Barbee ACCT 201
Dr. Fred Barbee
1
 Day
#1
ACCT 201 ACCT 201 ACCT 201
 Chapter 5 - Day 1 -
Topic Agenda
LO Read HW

Assigning Costs to P1 210-214 QS1,

Inventory QS2; E1,
E3, E4

Inventory Analysis and A1, A2 214-218 E2, E6

Effects

No Homework Due Today!

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What is Inventory?

Usually, inventory includes

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tangible property that:

Is held for sale, or

Will be used in producing goods or

services for sale.
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Dr. Fred Barbee ACCT 201 4

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What is Inventory?

Inventory is classified as a
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current asset;

It is listed below accounts

receivable on the balance sheet.
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Dr. Fred Barbee ACCT 201 5

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5
Reporting and
Chapter

Analyzing Inventories
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Assigning Costs
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to Inventory
Dr. Fred Barbee ACCT 201 6
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Management Issues

Costing Method
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FIFO, LIFO, WA, or Specific ID

Inventory System
Perpetual or Periodic
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Management Issues

Items included in inventory and

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their costs.
Use of market values or other
estimates.
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Dr. Fred Barbee ACCT 201 8

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The Text Notes (p. 210)

Accounting for inventory affects

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both the balance sheet and the

income statement.
A major goal for accounting for
inventory is to match relevant
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costs against revenues.

Dr. Fred Barbee ACCT 201 9

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Conflicting Objectives

Proper determination of net

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income
Income Statement

Proper valuation of inventory

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Balance Sheet

Dr. Fred Barbee ACCT 201 10

Determining Cost of Goods
Sold
Allocating costs to ending Net
Beginning
inventory and cost of goods Purchases
Inventory sold is
not a problem if prices are
constant.
Goods
Available
For Sale

Ending Cost of
Inventory Goods Sold
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At an example
Dr. Fred Barbee ACCT 201 12
Determining
Assume this
Cost of
Assume Goods
2,000 gallons cost
Sold
cost $1.00 $1.10 and 2,000 cost $1.25

Beginning
Beginning Net
Net
Inventory
Inventory Purchases
Purchases
1,000
1,000Gallons
Gallons 4,000
4,000Gallons
Gallons

GAS
GAS
5,000
5,000
Gallons
Gallons

Ending
Ending Cost
Costof
of
Inventory
Inventory Goods
GoodsSold
Sold
Determining
Assume this
Cost of
Assume Goods
2,000 gallons cost
Sold
cost $1.00 $1.10 and 2,000 cost $1.25

Beginning
Beginning Purchase 20 Net
Net
Inventory
Inventory Gallons of Gas. Purchases
Purchases
1,000
1,000Gallons
Gallons 4,000
4,000Gallons
Gallons

GAS
GAS
4,980 Gallons. 5,000
5,000 20 Gallons.
Cost ??? Gallons
Gallons Cost ???

Ending
Ending Cost
Costof
of
Inventory
Inventory Goods
GoodsSold
Sold
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Assigning Costs to Inventory

Inventory
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affects . . .

Balance Income
Sheet Statement
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The matching
principle requires
matching cost of
sales with sales.
Dr. Fred Barbee ACCT 201 15
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Physical Flow
Vs. Cost Flow
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The Physical Flow of Goods

BEGINNING END
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P HYSICAL
U NITS  

   
SALES
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The Flow of Dollars (Costs)

BEGINNING END
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$
   
SALES
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COST FLOW CAN BE :  SPECIFIC IDENTIFICATION ;  FIRST -IN ,

F IRST -OUT ;  LAST -IN , FIRST -OUT ; OR  WEIGHTED -AVERAGE

Dr. Fred Barbee ACCT 201 18

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Exh.

Use of Inventory Methods in

5.1

Practice . . .
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Inventory:
The Text Example
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Trekking Sporting Goods

Among its products, Trekking carries

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one type of mountain bike whose sales

are directed at biking clubs.

Its customers usually purchase in

amounts of 10 or more bikes.
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Trekking’s mountain bike inventory (in

units) is shown in Exhibit 5.2 (p. 211).
Dr. Fred Barbee ACCT 201 21
Example Inventory Information

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 Direct Transaction Effects
Inventory COGS
Purchases Increase N/A

Merchandise Sales Decrease Increase

Transportation-In Increase N/A

Purchases Discounts Decrease N/A

and Returns

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At Specific
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Identification
Dr. Fred Barbee ACCT 201 24
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Specific Identification

When units are

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sold, the
specific cost
of the unit
sold is added
to cost of
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goods sold.
Dr. Fred Barbee ACCT 201 25
 Specific Identification

The above purchases were made by

Trekking in August. On August 14,
Trekking sold 8 bikes originally
costing $91 and 12 bikes originally
costing $106.
 Specific Identification

The Cost of Goods Sold COGS =

$2,000
for the August 14 sale is
$2,000, leaving $500 and EI =
5 units in inventory. $500
 Exh.
5.4

Specific Identification

Additional purchases were made on August 17

and 28.
Cost of sales on August 31 were as follows:

2 @ $91, 3 @ $106, 15 @ $115, & 3 @ $119.

 Exh.
5.4

Specific Identification

Cost of Goods Sold for

August 31 = $2,582
 Specific Identification

Income
Statement
COGS = $4,582

Balance Sheet
Inventory = $1,408
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Cost Flow
Assumptions
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Cost Flow Assumptions

When specific identification is

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not used, the accountant must

make an assumption regarding the
movement of costs through a
firm’s accounting system.
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Dr. Fred Barbee ACCT 201 32

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Cost Flow Assumptions

Remember . . .
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The flow of costs is an accounting

consideration, and
Has no direct relationship to the
physical flow of goods through the
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firm.

Dr. Fred Barbee ACCT 201 33

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Cost Flow Assumptions

Cost flow assumptions are used to

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derive computations for . . .

Cost of Goods Sold on the Income
Statement, and

Ending Inventory on the Balance Sheet.

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Dr. Fred Barbee ACCT 201 34

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LIFO
and FIFO
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Dr. Fred Barbee ACCT 201 35

 FIFO Inventory LIFO
Allocation Costs Allocation

COGS Oldest EI
Costs

EI COGS
Recent
Costs
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At FIFO
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First-in, First-out
Dr. Fred Barbee ACCT 201 37
First-In, First-Out (FIFO)

The above purchases were made by

Trekking in August. On August 14,
Trekking sold 20 bikes.
 First-In, First-Out (FIFO)

The Cost of Goods Sold for the August

14 sale is $1,970, leaving $530 and 5
units in inventory.
 First-In, First-Out (FIFO)

Additional purchases were made on

August 17 and August 28. On August
31, an additional 23 units were sold.
 First-In, First-Out (FIFO)

Cost of Goods Sold for August

31 = ($530 + $2,070)
= $2,600
 First-In, First-Out (FIFO)

Income Statement
COGS = $4,570

Balance Sheet
Inventory = $1,420
 FIFO Inventory LIFO
Allocation Costs Allocation

COGS Cost of Goods Sold

Oldest EI
consists
Costs of older
costs.

EI COGS
Ending Inventory
Recent
approximates
Costs
replacement costs.
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At LIFO
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Last-in, First-out
Dr. Fred Barbee ACCT 201 44
 FIFO Inventory LIFO
Allocation Costs Allocation

COGS Oldest EI
Costs

EI COGS
Recent
Costs
Last-In, First-Out (LIFO)

The above purchases were made by

Trekking in August. On August 14,
Trekking sold 20 bikes.
 Last-In, First-Out (LIFO)

The Cost of Goods Sold for the August

14 sale is ($1,590 + $455) $2,045,
leaving $455 and 5 units in inventory.
Last-In, First-Out (LIFO)

Additional purchases were made on

August 17 and August 28. On August
31, an additional 23 units were sold.
 Last-In, First-Out (LIFO)

Cost of Goods Sold for August

31 = ($1,190 + $1,495) = $2,685
 Last-In, First-Out (LIFO)

Income Statement
COGS = $4,730

Balance Sheet
Inventory = $1,260
 FIFO Inventory LIFO
Allocation Costs Allocation
Ending
COGS Inventory
Oldest EI
consists ofCosts
older
costs.

EICost of Goods Sold COGS

is approximately
Recent
equal to current
Costs
costs
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At Weighted-Average
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Dr. Fred Barbee ACCT 201 52

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

Cost of Goods Units on hand

Available for ÷ on the date
Sale of sale
 Weighted Average

The above purchases were made by

Trekking in August. On August 14,
Trekking sold 20 bikes.
 Weighted Average

Cost of goods available for sale $ 2,500

Total units in inventory ÷ 25
Weighted average cost per unit $ 100

The weighted average cost per unit is

computed prior to each sale.
 Weighted Average

Additional purchases were made on

August 17 and August 28. On August 31,
an additional 23 units were sold.
 Weighted Average

Purchase 8/1 10
Purchase 8/3 15
Sale 8/14 (20) C ost of goods available for sale $ 3,990
Purchase 8/17 10
Purchase 8/28 20
Total units in inventory ÷ 35
Units available for sale 35 W eighted average cost per unit $ 114
 Weighted Average

Income
Statement COGS
= $4,622

Balance Sheet
Inventory =
$1,368
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Compare the
Alternatives
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Specific Identification
First-in, First-out
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Last-in-First-
out Weighted
Dr. Fred Barbee ACCT 201 Average
59
 LIFO AVG FIFO ID
Sales $6,050 $6,050 $6,050 $6,050
COGS 4,730 4,622 4,570 4,582
GM $1,320 $1,428 $1,480 $1,468

LIFO charges FIFO charges

recent (higher) recent (lower)
costs to COGS  costs to COGS 
Report lower NI. Report higher NI.

Compromise
Dr. Fred Barbee ACCT 201 60
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5
Reporting and
Chapter

Analyzing Inventories
ACCT 201

Inventory Analysis
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and Effects
Dr. Fred Barbee ACCT 201 61
 Net Income Comparisons

LIFO FIFO

In Periods of Lowest Net Highest Net

Rising Prices Income Income

In Periods of Highest Net Lowest Net

Falling Prices Income Income

Dr. Fred Barbee ACCT 201 62

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Financial Reporting

Because prices change, the

choice of an inventory
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method is important.

Let’s look at income

statements under each
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method.
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Tax Reporting

The IRS identifies several

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acceptable methods for inventory

costing for financial reporting and
reporting taxable income.

If LIFO is used for tax purposes,

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the IRS requires it be used in

financial statements.
Dr. Fred Barbee ACCT 201 64
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Consistency in Reporting

The consistency principle requires a

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company to use the same accounting

methods period after period so that
financial statements are comparable
across periods.
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Dr. Fred Barbee ACCT 201 65

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Errors in Reporting Inventory
– Income Statement
Inventory Error Cost of Goods Net Income
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Sold
Understate EI Overstated Understated

Understate BI Understated Overstated

Overstate EI Understated Overstated

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Overstate BI Overstated Understated

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Errors in Reporting Inventory
– Balance Sheet
Inventory Error Assets Equity
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Understate EI Understated Understated

Overstate EI Overstated Overstated

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5
Reporting and
Chapter

Analyzing Inventories
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FIFO Vs. LIFO

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Which should it be?

Dr. Fred Barbee ACCT 201 68

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Income Statement

Objective: Match expenses

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to revenues

LIFO does a better job

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Dr. Fred Barbee ACCT 201 69

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Income Statement

Tradeoff
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Over time the use of LIFO could

result in a meaningless inventory
figure - affecting both
Working capital, and
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Current ratio

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Balance Sheet

Objective: Fairly reflected

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assets

FIF0 does a better job

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Balance Sheet

Tradeoff
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Use of FIFO results in a mismatch

of revenue and expenses

COGS is determined using older

costs while revenues are based
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on current selling prices

Dr. Fred Barbee ACCT 201 72