Inventories
ACG 2021: Chapter 6
Created by: M. Mari
Fall 2007
Inventories

is used to indicate:


Merchandise held for sale in the normal course of
business
Materials in the process of production or held for
production.
What is included in the cost of
inventory?




Costs
Transportation
Import duties
Insurance against losses in transit
Effect of Inventory Errors on
Financial Statements


Any errors in the inventory count will affect
both the balance sheet and the income
statement.
Inventory could be overstated or understated
Inventory Cost Flow Assumptions




A major accounting issue arises with identical
units of merchandise are acquired at different
unit costs during a period.
First in, first out method – cost flow is in
the order in which the costs were incurred.
Last in, first out method – cost flow is in the
reverse order in which the costs are incurred.
Average cost – cost flow is an average of
the costs
Inventory Costing Methods under a
Perpetual Inventory System




All merchandise increases and decreases are
recorded in a manner similar to the recording or
increases and decreases in cash.
The merchandise inventory account at the beginning
of an accounting period indicates the merchandise
in stock on that date.
Purchases are recorded by debiting Merchandise
Inventory and crediting Cash or Accounts payable.
On the date of each sale, the cost of the
merchandise sold is recorded by debiting Cost of
Merchandise Sold and crediting Merchandise
Inventory.
First in, First out Method



Most businesses dispose of goods in the
order in which the goods are purchased.
Especially true of perishables and goods
whose styles or models often change.
The FIFO method is often consistent with the
physical flow or movement of merchandise.
First in, First out Method
Date
Activity
Units
Jan 1
Inventory
100
Jan 4
Sale
70
Jan 10
Purchase
80
Jan 22
Sale
40
Jan 28
Sale
20
Jan 30
Purchase
100
Cost per unit
$20
$21
$22
Example 1: FIFO
Questions:
1.What is cost of merchandise sold in January under FIFO?
Date
Units
Cost per
unit
Total Cost
Jan 4
70
$20
$1400
Jan 22
30
10
$20
$21
$810
Jan 28
20
$21
$420
Total cost
What is value of Ending inventory
50 units @ $21 per unit
100 units @ $22 per unit
Total
$2630
$1050
2200
3250
Last in First Out

When the LIFO method is used in a perpetual
inventory system, the cost of units sold is the
cost of the most recent purchases.
Purchased in
December 150
units.
100 units
come from
December
Purchase
Sold 100
units
Purchased in
January 200
units
Last in First Out
Information below from last year’s activity
Date
Activity
Units
Jan 1
Inventory
100
Jan 4
Sale
70
Jan 10
Purchase
80
Jan 22
Sale
40
Jan 28
Sale
20
Jan 30
Purchase
100
Cost per unit
$20
$21
$22
Example 2: LIFO
Questions:
1.What is cost of merchandise sold in January under LIFO?
Date
Units
Cost per
unit
Total Cost
Jan 4
70
$20
$1400
Jan 22
40
$21
840
Jan 28
20
$21
$420
Total cost
2660
1.What is the value of ending inventory on January 30?
30 units @ $20 per unit
$ 600
20 units @ $21 per unit
420
100 units @ $22 per unit
2200
Total
3220
Average Cost Method

When the average cost method is used in a
perpetual inventory system, an average unit
cost for each type of item is computed each
time a purchase is made.
Inventory Costing Methods under a
Periodic Inventory System


When the periodic inventory system is used,
only revenue is recorded each time a sale is
made.
No entry is made at the time of the sale to
record the cost of the merchandise sold.
Computation of Cost of merchandise sold
Merchandise inventory 1/1
$59,700
Purchases
Less purchases returns
Purchases discounts
Net purchases
Add transportation in
Cost of merchandise purchased
Merchandise available for sale
Less merchandise inventory 12/31
Cost of merchandise sold
$521,980
$9,100
2,525
11,625
510,355
17,400
527,755
587,455
62,150
525,305
First in, First out Method



A physical
inventory is
conducted at the
end of the year.
Start at the
beginning of
year to calculate
cost of
merchandise
sold
At end of year:
300 units still in
inventory.
Date
Units
Unit
cost
Total
Cost
Jan 1
Inventory 200
$9
$1800
Mar 10
Purchase 300
$10
$3000
Sept 21
Purchase 400
$11
$4400
Nov 13
Purchase 100
$12
$1200
TOTAL
1000
$10,400
First In, First Out Method
Cost of merchandise sold:
Total available for sale
Ending inventory
Units sold
1,000
300
700
Units
Cost/unit Total Cost
Inventory
200
$9
$1,800
Mar 10 Purchase
300
10
3,000
Sept 21
200
11
2,200
Jan 1
Nov 18
Cost of
merchandise
sold
700
$7,000
First In, First Out Method
Value of ending inventory =
Total cost – Cost of merchandise sold
= $10,400 – $7,000
= $3,400
Comprised of:
Sept: 200 units @ $11 = $2,200
Nov: 100 @ $12 =
$1,200
$3,400
Example for Students
Jan 1
Inventory
150
$5
750
Mar 10
Purchase
220
6
1320
Sept 21
300
7
2100
Nov 18
250
7
1750
Total available
for sale
920
5920
Units in ending inventory 120. Compute Cost of merchandise under
FIFO.
Last in, First out Method


A physical inventory is conducted at the end
of the year.
Calculate the cost of merchandise sold by
starting at the end of the year and working
forward
Last in, First Out Method
Jan 1
Inventory
200
$9
$1,800
Mar 10
Purchase
300
10
3,000
Sept 21
400
11
4,400
Nov 18
100
12
1,200
Total available for
sale
1,000
$10,400
Suppose that ending inventory is 100 units, compute under FIFO:
Cost of merchandise sold
Ending inventory value
Last in, First Out Method

Cost of merchandise sold:
Total available for sale
Ending inventory
Units sold
1,000
300
700
Last in, First Out Method
Nov 18
Purchase
100
$12
$1,200
Sept
Purchase
400
11
4,400
200
10
2,000
Mar
Cost of merchandise
sold
700
$7,600
Last in, First Out Method

Value of ending inventory =
Total cost – Cost of merchandise sold
= $10,400 – 7,600
Comprised of:
Mar: 100 @ $10 = $1,000
= $2,800
Jan: 200 @ $ 9 = $1,800
TOTAL
$2,800
Example for Students
Jan 1
Inventory
150
$5
750
Mar 10
Purchase
220
6
1320
Sept 21
300
7
2100
Nov 18
250
7
1750
Total available
for sale
920
5920
Units in ending inventory 120. Compute Cost of merchandise under
LIFO.
Average Cost Method




A physical inventory is conducted at the end
of the year.
Calculate the cost of merchandise sold by
getting an average of the cost and multiplying
by the number of units in ending inventory
Average costs = Total cost/Total units
Cost of merchandise sold:
= Average cost X units sold
Average Cost Method
Jan 1
Inventory
200
$9
$1,800
Mar 10
Purchase
300
10
3,000
Sept 21
400
11
4,400
Nov 18
100
12
1,200
Total available for sale
1,000
$10,400
Ending inventory is 300 units, compute cost of goods sold under
Average cost method.
Average Cost Method
What is cost of merchandise sold in January under Average cost?
Average costs

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



= Total cost / Total units
= $10,400/1000
= $10.40 per unit
Cost of merchandise sold
= Average costs X units sold
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= $10.4 per unit X 700 units
= $7,200
Ending inventory
= Average costs x units in ending inventory
= $10.40 per unit x 300 units = $3200
Example for Students
Jan 1
Inventory
150
$5
750
Mar 10
Purchase
220
6
1320
Sept 21
300
7
2100
Nov 18
250
7
1750
Total available
for sale
920
5920
Units in ending inventory 120. Compute Cost of merchandise under
Average cost method.
Retail Method of Inventory
Costing

Estimates inventory cost based on the
relationship of the cost of merchandise
available for sale to the retail price of the
same merchandise.
Retail Method of Inventory
Costing
Cost
Retail
Merchandise inventory
1/1
$19,400
$36,000
Purchases
42,600
64,000
Merchandise available
for sale
62,000
100,000
Retail Method of Inventory
Costing


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
Ratio of cost to retail price
= $62,000/$100,000 = 62%
Sales for January
$70,000
Merchandise inventory
January1st at retail:
$30,000
Merchandise inventory at cost
$30,000 x 62% = $18,600
Lower of Cost or Market


Used for commodities
Minerals
Lower of Cost or Market
Commodity
Quantity
Unit Cost
Unit
Market
Cost
Market
Lower
A
400
$10.25
$9.50
$4,100
$3,800
$3,800
B
120
22.50
24.10
2,700
2,892
2,700
C
600
8.00
7.75
4.800
4,650
4,650
D
280
14.00
14.75
3,920
4,130
3,920
15,530
15,472
15,070