Chapter 9
Inventories
Accounting, 21st Edition
Warren Reeve Fess
PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
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Objectives
1. Summarize and provide examples of internal
After studying
thisto inventories.
control procedures
that apply
chapter,
should errors on the
2. Describe the
effect ofyou
inventory
financial statement.
be able 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; lastin, first-out; average cost.
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-ormarket and net realization value concepts.
8. Prepare a balance sheet presentation of
merchandise inventory.
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?
 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
report
AGREE
Purchase
order
Invoice
JOURNAL
Date
Description
Nov. 9 Inventory
Accounts Payable--XYZ Co.
Purchased merchandise on
account.
Post.
Ref.
1 222 00
1 222 00
Effect of Inventory Errors on
Financial Statements
LIABILITIES
Merchandise
Inventory
ASSETS
OWNER’S
EQUITY
Net Income
Cost of
Merchandise Sold
COSTS &
EXPENSES
REVENUES
If merchandise inventory is . . . . . . .
overstated
Cost of merchandise sold is . . . . . .
understated
Gross profit and net income are . . .
overstated
Ending owner’s equity is . . . . . . . . .
overstated
Effect of Inventory Errors on
Financial Statements
If merchandise inventory is . . . . . . . understated
Cost of merchandise sold is . . . . . .
overstated
Gross profit and net income are . . .
understated
Ending owner’s equity is . . . . . . . . . understated
Inventory Cost Flow Assumptions
Purchased
goods
Sold
goods
Inventory Cost Flow Assumptions
Sold
Purchased
goods
goods
Inventory Cost Flow Assumptions
Purchased
goods
Sold
goods
Inventory Costing Methods
43%
40%
34%
30%
19%
20%
10%
0%
4%
Fifo
Lifo
Average
Other
Perpetual Inventory Costs
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Jan. 1 Inventory
4CostSale
of
10 Purchase
Mdse.
Sold
22 Sale
28 Sale
30 Purchase
Units
Cost
10
7
8
4
2
10
$20
Price
$30
21
31
32
22
FIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
Qty.
Unit
Cost
Cost of Mdse. Sold
Total
Cost
Qty.
Unit
Cost
Total
Cost
Inventory Balance
Qty.
10
The firm begins the year with 10
units of Item 127B on hand at a
total cost of $200.
Unit Total
Cost Cost
20
200
FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Jan. 1 Inventory
4CostSale
of
10 Purchase
Mdse.
Sold
22 Sale
28 Sale
30 Purchase
Units
Cost
10
7
8
4
2
10
$20
Price
$30
21
31
32
22
On January 4, 7 units of Item
127B are sold at $30 each.
FIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
4
Qty.
Unit
Cost
Cost of Mdse. Sold
Total
Cost
Qty.
7
Unit
Cost
20
Total
Cost
140
Inventory Balance
Qty.
10
3
The sale of 7 units leaves a
balance of 3 units.
On January 4, 7 units of Item
127B are sold at $30 each.
Unit Total
Cost Cost
20
20
200
60
FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Jan. 1 Inventory
4CostSale
of
10 Purchase
Mdse.
Sold
22 Sale
28 Sale
30 Purchase
Units
Cost
10
7
8
4
2
10
$20
Price
$30
21
31
32
22
On January 10, the firm purchased
eight units at $21 each.
FIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
Unit
Cost
Cost of Mdse. Sold
Total
Cost
Qty.
7
8
21
168
Unit
Cost
20
Total
Cost
140
Inventory Balance
Qty.
10
3
3
8
Because the purchase price of $21 is
different than the cost of the previous 3
units On
on hand,
the inventory
balance of
January
10, the firm
11 units is accounted for separately.
purchased eight units at $21 each.
Unit Total
Cost Cost
20
20
20
21
200
60
60
168
FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Jan. 1 Inventory
4CostSale
of
10 Purchase
Mdse.
Sold
22 Sale
28 Sale
30 Purchase
Units
Cost
10
7
8
4
2
10
$20
Price
$30
21
31
32
22
On January 22, the firm sold
four units for $31 each.
FIFO Perpetual Inventory Account
Item 127B
Purchases
Cost of Mdse. Sold
On January 22, the
Unit
Total
firm
sold
four
unitsQty.
Date Qty. Cost
Cost
for $31 each.
Jan. 1
4
10
22
8
21
Unit
Cost
Inventory Balance
Total
Cost
7
20
140
3
1
20
21
60
21
168
Qty.
Unit Total
Cost Cost
10
3
3
8
20
20
20
21
200
60
60
168
7
21
147
Of the four units sold, three are
from the first units in (fifo) at a
cost of $20.
FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Jan. 1 Inventory
4CostSale
of
10 Purchase
Mdse.
Sold
22 Sale
28 Sale
30 Purchase
Units
Cost
10
7
8
4
2
10
$20
Price
$30
21
31
32
22
On January 28, the firm
sold two units at $32.
FIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
4
10
22
28
Qty.
8
Unit
Cost
21
Cost of Mdse. Sold
Total
Cost
Qty.
Unit
Cost
Inventory Balance
Total
Cost
7
20
140
3
1
2
20
21
21
60
21
42
168
On January 28, the firm
sold two units at $32.
Qty.
Unit Total
Cost Cost
10
3
3
8
20
20
20
21
200
60
60
168
7
5
21
21
147
105
FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Jan. 1 Inventory
4CostSale
of
10 Purchase
Mdse.
Sold
22 Sale
28 Sale
30 Purchase
Units
Cost
10
7
8
4
2
10
$20
Price
$30
21
31
32
22
On January 30, purchased ten additional
units of Item 127B at $22 each.
FIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
4
10
22
Qty.
Unit
Cost
Cost of Mdse. Sold
Total
Cost
Qty.
Unit
Cost
On January 30, purchased
7
20
8ten additional
21
168 units of Item
127B at $22 each.
3
1
2
28
30
10
Totals
18
22
20
21
21
Inventory Balance
Total
Cost
140
60
21
42
220
$388
13
$263
Qty.
Unit Total
Cost Cost
10
3
3
8
20
20
20
21
200
60
60
168
7
5
5
10
15
21
21
21
22
147
105
105
220
$325
LIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
Qty.
Unit
Cost
Cost of Mdse. Sold
Total
Cost
Qty.
Unit
Cost
Total
Cost
Inventory Balance
Qty.
10
The firm begins the year with
10 units of Item 127B on
hand at a total cost of $200.
Unit Total
Cost Cost
20
200
LIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
4
Qty.
Unit
Cost
Cost of Mdse. Sold
Total
Cost
Qty.
7
Unit
Cost
20
Total
Cost
Inventory Balance
Qty.
140
On January 4, the firm sold
7 units at $30 each.
10
3
Unit Total
Cost Cost
20
20
200
60
LIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
Unit
Cost
Cost of Mdse. Sold
Total
Cost
Qty.
7
8
21
Unit
Cost
20
168
On January 10, the
firm purchased eight
units at $21 each.
Total
Cost
140
Inventory Balance
Qty.
10
3
3
8
Unit Total
Cost Cost
20
20
20
21
200
60
60
168
Note that a new
layer is formed.
LIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
4
10
22
Qty.
8
Unit
Cost
21
Cost of Mdse. Sold
Total
Cost
Qty.
Unit
Cost
Inventory Balance
Total
Cost
7
20
140
4
21
84
Qty.
168
On
22,sold,
the all come
Of January
the 4 units
firm
four
from
thesells
most
recent purchase
unitsatata $31
cost each.
of $21 each.
10
3
3
8
3
4
Unit Total
Cost Cost
20
20
20
21
20
21
200
60
60
168
60
84
LIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
Unit
Cost
Cost of Mdse. Sold
Total
Cost
Qty.
Unit
Cost
Inventory Balance
Total
Cost
7
20
140
22
4
21
84
28
2
21
42
8
21
168
On January 28, sold
two units at $32 each.
Qty.
10
3
3
8
3
4
3
2
Unit Total
Cost Cost
20
20
20
21
20
21
20
21
200
60
60
168
60
84
60
42
LIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
Unit
Cost
Cost of Mdse. Sold
Total
Cost
Qty.
Unit
Cost
Inventory Balance
Total
Cost
7
20
140
22
4
21
84
28
2
21
42
30
8
10
21
22
168
220
On January 30, purchase
10 units at $22 each.
Qty.
10
3
3
8
3
4
3
2
3
2
10
Unit Total
Cost Cost
20
20
20
21
20
21
20
21
20
21
22
200
60
60
168
60
84
60
42
60
42
220
LIFO Perpetual Inventory Account
Item 127B
Purchases
Date
Jan. 1
4
10
Qty.
Unit
Cost
Cost of Mdse. Sold
Total
Cost
Qty.
Unit
Cost
Inventory Balance
Total
Cost
7
20
140
22
4
21
84
28
2
21
42
8
30
10
Totals
18
21
22
168
220
$388
13
$266
Qty.
10
3
3
8
3
4
3
2
3
2
10
15
Unit Total
Cost Cost
20
20
20
21
20
21
20
21
20
21
22
200
60
60
168
60
84
60
42
60
42
220
$322
Fifo
Periodic
Fifo Periodic
200 units @ $9
Jan. 1 Beginning
Inventory
300 units @ $10
Mar. 10 Purchase
400 units @ $11
Sept. 21 Purchase
100 units @ $12
Nov. 18 Purchase
1,000 units available
for sale during
year
Fifo Periodic
200 units @ $9
= $1,800
Jan. 1
300 units @ $10
=
3,000
Mar. 10
400 units @ $11
=
4,400
Sept. 21
100 units @ $12
=
1,200
Nov. 18
1,000 units available
$10,400
for sale during
Cost of merchandise
year
available for sale
Fifo Periodic
A physical count on
December 31 reveals that
700 of the 1,000 units
have been sold.
Using fifo, the first units
purchased are theoretically the
first units sold. We begin the
count with January 1.
Fifo Periodic
Soldunits
these@200
200
$9
= $$1,800
0
Jan. 1
Soldunits
these
300
@300
$10
=
3,0000
Mar. 10
Sold
400 units
200 of
@these
$11
200
=
4,400
2,200
Sept. 21
100 units @ $12
=
1,200
Nov. 18
1,000 units available
$10,400
$ 3,400
for sale during
year
Ending inventory
Fifo Periodic
Cost of merchandise available for sale $10,400
Less ending inventory
3,400
Cost of merchandise sold
$ 7,000
Summary of Fifo Periodic
Purchases
Jan. 1
200 units at $9
Mar. 10
300 units at $10
Sep. 21
400 units at $11
Nov. 18
100 units at $12
1,000 units
Merchandise
Available
for Sale
$1,800
$3,000
$4,400
$1,200
$10,400
Cost of
Merchandise
Sold
$1,800
200 units at $9
$3,000
300 units at $10
$2,200
200 units at $11
$7,000
700 units
Merchandise
Inventory
$2,200
200 units at $11
$1,200
100 units at $12
$3,400
300 units
Lifo
Periodic
Lifo Periodic
200 units @ $9
Jan. 1 Beginning
Inventory
300 units @ $10
Mar. 10 Purchase
400 units @ $11
Sept. 21 Purchase
100 units @ $12
Nov. 18 Purchase
1,000
units lifo,
available
Using
the most recent batch
for sale during
purchased
is considered the first
year
batch of merchandise sold.
Lifo Periodic
200 units @ $9
Jan. 1 Beginning
Assume again that
Inventory
300 units @ $10
700 units were sold
Mar.during
10 Purchase
the year.
400 units @ $11
Sept. 21 Purchase
100 units @ $12
Nov. 18 Purchase
1,000 units available
for sale during
year
Lifo Periodic
= $1,800
Jan. 1
Sold
200 of
100
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
200 units @ $9
1,000 units available
$10,400
$2,800
for sale during
year
Ending Inventory
Lifo Periodic
Cost of merchandise available for sale $10,400
Less ending inventory
2,800
Cost of merchandise sold
$ 7,600
Summary of Lifo Periodic
Purchases
Jan. 1
200 units at $9
Cost of
Merchandise Merchandise Sold
Available
200 units at $9
for Sale
$1,800
$1,800
$2,800
Mar. 10
300 units at $10
$3,000
Sep. 21
400 units at $11
$4,400
Nov. 18
100 units at $12
1,000 units
$1,800
$1,000
$1,200
$10,400
100 units at $10
300 units
Cost of
Merchandise
Sold
$2,000
200 units at $10
$4,400
400 units at $11
$1,200
100 units at $12
$7,600
700 units
Average Cost Periodic
Jan. 1 Beginning
200 units @
$9
The average cost Inventory
periodic method is based
300 units @ $10
Mar. 10 Purchase
on the average
cost of
units.21 Purchase
Sept.
400 units @identical
$11
100 units @ $12
1,000 units available
for sale during
year
Nov. 18 Purchase
Average Cost Periodic
200 units @ $9
= $ 1,800
300 units @ $10
= $ 3,000
400 units @ $11
= $ 4,400
100 units @ $11
= $ 1,200
1,000 units available
for sale during
year
$10,400 Cost of
merchandise
available for
sale
Average Cost Periodic
Cost of Merchandise
Available for Sale
= Average Unit Cost
Units Available for Sale
During Year
$10,400
1,000 Units
= $10.40 per Unit
Average Cost Periodic
Cost of merchandise available for sale $10,400
Less ending inventory ($10.40 x 300)
3,120
Cost of merchandise sold
$ 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
Inventory
Item Quantity
A
B
C
D
Total
400
120
600
280
Unit
Cost
Price
$10.25
22.50
8.00
14.00
Unit
Market
Price
$ 9.50
24.10
7.75
14.75
Total
Cost
Total
Market
Lower
C or M
$ 4,100
2,700
4,800
3,920
$ 3,800
2,892
4,650
4,130
$ 3,800
2,700
4,650
3,920
$15,520
$15,472
$15,070
The market decline based on individual items
($15,520 – $15,070) = $450
Presentation of Merchandise Inventory
on the Balance Sheet
Metro-Arts
Balance Sheet
December 31, 2007
Assets
Current assets:
Cash
$ 19 400 00
Accounts receivable
$80 000 00
Less allowance for
doubtful accounts
3 000 00 77 000 00
Merchandise inventory
at lower of cost (first-in,
first-out method) or market
216 300 00
Estimating Inventory Cost
Retail Method of Estimating Inventory Cost
 Retail method is based on relationship between
cost of merchandise available for sale and the
retail price.
 Retail prices of all merchandise must be
accumulated and totaled.
 Inventory at retail is calculated at retail price of
merchandise available for sale less net sales at
retail.
 Ratio is calculated as cost divided by retail
price.
 Inventory at retail price times cost ratio equals
estimated cost of inventory.
Retail Inventory Method
Merchandise inventory, Jan. 1
Purchases in January (net)
Merchandise available for sale
Cost
$19,400
42,600
$62,000
Retail
$ 36,000
64,000
$100,000
$62,000
Ratio of cost to retail price =
= 62%
$100,000
Step 1: Determine the ratio of
cost to the retail price.
Retail Inventory Method
Cost
$19,400
42,600
$62,000
Retail
Merchandise inventory, Jan. 1
$ 36,000
Purchases in January (net)
64,000
Merchandise available for sale
$100,000
Sales for January (net)
70,000
Merchandise inventory, January 31, at retail $ 30,000
Step 2: Determine the ending
inventory at retail.
Retail Inventory Method
Cost
$19,400
42,600
$62,000
Retail
Merchandise inventory, Jan. 1
$ 36,000
Purchases in January (net)
64,000
Merchandise available for sale
$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 3: Calculate the estimated
inventory at 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 Profit Method
Merchandise inventory, January 1
Purchases in January (net)
Merchandise available for sale
Sales in January (net)
Less: Estimated gross profit
($250,000 x 30%)
$ 57,000
180,000
$237,000
$250,000
75,000
Estimated cost of merchandise sold
Estimated merchandise inventory, January 31
175,000
$ 62,000
The gross profit method is useful for estimating
inventories for monthly or quarterly financial
statements in a periodic inventory system.
Inventory Turnover
Cost of merchandise sold
Inventories:
Beginning of year
End of year
Total
Average
Inventory turnover
SUPERVALU
Zale
$15,620,127,000
$ 737,188,000
$1,115,529,000
1,067,837,000
$2,183,366,000
$1,091,683,000
$478,467,000
571,669,000
$1,050,136,000
$525,068,000
14.3 times
1.4 times
Use: Inventory turnover measures the relationship
between the volume of goods sold and the
amount of inventory carried during the period.
Number of Days’ Sales in Inventory
SUPERVALU
Average daily cost of
merchandise sold:
$15,620,127,000/365
$737,188,000/365
Ending inventory
Average selling period
Zale
$42,794,868
$1,067,837,000
25 days
$2,019,693
$571,669,000
283 days
Use: To assess the efficiency in the
management of inventory
Chapter 9
The End