WHY IS INVENTORY IMPORTANT?
Ms. Naira
IMPORTANCE OF INVENTORY
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Inventory on hand is usually the largest asset of a
merchandising business (sell products like clothing, electronics,
furniture, cars, CD’s, food).
Successful business must have merchandise available for
sale that customers want (example they need various colors,
sizes,)
Keeping track of inventory can assist managers in
maintaining inventory of sufficient quantity, variety,
price.
Cost of inventory is reported on both the balance sheet
and Income statement, therefore needs to be accurate in
order to calculate current assets and retained earnings (on BS)
and gross profit and net income (on IS). These are official
documents for IRS
Most businesses fail because incorrect inventory
records
WHY KEEP EFFICIENT QUANTITY OF
INVENTORY?
To keep most efficient quantity of inventory, a business
makes frequent analysis of purchase, sales and
inventory records.
If inventory levels are too high, then Net Income
may decrease for several reasons:
1.
May require business to spend money on storage and
warehouse space.
2.
May Use capital that could be invested in other
assets to earn a profit (ei., storage)
3.
May require a business to spend money for expenses,
such as taxes and insurance premiums, which
increase the cost of merchandise inventory.
4.
Inventory may become obsolete and unsalable (there
is no demand for product, ei. Tickle me Elmo)
WHY KEEP EFFICIENT QUANTITY OF
INVENTORY?
If inventory levels are too low, then Net
Income
may decrease for several reasons:
1.
Sales may be lost to competitors if items
wanted by customers are not on hand. (Ei.
Store doesn’t have your brand)
2.
Sales may be lost to competitors if there is
insufficient variety to satisfied customers (Ei.
Color, Size)
3.
When business order small quantities of an
item, the price paid is often higher per unit
than when is order in larger quantities
METHODS USED TO DETERMINE THE
QUANTITY OF MERCHANDISE INVENTORY
The quantity of items in inventory at the
end of a fiscal period must be determined in
order to calculate the cost of merchandise
sold.
 Two methods are used to determine the
quantity of each item of merchandise on hand –
1) Periodic 2)Perpetual
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PERIODIC VS. PERPETUAL
Periodic Inventory means that inventory is
determined by physically counting, weighing, or
measuring items (usually referred to as physical
inventory)
 Perpetual Inventory means that inventory is
determined by keeping continuous record of
increases, decreases and balance on hand
(usually referred to as book inventory)
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FIRST IN FIRST OUT
A. The FIFO Method
The FIFO method considers the oldest goods
sold first. The ending inventory consists of the
newer purchases. During times of rising prices,
FIFO will result in a higher ending inventory
value and a lower cost of goods sold
(i.e., in comparision to LIFO).
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LAST IN FIRST OUT
B. The LIFO Method
The LIFO method considers the most recent
purchases as being sold first. The ending
inventory consists of the older purchases.
During times of rising prices, LIFO will result in a
lower ending inventory and a higher cost of
goods sold (i.e., in comparison to FIFO)
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COMPUTING COST OF GOODS SOLD IN A
PERIODIC INVENTORY SYSTEM
The calculations can be broken
down into three basic parts:
determine goods available
for sale,
(2) determine the value of
ending inventory, and
(3) determining cost of goods
sold.
(1)
EXAMPLE
Beginning Inventory,
Jan. 1, 10 units @ $20 per unit
Purchases:
Jan 10, 8 units @ $21 per unit
Jan 30, 10 units @ $22 per unit
Sales:
Jan 4, 7 units
Jan 22, 4 units
Jan 28, 2 units
STEP 1- DETERMINE GOODS AVAILABLE
FOR SALE
Units
Total
 Beginning Inventory
10
= $200
 Purchases, Jan 10
8
= $168
 Purchases, Jan 30
10
= $220
 Goods available for sale 28
$588
Cost
x
$20
x
$21
x
$22
2- DETERMINE ENDING INVENTORY
(28 UNITS AVAILABLE - 13 UNITS SOLD = 15)
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A. FIFO
Units
10 x
5
x
15
Cost
Total
$22 = $220
$21 = $105
$325
2- DETERMINE ENDING INVENTORY
(28 UNITS AVAILABLE - 13 UNITS SOLD = 15)
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A. LIFO
Units
10 x
5x
15
Cost
Total
$20 = $200
$21 = $105
$305
STEP 3: DETERMINE COST OF GOODS
SOLD
Goods Available for Sale
Less Ending Inventory
Cost of Goods Sold
FIFO
LIFO
$588
$588
325
305
$263
$283
CASE FOR CRITICAL THINKING PG. 581
Case 1
 Ballston Company uses the FIFO method of
costing its merchandise inventory. The manager
is considering a change to the LIFO method.
Cost have increased steadily over the past three
years. What effect will the change have on the
following items? 1) the amount of net income on
the income statement. 2) the amount of income
taxes to be paid. 3) the quantity of each item of
merchandise that must be kept in stock. Why?
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CASES FOR CRITICAL THINKING P. 581
The net Income on the income statement will be
less because the LIFO method gives the lowest
possible ending inventory cost during a period of
rising prices. Therefore, the cost of merchandise
sold will be higher, using the LIFO method.
Thus, net income will be less.
 The amount of income taxes to be paid will be
less because of lower net income.
 There will be no effect on the amount of
inventory kept on stock.
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