Summary Sheet
Final Examination
Subject : Intermediate Accounting 1
(ACT 3602)
BY
Atikarn Bhumibhamorn
5310140
Chapter 9
Inventory and Cost of Goods
Sold.
Section 1 : Understanding Inventory and Cost
of Goods Sold
Inventory and Cost of Goods Sold
Inventory
o Includes items a company intends for sale to customers . For example, clothes at The
Limited, shoes at Payless ShoeSource, building supplies at Home Depot, and so on.
o Also includes items that are not yet finished products. For instance, lumber at a
cabinet manufacturer and rubber at a tire manufacturer are part of inventory because
the firm will use them to make a finished product for sale to customers
Manufacturing Companies
o Companies manufacture the inventories they sell, rather than buying them from
suppliers in finished form.
o We classify inventory into three categories
 Raw materials inventory: Includes the cost of
components that will become part of the finished
product but have not yet been used in production.
 Work-in-process inventory: Refers to the products
that have started the production process but are not
yet complete at the end of the period.
 Finished goods inventory: Once the manufacturing
process is complete, transfer these costs to finished
goods inventory.
LO2. Calculate cost of goods sold
 Inventory represents the cost of inventory not sold, while cost
of goods sold represents the cost of inventory sold.
 Also referred to as cost of sales, cost of merchandise sold, or
cost of products sold.
 The costs of beginning inventory plus additional purchases
make up the cost of goods (or inventory) available for sale.
LO3. Determine the cost of goods sold and ending inventory using
different inventory cost methods.
Example :
Inventory Transactions for Mario’s Game Shop
o It has 100 units of inventory at the beginning of the year and then makes two
purchases during the year—one on April 25 and one on October 19.
o There are 1,000 game cartridges available for sale.
o During the year, it sells 800 video game cartridges for $10 each. This means that 200
cartridges remain in ending inventory at the end of the year.
First-In, First-Out (FIFO)
o First units purchased are the first ones sold. Beginning inventory sells first, followed
by the inventory from the first purchase during the year, followed by the inventory
from the second purchase during the year, and so on.
o Mario’s Game Shop, which 800 units were sold?
o They were the first 800 units purchased, and that all other units remain in ending
inventory.
Last-In, First-Out (LIFO)
o Last units purchased are the first ones sold.
o Mario’s, If 800 units were sold, all the 600 units purchased on October 19 were sold,
along with 200 units from the April 25 purchase. That leaves 100 of the units from the
April 25 purchase and all 100 units from beginning inventory assumed to remain in
ending inventory.
Average Cost Method
o Both cost of goods sold and ending inventory consist of a random mixture of all the
goods available for sale.
o Each unit of inventory has a cost equal to the weighted-average cost of all inventory
items.
Comparison of Cost of Goods Sold Under The Three Inventory Cost Flow Assumptions
A company purchases three units of inventory and sells two.
 FIFO: Inventory is sold in the order purchased.
 LIFO: Inventory is sold in the opposite order that we purchased it.
 Weighted average cost: Inventory is sold using an average of all inventory purchased.
LO4 Explain the financial statement effects and tax effects of
inventory cost flow assumptions
Comparison of Inventory Cost Flow Assumptions When Prices Are Rising
LIFO Reserve
o Choice between FIFO and LIFO results in different amounts for ending
inventory and cost of goods sold.
o It complicates the investment decisions of stockholders.
o Due to financial statement effects of different inventory methods,
companies that choose LIFO must report what’s called their LIFO
reserve.
o It is the additional amount of inventory a company would
report if it used FIFO instead of LIFO.
o Companies that have been using LIFO for a long time or that have
seen dramatic increases in inventory costs, the LIFO reserve can be
substantial.
o The effect of the LIFO reserve for Lone Star Technologies, which
uses LIFO to account for most of its inventory follows.
Section 2 : Recording Inventory Transactions
LO5. Explain the differences between a perpetual inventory system
and a periodic inventory system
Perpetual
Inventory
System
It maintains a continual—or perpetual—record of
inventory purchased and sold.
A continual tracking of inventory has the advantage of
helping a company to better manage its inventory levels.
Periodic
Inventory
System
It does not continually modify
inventory amounts, but instead
periodically adjusts for purchases
and sales of inventory at the end of
the reporting period based on a
physical count of inventory on
hand.
Inventory Information for Incredible Electronics for 2010
To record inventory transactions under the perpetual
system and periodic system. We keep the amount of
inventory small to make the calculations easy, but both
systems can be applied to inventory of any size. Consider
the given information below during 2010:
Inventory Purchases
Freight Charges
Purchase Returns
Purchase Discounts
Inventory Sales
Period End Adjustment
LO6 Prepare a multiple-step income statement
Multiple-step Income Statement
LO7 Apply the lower-of-cost-or-market rule for inventories
o
When the value of inventory falls below its cost,
companies are required to report inventory at
the lower market value. And it is considered to
be the replacement cost .
o
Once it has determined both the cost and market
value of inventory, Inventory is reported at the
lower of the two amounts
Calculating the Lower of Cost or Market
1. Mario’s reports the FunStation 2 in ending inventory at
market value.
2.
The 15 FunStation 2s were originally reported in inventory at
their cost of $4,500.
3. To reduce the inventory from that original cost of $4,500 to its
lower market value of $3,000, Mario records the following
year-end adjustment.
LO8 Analyze management of inventory using the inventory
turnover ratio and gross profit ratio
o If managers purchase too much inventory, the
company runs the risk of the inventory
becoming obsolete and market value falling
below cost.
o Analysts as well as managers often use the
inventory turnover ratio to evaluate a company’s
effectiveness in managing its investment in
inventory.
o Investors often rely on the gross profit ratio to
determine the core profitability of a company’s
operations.
Analyze the inventory of Best Buy and Sharper Image Corporation
Computation of the Inventory Turnover Ratio
LO8 Analyze management of inventory using the inventory
turnover ratio and gross profit ratio
Gross profit ratio: Important indicator of the company’s successful management of
inventory.
Calculation of Gross Profit Ratio for Best buy and Sharper Image
Calculation of Gross Profit Ratio for Best buy and Sharper Image
LO9 Calculate inventory amounts using FIFO and LIFO under a
perpetual inventory system
FIFO with Perpetual System
LIFO with Perpetual System
LO10. Determine the financial statement effects of inventory errors
Determine the financial statement effects of inventory errors
Inventory Amounts