Chapter 5
Reporting and Analyzing
Inventories
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-2
Conceptual Chapter Objectives
C1: Identify the items making up
merchandise inventory
C2: Identify the costs of merchandise
inventory
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-3
Analytical Chapter Objectives
A1: Analyze the effects of inventory methods
for both financial and tax reporting
A2: Analyze the effects of inventory errors on
current and future financial statements
A3: Assess inventory management using both
inventory turnover and days’ sales in
inventory
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-4
Procedural Chapter Objectives
P1: Compute inventory in a perpetual system using the
methods of specific identification, FIFO, LIFO, and
weighted average
P2: Compute the lower of cost or market amount of
inventory
P3: Appendix 6A: Compute inventory in a periodic
system using the methods of specific identification,
FIFO, LIFO, and weighted average
P4: Appendix 6B: Apply both the retail inventory and
gross profit methods to estimate inventory.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-5
C1
Determining Inventory Items
Merchandise inventory includes all goods that
a company owns and holds for sale, regardless
of where the goods are located when inventory
is counted.
Items requiring special attention include:
Goods in
Transit
McGraw-Hill/Irwin
Goods on
Consignment
Goods
Damaged or
Obsolete
© The McGraw-Hill Companies, Inc., 2008
5-6
C1
Goods in Transit
FOB Shipping Point
Public
Carrier
Seller
Buyer
Ownership passes
to the buyer here.
Public
Carrier
Seller
McGraw-Hill/Irwin
FOB Destination Point
Buyer
© The McGraw-Hill Companies, Inc., 2008
5-7
C1
Goods on Consignment
Merchandise is included in the inventory of
the consignor, the owner of the inventory.
Consignee
Thanks for selling
my inventory in
your store.
Consignor
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-8
C1
Goods Damaged or Obsolete
Damaged or obsolete goods are not counted in
inventory if they cannot be sold.
Cost should be reduced to net realizable value if
they can be sold.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-9
C2
Determining Inventory Costs
Include all expenditures necessary to bring an
item to a salable condition and location.
Minus
Discounts
and
Allowances
Plus Import
Duties
McGraw-Hill/Irwin
Invoice
Cost
Plus
Freight
Plus
Insurance
Plus
Storage
© The McGraw-Hill Companies, Inc., 2008
5-10
C2
Internal Controls and Taking a Physical
Count

Most companies take
a physical count of
inventory at least once
each year.

When the physical
count does not match
the Merchandise
Inventory account, an
adjustment must be
made.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-11
P1
Inventory Costing Under a Perpetual
System
Inventory
affects . . .
Balance
Sheet
Income
Statement
The matching
principle requires
matching cost of
sales with sales.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-12
P1
Inventory Costing Under a Perpetual
System
Accounting for
inventory
requires several
decisions . . .

Costing Method
 Specific Identification, FIFO, LIFO,
or Weighted Average

Inventory System
 Perpetual or Periodic
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
P1
Frequency in Use of Inventory
Methods
5-13
FIFO
46%
LIFO
30%
Weighted
Average
20%
McGraw-Hill/Irwin
Other
4%
© The McGraw-Hill Companies, Inc., 2008
Inventory Cost Flow
Assumptions
P1
5-14
First-In, First-Out
(FIFO)
Assumes costs flow in the order
incurred.
Last-In, First-Out
(LIFO)
Assumes costs flow in the
reverse order incurred.
Weighted
Average
Assumes costs flow at an
average of the costs available.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-15
P1
Inventory Costing Illustration
Cost of Goods Available
Aug. 1 Beg. Inventory
Aug. 3 Purchased
Aug. 17 Purchased
Aug. 28 Purchased
for Sale
10 units
15 units
20 units
10 units
=
=
=
=
$
910
$ 1,590
$ 2,300
$ 1,190
Retail Sales of Goods
Aug. 14 Sales
Aug. 31 Sales
20 units @ $ 130 =
23 units @ $ 150 =
$ 2,600
$ 3,450
McGraw-Hill/Irwin
@
@
@
@
$
$
$
$
91
106
115
119
© The McGraw-Hill Companies, Inc., 2008
5-16
P1
Specific Identification
When units are sold, the
specific cost of the unit
sold is added to cost of
goods sold.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-17
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Specific Identification
Purchases
10 @
$
91 =
15 @
$ 106 =
Cost of Goods Sold
$
910
$ 1,590
8 @
20 @
$ 115 =
10 @
$ 119 =
$
91 =
$
728
12 @purchases
$ 106 =
$ were
1,272 $
500
The above
$ 2,300
$ 2,800
made
in
August.
On
August
14,
$ 1,190
$ 3,990
a company
eight
2 @ sold
$
91
=
$bikes
182
@ $ 106 $91
=
$and
31812
originally3 costing
14 @ $ 115 =
$ 1,610
bikes originally
costing
$106.
4 @
McGraw-Hill/Irwin
Inventory
Balance
$
910
$ 2,500
$ 119 =
$
476
$ 1,404
© The McGraw-Hill Companies, Inc., 2008
5-18
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Specific Identification
Purchases
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
8
@
$ 91
=
$
Inventory
Balance
$
910
$
2,500
728
The Cost of Goods Sold12for@the$August
106 = 14$sale
1,272 $
$2,000.
20 is@
$ 115 = $ 2,300
$
10 @ $ 119
= $@1,190
$
8 bikes
91 =
$ 728
$ 91 =
$ 182
12 bikes @ 106 =2 @ $1,272
3
@
$ 106
=
$
500
2,800
3,990
318
After this sale, there are five units in inventory
14 @ $ 115 =
$ 1,610
at $500:
2 bikes @ $91 =
$ 182
3 bikes @ $106 =
$ 318
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-19
P1
Specific Identification
Date
Aug. 1
Aug. 3
Aug. 14
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
8
@
$ 91
=
$
728
12
@
$ 106
=
$ 1,272
Aug. 17 20 @ $ 115 = $ 2,300
Aug. 28 10 @ $ 119 = $ 1,190
Aug. 31
2 @ $ 91 =
$ 182
Additional purchases were made3 on@August
$ 106 17
= and
$ 28.
318
$
500
$ 2,800
$ 3,990
14 @ 31
$ were
115 =as follows:
$ 1,610
The cost of the 23 items sold on August
2 @ $91 4 @ $ 119 = $ 476 $ 1,404
3 @ $106
15 @ $115
3 @ $119
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-20
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Specific Identification
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
8
@
$ 91
=
$
728
12
@
$ 106
=
$ 1,272
2
@
$ 91
=
$
182
3
@
$ 106
=
$
318
15
@
$ 115
=
$ 1,725
3
@
$ 119
=
$
357
$
500
$ 2,800
$ 3,990
$ 1,408
Cost of Goods Sold for
August 31 = $2,582
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-21
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Specific Identification
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
After the August 31 sale, there are
12 units in inventory at $1,408:
5 @ $115
7 @ $119
McGraw-Hill/Irwin
8
@
$ 91
=
$
728
12
@
$ 106
=
$ 1,272
2
@
$ 91
=
$
182
3
@
$ 106
=
$
318
15
@
$ 115
=
$ 1,725
3
@
$ 119
=
$
357
$
500
$ 2,800
$ 3,990
$ 1,408
© The McGraw-Hill Companies, Inc., 2008
5-22
P1
Specific Identification
Date
Aug. 1
Aug. 3
Aug. 14
Purchases
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
= $4,582
McGraw-Hill/Irwin
Cost of Goods Sold
10
Aug. 17 20 @ $ 115 =
Aug. 28Income
10 @ $ 119 =
Statement
COGS
Aug.
31
Inventory
Balance
$
910
$ 2,500
910
8
@
$ 91
=
$
728
12
@
$ 106
=
$ 1,272
2
@
$ 91
=
$
182
3
@
$ 106
=
$
318
15
@
$ 115
=
$ 1,725
3
@
$ 119
=
$
$ 2,300
$ 1,190
357
$
500
$ 2,800
$ 3,990
$ 1,408
Balance Sheet
Inventory = $1,408
© The McGraw-Hill Companies, Inc., 2008
5-23
P1
Specific Identification
Here are the entries to record the purchases and sales. The
numbers in red are determined by the cost flow assumption
used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
McGraw-Hill/Irwin
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise inventory
1,590
Accounts payable
1,590
Accounts receivable
2,600
Sales
2,600
Cost of goods sold
2,000
Merchandise inventory
2,000
Merchandise inventory
2,300
Accounts payable
2,300
Merchandise inventory
1,190
Accounts payable
1,190
Accounts receivable
3,450
Sales
3,450
Cost of goods sold
2,582
Merchandise inventory
2,582
© The McGraw-Hill Companies, Inc.,
2008
5-24
P1
First-In, First-Out (FIFO)
Oldest
Costs
Cost of
Goods Sold
Recent
Costs
Ending
Inventory
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-25
P1
Date
Aug. 1
Aug. 3
First-In, First-Out (FIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
Aug. 17 20 @ $ 115 = $ 2,300
The28above
Aug.
10 @ purchases
$ 119 = $ 1,190were
Aug.
31 in August.
5 @
made
18
@
$ 2,300
$ 3,490
$ 106
=
$
530
$ 115
=
$ 2,070
$
890
On August 14, the company
sold 20 bikes.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-26
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
First-In, First-Out (FIFO)
Purchases
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
Inventory
Balance
$
910
$ 2,500
910
10
@
$ 91
=
$
910
10
@
$ 106
=
$ 1,060
$ 2,300
The
Sold for the
10 @Cost
$ 119 of
= Goods
$ 1,190
5 @ $ 106 =
August 14 sale is $1,970.
18
@
$ 115
=
$
$
530
$ 2,830
$ 4,020
530
$ 2,070
$ 1,420
After this sale, there are five units in
inventory at $530:
5 @ $106
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-27
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
First-In, First-Out (FIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
10
@
$ 91
=
$
910
10
@
$ 106
=
$ 1,060
5
@
$ 106
=
$
18
@
$ 115
=
$ 2,070
$
530
$ 2,830
$ 4,020
530
$ 1,420
Additional purchases were made on August 17 and 28.
Twenty-three bikes were sold on August 31.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-28
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
First-In, First-Out (FIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
10
@
$ 91
=
$
910
10
@
$ 106
=
$ 1,060
5
@
$ 106
=
$
18
@
$ 115
=
$ 2,070
$
530
$ 2,830
$ 4,020
530
$ 1,420
Cost of Goods Sold for
August 31 = $2,600
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-29
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
First-In, First-Out (FIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
10
@
$ 91
=
$
910
10
@
$ 106
=
$ 1,060
5
@
$ 106
=
$
18
@
$ 115
=
$ 2,070
$
530
$ 2,830
$ 4,020
530
$ 1,420
After the August 31 sale, there are
12 units in inventory at $1,420:
2 @ $115
10 @ $119
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-30
P1
Date
Aug. 1
Aug. 3
Aug. 14
First-In, First-Out (FIFO)
Purchases
Aug. 31
Cost of Goods Sold
10
@
$
91
=
$
15
@
$ 106
=
$ 1,590
Income
Statement
Aug. 17 20
@ $ 115 =
Aug.
28 10
@ $ 119 =
COGS
= $4,570
Inventory
Balance
$
910
$ 2,500
910
10
@
$
91
=
$
910
10
@
$ 106
=
$ 1,060
5
@
$ 106
=
$
18
@
$ 115
=
$ 2,070
$ 2,300
$ 1,190
$
530
$ 2,830
$ 4,020
530
$ 1,420
Balance Sheet
Inventory = $1,420
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-31
P1
First-In, First-Out (FIFO)
Here are the entries to record the purchases and sales
entries. The numbers in red are determined by the cost flow
assumption used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
McGraw-Hill/Irwin
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise inventory
1,590
Accounts payable
1,590
Accounts receivable
2,600
Sales
2,600
Cost of goods sold
1,970
Merchandise inventory
1,970
Merchandise inventory
2,300
Accounts payable
2,300
Merchandise inventory
1,190
Accounts payable
1,190
Accounts receivable
3,450
Sales
3,450
Cost of goods sold
2,600
Merchandise inventory
2,600
© The McGraw-Hill Companies, Inc.,
2008
5-32
P1
Last-In, First-Out (LIFO)
Recent
Costs
Cost of
Goods Sold
Oldest
Costs
Ending
Inventory
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-33
P1
Date
Aug. 1
Aug. 3
Aug. 14
Last-In, First-Out (LIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
15
@
$ 106
=
$ 1,590
5
@
$ 91
=
$
Aug.
20 @ $ 115 = $ 2,300
The17above
purchases were
Aug. 28 10 @ $ 119 = $ 1,190
made
Aug.
31 in August.
10 @
$ 119
=
$ 1,190
$ 115
=
$ 1,495
13
@
On August 14, the company
sold 20 bikes.
McGraw-Hill/Irwin
455
$
455
$ 2,755
$ 3,945
$ 1,260
© The McGraw-Hill Companies, Inc., 2008
5-34
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Last-In, First-Out (LIFO)
Purchases
Cost of Goods Sold
10
@
$ 91
=
$
15
@
$ 106
=
$ 1,590
20
10
Inventory
Balance
$
910
$ 2,500
910
15
@
$ 106
=
$ 1,590
5
@
$ 91
=
$
455
@
$ 115 = $ 2,300
The
Cost of Goods Sold for the
@ $ 119 = $ 1,190
August 14 sale
is $$2,045.
10 @
119 =
$ 1,190
13
@
$ 115
=
$ 1,495
After this sale, there are five units in
inventory at $455:
5 @ $91
McGraw-Hill/Irwin
$
455
$ 2,755
$ 3,945
$ 1,260
© The McGraw-Hill Companies, Inc., 2008
5-35
P1
Date
Aug. 1
Aug. 3
Aug. 14
Last-In, First-Out (LIFO)
Purchases
10 @
$
91 =
15 @
$ 106 =
Cost of Goods Sold
$
910
$ 1,590
15 @
5 @
Aug. 17
Aug. 28
Aug. 31
Inventory
Balance
$
910
$ 2,500
20 @
$ 115 =
$ 2,300
10 @
$ 119 =
$ 1,190
10 @
$ 106 =
$ 1,590
$
$
91 =
$ 119 =
455
$
455
$ 2,755
$ 3,945
$ 1,190
13 @on$ August
115 =
$
Additional purchases were made
171,495
and $28.1,260
Twenty-three bikes were sold on August 31.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-36
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Last-In, First-Out (LIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
15
@
$ 106
=
$ 1,590
5
@
$ 91
=
$
10
@
$ 119
=
$ 1,190
13
@
$ 115
=
$ 1,495
455
$
455
$ 2,755
$ 3,945
$ 1,260
Cost of Goods Sold for
August 31 = $2,685
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-37
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Last-In, First-Out (LIFO)
Purchases
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
15
@
$ 106
=
$ 1,590
5
@
$ 91
=
$
10
@
$ 119
=
$ 1,190
13
@
$ 115
=
$ 1,495
455
$
455
$ 2,755
$ 3,945
$ 1,260
After the August 31 sale, there are
12 units in inventory at $1,260:
5 @ $91
7 @ $115
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-38
P1
Date
Aug. 1
Aug. 3
Aug. 14
Last-In, First-Out (LIFO)
Purchases
Cost of Goods Sold
10
@
$
91
=
$
15
@
$ 106
=
$ 1,590
Aug. 17Income
20 @ $ 115 =
Statement
Aug.
28 10 @COGS
$ 119 =
= $4,730
Aug. 31
Inventory
Balance
$
910
$ 2,500
910
15
@
$ 106
=
$ 1,590
5
@
$
91
=
$
10
@
$ 119
=
$ 1,190
13
@
$ 115
=
$ 1,495
455
$ 2,300
$ 1,190
$
455
$ 2,755
$ 3,945
$ 1,260
Balance Sheet
Inventory = $1,260
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-39
P1
Last-In, First-Out (LIFO)
Here are the entries to record the purchases and sales
entries. The numbers in red are determined by the cost flow
assumption used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
McGraw-Hill/Irwin
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise inventory
1,590
Accounts payable
1,590
Accounts receivable
2,600
Sales
2,600
Cost of goods sold
2,045
Merchandise inventory
2,045
Merchandise inventory
2,300
Accounts payable
2,300
Merchandise inventory
1,190
Accounts payable
1,190
Accounts receivable
3,450
Sales
3,450
Cost of goods sold
2,685
Merchandise inventory
2,685
© The McGraw-Hill Companies, Inc.,
2008
5-40
P1
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 of
Sale
sale
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-41
P1
Weighted Average
Date
Purchases
Cost of Goods Sold
Aug. 1
10 @ $
91 = $
910
Aug. 3
15 @ $ 106 = $ 1,590
Aug. 14
20 @ $ 100 = $ 2,000
Aug. 17 20 @ $ 115 = $ 2,300
Aug.
28 above
10 @ $purchases
119 = $ 1,190were
The
Aug.
31 in August.
23 @ $ 114 = $ 2,622
made
Inventory
Balance
$ 910
$ 2,500
$ 500
$ 2,800
$ 3,990
$ 1,368
On August 14, 20 bikes were
sold.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-42
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
10
15
20
10
Inventory
Balance
Purchases
Cost of Goods Sold
@ $
91 = $
910
$ 910
@ $ 106 = $ 1,590
$ 2,500
20 @ $ 100 = $ 2,000 $
500
@ First,
$ 115 we
= $need
2,300to compute the weighted
$ 2,800
@ average
$ 119 = cost
$ 1,190
per unit of items in inventory. $ 3,990
23 @ $ 114 = $ 2,622 $ 1,368
Cost of goods available for sale
Total units in inventory
Weighted average cost per unit
McGraw-Hill/Irwin
$
$
÷
2,500
25
100
© The McGraw-Hill Companies, Inc., 2008
5-43
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
Inventory
Balance
Purchases
Cost of Goods Sold
10 @ $ 91 = $ 910
$
910
15 @ $ 106 = $ 1,590
$ 2,500
20 @ $ 100 = $ 2,000 $
500
20 @ $ 115 = $ 2,300
$ 2,800
10
$ 119
$ 1,190Sold for the August 14
$ 3,990
The@Cost
of =Goods
23 @ $ 114 = $ 2,622 $ 1,368
sale is $2,000.
After this sale, there are five units in
inventory at $500:
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-44
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
Purchases
Cost of Goods Sold
10 @
$
91 =
$
910
15 @
$ 106 =
$
1,590
20 @
20 @
$ 115 =
$
2,300
10 @
$ 119 =
$
1,190
$ 100 =
$
2,000
Inventory
Balance
$ 910
$ 2,500
$ 500
$ 2,800
$ 3,990
$ 1,368
23 @ $ 114 = $ 2,622
Additional purchases were made
on August 17 and 28.
Twenty-three bikes were sold on August 31.
What is the weighted average cost per unit
of items in inventory?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-45
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
Purchases
10 @
$
91 =
$
910
15 @
$ 106 =
$
1,590
20 @
$ 115 =
$
2,300
10 @
$ 119 =
$
1,190
Units
Inventory 8/14
5
Purchase 8/17
20
Purchase 8/28
10
Units available for sale
35
McGraw-Hill/Irwin
Cost of Goods Sold
20 @
$ 100 =
$
2,000
23 @
$ 114 =
$
2,622
Cost of goods available for sale
Total units in inventory
Weighted average cost per unit
Inventory
Balance
$ 910
$ 2,500
$ 500
$ 2,800
$ 3,990
$ 1,368
$
3,990
÷ 35
$
114
© The McGraw-Hill Companies, Inc., 2008
5-46
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
Purchases
10
@ $ 91
= $
910
15
@ $ 106
= $ 1,590
20
@ $ 115
= $ 2,300
10
@ $ 119
= $ 1,190
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$ 2,800
$ 3,990
23 @ $ 114 = $ 2,622 $ 1,368
Cost of Goods Sold for
August 31 = $2,622
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-47
P1
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Weighted Average
Purchases
10
@ $ 91
= $
910
15
@ $ 106
= $ 1,590
20
@ $ 115
= $ 2,300
10
@ $ 119
= $ 1,190
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$ 2,800
$ 3,990
23 @ $ 114 = $ 2,622 $ 1,368
After the August 31 sale, there are
12 units in inventory at $1,368:
12 @ $114
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-48
P1
Weighted Average
Date
Purchases
Aug. 1
10 @ $ 91 =
Aug. 3
15 @ $ 106 =
Aug. 14
Aug. 17 Income
20 @ $ 115 =
Aug.Statement
28 10 @ $COGS
119 =
Aug. 31 = $4,622
$
910
$ 1,590
$ 2,300
$ 1,190
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$ 2,800
$ 3,990
23 @ $ 114 = $ 2,622 $ 1,368
Balance Sheet
Inventory = $1,368
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-49
P1
Weighted Average
Here are the entries to record the purchases and sales
entries for Trekking. The numbers in red are determined by
the cost flow assumption used.
All purchases
and sales are
made on
credit.
The selling
price of
inventory was
as follows:
8/14 $130
8/31 150
McGraw-Hill/Irwin
Aug. 3
Aug. 14
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Aug. 31
Merchandise inventory
1,590
Accounts payable
1,590
Accounts receivable
2,600
Sales
2,600
Cost of goods sold
2,000
Merchandise inventory
2,000
Merchandise inventory
2,300
Accounts payable
2,300
Merchandise inventory
1,190
Accounts payable
1,190
Accounts receivable
3,450
Sales
3,450
Cost of goods sold
2,622
Merchandise inventory
2,622
© The McGraw-Hill Companies, Inc.,
2008
5-50
A1
Financial Statement Effects of Costing
Methods
Because prices change, inventory methods nearly
always assign different cost amounts.
Trekking Company
For Month Ended August 31
Specific
Identification
Sales
$
6,050
Cost of goods sold
4,582
Gross profit
$
1,468
Operating expenses
450
Income before taxes
$
1,018
Income tax expense (30%)
305
Net income
$
713
Balance sheet inventory
McGraw-Hill/Irwin
$
1,408
$
FIFO
6,050
4,570
1,480
450
1,030
309
721
$
1,420
$
$
$
$
$
$
$
LIFO
6,050
4,730
1,320
450
870
261
609
Weighted
Average
$
6,050
4,622
$
1,428
450
$
978
293
$
685
$ McGraw-Hill
1,260Companies,
$ Inc.,
1,368
© The
2008
5-51
A1
Financial Statement Effects of Costing
Methods
Advantages of Methods
Weighted
Average
First-In,
First-Out
Last-In,
First-Out
Smoothes out
price changes.
Ending inventory
approximates
current
replacement cost.
Better matches
current costs in cost
of goods sold with
revenues.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
A1
Tax Effects of Costing
Methods
5-52
The Internal Revenue Service (IRS)
identifies several acceptable
methods for inventory costing for
reporting taxable income.
If LIFO is used for tax
purposes, the IRS requires
it be used in financial
statements.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
Consistency in Using Costing
Methods
A1
5-53
The consistency principle requires a
company to use the same accounting
methods period after period so that
financial statements are comparable
across periods.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008
5-54
P2
Lower of Cost or Market
Inventory must be reported at market
value when market is lower than
cost.
Defined as current
replacement cost
(not sales price).
Consistent with
the conservatism
principle.
McGraw-Hill/Irwin
Can be applied three ways:
(1)
(2)
(3)
separately to each
individual item.
to major categories of
assets.
to the whole inventory.
© The McGraw-Hill Companies, Inc., 2008
5-55
P2
Lower of Cost or Market
A motorsports retailer has the following items in
inventory:
Per Unit
Inventory Items
Cycles:
Roadster
Sprint
Category subtotal
Off-Road
Trax-4
Blazer
Category subtotal
Total
McGraw-Hill/Irwin
Units on
Hand
Cost
20 $ 8,000
10
5,000
8
5
5,000
9,000
Market
Total
Cost
Total
Market
$ 7,000
6,000
$160,000
50,000
210,000
$ 140,000
60,000
200,000
6,500
7,000
40,000
45,000
85,000
$295,000
52,000
35,000
87,000
$ 287,000
© The McGraw-Hill Companies, Inc., 2008
5-56
P2
Lower of Cost or Market
Here is how to compute lower of cost or
market for individual inventory items.
LCM Applied to
Units on
Inventory Items Hand
Total Cost
Cycles:
Roadster
20 $ 160,000
Sprint
10
50,000
Category subtotal
$ 210,000
$ 140,000 $ 140,000
60,000
50,000
$ 200,000
Off-Road
Trax-4
Blazer
Category subtotal
Total
$ 52,000
40,000
35,000
35,000
$ 87,000
$ 287,000 $ 265,000
McGraw-Hill/Irwin
8
5
$ 40,000
45,000
$ 85,000
$ 295,000
Total
Market
Items
Categories
Whole
© The McGraw-Hill Companies, Inc., 2008
5-57
P2
Lower of Cost or Market
Here is how to compute lower of cost or market
for the two groups of inventory items.
LCM Applied to
Units on
Inventory Items Hand
Total Cost
Cycles:
Roadster
20 $ 160,000
Sprint
10
50,000
Category subtotal
$ 210,000
$ 140,000 $ 140,000
60,000
50,000
$ 200,000
$ 200,000
Off-Road
Trax-4
Blazer
Category subtotal
Total
$ 52,000
40,000
35,000
35,000
$ 87,000
$ 287,000 $ 265,000
85,000
$ 285,000
McGraw-Hill/Irwin
8
5
$ 40,000
45,000
$ 85,000
$ 295,000
Total
Market
Items
Categories
Whole
© The McGraw-Hill Companies, Inc., 2008
5-58
P2
Lower of Cost or Market
Here is how to compute lower of cost or market
for the entire inventory.
LCM Applied to
Units on
Inventory Items Hand
Total Cost
Cycles:
Roadster
20 $ 160,000
Sprint
10
50,000
Category subtotal
$ 210,000
$ 140,000 $ 140,000
60,000
50,000
$ 200,000
$ 200,000
Off-Road
Trax-4
Blazer
Category subtotal
Total
$ 52,000
40,000
35,000
35,000
$ 87,000
$ 287,000 $ 265,000
85,000
$ 285,000
McGraw-Hill/Irwin
8
5
$ 40,000
45,000
$ 85,000
$ 295,000
Total
Market
Items
Categories
Whole
$ 287,000
© The McGraw-Hill Companies, Inc., 2008
Exh.
5-59
A2
Financial Statement Effects of Inventory
Errors
5.10
Income Statement Effects
Inventory Error
Understate ending inventory
Understate beginning inventory
Overstate ending inventory
Overstate beginning inventory
McGraw-Hill/Irwin
Cost of Goods Sold Net Income
Overstated
Understated
Understated
Overstated
Understated
Overstated
Overstated
Understated
© The McGraw-Hill Companies, Inc., 2008
5-60
A2
Financial Statement Effects of Inventory
Errors
Balance Sheet Effects
Inventory Error
Understate ending inventory
Overstate ending inventory
McGraw-Hill/Irwin
Assets
Equity
Understated Understated
Overstated
Overstated
© The McGraw-Hill Companies, Inc., 2008
5-61
A3
Inventory Turnover
Shows how many times a company turns over its
inventory during a period. Indicator of how well
management is controlling the amount of
inventory available.
Inventory
Turnover
Average
Inventory
McGraw-Hill/Irwin
=
=
Cost of goods sold
Avg. inventory
(Beg. Inv. + End Inv.) ÷ 2
© The McGraw-Hill Companies, Inc., 2008
5-62
A3
Days’ Sales in Inventory
Reveals how much inventory is available in
terms of the number of days’ sales.
Days' Sales in
Inventory
McGraw-Hill/Irwin
=
Ending Inventory
Cost of goods sold
×
365
© The McGraw-Hill Companies, Inc., 2008
5-63
End of Chapter 5
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2008