Ch7: Inventories
The raw materials, work-in-process goods and completely finished goods that are
considered to be the portion of a business's assets that are ready or will be ready
for sale
Control of Inventory:
Two primary objectives of control over inventory are:
1. Safeguarding the inventory from damage or theft.
2. Reporting inventory in the financial statements.
Reporting Inventory:
 A physical inventory or count of inventory should be taken near yearend to make sure that the quantity of inventory reported in the financial
statements is accurate.
Inventory cost flow assumptions:
 First-in, first out (FIFO)
 Last-in, first out (LIFO)
 Average cost
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Ch7: Inventories
To illustrate, assume that three identical unite of merchandise are
purchased during May, as follows:
Assume that one unit is sold on May 30 for $20. Depending upon
which unit was sold, the gross profit varies from $11 to $6 as
shown below:
 Under the specific identification inventory cost flow method, the
unit sold is identified with a specific purchase.
The specific identification method is normally used by automobile dealerships,
jewelry stores, and art galleries.
 Under the first-in, first out (FIFO) inventory cost flow method,
the first units purchased are assumed to be sold first and the ending
inventory is made up of the most recent purchases
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Ch7: Inventories
 Under the last-in, first out (LIFO) inventory cost flow method, the
last units purchased are assumed to be sold first and the ending inventory is
made up of the first units purchased.
 Under the average inventory cost flow method, the cost of the units
sold and in ending inventory is an average of the purchase costs.
Inventory Costing Methods under the perpetual
inventory system:
 For purposes of illustration, the data for Item 127B are used, as shown
below. We will examine the perpetual inventory system first.
First-In, First-Out Method
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Ch7: Inventories
Last-In, First-Out Method
Average Cost Method:
 When the average cost method is used in a perpetual system, an average
unit cost for each item is computed each time a purchase is made.
 This unit cost is then used to determine the cost of each sale until another
purchase is made and a new average is computed. This averaging
technique is called a moving average.
Reporting Merchandise Inventory in the financial
statements
 Cost is the primary basis for valuing and reporting inventories in the financial
statements. However, inventory may be valued at other than cost in the
following cases:
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Ch7: Inventories


The cost of replacing items in inventory is below the recorded cost.
The inventory cannot be sold at normal prices due to imperfections,
style changes, or other causes.
Valuation at Lower of Cost or Market
Cost and replacement cost can be determined for the following:



Each item in the inventory.
Each major class or category of inventory.
Total inventory as a whole.
Example Exercise 7-5: page 325
Valuation at Net Realizable Value
 Merchandise that is out of date, spoiled, or damaged should be written down
to its net realizable value. This is the estimated selling price less any direct
costs of disposal, such as sales commissions or special advertising.
 Assume the following data about an item of damaged merchandise:
Original cost
$1,000
Estimated selling price
800
Selling expenses
150
 The merchandise should be valued at its net realizable value of $650
Net Realizable Value = $800 – $150= $650
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Ch7: Inventories
Merchandise Inventory on the Balance Sheet
 Merchandise inventory is usually presented in the Current Assets
section of the balance sheet, following receivables.
 The method of determining the cost of the inventory (FIFO, LIFO, or
weighted average) and the method of valuing the inventory (cost or the
lower of cost or market) should be shown.
Illustrative Problem Page 336 – 337
PR 7-1B – 7-2A Page 339
PR 7-5B – Page 340
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