Chapter 5 Accounting Inventories
Chapter 5
Accounting Inventories
Chapter Objectives
Explain the importance of inventory valuation.
Explain the difference between a perpetual and a periodic inventory system.
Determine the cost of merchandise inventory using the specific identification methods.
Assign a value to merchandise inventory using the lower-of-cost-or-market-rule.
Estimate the cost of the ending inventory using the retail and the gross profit methods.
Explain how incorrect valuation of inventory affects financial statements.
Analyze inventory turnover.
Chapter 5 Section 1
Determining the Quantity of Inventories
Merchandise Inventory
Account that appears on:
Balance sheet (current asset)
Income statement (cost of merchandise sold).
Cost of Merchandise Sold
Determined using merchandise inventory
Largest deduction from net sales
Reasons for Managing the Inventory
The amount of merchandise on hand
The cost of that merchandise
Which items are selling (or not)
The optimal amount of merchandise to have available for customers.
Inventory Systems
1.
2.
Perpetual Inventory System
Periodic Inventory System
Perpetual Inventory System
The business keeps a constant up-todate record of the amount of merchandise on hand.
Most retail stores
Product code number on each item
Quantity
Selling price
Known as point-of-sale terminal
The Periodic Inventory System
Does not keep exact quantity of merchandise they have on hand.
Businesses determine the quantity on hand by physically counting the goods.
The Physical Inventory
An actual count of the merchandise on hand (merchandise at lowest level).
Helps detect losses due to breakage, spoilage, theft, or other causes.
Periodic system – used to update records
Perpetual system – counted once a year
Chapter 5 Section 2
Assigning Costs to the Ending Inventory
Methods of Determining
Inventory Costs
“Once the quantity of merchandise on hand is determined, the cost of that merchandise is calculated. There are four methods used to assign costs to inventory.”
1.) The Specific Identification Method
Actual cost of each item in the ending inventory is assigned to the item.
Checks the purchase invoice to determine actual cost of item
“big-ticket” items
1.) The Specific Identification Method
(Example)
Spectrum began the period with a beginning inventory of 22 sets of Wallace headphones that cost $27 per set. During the year, Spectrum purchased 184 sets. At the end of the year, there were 26 sets in stock.
1.) The Specific Identification Method
(Example)
Of the 26 sets on hand, 12 were purchased in
November, 10 in July, and 4 in March. When the specific identification method is used, the cost of the ending inventory is $852.
1.) The Specific Identification Method
(Example)
Once the cost of ending inventory is calculated, the cost of merchandise sold can be computed:
-
Cost of merchandise available for sale
Ending Inventory = Cost of merchandise sold
2.) First-In, First-Out Method (FIFO)
Based on the assumption that the first items purchased (first in) are the first items sold (first out).
Ending inventory purchased most recently.
Logical way for a business to rotate merchandise.
Ex: Milk in a grocery store.
2.) First-In, First-Out Method (FIFO)
(Example)
Using the FIFO method, the 26 sets of headphones in the ending inventory are those purchased most recently. They are part of the
November purchase. The cost of ending inventory is _______.
26 sets @ $___ a set = $ ______
What is the cost of merchandise sold? (unit and value)
2.) First-In, First-Out Method (FIFO)
(Example)
The cost of merchandise sold under the FIFO method is:
Practice Problems
Specific Identification Method
Open Google – Drive
Instructions: Calculate the cost of ending inventory using the specific identification method.
FIFO
Demonstration Problem 5-1 (#1 Only)
3.) The Last-In, First-Out Method
Based on the assumption that the last items purchased (last in) are the first items sold (first out).
Items in ending inventory are those that were purchased first.
Ex: a business that sells coal
3.) The Last-In, First-Out Method
(Headphones example) Using the LIFO method, the 26 sets in ending inventory consist of 22 sets that were in the beginning inventory and 4 sets purchased in March.
The cost of ending inventory is ______.
Write the following in your notes:
22 sets @ $27 per set = $594
4 sets @ $28 per set = 112
26 sets $706
3.) The Last-In, First-Out Method
The cost of merchandise sold using the LIFO method is $________.
Units: 206 – 26 = 180
Cost: $6,389 – 706 = $5,683
4.) The Weighted Average Cost Method
Assigns the average cost to each unit in inventory.
Average cost is calculated by:
Adding the number of units on hand at the beginning of the period and the number of units purchased.
Adding the cost of units on hand at the beginning of the period and the cost of units purchased, and
Dividing the total cost by the total number of units
4.) The Weighted Average Cost Method
(Headphone Example) The number of sets available for sale is 206. The cost of these sets is
$6,389.
The average cost per set is $31.01 (6,389/206).
The cost of ending inventory is $806.26.
26 sets @ $31.01 = $806.26
4.) The Weighted Average Cost Method
The cost of merchandise sold using the weighted average cost method is $______.
Units: 206 – 26 = 180
Cost: $6,389 – 806.26
= $5,582.74
In class:
1.
2.
Read page 151, take notes
Complete Demonstration Problem 5-1
Chapter 5 Section 3
Inventory Valuation, Reporting, and Analysis
Lower-of-Cost-or-Market Rule
Used by accountants when reporting the cost of ending inventory on the financial statement
Cost is calculated using one of the four inventory methods.
Market Value – the current price that is charged for similar items in the market (cost at which the items could be replaced).
Example (using FIFO)
Suppose the cost of the ending inventory of the headphones is $35 per set.
Market value is $31.50
Since market value of the inventory is less than the FIFO cost, Spectrum reports the cost of the inventory at :
$819 ($31.50 x 26)
Two common methods used to estimate the cost of inventory:
1.
2.
The Retail Method of Estimating
Inventory Cost
The Gross Profit Method
The Retail Method of Estimating
Inventory Cost
Markup – a dollar amount or a percentage of the cost that is added to the cost to arrive at the selling price.
Step 1 : Calculate the cost of merchandise available for sale at cost and at retail (cost + markup = selling price)
Step 2 : Calculate the cost ratio (total cost divided by total retail)
Step 3 : Retail Price – Total Sales = Retail Value
Step 4 : Retail Value of Ending Inventory x Cost
Ratio = Estimated Cost of Ending Inventory
The Retail Method of
Estimating Inventory Cost
Example:
Textbook
Page 156
The Gross Profit Method of
Estimating Inventory Cost
Uses the percentage of gross profit to estimate the cost of the inventory.
Gross Profit Percentage divided by Net
Sales
Gross Profit Percentage is based on financial statements from several previous periods.
Example: Textbook Page 156-157
Reporting Inventory on
Financial Statements
Merchandise Inventory – appears on income statement AND balance sheet
Errors in net income carry over to the statement of retained earnings and the balance sheet.
Textbook page 158
Analyzing Inventory Turnover
Merchandise Inventory Turnover
Measure of performance by a business
Number of times inventory is sold during a year.
Used to determine the number of days merchandise is in stock.
Helps to evaluate the efficiency of a business
Analyzing Inventory Turnover
Calculated by dividing the cost of merchandise sold by the average of merchandise inventory.
Higher Inventory Rate – money tied up in inventory for shorter periods of time
Lower Inventory Rate – possible lower sales than expected or wrong quantity available (requires management investigation)
Textbook page 159
Complete in your notes:
Demonstration Problems
5-2, 5-3
