Note for Chapter 7
1. Control of inventory
Primary purposes: Safeguarding inventory and reporting inventory
2. Inventory Cost Flow Assumptions (See exhibit 1 on page 315)
Specific identification: Unit sold is identified with a specific purchase.
First-in, First-out (FIFO): Cost flow is in the order in which the costs were incurred.
Last-in, First-out (LIFO): Cost flow is in the reverse order in which the costs were incurred.
Weighted Average: cost flow is an average of the costs.
Please pay attention to term of cost flow, not any difference in unit. Because of different cost flow
method, the figure of ending inventory, cost of merchandise sold and gross profit will be different
3. Cash flow method under perpetual system (Important)
FIFO (See Exhibit 3 in page 316)
LIFO (See Exhibit 4 in page 318)
Weighted average: (See Exhibit 5 in page 319)
You need to know how to calculate remaining units, cost of merchandise sold and ending
inventory. You will also need to know the related journal entries.
4. Inventory costing methods under periodic system (Important)
See the formula in Page 321 and how to illustrate in FIFO, LIFO and Weighted average in Exhibit 6, 7
and 8. Remember that under periodic system, we have physical inventory courting at period end.
5. Comparing Inventory costing method
See Exhibit 8 in page 324. Need to know how to answer questions such as under increasing costs,
which methods lead to highest cost of merchandise sold or ending inventory.
6. Report merchandise inventory in the financial statements
Valuation at lower of cost or market (LCM). Know how to calculate net realizable value: (Direct
selling price-direct costs of disposal), one type of market value of inventory. If inventory value
decline, related cost of merchandise sold will be declined as well
Present merchandise inventory on B/S, explaining method of cost flow and valuing
Errors of inventory on I/S and B/S (See Exhibit 10, 11 and 12 in Page 328-329) Pay attention to value
of cost of merchandise sold and ending inventory.
7. Financial analysis and interpretation: Inventory turnover and number of days’ sales in inventory
Determine efficiency and effectiveness of a company’s management of inventory
Inventory Turnover= cost of merchandise sold/ average inventory
Number of days’ sales in inventory=average inventory/ average daily cost of merchandise sold, or
just using 365 days divide inventory turnover