ACG 2021
Chapter 6
Inventories
Inventory – is used to indicate
1. Merchandise held for sale in the normal course of business
2. Materials in the process of production or held for production.
What is included in the cost of inventory?
Costs
Transportation
Import duties
Insurance against losses in transit
Effect of Inventory Errors on Financial Statements
Any errors in the inventory count will affect both the balance sheet
and the income statement.
Inventory could be overstated or understated
Inventory Cost Flow Assumptions
A major accounting issue arises with identical units of merchandise
are acquired at different unit costs during a period.
First in, first out method – cost flow is in the order in which the costs
were incurred.
Last in, first out method – cost flow is in the reverse order in which
the costs are incurred.
Average cost – cost flow is an average of the costs
Inventory Costing Methods under a Perpetual Inventory System
All merchandise increases and decreases are recorded in a manner
similar to the recording or increases and decreases in cash.
The merchandise inventory account at the beginning of an accounting
period indicates the merchandise in stock on that date.
Created by: M. Mari
Fall, 2007
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Chapter 6
Purchases are recorded by debiting Merchandise Inventory and
crediting Cash or Accounts payable.
On the date of each sale, the cost of the merchandise sold is recorded
by debiting Cost of Merchandise Sold and crediting Merchandise
Inventory.
First in, First out Method
Most businesses dispose of goods in the order in which the
goods are purchased.
Especially true of perishables and goods whose styles or models
often change.
The FIFO method is often consistent with the physical flow or
movement of merchandise.
Example 1: Below are inventory records for a product
Date
Jan 1
Jan 4
Jan 10
Jan 22
Jan 28
Jan 30
Activity
Inventory
Sale
Purchase
Sale
Sale
Purchase
Units
100
70
80
40
20
100
Cost per unit
$20
$21
$22
Questions:
1. What is cost of merchandise sold in January under FIFO?
Date
Jan 4
Jan 22
Jan 28
Total cost
Created by: M. Mari
Fall, 2007
Page 2 of 9
Units
70
30
10
20
Cost per unit
$20
$20
$21
$21
Total Cost
$1400
$810
$420
$2630
ACG 2021
Chapter 6
2. What is the value of ending inventory on January 30?
50 units @ $21 per unit
100 units @ $22 per unit
Total
$1050
2200
3250
Last in, First out Method
When the LIFO method is used in a perpetual inventory system, the
cost of units sold is the cost of the most recent purchases.
Example 2: Below are inventory records for a product
Date
Jan 1
Jan 4
Jan 10
Jan 22
Jan 28
Jan 30
Activity
Inventory
Sale
Purchase
Sale
Sale
Purchase
Units
100
70
80
40
20
100
Cost per unit
$20
$21
$22
Questions:
3. What is cost of merchandise sold in January under LIFO?
Date
Units
Jan 4
Jan 22
70
40
Cost per unit
$20
$21
Jan 28
Total cost
20
$21
4. What is the value of ending inventory on January 30?
30 units @ $20 per unit
20 units @ $21 per unit
100 units @ $22 per unit
Total
Created by: M. Mari
Fall, 2007
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$ 600
420
2200
3220
Total Cost
$1400
840
$420
2660
ACG 2021
Chapter 6
Average cost Method
When the average cost method is used in a perpetual inventory
system, an average unit cost for each type of item is computed each
time a purchase is made.
Inventory Costing Methods under a Periodic Inventory System
When the periodic inventory system is used, only revenue is recorded
each time a sale is made.
No entry is made at the time of the sale to record the cost of the
merchandise sold.
Cost of merchandise sold:
Merchandise inventory 1/1
Purchases
Less purchases returns
Purchases discounts
Net purchases
Add transportation in
Cost of merchandise purchased
Merchandise available for sale
Less merchandise inventory 12/31
Cost of merchandise sold
$59,700
$521,980
$9,100
2,525
11,625
510,355
17,400
527,755
587,455
62,150
525,305
First in, First out Method
A physical inventory is conducted at the end of the year.
Start at the beginning of year to calculate cost of merchandise sold
Example 3:
Units
Unit cost
Total cost
Jan 1
Inventory
200
$9
$1,800
Mar 10
Purchase
300
10
3,000
Sept 21
400
11
4,400
Nov 18
100
12
1,200
Total available for sale
At end of year: 300 units still in inventory.
Created by: M. Mari
Fall, 2007
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ACG 2021
Chapter 6
Under FIFO method compute cost of merchandise sold and cost of ending
inventory.
Cost of merchandise sold:
Total available for sale
Ending inventory
Units sold
1,000
300
700
FIFO:
Jan 1
Mar 10
Sept 21
Nov 18
Inventory
Purchase
Units
200
300
200
Cost of
700
merchandise sold
Cost per unit Total cost
$9
$1,800
10
3,000
11
2,200
$7,000
Value of ending inventory = Total cost – Cost of merchandise sold
= $10,400 – 7000
= $3,400
Example 4: Under FIFO method compute cost of merchandise sold and
cost of ending inventory.
Units
Unit cost
Total cost
Jan 1
Inventory
150
$5
750
Mar 10
Purchase
220
6
1320
Sept 21
300
7
2100
Nov 18
250
7
1750
Total
available for
sale
920
5920
At end of year: 120 units still in inventory.
Created by: M. Mari
Fall, 2007
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ACG 2021
Chapter 6
Last in, First out Method
A physical inventory is conducted at the end of the year.
Calculate the cost of merchandise sold by starting at the end of the
year and working forward.
Example 5:
Units
Jan 1
Mar 10
Sept 21
Nov 18
Inventory
Purchase
200
300
400
100
Unit cost
$9
10
11
12
Total cost
$1,800
3,000
4,400
1,200
Total available
for sale
1,000
$10,400
At end of year: 300 units still in inventory.
Under LIFO method compute cost of merchandise sold and cost of ending
inventory.
Cost of merchandise sold:
Total available for sale
1,000
Ending inventory
300
Units sold
700
Nov 18
Purchase
Purchase
Units
100
400
200
Cost of
700
merchandise sold
Cost per unit Total cost
$12
$1,200
11
4,400
10
2,000
$7,600
Value of ending inventory = Total cost – Cost of merchandise sold
= $10,400 – 7,600
= $2,800
Created by: M. Mari
Fall, 2007
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Chapter 6
Example 6: Under LIFO method compute cost of merchandise sold and
cost of ending inventory.
Units
Unit cost
Total cost
Jan 1
Inventory
150
$5
750
Mar 10 Purchase
220
6
1320
Sept 21
300
7
2100
Nov 18
250
7
1750
Total available for sale
920
5920
At end of year: 120 units still in inventory.
Average Cost Method
A physical inventory is conducted at the end of the year.
Calculate the cost of merchandise sold by getting an average of the
cost and multiplying by the number of units in ending inventory.
Example 7:
Jan 1
Mar 10
Sept 21
Nov 18
Inventory
Purchase
Total available for sale
Units
200
300
400
100
1,000
Unit cost
$9
10
11
12
Total cost
$1,800
3,000
4,400
1,200
$10,400
At end of year: 300 units still in inventory.
5. What is cost of merchandise sold in January under Average cost?
Average costs = Total cost / Total units = $10,400/1000 = $10.40
per unit
Cost of merchandise sold = Average costs X units sold
= $10.4 per unit X 700 units
= $7,200
Created by: M. Mari
Fall, 2007
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ACG 2021
Chapter 6
Ending inventory = Average costs x units in ending inventory
= $10.40 per unit x 300 units = $3200
6. What is the value of ending inventory on January 30?
Ending inventory = Average costs x units in ending inventory
= $10.40 per unit x 300 units = $3200
Example 8: Under average cost method compute cost of merchandise sold
and cost of ending inventory.
Units
Unit cost
Total cost
Jan 1
Inventory
150
$5
750
Mar 10 Purchase
220
6
1320
Sept 21
300
7
2100
Nov 18
250
7
1750
Total available for sale
920
5920
At end of year: 120 units still in inventory.
Retail Method of Inventory Costing
Estimates inventory cost based on the relationship of the cost of
merchandise available for sale to the retail price of the same
merchandise.
Cost
Merchandise inventory
1/1
Purchases
Merchandise available
for sale
Retail
$19,400
42,600
$36,000
64,000
62,000
100,000
Ratio of cost to retail price = 62000/100,000 = 62%
Sales for January
Merchandise inventory 1/1 at retail
Merchandise inventory at cost
$30,000 x 62% = $18,600
Created by: M. Mari
Fall, 2007
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70,000
30,000
ACG 2021
Chapter 6
Valuation at Lower of Cost or Market
Commodities
Minerals
Commodity Quantity
A
B
C
D
400
120
600
280
Unit
Cost
$10.25
22.50
8.00
14.00
Unit
Market
$9.50
24.10
7.75
14.75
Value of the inventory is $15,070
Created by: M. Mari
Fall, 2007
Page 9 of 9
Cost
$4,100
2,700
4.800
3,920
15,530
Market
$3,800
2,892
4,650
4,130
15,472
Lower
$3,800
2,700
4,650
3,920
15,070