Accounting for Inventories
• Inventory Systems:
– Perpetual—Maintains a moving inventory
balance (i.e., Merchandise inventory increases
as merchandise is purchased and decreases as it
sold
– Periodic—A physical inventory is taken and
priced at the end of an accounting period and
adjusted into the merchandise inventory account
at the end of the period to obtain cost of goods
sold in the current period
Inventory Valuation Methods
• Cost
– Inventory is valued at what the business paid
for it (includes cash discounts, freight-in, and
returns allowed)
• Lower of Cost or Market
– Current replacement cost is compared with the
purchase price of each item in inventory; then
the lower of the amount on an aggregate basis
is used for inventory valuation
Flow of Cost Considerations
• Specific Identification—Cost of specific items
•
purchased follow those items as they are sold
First-in; first-out (applies to cost of goods sold)
– First purchase prices apply to first goods sold; Most
recent purchase prices apply to what is left in ending
inventory
• Last-in; first-out (applies to cost of goods sold)
– First purchase prices apply to ending inventory; Most
recent purchase prices apply to first goods sold
• Weighted average
– Average cost of purchases is determined and the
same price per unit is applied to both cost of goods
sold and ending inventory
Example of Cost Flows
• Specific Identification
– 1st purchase item A @ $50; 2nd purchase item
A @ $100
– 1st sale is item A is the second purchase; CGS
would be $100 and ending inventory would be
$50
• First-In, First-Out same example
– Cost of goods sold would be $50 and ending
inventory would be $100
Example of Cost Flows, Continued
• Last-In, First-Out
– Cost of goods sold would be $100 and ending
inventory would be $50
• Weighted Average
– ($50 + 100)/2 = $75 average cost
– Cost of goods sold would be $75 (one item @
$75)
– Ending inventory would be $75 (one item @
$75
Inventory And Profit Determination
• An important equation in this pricing
process is—
– Beginning inventory + purchases = Total
available for sale
– Total available for sale = Cost of Goods Sold +
Ending Inventory
• So one can calculate the cost of goods
sold first or the ending inventory first
and subtract from total available for
sale to get the other amount