Slide
8-1
Chapter
8
McGraw-Hill/Irwin
INVENTORIES AND THE
COST OF GOODS SOLD
© The McGraw-Hill Companies, Inc., 2002
Slide
8-2
Inventory Defined
Inventory
Goods owned
and held for sale
to customers
McGraw-Hill/Irwin
Current
asset
© The McGraw-Hill Companies, Inc., 2002
Slide
8-3
The Flow of Inventory Costs
BALANCE SHEET
As purchase costs
(or manufacturing
costs) are incurred
Current assets:
Inventory
$
$
INCOME STATEMENT
Revenue
Cost of goods sold
Gross profit
Expenses
Net income
McGraw-Hill/Irwin
as goods
are sold
$
© The McGraw-Hill Companies, Inc., 2002
Slide
8-4
The Flow of Inventory Costs
In a perpetual inventory system, inventory entries
parallel the flow of costs.
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
Entry on Purchase Date
Inventory
$$$$
Accounts Payable
$$$$
Entry on Sale Date
Cost of Goods Sold
Inventory
McGraw-Hill/Irwin
$$$$
$$$$
© The McGraw-Hill Companies, Inc., 2002
Slide
8-5
Which Unit Did We Sell?
When identical units of inventory have
different unit costs, a question naturally
arises as to which of these costs should be
used in recording a sale of inventory.
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
Entry on Sale Date
Cost of Goods Sold
Inventory
McGraw-Hill/Irwin
$$$$
$$$$
© The McGraw-Hill Companies, Inc., 2002
Slide
8-6
Inventory Subsidiary Ledger
A separate subsidiary account is maintained
for each item in inventory.
Item LL002
Description Laser Light
Location Storeroom 2
Purchased
Date
Sept. 5
Sept. 9
Units
100
75
Sept. 10
Unit
Cost
$ 30
50
Total
$ 3,000
3,750
Sold
Units
Unit
Cost
10
?
Primary supplier Electronic City
Secondary supplier Electric Company
Inventory level: Min: 25 Max: 200
Balance
Cost of
Goods
Unit
Sold
Units
Cost
Total
100
$
30 $ 3,000
100
30
3,000
75
50
3,750
?
?
?
?
?
?
?
How can we determine the unit cost for the Sept. 10 sale?
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-7
Inventory Cost Flows
We use one of these inventory valuation
methods to determine cost of inventory sold.
Specific
identification
Average
cost
FIFO
LIFO
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-8
Information for the Following
Inventory Examples
The Bike Company (TBC)
Cost of Goods Available for Sale
Aug.
1 Beg. Inventory 10 units @
Aug.
3 Purchased
15 units @
Aug. 17 Purchased
20 units @
Aug. 28 Purchased
10 units @
Retail Sales of Goods
Aug. 14 Sales
Aug. 31 Sales
McGraw-Hill/Irwin
$
$
$
$
91
106
115
119
=
=
=
=
$
910
$ 1,590
$ 2,300
$ 1,190
20 units @ $ 130 =
23 units @ $ 150 =
$ 2,600
$ 3,450
© The McGraw-Hill Companies, Inc., 2002
Slide
8-9
Specific Identification
When a unit
is sold, the
specific cost of
the unit sold is
added to cost
of goods sold.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-10
Specific Identification – Example
Date
Aug. 1
Aug. 3
Purchases
Cost of Goods Sold
10
@
$ 91
=
$
910
15
@
$ 106
=
$ 1,590
Inventory
Balance
$
910
$ 2,500
On August 14, TBC sold 20 bikes for $130 each.
Nine bikes originally cost $91 and 11 bikes
originally cost $106.
Continue
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-11
Specific Identification – Example
Date
Purchases
Aug. 1 10 @ $ 91 = $ 910
Aug. 3 15 @ $ 106 = $ 1,590
Aug. 14
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
9
@
$ 91
=
$
819
11
@
$ 106
=
$ 1,166
$
515
The Cost of Goods Sold for the August 14 sale is
$1,985, leaving $515 and 5 units in inventory.
Continue
McGraw-Hill/Irwin
Let’s look at the entries for
the Aug. 14 sale.
© The McGraw-Hill Companies, Inc., 2002
Slide
8-12
Specific Identification – Example
GENERAL JOURNAL
Date
Account Titles and Explanation
Aug. 14 Cash
Retail
Debit
2,600
Sales
14 Cost of Goods Sold
2,600
Cost
1,985
Inventory
A similar entry is
made after each sale.
McGraw-Hill/Irwin
Credit
1,985
Continue
© The McGraw-Hill Companies, Inc., 2002
Slide
8-13
Specific Identification – Example
Date
Purchases
Aug. 1 10 @ $ 91 = $ 910
Aug. 3 15 @ $ 106 = $ 1,590
Aug. 14
Cost of Goods
Sold for
August 31 =
20 @ $ 115 = $ 2,300
$2,610
10 @ $ 119 = $ 1,190
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
9
@
$ 91
=
$
819
11
@
$ 106
=
$ 1,166
$
515
$ 2,815
$ 4,005
Aug. 17
Aug. 28
Aug. 31 Additional purchases were made
1 @on$August
91 = 17$and9128.
3
@
$ 106
=
$
318
Costs associated with sales on August 31 were as follows: 1 @ $91,
15 @ $ 115 =
$ 1,725
3 @ $106, 15 @ $115, & 4 @ $119.
4 @ $ 119 =
$ 476 $ 1,395
McGraw-Hill/Irwin
Continue
© The McGraw-Hill Companies, Inc., 2002
Slide
8-14
Specific Identification – Example
Date
Purchases
Aug. 1
10 @ $ 91 = $ 910
Aug. 3
15 @ $ 106 = $ 1,590
Income Statement
Aug. 14
COGS = $4,595
Aug. 17
Aug. 28
Aug. 31
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
Balance Sheet
Inventory = $1,395
McGraw-Hill/Irwin
Inventory
Balance
$
910
$
2,500
Cost of Goods Sold
9
@
$ 91
=
$
819
11
@
$ 106
=
$ 1,166
1
@
$ 91
=
$
91
3
@
$ 106
=
$
318
15
@
$ 115
=
$ 1,725
4
@
$ 119
=
$
476
$
$
$
515
2,815
4,005
$
1,395
1 @ $ 106 = $ 106
5 @ $ 115 =
575
6 @ $ 119 =
714
End. Inv. © The$McGraw-Hill
1,395 Companies, Inc., 2002
Slide
8-15
Since specific
identification is so
easy, can’t we use it
all the time?
McGraw-Hill/Irwin
Not really. Specific
identification is hard to use
when we sell a lot of
inventory that has lots of
different costs.
© The McGraw-Hill Companies, Inc., 2002
Slide
8-16
Average-Cost Method
When a unit is sold,
the average cost of each unit
in inventory is assigned to
cost
of goods sold.
Cost of Goods Units on hand
Available for ÷ on the date of
Sale
sale
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-17
Average-Cost Method – Example
Date
Aug. 1
Aug. 3
Purchases
Cost of Goods Sold
10
@
$ 91
= $
910
15
@
$ 106
= $ 1,590
The average cost per unit
must be computed prior
to each sale.
Inventory
Balance
$
910
$ 2,500
$100 = $2,500  25
On August 14, TBC sold 20 bikes for $130 each.
Continue
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-18
Average-Cost Method – Example
Date
Purchases
Aug. 1 10 @ $ 91 = $ 910
Aug. 3 15 @ $ 106 = $ 1,590
Aug. 14
The average cost per
unit is $100.
Continue
McGraw-Hill/Irwin
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$100 = $2,500  25
Let’s look at the entries
for the Aug.
14
sale.
© The McGraw-Hill Companies, Inc., 2002
Slide
8-19
Average-Cost Method – Example
GENERAL JOURNAL
Date
Account Titles and Explanation
Aug. 14 Cash
Retail
Debit
2,600
Sales
14 Cost of Goods Sold
2,600
Cost
2,000
Inventory
A similar entry is
made after each sale.
McGraw-Hill/Irwin
Credit
2,000
Continue
© The McGraw-Hill Companies, Inc., 2002
Slide
8-20
Average-Cost Method – Example
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Purchases
10
@
$ 91
= $
910
15
@
$ 106
= $ 1,590
20
@
$ 115
= $ 2,300
10
@
$ 119
= $ 1,190
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$ 2,800
$ 3,990
Additional purchases were made on August 17 and
August 28.
On August 31, an additional 23 units were sold.
Continue
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-21
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Average-Cost Method – Example
Purchases
10
@
$ 91
= $
15
@
$ 106
= $ 1,590
20
@
$ 115
= $ 2,300
10
@
$ 119
= $ 1,190
Total Purchases
Less: Sales to Date
Units on Hand
McGraw-Hill/Irwin
55
-20
35
910
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$ 2,800
$ 3,990
$114 = $3,990  35
© The McGraw-Hill Companies, Inc., 2002
Slide
8-22
Date
Aug. 1
Aug. 3
Aug. 14
Aug. 17
Aug. 28
Aug. 31
Average-Cost Method – Example
Purchases
10
@
$ 91
= $
910
15
@
$ 106
= $ 1,590
20
@
$ 115
= $ 2,300
10
@
$ 119
= $ 1,190
The average cost per
unit is $114.
McGraw-Hill/Irwin
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$ 2,800
$ 3,990
23 @ $ 114 = $ 2,622 $ 1,368
$114 = $3,990  35
© The McGraw-Hill Companies, Inc., 2002
Slide
8-23
Average-Cost Method – Example
Date
Purchases
Aug. 1 10 @ $ 91 = $ 910
Income
Statement
Aug.
3 15
@ $ 106 = $ 1,590
= $4,622
Aug. COGS
14
Aug. 17 20 @ $ 115 = $ 2,300
Aug. 28 10 @ $ 119 = $ 1,190
Aug. 31
Inventory
Balance
Cost of Goods Sold
$
910
$ 2,500
20 @ $ 100 = $ 2,000 $
500
$ 2,800
$ 3,990
23 @ $ 114 = $ 2,622 $ 1,368
Balance Sheet
Inventory = $1,368
$114 × 12 = $1,368
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-24
First-In, First-Out Method (FIFO)
Oldest
Costs
Costs of
Goods Sold
Recent
Costs
Ending
Inventory
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-25
FIFO – Example
Date
Purchases
Aug. 1 10 @ $ 91 = $ 910
Aug. 3 15 @ $ 106 = $ 1,590
Aug. 14
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
10
@
$ 106
=
$ 1,060
$
530
The Cost of Goods Sold for the August 14 sale is $1,970,
leaving $530 and 5 units in inventory.
On August 14, TBC sold 20 bikes for $130 each.
Continue
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-26
FIFO – Example
GENERAL JOURNAL
Date
Account Titles and Explanation
Aug. 14 Cash
Retail
Debit
2,600
Sales
14 Cost of Goods Sold
2,600
Cost
1,970
Inventory
A similar entry is
made after each sale.
McGraw-Hill/Irwin
Credit
1,970
Continue
© The McGraw-Hill Companies, Inc., 2002
Slide
8-27
FIFO – Example
Purchases
Date
Aug. 1 10 @ $ 91 = $ 910
Aug. 3 15 @ $ 106 = $ 1,590
Aug. 14
Aug. 17 20 @
Aug. 28 10 @
Aug. 31
$ 115
=
$ 2,300
$ 119
=
$ 1,190
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
10
@
$ 106
=
$ 1,060
5
@
$ 106
=
$
18
@
$ 115
=
$ 2,070
$
530
$ 2,830
$ 4,020
530
$ 1,420
Additional purchases were made on Aug. 17 and Aug. 28.
CostOn
ofAugust
Goods
Sold for August 31 = $2,600
31, an additional 23 units were sold.
McGraw-Hill/Irwin
Continue
© The McGraw-Hill Companies, Inc., 2002
Slide
8-28
FIFO – Example
Date
Purchases
Aug. 1
10 @ $ 91 = $ 910
Aug.
3
15 @ $ 106 = $ 1,590
Income
Statement
Aug. 14
COGS = $4,570
Aug. 17
Aug. 28
Aug. 31
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
Balance Sheet
Inventory = $1,420
McGraw-Hill/Irwin
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
10
@
$ 91
=
$
910
10
@
$ 106
=
$ 1,060
5
@
$ 106
=
$
18
@
$ 115
=
$ 2,070
$
530
$ 2,830
$ 4,020
530
$ 1,420
2 @ $ 115 = $ 230
10 @ $ 119 =
1,190
End. Inv.
$ 1,420
© The McGraw-Hill Companies, Inc., 2002
Slide
8-29
Last-In, First-Out Method (LIFO)
Recent
Costs
Costs of
Goods Sold
Oldest
Costs
Ending
Inventory
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-30
LIFO – Example
Date
Purchases
Aug. 1 10 @ $ 91 = $ 910
Aug. 3 15 @ $ 106 = $ 1,590
Aug. 14
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
15
@
$ 106
=
$ 1,590
5
@
$ 91
=
$
455
$
455
The Cost of Goods Sold for the August 14 sale is
$2,045, leaving $455 and 5 units in inventory.
On August 14, TBC sold 20 bikes for $130 each.
Continue
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-31
LIFO – Example
GENERAL JOURNAL
Date
Account Titles and Explanation
Aug. 14 Cash
Retail
Debit
2,600
Sales
14 Cost of Goods Sold
2,600
Cost
2,045
Inventory
A similar entry is
made after each sale.
McGraw-Hill/Irwin
Credit
2,045
Continue
© The McGraw-Hill Companies, Inc., 2002
Slide
8-32
LIFO – Example
Purchases
Date
Aug. 1 10 @ $ 91 = $ 910
Aug. 3 15 @ $ 106 = $ 1,590
Aug. 14
Aug. 17 20 @
Aug. 28 10 @
Aug. 31
$ 115
=
$ 2,300
$ 119
=
$ 1,190
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
15
@
$ 106
=
$ 1,590
5
@
$ 91
=
$
10
@
$ 119
=
$ 1,190
13
@
$ 115
=
$ 1,495
455
$
455
$ 2,755
$ 3,945
$ 1,260
Additional purchases were made on Aug. 17 and Aug. 28.
Cost of
Goods Sold for August 31 = $2,685
On Aug. 31, an additional 23 units were sold.
McGraw-Hill/Irwin
Continue
© The McGraw-Hill Companies, Inc., 2002
Slide
8-33
LIFO – Example
Date
Purchases
Aug. 1
10 @ $ 91 = $ 910
Aug.
3
15 @ $ 106 = $ 1,590
Income
Statement
Aug. 14
COGS = $4,730
Aug. 17
Aug. 28
Aug. 31
20
@
$ 115
=
$ 2,300
10
@
$ 119
=
$ 1,190
Balance Sheet
Inventory = $1,260
McGraw-Hill/Irwin
Inventory
Balance
$
910
$ 2,500
Cost of Goods Sold
15
@
$ 106
=
$ 1,590
5
@
$ 91
=
$
10
@
$ 119
=
$ 1,190
13
@
$ 115
=
$ 1,495
455
$
455
$ 2,755
$ 3,945
$ 1,260
5 @ $ 91 = $ 455
7 @ $ 115 =
805
End. Inv.
$ 1,260
© The McGraw-Hill Companies, Inc., 2002
Inventory Valuation Methods: A Summary
Costs Allocated to:
Valuation
Cost of Goods
Method
Sold
Inventory
Comments
Specific
Actual cost of
Actual cost of units Parallels physical flow
identification
the units sold
remaining
Logical method when units
are unique
May be misleading for
identical units
Average cost
Number of units Number of units on Assigns all units the same
sold times the
hand times the
average unit cost
average unit cost average unit cost
Current costs are averaged
in with older costs
First-in, First-out Cost of earliest
Cost of most
Cost of goods sold is based
(FIFO)
purchases on
recently
on older costs
hand prior to the purchased units
Inventory valued at current
sale
costs
May overstate income during
periods of rising prices; may
increase income taxes due
Last-in, First-out Cost of most
Cost of earliest
Cost of goods sold shown at
(LIFO)
recently
purchases
recent prices
purchased units (assumed still in
Inventory shown at old (and
inventory)
perhaps out of date) costs
Most conservative method
during periods of rising
prices; often results in lower
© The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
income
taxes
Slide
8-34
Slide
8-35
The Principle of Consistency
Once a company has
adopted a particular
accounting method, it
should follow that
method consistently,
rather than switch
methods from one
year to the next.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-36
Just-In-Time (JIT) Inventory
Systems
This inventory arrived
just in time for us to use
in the manufacturing
process.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-37
Taking a Physical Inventory
The primary reason for taking a physical inventory
is to adjust the perpetual inventory records for
unrecorded shrinkage losses, such as theft,
spoilage, or breakage.
GENERAL JOURNAL
Date
Account Titles and Explanation
Dec. 31 Cost of Goods Sold
Inventory
McGraw-Hill/Irwin
Debit
Credit
$$$$
$$$$
© The McGraw-Hill Companies, Inc., 2002
Slide
8-38
LCM and Other Write-Downs
of Inventory
Obsolescence
Lower of Cost
or Market
(LCM)
McGraw-Hill/Irwin
Reduces the value
of the inventory.
Adjust inventory
value to the lower
of historical cost or
current
replacement cost
(market).
© The McGraw-Hill Companies, Inc., 2002
Slide
8-39
Goods In Transit
A sale should be recorded when title
to the merchandise passes to the
buyer.
F.O.B.
shipping
point ⎯ title
passes to
buyer at the
point of
shipment.
McGraw-Hill/Irwin
Year
End
F.O.B.
destination
point ⎯ title
passes to
buyer at the
point of
destination.
© The McGraw-Hill Companies, Inc., 2002
Slide
8-40
Periodic Inventory Systems
In a periodic inventory system, inventory entries
are as follows.
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
Entry on Purchase Date
Purchases
Accounts Payable
$$$$
$$$$
Note that an entry is not
made to inventory.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-41
Periodic Inventory Systems
In a periodic inventory system, inventory entries
are as follows.
GENERAL JOURNAL
Account Titles and Explanation
Date
Debit
Credit
Entry on Sale Date
No entry to inventory.
Accounts Receivable
Sales
McGraw-Hill/Irwin
$$$$
$$$$
© The McGraw-Hill Companies, Inc., 2002
Slide
8-42
Periodic Inventory Systems
The inventory on
hand and the
cost of goods
sold for the year
are not
determined until
year-end.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-43
Periodic Inventory Systems
We use one of these inventory valuation
methods in a periodic inventory system.
Specific
identification
Average
cost
FIFO
LIFO
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-44
Information for the Following
Inventory Examples
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory
Cost of
Goods Sold
McGraw-Hill/Irwin
1,000 $
300
150
200
150
Total
5.25
$ 5,250.00
5.30
5.60
5.80
5.90
1,590.00
840.00
1,160.00
885.00
1,800
$ 9,725.00
1,200
?
600
?
© The McGraw-Hill Companies, Inc., 2002
Slide
8-45
Specific Identification – Example
By reviewing actual
purchase invoices,
Computers, Inc. determines
that the 1,200 mouse pads
on hand at year-end have
an actual total cost of
$6,400.
Determine the cost of
goods sold for the year.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-46
Specific Identification – Example
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
Date
Beginning
Inventory
1,000 $
Purchases:
Jan. 3
300
June 20
150
Sept.
200
Cost15
of Goods Sold
Nov. 29
150
$9,725
Goods $6,400 = $3,325
Available
for Sale
1,800
-
Ending
Inventory
Cost of
Goods Sold
McGraw-Hill/Irwin
Total
5.25
$ 5,250.00
5.30
5.60
5.80
5.90
1,590.00
840.00
1,160.00
885.00
$ 9,725.00
1,200
$ 6,400.00
600
$ 3,325.00
© The McGraw-Hill Companies, Inc., 2002
Slide
8-47
Average-Cost Method
The average cost is
calculated at yearend as follows:
Total Cost of
Goods
Available for
Sale
McGraw-Hill/Irwin
÷
Total Number
of Units
Available for
Sale
© The McGraw-Hill Companies, Inc., 2002
Slide
8-48
Average-Cost Method – Example
Avg. Cost $9,725  1,800 =
$5.40278
Ending Inventory
Avg. Cost $5.40278  1,200 =
$6,483
Cost of Goods Sold
Avg. Cost $5.40278  600 =
$3,242
Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory
Cost of
Goods Sold
McGraw-Hill/Irwin
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
Total
1,000 $
5.25
$ 5,250.00
300
150
200
150
5.30
5.60
5.80
5.90
1,590.00
840.00
1,160.00
885.00
1,800
$ 9,725.00
1,200
1,200
$ 6,483.00
?
600
$ 3,242.00
?
© The McGraw-Hill Companies, Inc., 2002
Slide
8-49
First-In, First-Out Method (FIFO)
Oldest
Costs
Costs of
Goods Sold
Recent
Costs
Ending
Inventory
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-50
FIFO – Example
Remember: Start
with the 11/29
purchase and then
add other purchases
until you reach the
number of units in
ending inventory.
Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory
Cost of
Goods Sold
McGraw-Hill/Irwin
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
Total
1,000 $
5.25
$ 5,250.00
300
150
200
150
5.30
5.60
5.80
5.90
1,590.00
840.00
1,160.00
885.00
1,800
$ 9,725.00
1,200
?
600
?
© The McGraw-Hill Companies, Inc., 2002
Slide
8-51
FIFO – Example
Date
Jan. 3
June 20
Sept. 15
Nov. 29
Units
Beg. Inv. Purchases
1,000@$5.25
300@$5.30
150@$5.60
200@$5.80
150@$5.90
Now, we have allocated
Costs
End. Inv.
Cost of
Goods Sold
600@$5.25
400@$5.25
300@$5.30
150@$5.60
200@$5.80
150@$5.90
1,200
150
600
$6,575
$3,150
the cost to allNow,
1,200 let’s
unitscomplete the
table.
endingAvailable
inventory.
Cost in
of Goods
for Sale
$9,725
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-52
FIFO – Example
Completing the table
summarizes the
computations just
made.
Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory
Cost of
Goods Sold
McGraw-Hill/Irwin
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
Total
1,000 $
5.25
$ 5,250.00
300
150
200
150
5.30
5.60
5.80
5.90
1,590.00
840.00
1,160.00
885.00
1,800
$ 9,725.00
1,200
$ 6,575.00
600
$ 3,150.00
© The McGraw-Hill Companies, Inc., 2002
Slide
8-53
Last-In, First-Out Method (LIFO)
Recent
Costs
Costs of
Goods Sold
Oldest
Costs
Ending
Inventory
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-54
LIFO – Example
Remember: Start with
beginning inventory
and then add other
purchases until you
reach the number of
units in ending
inventory.
Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory
Cost of
Goods Sold
McGraw-Hill/Irwin
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
Total
1,000 $
5.25
$ 5,250.00
300
150
200
150
5.30
5.60
5.80
5.90
1,590.00
840.00
1,160.00
885.00
1,800
$ 9,725.00
1,200
?
600
?
© The McGraw-Hill Companies, Inc., 2002
Slide
8-55
LIFO – Example
Date
Jan. 3
June 20
Sept. 15
Nov. 29
Units
Beg. Inv. Purchases End. Inv.
1,000@$5.25
1,000@$5.25
300@$5.30 200@$5.30
150@$5.60
200@$5.80
150@$5.90
Now, we have allocated
Costs
the cost to all 1,200 units
inventory.
Cost in
of ending
Goods Available
for Sale
McGraw-Hill/Irwin
1,000
1,200
Cost of
Goods Sold
100@$5.30
150@$5.60
200@$5.80
150@$5.90
100
600
$6,310
$3,415
Next, let’s
complete the
$9,725
table.
© The McGraw-Hill Companies, Inc., 2002
Slide
8-56
LIFO – Example
Completing the table
summarizes the
computations just
made.
Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory
Cost of
Goods Sold
McGraw-Hill/Irwin
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit
Total
1,000 $
5.25
$ 5,250.00
300
150
200
150
5.30
5.60
5.80
5.90
1,590.00
840.00
1,160.00
885.00
1,800
$ 9,725.00
1,200
$ 6,310.00
600
$ 3,415.00
© The McGraw-Hill Companies, Inc., 2002
Slide
8-57
Importance of an Accurate
Valuation of Inventory
Errors in Measuring Inventory
Beginning Inventory
Ending Inventory
Effect on Income Statement Overstated Understated Overstated Understated
+
+
-
+
+
Ending Inventory
0
0
Retained Earnings
-
+
Goods Available for Sale
Cost of Goods Sold
Gross Profit
Net Income
0
0
+
+
+
-
+
+
-
Effect on Balance Sheet
An error in ending inventory in a year will result in the
same error in the beginning inventory of the next year.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-58
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-59
The Gross Profit Method
 Determine cost of goods
available for sale.
 Estimate cost of goods sold
by multiplying the net sales
by the cost ratio.
 Deduct cost of goods sold
from cost of goods available
for sale to determine ending
inventory.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-60
Gross Profit Method – Example
In March of 2003, Chemico’s inventory was
destroyed by fire. Chemico’s normal gross profit
ratio is 30% of net sales. At the time of the fire,
Chemico showed the following balances:
Sales
$ 31,500
Sales returns
1,500
Beginning Inventory
12,000
Net cost of goods purchased
20,500
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-61
Gross Profit Method – Example
Computing Inventory using the Gross Profit Method
Goods Available for Sale:
$
Beginning Inventory
Net cost of goods purchased
 Goods available for sale
$
Less estimated cost of goods sold:
$ 31,500
Sales
(1,500)
Less sales returns
$ 30,000
Net sales
 Estimated cost of goods sold
Estimated March inventory loss
$
McGraw-Hill/Irwin
12,000
20,500
32,500
× 70%
(21,000)
11,500
© The McGraw-Hill Companies, Inc., 2002
Slide
8-62
Inventory Turnover Rate
Measures how quickly a company
sells its merchandise inventory.
Merchandise
Turnover
=
Cost of goods sold
Average inventory
Average Inventory = (Beg. Inv. + End. Inv.) ÷ 2
A ratio that is low compared to competitors
suggests inefficient use of assets.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-63
Accounting Methods Can Affect
Analytical Ratios
Remember that identical
companies that use different
inventory methods (e.g., FIFO
and LIFO) will have different
inventory turnover ratios.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Slide
8-64
End of Chapter 8
Careful! If you
drop the inventory
we will have another
write down.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002