Chapter 7
Inventories
Accounting, 21st Edition
Warren Reeve Fess
PowerPoint Presentation by Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
© Copyright 2004 South-Western, a division
of Thomson Learning. All rights reserved.
Task Force Image Gallery clip art included in this
electronic presentation is used with the permission of
NVTech Inc.
Objectives
1. Summarize and provide examples of internal
control procedures that apply to inventories.
2. Describe the effect of inventory errors on the
financial statement.
3. Describe the three inventory cost flow
assumptions and how they impact the income
statement and balance sheet.
4. Compute the cost of inventory under the
perpetual inventory system, using the
following cost methods: first-in, first-out; lastin, first-out; average cost.
Objectives
5. Compute the cost of inventory under the
periodic inventory system, using the
following costing methods: first-in, first-out;
last-in, first-out; average cost.
6. Compare and contrast the use of the three
inventory costing methods.
7. Compute the proper valuation of inventory at
other than cost, using the lower-of-cost-ormarket and net realization value concepts.
8. Prepare a balance sheet presentation of
merchandise inventory.
Objectives
9. Estimate the cost of inventory, using the
retail method and the gross profit method.
10. Compute the interpret the inventory
turnover ratio and number of days’ sales in
inventory.
Why is Inventory Control Important?
✔ Inventory is a significant asset and for many
companies the largest asset.
✔ Inventory is central to the main activity of
merchandising and manufacturing
companies.
✔ Mistakes in determining inventory cost can
cause critical errors in financial statements.
✔ Inventory must be protected from external
risks ( such as fire and theft) and internal
fraud by employees.
• Two primary objectives of control over inventory are as
follows:
• 1. Safeguarding the inventory from damage or theft.
• 2. Reporting inventory in the financial statements.
• Safeguarding Inventory
• Controls for safeguarding inventory begin as soon as the
inventory is ordered. The
• following documents are often used for inventory
control:
• Purchase order
• Receiving report
• Vendor’s invoice
• The purchase order authorizes the
purchase of the inventory from an approved
• vendor. As soon as the inventory is
received, a receiving report is completed.
The receiving report establishes an initial
record of the receipt of the inventory. To
make sure the inventory received is what
was ordered, the receiving report is
compared with the company’s purchase
order
• The price, quantity, and description of the
item
• on the purchase order and receiving
report are then compared to the vendor’s
invoice.
• If the receiving report, purchase order,
and vendor’s invoice agree, the inventory
is recorded in the accounting records
Receiving
report
AGREE
Purchase
order
Invoice
JOURNAL
Date
Description
Nov. 9 Inventory
Accounts Payable--XYZ Co.
Purchased merchandise on
account.
Post.
Ref.
1 222 00
1 222 00
Perpetual Inventory Costs
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Units
Cost
Price
Jan.
1
Inventory
Cost
of Sale 7
4
Mdse.
Sold
10
Purchase
22
Sale 4
28
Sale 2
30
Purchase
10
8
10
$20
$30
21
31
32
22
FIFO Perpetual Inventory Account
Item 127B
Purchases
Jan. 1
Total
Date
Cost
Qty.
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Cost
Total
Cost
Qty.
Total
Cost
10
The firm begins the year with 10
units of Item 127B on hand at a
total cost of $200.
Unit
Cost
20
Qty.
200
FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Units
Cost
Price
Jan.
1
Inventory
Cost
of Sale 7
4
Mdse.
Sold
10
Purchase
22
Sale 4
28
Sale 2
30
Purchase
10
8
10
$20
$30
21
31
32
22
On January 4, 7 units of Item
127B are sold at $30 each.
FIFO Perpetual Inventory Account
Item 127B
Purchases
Jan. 1
Total
Date Qty.
Cost
Cost
4
60
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Cost
Total
Cost
7
Qty.
20
Total
Cost
10
140
The sale of 7 units leaves a
balance of 3 units.
On January 4, 7 units of Item
127B are sold at $30 each.
Unit
Cost
20
3
Qty.
200
20
FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Units
Cost
Price
Jan.
1
Inventory
Cost
of Sale 7
4
Mdse.
Sold
10
Purchase
22
Sale 4
28
Sale 2
30
Purchase
10
8
10
$20
$30
21
31
32
22
On January 10, the firm purchased
eight units at $21 each.
FIFO Perpetual Inventory Account
Item 127B
Purchases
Jan. 1
Total
Date Qty.
Cost
Cost
4
60 10 8
60
168
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Total
Cost
Cost
7
21
Qty.
20
Total
Cost
10
140
168
Unit
Cost
20
3
3
Qty.
200
20
20
8
21
Because the purchase price of $21 is
different than the cost of the previous 3
units On
on hand,
the inventory
balance of
January
10, the firm
11 units is accounted for separately.
purchased eight units at $21 each.
FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Units
Cost
Price
Jan.
1
Inventory
Cost
of Sale 7
4
Mdse.
Sold
10
Purchase
22
Sale 4
28
Sale 2
30
Purchase
10
8
10
$20
$30
21
31
32
22
On January 22, the firm sold
four units for $31 each.
FIFO Perpetual Inventory Account
Item 127B
Purchases
Cost of Mdse. Sold
On January 22, the
Unit
Total
firm
sold
four
units
Total
Date
Qty. each.
Cost
Cost
for $31
Jan. 1
Cost
4
60 10
60
22
168
147
Cost
8
21
Inventory Balance
Unit
Qty.
Total
7
20
Cost
10
140
3
1
20
21
60
21
168
Unit
Cost
20
3
3
Qty.
200
20
20
8
7
21
21
Of the four units sold, three are
from the first units in (fifo) at a
cost of $20.
FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Units
Cost
Price
Jan.
1
Inventory
Cost
of Sale 7
4
Mdse.
Sold
10
Purchase
22
Sale 4
28
Sale 2
30
Purchase
10
8
10
$20
$30
21
31
32
22
On January 28, the firm
sold two units at $32.
FIFO Perpetual Inventory Account
Item 127B
Purchases
Jan. 1
Total
Date Qty.
Cost
Cost
4
60 10 8
60
22
168
14728
105
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Total
Cost
21
Cost
Qty.
Total
7
20
Cost
10
140
3
1
2
20
21
21
60
21
42
168
On January 28, the firm
sold two units at $32.
Unit
Cost
20
3
3
Qty.
200
20
20
8
7
5
21
21
21
FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B
Units
Cost
Price
Jan.
1
Inventory
Cost
of Sale 7
4
Mdse.
Sold
10
Purchase
22
Sale 4
28
Sale 2
30
Purchase
10
8
10
$20
$30
21
31
32
22
On January 30, purchased ten additional
units of Item 127B at $22 each.
FIFO Perpetual Inventory Account
Item 127B
Purchases
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Total
Total
Date Qty.
Cost
Cost
Qty.
Jan. 1 Cost
Cost
4On January 30, purchased
7
20
60 10
21
168 of Item
ten 8additional
units
60
127B at $22 each.3
22
20
168
1
21
14728
2
21
10530 10
22
220
105
Totals 18
$388
13
$263
15
$325
220
Total
Unit
Cost
10
140
Cost
20
3
3
Qty.
200
20
20
60
21
42
8
7
5
5
21
21
21
21
10
22
LIFO Perpetual Inventory Account
Item 127B
Purchases
Total
Date
Jan. 1
Cost
Qty.
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Cost
Total
Cost
Qty.
Total
Cost
10
The firm begins the year with
10 units of Item 127B on
hand at a total cost of $200.
Unit
Cost
20
Qty.
200
LIFO Perpetual Inventory Account
Item 127B
Purchases
Total
Date
Jan. 1
Cost
4
Qty.
Cost
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Cost
Total
Cost
Qty.
7
20
Total
Cost
10
140
60
On January 4, the firm sold
7 units at $30 each.
Unit
Cost
20
3
Qty.
200
20
LIFO Perpetual Inventory Account
Item 127B
Purchases
Total
Date
Jan. 1
Cost
Qty.
Cost
4
60 10 8
60
168
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Total
Cost
Cost
Qty.
7
21
168
On January 10, the
firm purchased eight
units at $21 each.
20
Total
Cost
10
140
Unit
Cost
20
3
3
Qty.
200
20
20
8
21
Note that a new
layer is formed.
LIFO Perpetual Inventory Account
Item 127B
Purchases
Total
Date
Jan. 1
Cost
Qty.
Cost
4
60 10 8
60
22
168
60
84
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Total
Cost
21
Cost
Qty.
Total
7
20
Cost
10
140
4
21
84
168
On
22,sold,
the all come
Of January
the 4 units
firm
four
from
thesells
most
recent purchase
unitsatata $31
cost each.
of $21 each.
Unit
Cost
20
3
3
Qty.
200
20
20
83
21
20
4
21
LIFO Perpetual Inventory Account
Item 127B
Purchases
Total
Date
Jan. 1
Cost
Qty.
Cost
4
60 10 8
60
22
168
60
28
60
84
42
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Total
Cost
21
Cost
Qty.
Total
Unit
7
20
Cost
10
140
4
21
84
83
21
20
2
21
42
34
20
21
2
21
168
On January 28, sold
two units at $32 each.
Cost
20
3
3
Qty.
200
20
20
LIFO Perpetual Inventory Account
Item 127B
Purchases
Total
Date
Jan. 1
Cost
Qty.
Cost
4
60 10 8
60
22
168
60
28
60
84
30 10
42
60
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Total
Cost
21
22
Cost
Qty.
Total
7
20
Cost
10
140
4
21
84
83
21
20
2
21
42
34
20
21
2
3
21
20
2
21
168
220
On January 30, purchase
1042units at $22 each.
Unit
Cost
20
3
3
Qty.
200
20
20
LIFO Perpetual Inventory Account
Item 127B
Purchases
Total
Date
Jan. 1
Cost
Qty.
Cost
4
60 10 8
60
22
168
60
28
60
84
30 10
42
60
Totals 42
18
$388
Cost of Mdse. Sold
Inventory Balance
Unit
Unit
Total
Cost
21
22
13
Cost
Qty.
Total
7
20
Cost
10
140
4
21
84
83
21
20
2
21
42
34
20
21
2
3
21
20
2
21
168
220
$266
Unit
15
$322
Cost
20
3
3
Qty.
200
20
20
Fifo
Periodic
Fifo Periodic
200 units @ $9
Jan. 1
Beginning
Inventory
300 units @ $10
Mar. 10
Purchase
400 units @ $11
Sept. 21 Purchase
100 units @ $12
Nov. 18 Purchase
1,000 units available
for sale during
year
Fifo Periodic
200 units @ $9
=
$1,800
300 units @ $10
=
3,000 Mar. 10
400 units @ $11
=
4,400 Sept. 21
100 units @ $12
=
1,200 Nov. 18
1,000 units available
$10,40
for sale during 0
Cost of merchandise
year
available for sale
Jan. 1
Fifo Periodic
A physical count on
December 31 reveals that
700 of the 1,000 units
have been sold.
Using fifo, the first units
purchased are theoretically the
first units sold. We begin the
count with January 1.
Fifo Periodic
Soldunits
these@200
200
$9
=
$$1,800
0
Soldunits
these
300
@300
$10
=
3,000 Mar. 10
0
Sold
400 units
200 of
200
@these
$11
=
4,400 Sept. 21
2,200
100 units @ $12
=
1,200 Nov. 18
1,000 units available
$10,40
$
for sale during 0
3,400
year
Ending inventory
Jan. 1
Fifo Periodic
Cost of merchandise available for sale $10,400
Less ending inventory 3,400
Cost of merchandise sold $ 7,000
Summary of Fifo Periodic
Purchases
Jan. 1
200 units at $9
Mar. 10
300 units at $10
Sep. 21
400 units at $11
Nov. 18
100 units at $12
1,000 units
Merchandise
Available
for Sale
$1,800
$3,000
$4,400
$1,200
$10,400
Cost of
Merchandise
Sold
$1,800
200 units at $9
$3,000
300 units at $10
$2,200
200 units at $11
$7,000
700 units
Merchandise
Inventory
$2,200
200 units at $11
$1,200
100 units at $12
$3,400
300 units
Lifo
Periodic
Lifo Periodic
200 units @ $9
Jan. 1
Beginning
Inventory
300 units @ $10
Mar. 10
Purchase
400 units @ $11
Sept. 21 Purchase
100 units @ $12
Nov. 18
Purchase
1,000
units lifo,
available
Using
the most recent batch
for sale during
purchased
is considered the first
year
batch of merchandise sold.
Lifo Periodic
300 units @ $10
Beginning
Assume again
that 700
Inventory
units were sold during
Mar. 10thePurchase
year.
400 units @ $11
Sept. 21 Purchase
100 units @ $12
Nov. 18
200 units @ $9
1,000 units available
for sale during
year
Jan. 1
Purchase
Lifo Periodic
200 units @ $9
=
$1,800
Sold
200 of
100
300 units
@these
$10
=
3,000 Mar. 10
1,000
400
Soldunits
these
@400
$11
=
4,400
0 Sept. 21
100
Soldunits
these
@100
$12
=
1,200
0 Nov. 18
1,000 units available
$10,40
$2,800
for sale during 0
year
Ending Inventory
Jan. 1
Lifo Periodic
Cost of merchandise available for sale $10,400
Less ending inventory 2,800
Cost of merchandise sold $ 7,600
Summary of Lifo Periodic
Purchases
Cost of
Merchandise Merchandise Sold
Available
200 units at $9
for Sale
$1,800
Jan. 1
200 units at $9
$1,800
Mar. 10
300 units at $10
$3,000
Sep. 21
400 units at $11
$4,400
Nov. 18
100 units at $12
1,000 units
$1,200
$10,400
$1,800
$1,000
100 units at $10
$2,800
300 units
Cost of
Merchandise
Sold
$2,000
200 units at $10
$4,400
400 units at $11
$1,200
100 units at $12
$7,600
700 units
Average Cost Periodic
Jan. 1 Beginning
200 units
@
$9
The average cost periodicInventory
method is based on the
300 units @ $10
Mar. 10 Purchase
average cost of
identical
Sept. 21 Purchase
400 units @ $11 units.
100 units @ $12
1,000 units available
for sale during
year
Nov. 18
Purchase
Average Cost Periodic
200 units @ $9
1,800
300 units @ $10
3,000
= $
=$
400 units @ $11
= $ 4,400
100 units @ $11
= $ 1,200
1,000 units available
for sale during
year
$10,400 Cost of
merchandise
available for
sale
Average Cost Periodic
Cost of Merchandise
Available for Sale
= Average Unit Cost
Units Available for Sale
During Year
$10,400
1,000 Units
= $10.40 per Unit
Average Cost Periodic
Cost of merchandise available for sale $10,400
Less ending inventory ($10.40 x 300)
3,120
Cost of merchandise sold $ 7,280
To verify this
amount, multiply
700 units sold
times $10.40 to get
the same $7,280.
Valuation of Inventory at
Lower-of-Cost-or-Market
Item
A
B
C
D
Unit
Inventory
Quantity
400
120
600
280
$10.25
22.50
8.00
14.00
Unit
Cost
Price
MarketTotal Total Lower
Price Cost MarketC or M
9.50 $ 4,100$ 3,800
$$ 3,800
24.10 2,700 2,892
2,700
7.75
4,800 4,650
4,650
14.75 3,920 4,130
3,920
Total $15,520$15,472$15,070
The market decline based on individual items
($15,520 – $15,070) = $450
Presentation of Merchandise Inventory
on the Balance Sheet
Metro-Arts
Balance Sheet
December 31, 2007
Assets
Current assets:
Cash
$ 19 400 00
Accounts receivable$80 000 00
Less allowance for
doubtful accounts 3 000 00
00
Merchandise inventory
at lower of cost (first-in,
first-out method) or market
00
77 000
216 300
Estimating Inventory
Cost
Retail Method of Estimating Inventory Cost
▪ Retail method is based on relationship between
cost of merchandise available for sale and the
retail price.
▪ Retail prices of all merchandise must be
accumulated and totaled.
▪ Inventory at retail is calculated at retail price of
merchandise available for sale less net sales at
retail.
▪ Ratio is calculated as cost divided by retail
price.
▪ Inventory at retail price times cost ratio equals
estimated cost of inventory.
Retail Inventory Method
Cost
Retail
Merchandise inventory, Jan. 1 $19,400
$ 36,000
Purchases in January (net)
42,600
64,000
Merchandise available for sale $62,000
$100,000
$62,000
Ratio of cost to retail price =
= 62%
$100,000
Step 1: Determine the ratio of
cost to the retail price.
Retail Inventory Method
Cost
Retail
Merchandise inventory, Jan. 1 $19,400
$ 36,000
Purchases in January (net)
42,600
64,000
Merchandise available for sale $62,000
$100,000
Sales for January (net)
70,000
Merchandise inventory, January 31, at retail $ 30,000
Step 2: Determine the ending
inventory at retail.
Retail Inventory Method
Cost
Retail
Merchandise inventory, Jan. 1 $19,400
$ 36,000
Purchases in January (net)
42,600
64,000
Merchandise available for sale $62,000
$100,000
Sales for January (net)
70,000
Merchandise inventory, January 31, at retail $ 30,000
Merchandise inventory, January 31, at cost
($30,000 x 62%)
$18,600
Step 3: Calculate the estimated
inventory at cost.
Gross Profit Method of Estimating
Inventory Cost
1. A gross profit percentage rate is estimated based on
previous experience adjusted for known changes.
2. Estimated gross profit is calculated by multiplying
the estimated gross profit rate times the actual net
sales.
3. Estimated cost of merchandise sold is calculated by
subtracting the gross profit from actual sales.
4. The cost of merchandise sold estimate is deducted
from actual merchandise available for sale to
determine the estimated cost of merchandise
inventory.
Gross Profit Method
Merchandise inventory, January 1
$ 57,000
Purchases in January (net)
180,000
$237,000
Merchandise available for sale
Sales in January (net)
$250,000 x 30%)
($250,000
75,000
Less: Estimated gross profit
175,000
$ 62,000
Estimated cost of merchandise sold
Estimated merchandise inventory, January 31
The gross profit method is useful for estimating
inventories for monthly or quarterly financial
statements in a periodic inventory system.
Inventory Turnover
SUPERVALU
Zale
Cost of merchandise sold
$15,620,127,000
$
737,188,000
Inventories:
Beginning of year
$1,115,529,000 $478,467,000
End of year
1,067,837,000 571,669,000
Total $2,183,366,000 $1,050,136,000
Average
Inventory
turnover $1,091,683,000
14.3 times $525,068,000
1.4 times
Use: Inventory turnover measures the relationship
between the volume of goods sold and the
amount of inventory carried during the period.
Number of Days’ Sales in Inventory
SUPERVALU
Average daily cost of
merchandise sold:
$15,620,127,000/365 $42,794,868
$737,188,000/365
$2,019,693
Ending inventory
$1,067,837,000 $571,669,000
Average selling period
25 days
283 days
Use: To assess the efficiency in the
management of inventory
Zale
Chapter 9
The
End