Inventory
BY RACHELLE AGATHA, CPA, MBA
Slides by Rachelle Agatha, CPA,
with excerpts from Warren, Reeve, Duchac
Objectives
1. Describe the importance of control over
inventory.
2. Describe three inventory cost flow
assumptions and how they impact the
income statement and balance sheet.
3. Determine the cost of inventory under
the perpetual system, using the FIFO,
LIFO, and average cost methods.
Objectives
4. Determine the cost of inventory under the
periodic system, using the FIFO, LIFO,
and average cost methods.
5. Compare and contrast the use of the three
inventory costing methods.
6. Describe and illustrate the reporting
of merchandise inventory in the
financial statement.
Objective 1
Describe the
importance of
control over
inventory.
Two primary objectives of
control over inventory are:
1) Safeguarding the inventory,
and
2) Properly reporting it in the
financial statements.
Controls over inventory
include developing and
using security measures to
prevent inventory damage
or customer or employee
theft.
To ensure the accuracy of the
amount of inventory reported in
the financial statements, a
merchandising business should
take a physical inventory.
Objective 2
Describe three inventory
cost flow assumptions
and how they impact the
income statement and
balance sheet.
Inventory Costing Methods
COMPARISON OF CGS PER INVENTORY METHOD
FIFO
BEG INVENTORY
PURCHASES
+
GOODS AVAILABLE
ENDING INVENTORY
CGS
=
LIFO
WTD AVG
$ 2,500.00 $ 2,500.00 $
2,500.00
$ 2,031.25 $ 2,031.25 $
2,031.25
$ 4,531.25 $ 4,531.25 $
4,531.25
$ 687.50
$ 625.00 $
647.32
$ 3,843.75
$ 3,906.25 $ 3,883.93
Three identical inventory items were purchases during July:
July
6
19
24
Total
Purchase
Purchase
Purchase
Average Cost
Units
1
1
1
3
$
$
$
$
$
Cost
115
118
121
354
118.00
($354/3)
Assume one unit is sold on July 28th for $150.
Determine gross profit for July under the three
methods.
Gross Profit
Ending Inventory
FIFO
$35 ($150 - $115)
$239 ($118 + $121)
$
115
LIFO
$29 ($150 - $121)
$233 ($115 + $118)
$
121
$236 ($118 × 2)
$
118
Avg Cost $32 ($150 - $118)
CGS
Objective 3
Determine the cost of
inventory under the
perpetual inventory
system, using FIFO,
LIFO, and average cost
methods.
In FIFO, the cost in ending
inventory are the newer costs and
the cost of merchandise sold has the
older cost (First In – First out).
FIFO - cost inventory from the
bottom up. Newest in is sitting in
inventory.
FIFO Perpetual Inventory
FIFO
Cost of merchandise sold (August 30):
Date
Units
Cost
Sales
Aug 8
15
$
34 $ 510
Aug 30
13
$
34 $ 442
Aug 30
7
$
38 $ 266
35
$ 1,218
Aug
Units
1
Beg Inv 28
8
Sale
15
15 Purchase 22
30
Sale
20
Cost SALES
$ 34
(28)
$ 38
(7)
INV
15
FIFO Perpetual Inventory
Beg inv
Sales
Purch
End Inv
28
(35) (sold 28 out of beg inv and 7 out of purchases on 8/15)
22
15 (Under FIFO cost from bottom)
FIFO End Inv Cost $
570 (15 units @ $38)
FIFO Perpetual Inventory
DATE
PURCHASES
UNIT TOTAL
QTY
COST COST
COST MERCH SOLD
UNIT TOTAL
QTY
COST COST
Aug 1
Aug 8
Aug 15
Aug 15
15 $
22 $
Aug 30
Aug 31 Balances
38
34
$ 510
$ 836
13 $
7 $
34
38
$ 442
$ 266
$ 1,218
INVENTORY
UNIT
TOTAL
QTY
COST
COST
28 $
34
$
952
13 $
34
$
442
13 $
22 $
34
38
$
$
442
836
15 $
38
$
570
$
570
In LIFO, the cost in ending
inventory are the older cost and the
cost of merchandise sold has the
newer cost (Last In – First out).
LIFO - cost inventory from the top
down. Oldest is sitting in inventory.
LIFO Perpetual Inventory
LIFO
Cost of merchandise sold (August 30):
Date
Units
Cost
Sales
Aug 8
15
$
34 $ 510
Aug 30
20
$
38 $ 760
35
$ 1,270
LIFO Perpetual Inventory
Aug
1
8
15
30
Units
Beg Inv 28
Sale
15
Purchase 22
Sale
20
Cost SALES
$ 34
(15)
$ 38
(20)
INV
13
2
LIFO Perpetual Inventory
DATE
PURCHASES
UNIT TOTAL
QTY
COST COST
COST MERCH SOLD
UNIT TOTAL
QTY
COST COST
Aug 1
Aug 8
Aug 15
Aug 15
15 $
22 $
Aug 30
Aug 31 Balances
38
34
$ 510
$ 836
20 $
38
$ 760
$ 1,270
INVENTORY
UNIT
TOTAL
QTY
COST
COST
28 $
34
$
952
13 $
34
$
442
13 $
22 $
34
38
$
$
442
836
13 $
2 $
34
38
$
$
442
76
$
518
When the Average Cost Method is used
with in a perpetual system, the average
cost for each type of item is computed
each time a purchase is made
The Average Cost Method is rarely used
in a perpetual system so it is not
illustrated.
Computerized Perpetual Accounting Systems
1. Most companies will use a computerized
system if they chose to do perpetual inventory
as is it very time intensive manually.
2. Computerized systems track all relevant
information about each inventory item, such
as description, quantity, cost, size, location.
3. For every inventory transaction, there is an
entry into the system. Companies will use
bar codes, scanners, and other technology.
4. A physical inventory is taken at the end of
the year and compared to the system
records.
Objective 4
Determine the cost of
inventory under the
periodic inventory
system, using FIFO,
LIFO, and average cost
methods.
FIFO Periodic
Using FIFO, the earliest batch
purchased is considered the
first batch of merchandise sold.
The physical flow does not have
to match the accounting
method chosen.
FIFO Periodic
Beginning inventory, purchases, and sales for Item SJ68 units:
Aug
1
8
15
30
Beg Inv
Sale
Purchase
Sale
Units
28
15
22
20
Cost
$
34
$
38
Assume a periodic inventory system using FIFO.
Determine the cost of merch sold in August and the
ending inventory balance.
FIFO Periodic
Aug 1
Aug 15
Available for Sale
28
22
50.0
Sales
35
Ending Inventory
15
@
@
$
$
34
38
$ 952
$ 836
$ 1,788
(15 units @ $38) $ 570
Sales
(28)
(7)
(35)
Inv
15
15
LIFO Periodic
Using LIFO, the most recent batch
purchased is considered the first batch
of merchandise sold. The actual flow of
goods does not have to be LIFO. For
example, a store selling fresh fish would
want to sell the oldest fish first (which is
FIFO) even though LIFO is used for
accounting purposes.
LIFO Periodic
Beginning inventory, purchases, and sales for Item SJ68 units:
Aug
1
8
15
30
Beg Inv
Sale
Purchase
Sale
Units
28
15
22
20
Cost
$
34
$
38
Assume a periodic inventory system using LIFO.
Determine the cost of merch sold in August and the
ending inventory balance.
LIFO Periodic
Aug 1
Aug 15
Available for Sale
28
22
50.0
@
@
$
$
34
38
$ 952
$ 836
$ 1,788
Sales
35
Ending Inventory
15 (15 units @ $34) $ 510
Sales
(13)
(22)
(35)
Inv
15
15
Average Cost
The weighted average unit
cost method is based on the
average cost of identical units.
The total cost of merchandise
available for sale is divided by
the related number of units of
that item.
Average Cost - Periodic
Beginning inventory, purchases, and sales for Item SJ68 units:
Aug
1
15
Beg Inv
Purchase
Available for Sale
Units
28
22
50
Cost
$
34.00
$
38.00
Total
$
952
$
836
$ 1,788
Assume a periodic inventory system using Avg Cost
Determine the cost of merch sold in August and the ending
inventory balance.
Average Cost - Periodic
Average Cost - Periodic
Aug
1
15
Units
Cost
Beg Inv
28
$
34.00
Purchase
22
$
38.00
Available for Sale
50
Average Cost ($1,788/50)
End Inventory Cost ($36 * 15)
$
$
$
$
Total
952
836
1,788
36
$
540
Objective 5
Compare and
contrast the use of
the three inventory
costing methods.
Comparison of Methods
Beginning inventory, purchases, and sales for Item SJ68 units:
Aug
1
8
15
30
Beg Inv
Sale
Purchase
Sale
Units
28
15
22
20
Assume items were sold at $40/unit
Sales (35 units @ $40)
Cost
$
34
$
38
$
1,400
Comparison of Methods
FIFO
Net sales
Cost of merchandise sold:
Beginning inventory
$ 952
Purchases
836
Merchandise available for sale
1,788
Less ending inventory
570
Cost of merchandise sold
Gross profit
$ 1,400
1,218
$
182
Comparison of Methods
LIFO
Net sales
Cost of merchandise sold:
Beginning inventory
$ 952
Purchases
836
Merchandise available for sale
1,788
Less ending inventory
510
Cost of merchandise sold
Gross profit
$ 1,400
1,278
$
122
Comparison of Methods
AVERAGE COST
Net sales
Cost of merchandise sold:
Beginning inventory
$ 952
Purchases
836
Merchandise available for sale
1,788
Less ending inventory
540
Cost of merchandise sold
Gross profit
$ 1,400
1,248
$
152
Comparison of Methods
COMPARISON
FIFO
$ 1,400
Net sales
Cost of merchandise sold:
Beginning inventory
$ 952
Purchases
836
Merchandise available for sale
1,788
Less ending inventory
570
Cost of merchandise sold
1,218
Gross profit
$ 182
Note - with FIFO and rising costs:
CMS is lower and ending inventory is higher
LIFO
$ 1,400
AVG
$1,400
952
952
836
836
1,788
1,788
510
540
1,278
1,248
$
122 $ 152
Note - with LIFO and rising costs:
CMS is higher and ending inventory is lower
Note - Average cost falls between FIFO and LIFO
Objective 6
Describe and illustrate
the reporting of
merchandise inventory
in the financial
statements.
Lower-of-Cost-or-Market Method
If the cost of replacing an
item in inventory is lower
than the original purchase
cost, the lower-of-costor-market (LCM)
method is used to value
the inventory.
7-6
Market, as used in
lower of cost or market,
is the cost to replace the
merchandise on the
inventory date.
Cost and replacement cost can be
determined for—
1) each item in the inventory,
2) major classes or categories of
inventory, or
3) the inventory as a whole.
Merchandise that is out of
date, spoiled, or damaged
should be written down to its
net realizable value. This
is the estimated selling price
less any direct cost of
disposal, such as sales
commissions.
Merchandise Inventory on the
Balance Sheet
Merchandise inventory is
usually presented in the
Current Assets section of the
balance sheet, following
receivables.
The method of
determining the cost of
inventory (FIFO, LIFO,
or weighted average)
should be shown.
Summary
 Inventory and Controls
 Inventory Costing Methods
 Perpetual vs. Periodic systems
 Reporting of Inventory