Chapter 8
INVENTORIES:
MEASUREMENT
McGraw-Hill /Irwin
© 2009 The McGraw-Hill Companies, Inc.
Slide 2
Recording and Measuring Inventory
Types of Inventory
Merchandise
Inventory
Goods acquired for
resale
Manufacturing
Inventory
•Raw Materials
•Work-in-Process
•Finished Goods
8-2
Slide 3
Manufacturing Inventories
Raw
Materials
(1) $XX
Work in
Process
$XX (4)
$XX
$XX (7)
Finished
Goods
$XX $XX (8)
Direct
Labor
(2) $XX
Cost of Goods
Sold
$XX (5)
Manufacturing
Overhead
(3) $XX
$XX
$XX (6)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
Raw materials purchased
Direct labor incurred
Manufacturing overhead incurred
Raw materials used
Direct labor applied
Manufacturing overhead applied
Work in process transferred to finished goods
Finished goods sold
8-3
Slide 4
Inventory Systems
Two accounting systems are used to record
transactions involving inventory:
Perpetual
Inventory System
Periodic Inventory
System
The inventory
account is
continuously
updated as
purchases and
sales are made.
The inventory
account is
adjusted at the end
of a reporting
cycle.
8-4
Slide 5
Perpetual Inventory System
Lothridge Wholesale Beverage Company (LWBC)
purchases on account $600,000 of merchandise
for resale to customers.
GENERAL JOURNAL
Date
2009
Description
Inventory
Accounts Payable
Debit
Credit
600,000
600,000
Returns of inventory are credited to the inventory account.
Discounts on inventory purchases can be recorded using
the gross or net method.
8-5
Slide 6
Perpetual Inventory System
LWBC sold, on account, inventory with a
retail price of $820,000 and a cost basis
of $540,000, to a customer.
GENERAL JOURNAL
Date
Description
Debit
2009
Accounts Receivable
Sales
820,000
Cost of Goods Sold
Inventory
540,000
Credit
820,000
540,000
8-6
Slide 7
Periodic Inventory System
Beginning Inventory
+ Net Purchases
Cost of Goods Available for Sale
- Ending Inventory
= Cost of Goods Sold
8-7
Slide 8
Periodic Inventory System
LWBC purchases on account $600,000
of merchandise for resale to customers.
GENERAL JOURNAL
Date
2009
Description
Purchases
Accounts Payable
Debit
Credit
600,000
600,000
Returns of inventory are credited to the Purchase
Returns and Allowances account.
Discounts on inventory purchases can be recorded
using the gross or net method.
8-8
Slide 9
Periodic Inventory System
LWBC sold on account, inventory with a
retail price of $820,000 and a cost basis
of $540,000, to a customer.
GENERAL JOURNAL
Date
Description
2009
Accounts Receivable
Sales
Debit
Credit
820,000
820,000
No entry is made to record Cost of Goods Sold. Assuming Beginning
Inventory of $120,000, a physical count of Ending Inventory shows
a balance of $180,000. Let’s calculate Cost of Goods Sold at
the end of the accounting period.
8-9
Slide 10
Periodic Inventory System
Calculation of Cost of Goods Sold
Beginning inventory
Plus: Purchases
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
$
$
120,000
600,000
720,000
(180,000)
540,000
Adjusting entry to determine Cost of Goods Sold
Date
Description
12/31/09 Cost of Goods Sold
Inventory (ending)
Inventory (beginning)
Purchases
Debit
Credit
540,000
180,000
120,000
600,000
8-10
Slide 11
Comparison of Inventory Systems
8-11
Slide 12
What is Included in Inventory?
General Rule
All goods owned by the company on the inventory
date, regardless of their location.
Goods in Transit
Goods on
Consignment
Depends on FOB
shipping terms.
8-12
Slide 13
Expenditures Included in Inventory
Invoice Price
Purchase
Returns
+
Freight-in on
Purchases
Purchase
Discounts
8-13
Slide 14
Purchase Discounts
Gross Method
Date
10/5/09
Description
Purchases
Accounts payable
10/14/09 Accounts payable
Purchase discounts
Cash
11/4/09
10/5/09
10/14/09
11/4/09
Accounts payable
Cash
Net Method
Purchases
Accounts payable
Debit
Credit
20,000
20,000
14,000
280
13,720
6,000
6,000
Discount terms
are 2/10, n/30.
$14,000
x 0.02
$ 280
Partial payment not
made within the
discount period
19,600
19,600
Accounts payable
Cash
13,720
Accounts payable
Interest expense
Cash
5,880
120
13,720
6,000
8-14
Slide 15
Inventory Cost Flow Assumptions

Specific identification

Average cost

First-in, first-out (FIFO)

Last-in, first-out (LIFO)
8-15
Slide 16
Perpetual Average Cost
The following schedule shows the Frame
inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30
shows 600 frames in ending inventory.
Use the perpetual average cost method to
determine:
(1) Ending inventory cost
(2) Cost of goods sold
8-16
Slide 17
Perpetual Average Cost
Date
9/1
9/10
9/30
Sales Units
600
300
450
8-17
Slide 18
Perpetual Average Cost
Date
Purchased
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
Sold
600 x
22.000 =
Balance
$ 17,600.00
13,200.00
4,400.00
8-18
Slide 19
Perpetual Average Cost
Date
Purchased
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep 300 x 24.00 =
7,200
10-Sep
Sold
600 x
22.000 =
300 x
23.200 =
Balance
$ 17,600.00
13,200.00
4,400.00
11,600.00
6,960.00
4,640.00
$11,600.00 ÷ (800-600+300) = $23.200
8-19
Slide 20
Perpetual Average Cost
Date
Beg. Inv.
1-Sep
3-Sep
10-Sep
15-Sep
21-Sep
29-Sep
30-Sep
Purchased
800 x 22.00 = 17,600
300 x
250 x
200 x
400 x
24.00 =
25.00 =
27.00 =
28.00 =
Sold
600 x
22.000 =
300 x
23.200 =
450 x
26.181 =
7,200
6,250
5,400
11,200
Balance
$ 17,600.00
13,200.00
4,400.00
11,600.00
6,960.00
4,640.00
10,890.00
16,290.00
27,490.00
11,781.45
15,708.55
$27,490.00 ÷ (800-600+300-300+250+200+400) = $26.181
8-20
Slide 21
Perpetual Average Cost
Date
Beg. Inv.
1-Sep
3-Sep
10-Sep
15-Sep
21-Sep
29-Sep
30-Sep
Purchased
800 x 22.00 = 17,600
300 x
250 x
200 x
400 x
24.00 =
25.00 =
27.00 =
28.00 =
Sold
600 x
22.000 =
300 x
23.200 =
450 x
26.181 =
7,200
6,250
5,400
11,200
Sum
Cost of Goods Sold in September
Sale Date
Units
Cost/Unit
Total
9/1
600
22.000 $ 13,200.00
9/10
300
23.200
6,960.00
9/30
450
26.181
11,781.45
Total
1,350
31,941.45
Balance
$ 17,600.00
13,200.00
4,400.00
11,600.00
6,960.00
4,640.00
10,890.00
16,290.00
27,490.00
11,781.45
15,708.55
8-21
Slide 22
Weighted-Average Periodic System
Let’s use the same information to assign costs to
ending inventory and cost of goods sold using the
periodic system.
Ending Inventory
(600 units)
Beginning Inventory
(800 units)
Available
for Sale
(1,950 units)
Goods Sold
(1,350)
$47,650 ÷ 1,950 = $24.4359 weightedaverage per unit cost
8-22
Slide 23
Weighted-Average Periodic System
Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
24.4359
24.4359
$ 47,650.00
14,661.54
$ 32,988.46
8-23
Slide 24
First-In, First-Out (FIFO)
The FIFO
method
assumes that
items are sold
in the
chronological
order of their
acquisition.
The cost of the oldest
inventory items are
charged to COGS
when goods are sold.
 The cost of the
newest inventory
items remain in
ending inventory.

8-24
Slide 25
First-In, First-Out (FIFO)
Even though the periodic
and the perpetual
approaches differ in the
timing of adjustments to
inventory . . .
. . . COGS and Ending
Inventory Cost are the
same under both
approaches.
8-25
Slide 26
First-In, First-Out (FIFO)
Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
These are
the 600
$ 47,650.00
most recently
acquired units.
8-26
Slide 27
First-In, First-Out (FIFO)
Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
$ 47,650.00
16,600.00
8-27
Slide 28
First-In, First-Out (FIFO)
Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
These are the first
$ 47,650.00
1,350 units
16,600.00
acquired.
8-28
Slide 29
First-In, First-Out (FIFO)
Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
$ 47,650.00
16,600.00
$ 31,050.00
8-29
Slide 30
Last-In, First-Out
The LIFO
method
assumes that
the newest
items are sold
first, leaving the
older units in
inventory.
The cost of the
newest inventory
items are charged to
COGS when goods
are sold.
 The cost of the oldest
inventory items
remain in inventory.

8-30
Slide 31
Last-In, First-Out
Unlike FIFO, using
the LIFO method
may result in COGS
and Ending
Inventory Cost that
differ under the
periodic and
perpetual
approaches.
8-31
Slide 32
When Prices Are Rising . . .
FIFO
 Matches low (older)
costs with current
(higher) sales.
 Inventory is valued at
approximate
replacement cost.
 Results in higher
taxable income.




LIFO
Matches high (newer)
costs with current
(higher) sales.
Inventory is valued
based on low (older)
cost basis.
Results in lower
taxable income.
Not permitted by
international
accounting standards.
8-32
Slide 33
Supplemental LIFO Disclosures
Many companies use LIFO for external reporting and
income tax purposes but maintain internal records using
FIFO or average cost.
The conversion from FIFO or average cost
to LIFO takes place at the end of the
period. The conversion may look like this:
Total inventories at FIFO
Less: LIFO allowance
Inventories, at LIFO cost
2009
2008
$ 15,429
(1,508)
$ 13,921
$ 15,387
(1,525)
$ 13,862
8-33
Slide 34
Decision Makers’ Perspective
Factors Influencing Method Choice
How closely do
reported
costs reflect actual
flow of inventory?
How well are costs
matched against
related revenues?
How are income
taxes affected by
inventory method
choice?
8-34
Slide 35
LIFO Liquidation
When prices rise . . .
LIFO inventory costs in the balance
sheet are “out of date” because they reflect
old purchase transactions.
If inventory declines,
these “out of date” costs
may be charged to
current earnings.
This LIFO
liquidation
results in
“paper profits.”
8-35
Slide 36
Inventory Management
Gross profit
ratio
=
Gross profit
Net sales
This measure indicates how much
of each sales dollar is left after
deducting the cost of goods sold to
cover expenses and provide a profit.
8-36
Inventory Management
Inventory
=
turnover ratio
Cost of goods sold
Average inventory
This ratio measures how many times a
company’s inventory has been sold
and replaced during the year.
If a company’s inventory
turnover is less than its industry
average, it may experience
difficulties in generating sales
because of obsolete or slowmoving inventory items.
8-37
Slide 38
Earnings Quality
Many believe that manipulating income reduces
earnings quality because it can mask permanent
earnings. Inventory write-downs and changes in
inventory method are two additional inventoryrelated techniques a company could use to
manipulate earnings.
8-38
Slide 39
Methods of Simplifying LIFO
LIFO Inventory Pools consist of
inventory units grouped
according to similarities.
Using Inventory Pools
with LIFO simplifies
record keeping.
For example, all
similar units
purchased at the same
time can be “pooled”
and assigned an
average unit cost.
8-39
Slide 40
Methods of Simplifying LIFO
Dollar-Value LIFO (DVL)
DVL inventory pools are viewed as layers of
value, rather than layers of similar units.
DVL simplifies LIFO
record-keeping.
DVL minimizes the
probability of layer
liquidation.
At the
end of the
Example
period, we determine if
The inventory
replacement
a new
layer
inventory
differs
was added
byfrom
the
old inventory
on
comparing
ending
hand.
We to
just
create a
inventory
beginning
new
layer.
inventory.
8-40
End of Chapter 8
McGraw-Hill /Irwin
© 2009 The McGraw-Hill Companies, Inc.