Chapter
8
Inventories: Measurement
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
LO8-1 Explain the difference between a perpetual inventory system and a periodic inventory
system.
LO8-2 Explain which physical quantities of goods should be included in inventory.
LO8-3 Determine the expenditures that should be included in the cost of inventory.
LO8-4 Differentiate between the specific identification, FIFO, LIFO, and average cost methods
used to determine the cost of ending inventory and cost of goods sold.
LO8-5 Discuss the factors affecting a company's choice of inventory method.
LO8-6 Understand supplemental LIFO disclosures and the effect of LIFO liquidations on net
income.
LO8-7 Calculate the key ratios used by analysts to monitor a company’s investment in
inventories.
LO8-8 Determine ending inventory using the dollar-value LIFO inventory method.
LO8-9 Discuss the primary difference between U.S. GAAP and IFRS with respect to
determining the cost of inventory.
CHAPTER HIGHLIGHTS
PART A:
RECORDING AND MEASURING INVENTORY
Types of Inventory
Inventory refers to the assets a company (1) intends to sell in the normal course of business, and (2)
has in production for future sale (work in process), or (3) uses currently in the production of goods
to be sold (raw materials). Inventory for a manufacturing company consists of raw materials, work
in process, and finished goods. Wholesale and retail companies purchase goods that are primarily
in finished form. Therefore, their inventory consists only of finished goods, often referred to as
merchandise inventory. In this course we focus primarily on merchandising companies
(wholesalers and retailers).
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Perpetual and Periodic Inventory Systems
There are two accounting systems used to record transactions involving inventory: the perpetual
inventory system and the periodic inventory system. The perpetual inventory system
continuously tracks and records both changes in inventory quantity and inventory cost. Inventory is
increased (debited) when merchandise is purchased or returned by a customer, and decreased
(credited) when merchandise is sold or returned to a supplier.
The periodic inventory system adjusts inventory and records cost of goods sold only at the end of
each period. Merchandise purchases, purchase returns, purchase discounts, and freight-in
(purchases plus freight-in less returns and discounts equals net purchases) are recorded in
temporary accounts and the period's cost of goods sold is determined at the end of the period by
combining the temporary accounts with the inventory account:
Beginning inventory + Net purchases - Ending inventory = Cost of goods sold
Ending inventory usually is determined by a physical count and then assigning costs to the
quantities determined.
The ability to track inventory quantities from their acquisition to their sale is an important internal
control feature of the perpetual system, thus providing more timely information. However, a
perpetual system is generally more expensive to implement than a periodic system. The periodic
system is less costly to implement during the period but requires a physical count before ending
inventory and cost of goods sold can be determined.
ILLUSTRATION
The Johnson & Sons Wholesale Meat Company began 2013 with merchandise inventory of
$60,000. During the year, additional merchandise was purchased at a cost of $350,000. Sales for
the year, all on account, totaled $440,000.
PERPETUAL INVENTORY SYSTEM
Summary inventory transactions assuming cost of goods sold for the year totaled $280,000.
To record the purchase of merchandise:
Inventory .............................................................................................
Accounts payable ............................................................................
350,000
To record sales on account:
Accounts receivable .............................................................................
Sales ...............................................................................................
440,000
To record cost of goods sold:
Cost of goods sold ..............................................................................
Inventory ........................................................................................
280,000
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350,000
440,000
280,000
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PERIODIC INVENTORY SYSTEM
Summary inventory transactions assuming an ending inventory of $130,000.
To record the purchase of merchandise:
Purchases ............................................................................................
Accounts payable ............................................................................
350,000
To record sales on account:
Accounts receivable .............................................................................
Sales ...............................................................................................
440,000
To record cost of goods sold at the end of the year:
Cost of goods sold ..............................................................................
Inventory (ending) .................................................................................
Inventory (beginning) ........................................................................
Purchases ........................................................................................
350,000
440,000
280,000
130,000
60,000
350,000
What Is Included in Inventory?
Physical Quantities Included In Inventory
Typically, determining the physical quantity that should be included in inventory is a simple matter
because it consists of items in the possession of the company. Three possible exceptions are goods
in transit, goods on consignment, and sales returns. For goods in transit, ownership depends on
the terms of the agreement between the purchaser and the seller. Inventory shipped f.o.b. shipping
point (purchaser is responsible for the shipping costs) is included in the purchaser's inventory as
soon as the merchandise is shipped. Inventory shipped f.o.b. destination (seller is responsible for
the shipping costs) is included in the purchaser's inventory only after it reaches the purchaser's
location. Goods on consignment are included in the inventory of the consignor until sold by the
consignee. Recall from our discussions in previous chapters that when the right of return exists, a
seller must be able to estimate those returns before revenue can be recognized. The adjusting entry
for estimated sales returns reduces sales revenue and accounts receivable. At the same time, cost
of goods sold is reduced and inventory is increased. As a result, a company includes in inventory
the cost of merchandise it anticipates will be returned.
Expenditures Included In Inventory
In general, expenditures necessary to bring inventory to its condition and location for sale or use are
included in its cost. Obviously, the cost includes the purchase price of the goods but also freight
charges paid by the purchaser (freight-in) and insurance costs paid by the purchaser while the
goods are in transit. The cost of inventory is reduced when merchandise is returned to the supplier
(purchase returns). Shipping charges on outgoing goods (freight-out) are reported in the income
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statement either as part of cost of goods sold or as an operating expense, usually among selling
expenses.
Purchase discounts represent reductions in the amount to be paid by the purchaser if remittance is
made within a designated period of time. As with the seller, the buyer can record purchase
discounts using either the gross method or the net method.
ILLUSTRATION
Fitzgerald Company purchased merchandise on credit. The invoice price was $5,000, subject to a
2% cash discount if paid within 10 days.
To record the purchase and cash payment using the Gross Method:
To record the purchase:
Purchases * .........................................................................................
Accounts payable ............................................................................
To record cash payment if made within the discount period:
Accounts payable .................................................................................
Purchase discounts * (2% x $100) .....................................................
Cash ................................................................................................
To record cash payment if made after the discount period:
Accounts payable ................................................................................
Cash ................................................................................................
5,000
5,000
5,000
100
4,900
5,000
5,000
* The inventory account is used in a perpetual system.
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To record the purchase and cash payment using the Net Method:
To record the purchase:
Purchases * (98% x $5,000) ....................................................................
Accounts payable ............................................................................
4,900
To record cash payment if made within the discount period:
Accounts payable .................................................................................
Cash ................................................................................................
4,900
To record cash payment if made after the discount period:
Accounts payable ................................................................................
Interest expense (2% x $5,000) ...............................................................
Cash ................................................................................................
4,900
100
4,900
4,900
5,000
* The inventory account is used in a perpetual system.
Inventory Cost Flow Assumptions
Regardless of the inventory system used, it's necessary to assign dollar amounts to physical
quantities of goods sold and goods remaining in ending inventory. If a perpetual system is used,
each time merchandise is sold we need to determine the cost of the items sold. If a periodic system
is used, we need to apportion the cost of goods available for sale (beginning inventory + net
purchases) between ending inventory and cost of goods sold at the end of the period.
Specific Identification
It's sometimes possible for each unit sold during the period or each unit on hand at the end of the
period to be matched with its actual cost. The specific identification method, however, is not
feasible for many types of products either because items are not uniquely identifiable or because it's
too costly to match a specific purchase price with each item sold or each item remaining in ending
inventory. Most companies use cost flow methods based on assumptions about how inventory
might flow in and out of a company. It's important to note that the actual flow of a company's
inventory does not have to correspond to the cost flow assumption employed.
Average Cost
The average cost method assumes that items sold and items in ending inventory come from a
mixture of all the goods available for sale. The average unit cost is applied to goods sold or to
ending inventory. In a periodic system, the weighted-average unit cost is determined as follows:
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Cost of goods available for sale
Weighted-average unit cost
=
Quantity available for sale
In perpetual system, the weighted-average unit cost becomes a moving average unit cost. A new
weighted-average unit cost is calculated each time that additional units are produced.
First-in, First-out (FIFO)
The first-in, first-out (FIFO) method assumes that items sold are those that were acquired first.
Therefore, ending inventory applying FIFO consists of the most recently acquired items. The same
ending inventory and cost of goods sold amounts are always produced in a perpetual inventory
system as in a periodic inventory system when FIFO is used. This is because the same units and
costs are first in and first out whether cost of goods sold is determined as each sale is made or at the
end of the period as a residual amount.
Last-in, First-out (LIFO)
The last-in, first-out (LIFO) method assumes that items sold are those that were most recently
acquired. Therefore, ending inventory applying LIFO consists of the items acquired first. Unlike
FIFO, applying LIFO in a perpetual inventory system will generally result in a different ending
inventory and cost of goods sold from the allocation arrived at applying LIFO in a periodic system.
Periodic LIFO applies the last in, first out concept to total sales and total purchases only at the
conclusion of the reporting period. Perpetual LIFO applies the same concept, but many times
during the period — every time a sale is made.
ILLUSTRATION
The Pringle Beverage Company began 2013 with 10,000 units of inventory on hand. These units
cost $15 each. The following transactions related to the company's merchandise inventory occurred
during the first quarter of 2013:
January 22
—
February 14 —
March 25
—
Total purchases
Purchased
Purchased
Purchased
5,000 units for $16 each =
6,000 units for $17 each =
4,000 units for $18 each =
15,000 units
$ 80,000
102,000
72,000
$254,000
All unit costs include the purchase price and freight charges borne by Pringle. During the quarter
ending March 31, 2013, sales in units totaled 17,000 units leaving 8,000 units in ending inventory.
The company uses the periodic inventory system. Ending inventory at March 31 and cost of goods
sold for the quarter using the various cost flow assumptions are determined as follows:
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Average Cost
Beginning inventory (10,000 units @ $15)
Plus: Purchases (15,000 units @ various prices)
Cost of goods available for sale (25,000 units)
Less: Ending inventory (determined below)
Cost of goods sold (17,000 units)
$150,000
254,000
404,000
(129,280)
$274,720
Cost of ending inventory:
$404,000
Weighted-average unit cost =
= $16.16
25,000 units
8,000 units x $16.16 = $129,280
Cost of goods sold could have been determined directly by multiplying the weighted-average unit
cost of $16.16 by the number of units sold ($16.16 x 17,000 = $274,720).
First-in, First-out (FIFO)
Beginning inventory (10,000 units @ $15)
Plus: Purchases (15,000 units @ various prices)
Cost of goods available for sale (25,000 units)
Less: Ending inventory (determined below)
Cost of goods sold (17,000 units)
Cost of ending inventory:
Date of
Purchase
Units
Feb. 14
4,000
March 15
4,000
Total
8,000
Unit Cost
$17
18
$150,000
254,000
404,000
(140,000)
$264,000
Total Cost
$ 68,000
72,000
$140,000
The 17,000 units sold could be costed directly as follows:
Date of
Purchase
Units
Beg. inv.
10,000
Jan. 22
5,000
Feb. 14
2,000
Total
17,000
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$15
16
17
Unit Cost
$150,000
80,000
34,000
$264,000
Total Cost
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Last-in, First-out (LIFO)
Beginning inventory (10,000 units @ $15)
Plus: Purchases (15,000 units @ various prices)
Cost of goods available for sale (25,000 units)
Less: Ending inventory (determined below)
Cost of goods sold (17,000 units)
Cost of ending inventory:
Date of
Purchase
Units
Beg. inv.
8,000
Total
8,000
Unit cost
$15
$150,000
254,000
404,000
(120,000)
$284,000
Total cost
$120,000
$120,000
The 17,000 units sold could be costed directly as follows:
Date of
Purchase
Units
Beg. inv.
2,000
Jan. 22
5,000
Feb. 14
6,000
March 25
4,000
Total
17,000
$15
16
17
18
Unit cost
Total cost
$ 30,000
80,000
102,000
72,000
$284,000
International Financial Reporting Standards
The primary difference between U.S. GAAP and IFRS with respect to determining the cost of
inventory is that IFRS does not allow the use of the LIFO method to value inventory.
Decision Makers' Perspective—Factors Influencing Method Choice
There are several factors that influence managers when choosing an inventory method. If a
company wanted to choose a method that most closely approximates specific identification, then
the actual physical flow of inventory in and out of the company would motivate the choice.
Remember, however, that a company is not required to choose an inventory method that
approximates actual physical flow.
If the unit cost of inventory changes during a period, the inventory method chosen can have a
significant effect on the amount of net income reported by the company and also on the amount of
income taxes paid. If a company uses LIFO to measure its taxable income, IRS regulations require
that LIFO also be used to measure income reported to investors and creditors (the LIFO
conformity rule). Therefore, the effect of method choice on income taxes is a significant factor
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affecting method choice. For example, when costs rise and inventory quantities are not decreasing,
LIFO produces a higher cost of goods sold, lower net income, and a lower current tax bill than the
other methods. Many companies choose LIFO to reduce income taxes in periods when costs are
rising. LIFO companies are allowed to report in a note the effect of using another method on
inventory valuation rather than LIFO.
Proponents of LIFO argue that it results in a better match of revenues and expenses because the
most recent costs are included in cost of goods sold which are then matched with revenue measured
at current selling prices. However, inventory costs in the balance sheet with LIFO generally are out
of date because they reflect old purchase transactions. This distortion could carry over to the
income statement as well if inventory layers are liquidated (if inventory quantity declines). If costs
have been rising, LIFO liquidations produce higher net income than would have resulted if the
liquidated inventory were included in cost of goods sold at current costs. The paper profits caused
by including out of date, low costs in cost of goods sold is referred to as the effect on income of
liquidations of LIFO inventory.
For example, in the example above illustrating the various cost flow assumptions, inventory
quantity declined from 10,000 units in beginning inventory to 8,000 units in ending inventory. This
means that 2,000 units of beginning inventory purchased at $15 each are included in cost of goods
sold. If the company had purchased 2,000 additional units during the period at the period-end price
of $18, cost of goods sold would have been higher by $6,000 ($18 - 15 = $3 x 2,000 units). This is
the before-tax LIFO liquidation profit. A company must disclose in a note any material effect of
a LIFO liquidation on net income.
Decision Makers' Perspective—Inventory Management
The inventory method also could affect the analysis of a company's liquidity and profitability by
investors, creditors, and financial analysts. Analysts must make adjustments when evaluating
companies that use different inventory methods. When one or more of the companies involved use
LIFO, supplemental LIFO disclosures can be used to make these adjustments by converting LIFO
inventory and cost of goods sold amounts to another method.
Two important ratios used involving inventory used by analysts are the gross profit ration and the
inventory turnover ratio. The gross profit ratio indicates the percentage of each sales dollar
available to cover expenses other than cost of goods sold and to provide a profit. The inventory
turnover ratio measures a company's efficiency in managing its investment in inventory. These
two ratios are calculated as follows:
Gross profit ratio
=
Gross profit
Net sales
Inventory turnover ratio
=
Cost of goods sold
Average inventory
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A convenient extension of the inventory turnover ratio is the average days in inventory, which is
calculated by dividing 365 days by the turnover ratio. This measure indicates the number of days it
normally takes to sell inventory.
The choice of inventory method also affects earnings quality, particularly in times of rapidly
changing prices. For example, a LIFO liquidation profit (or loss) reduces the quality of current
period earnings. Fortunately for analysts, companies must disclose these profits or losses, if
material. In addition, LIFO cost of goods sold determined using a periodic inventory system is
more susceptible to manipulation than is FIFO. Year-end purchases can have a dramatic effect on
LIFO cost of goods sold in rapid cost-change environments.
PART B:
METHODS OF SIMPLIFYING LIFO
The recordkeeping costs of unit LIFO can be significant. Another disadvantage of unit LIFO is the
possibility of LIFO liquidation. One way to simplify recordkeeping and reduce the risk of LIFO
layer liquidations is to group inventory into pools based on physical similarities. The average cost
for all of the pool purchases during the period is applied to the current year's LIFO layer. However,
grouping inventory based on physical similarities presents problems, particularly when items in the
pool are discontinued and have to be replaced. The dollar-value LIFO approach helps overcome
these problems.
Dollar-Value LIFO
The dollar-value LIFO (DVL) approach extends the concept of inventory pools by allowing a
company to combine a large variety of goods into a pool. Physical units are not used in calculating
ending inventory. Instead, the inventory is viewed as a quantity of value instead of a physical
quantity of goods. Instead of layers of units from different purchases, the DVL inventory pool is
viewed as being comprised of layers of dollar value from different years. DVL simplifies
recordkeeping and minimizes the possibility of LIFO liquidation through the aggregation of many
types of inventory into larger pools.
Under DVL, we determine whether a new LIFO inventory layer was added by comparing the
ending dollar amount with the beginning dollar amount after deflating inventory amounts to base
year with the aid of a cost index. The base year is the year in which the DVL method is adopted
and the layer year is any subsequent year in which an inventory layer is created. The cost index for
the base year is set at 1.00. Subsequent years’ indices reflect cost changes relative to the base year.
The starting point in DVL is determining the current year's ending inventory valued at year-end
cost. A three-step process is then used to determine ending inventory and cost of goods sold:
Step 1: Convert ending inventory valued at year-end cost to base year cost. This is
accomplished
by dividing the ending inventory at year-end cost by the current year's cost index.
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Step 2: Identify the layers of ending inventory and the years they were created.
Step 3: Convert each layer's base year cost to layer year cost using the cost index for the year it
was acquired.
ILLUSTRATION
Koch Industries, Inc. has only one inventory pool. On December 31, 2013, Koch adopted the
dollar-value LIFO inventory method. The inventory on that date using the dollar-value LIFO
method was $162,000. Inventory data for the following three years are as follows:
Year Ended
December 31
2014
2015
2016
Inventory at
Year-End Costs
$183,750
201,960
203,500
Cost Index
1.05
1.08
1.10
Ending inventory for each of the years is determined as follows:
Step 1
Date
12/31/13
Step 2
Ending Inventory
at Base Year Cost
Inventory Layers
at Base Year Cost
Step 3
Inventory Layers
Converted to Cost
Ending
Inventory
DVL Cost
$162,000
= $162,000
$162,000 (base)
$162,000 x 1.00
=
$162,000
$162,000
= $175,000
$162,000 (base)
13,000 (2014)
$162,000 x 1.00
13,000 x 1.05
=
=
$162,000
13,650
175,650
$162,000 (base)
13,000 (2014)
12,000 (2015)
$162,000 x 1.00
13,000 x 1.05
12,000 x 1.08
=
=
=
$162,000
13,650
12,960
188,610
$162,000 (base)
13,000 (2014)
10,000 (2015)
$162,000 x 1.00
13,000 x 1.05
10,000 x 1.08
=
=
=
$162,000
13,650
10,800
186,450
1.00
12/31/14
$183,750
1.05
12/31/15
$201,960
= $187,000
1.08
12/31/16
$203,500
= $185,000
1.10
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SELF-STUDY QUESTIONS AND EXERCISES
Concept Review
1.
Inventory for a manufacturing company consists of
.
2.
A
inventory system continuously tracks and records both changes in inventory
quantity and inventory cost.
3.
A
inventory system adjusts inventory and records cost of goods sold only at
the end of each reporting period.
4.
Inventory shipped
merchandise is shipped.
5.
Inventory shipped
reaches the purchaser's location.
6.
Goods held on consignment are included in the inventory of the consignor until
.
7.
Purchase discounts not taken are included as
using the net method.
8.
By
9.
The
method matches a specific purchase price with each item sold
or each item remaining in ending inventory.
either
the
,
, and
is included in the purchaser's inventory as soon as the
is included in the purchaser's inventory only after it
gross or net method of
is reduced by discounts taken.
using the gross method and as
accounting
for
purchase
discounts,
10. The
method assumes that items sold and items in ending inventory
come from a mixture of all the goods available for sale.
11. The weighted-average unit cost in a perpetual inventory system becomes a moving average
unit cost. A new weighted-average unit cost is calculated each time additional units are
.
12. The
first.
13. Ending inventory applying the
14. If unit costs are
ending inventory than FIFO.
method assumes that items sold are those that were acquired
method consists of the items acquired first.
, LIFO will result in a higher cost of goods sold and lower
15. IRS regulations require that if a company uses LIFO to measure
company also must use LIFO for
.
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, the
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16. If costs have been rising, LIFO liquidations produce
net income than would have
resulted if the liquidated inventory were included in cost of goods sold at current costs.
17. The
indicates the percentage of each sales dollar available to cover
expenses and provide a profit.
18. Dollar-value LIFO views inventory as a quantity of
goods.
instead of a physical quantity of
19. The starting point in dollar-value LIFO is determining the current year's ending inventory
valued at
costs.
20. Step 3 of the dollar-value LIFO technique converts each layer's base year cost to layer year
cost using the
.
Answers:
1. raw materials, work in process, finished goods 2. perpetual 3. periodic 4. f.o.b. shipping point 5.
f.o.b. destination 6. sold by the consignee 7. purchases, interest expense 8. net purchases 9.
specific identification 10. average cost 11. purchased 12. first-in, first-out 13. LIFO 14. increasing
15. taxable income, external financial reporting 16. higher 17. gross profit ratio 18. value
19. year-end 20. cost index for the year it was acquired
REVIEW EXERCISES
Exercise 1
The following information is available for the Lawler Wholesale Clothing Company for 2013:
Beginning inventory
Merchandise purchases (all on account)
Freight charges on purchases paid in cash
Ending inventory
Sales (all on account)
Cost of goods sold
$150,000
550,000
16,000
176,000
923,000
?
The company uses the net method to account for purchase discounts. Terms of all purchases were
2/10, n/30 and all of the purchases were paid for within the discount period.
Required:
1. Applying the periodic inventory system, prepare summary journal entries to account for
merchandise purchases, payment to suppliers, freight charges, sales, and the year-end adjusting
entry to record cost of goods sold.
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Merchandise purchases:
Payment to suppliers:
Freight charges:
Sales:
Adjusting entry to record cost of goods sold:
2. Applying the perpetual inventory system, prepare summary journal entries to account for
merchandise purchases, payment to suppliers, freight charges, and sales. Use the cost of goods
sold amount determined in requirement 1.
Merchandise purchases:
Payment to suppliers:
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Freight charges:
Sales:
Solution:
Requirement 1
Merchandise purchases:
Purchases ($550,000 x 98%) ............................................................................
Accounts payable ....................................................................................
539,000
539,000
Payment to suppliers:
Accounts payable .........................................................................................
Cash ........................................................................................................
539,000
Freight charges:
Freight-in ....................................................................................................
Cash .......................................................................................................
16,000
Sales:
Accounts receivable ....................................................................................
Sales .......................................................................................................
923,000
Adjusting entry to record cost of goods sold:
Cost of goods sold (determined below) ............................................................
Inventory (ending) .........................................................................................
Purchases ...............................................................................................
Freight-in ...............................................................................................
Inventory (beginning) ...............................................................................
Beginning inventory
Plus net purchases:
Purchases
Freight-in
Cost of goods available
Less: Ending inventory
Cost of goods sold
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539,000
16,000
923,000
529,000
176,000
539,000
16,000
150,000
$150,000
$539,000
16,000
555,000
705,000
(176,000)
$529,000
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Solution (continued):
Requirement 2
Merchandise purchases:
Inventory ($550,000 x 98%) .............................................................................
Accounts payable ....................................................................................
539,000
539,000
Payment to suppliers:
Accounts payable .........................................................................................
Cash ........................................................................................................
539,000
Freight charges:
Inventory .....................................................................................................
Cash .......................................................................................................
16,000
Sales:
Accounts receivable ....................................................................................
Sales .......................................................................................................
923,000
Cost of goods sold .......................................................................................
Inventory ...............................................................................................
539,000
16,000
923,000
529,000
529,000
Exercise 2
The following merchandise inventory transactions occurred during the month of September for the
Atrax Corporation:
September 1
6
16
20
25
30
—
—
—
—
—
—
Inventory on hand, 5,000 units at a cost $3.23 each
Sold 2,000 units.
Purchased 4,000 units at $3.50 each.
Sold 5,000 units.
Purchased 4,000 unit at $4.00 each.
Inventory on hand, 6,000 units.
Required:
1. Determine ending inventory at September 30 and cost of goods sold for the month using a
periodic inventory system and each of the following cost flow methods:
a. Average cost.
b. First-in, first-out (FIFO).
c. Last-in, first-out (LIFO).
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a. Average cost:
b. First-in, first-out (FIFO):
c. Last-in, first-out (LIFO)
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2. Assume that Atrax uses the perpetual inventory system. What would be the cost of goods sold
for the September 20th sale applying the average cost method and the LIFO method?
Average cost method (perpetual):
LIFO method (perpetual):
Solution:
Requirement 1
Cost of goods available for sale:
Beginning inventory (5,000 x $3.23)
Purchases:
4,000 x $3.50
4,000 x $4.00
Cost of goods available for sale (13,000 units)
$16,150
$14,000
16,000
a. Average cost:
Cost of goods available for sale
Less: Ending inventory (determined below)
Cost of goods sold
30,000
$46,150
$46,150
(21,300)
$24,850
Cost of ending inventory:
$46,150
Weighted-average unit cost =
= $3.55
13,000 units
6,000 units x $3.55 = $21,300
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Solution (continued):
b. First-in, first-out (FIFO):
Cost of goods available for sale
Less: Ending inventory (determined below)
Cost of goods sold
Cost of ending inventory:
Date of
Purchase
Units
Sept. 16
2,000
Sept. 25
4,000
6,000
$46,150
(23,000)
$23,150
Unit Cost
$3.50
4.00
c. Last-in, first-out (LIFO):
Cost of goods available for sale
Less: Ending inventory (determined below)
Cost of goods sold
Cost of ending inventory:
Date of
Purchase
Units
Beg. inv.
5,000
Sept. 16
1,000
6,000
Total cost
$ 7,000
16,000
$23,000
$46,150
(19,650)
$26,500
Unit Cost
$3.23
3.50
Total cost
$16,150
3,500
$19,650
Requirement 2
Average cost method (perpetual):
The weighted-average unit cost for the September 20th sale would be:
3,000 units x
$3.23 =
$9,690
+ 4,000 units x
3.50 =
14,000
7,000 units
$23,690 ÷ 7,000 units = $3.38
Cost of units sold = 5,000 units x $3.38 = $16,900
Last-in, first-out (LIFO) method:
Cost of units sold:
4,000 units x
$3.50 =
+ 1,000 units x
3.23 =
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$14,000
3,230
$17,230
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Inventories: Measurement
Exercise 3
The Carter Company has only one inventory pool. On December 31, 2013, Carter adopted the
dollar-value LIFO inventory method. The inventory on that date using the dollar-value LIFO
method was $450,000. Inventory data for the next two years are as follows:
Year Ended
December 31
2014
2015
Inventory at
Year-End Costs
$469,200
509,250
Inventory at
Base Year Costs
$460,000
485,000
Required:
Compute the ending inventory at December 31, 2014 and 2015, using the dollar-value LIFO method.
Solution:
Date
Ending Inventory
at Base Year Cost
12/31/13
$450,000
Inventory Layers
at Base Year Cost
= $450,000 $450,000 (base)
Inventory Layers
Converted to Cost
Ending
Inventory
DVL Cost
$450,000 x 1.00
= $450,000
$450,000
$450,000 x 1.00
10,000 x 1.02
= $450,000
=
10,200
460,200
$450,000 x 1.00
10,000 x 1.02
= $450,000
=
10,200
1.00
12/31/14
$469,200
= $460,000 Index = 1.02
Index
$450,000 (base)
10,000 (2014)
12/31/15
$509,250
= $485,000 Index = 1.05
Index
$450,000 (base)
10,000 (2014)
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25,000 (2015)
25,000 x 1.05
=
26,250
486,450
MULTIPLE CHOICE
Enter the letter corresponding to the response that best completes each of the following statements
or questions.
1.
In a perpetual inventory system, if merchandise is returned to a supplier:
a. Purchase returns is credited.
b. Inventory is credited.
c. Purchase discounts is credited.
d. Inventory is debited.
2.
The Hamlet Company uses the periodic inventory system. Information for 2013 is as
follows:
Sales
Beginning inventory
Purchases
Purchase returns
Ending inventory
$2,650,000
680,000
1,200,000
12,000
740,000
Hamlet's cost of goods sold for 2013 is:
a. $1,522,000
b. $1,188,000
c. $1,140,000
d. $1,128,000
3.
Symington Corporation uses the periodic inventory system. At December 31, 2013, the
end of the company's fiscal year, a physical count of inventory revealed an ending
inventory balance of $320,000. The following items were not included in the physical
count:
Goods held on consignment at Murphy Corporation
Merchandise shipped to a customer on 12/30 f.o.b. destination
(merchandise arrived at customer's location on 1/3/14)
Merchandise shipped to a customer on 12/29 f.o.b. shipping point
(merchandise arrived at customer's location on 1/2/14)
Merchandise purchased from a supplier, shipped f.o.b. destination
on 12/29, in transit at year-end
$23,000
12,000
6,000
24,000
Symington's 2013 ending inventory should be:
a. $320,000
b. $379,000
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c.
d.
$355,000
$332,000
4.
By the gross method of accounting for purchase discounts, a discount not taken is
recorded as:
a. Purchases.
b. Interest expense.
c. A reduction in sales revenue.
d. None of the above.
5.
By the net method of accounting for purchase discounts, a discount not taken is recorded
as:
a. Purchases.
b. Interest expense.
c. A reduction in sales revenue.
d. None of the above.
6.
Identify the statement below concerning the LIFO inventory method that is untrue.
a. In the absence of changes in costs, the results of using LIFO would be identical to
those obtained by FIFO.
b. LIFO will provide a close matching of current revenues with current costs since the
most recent costs are expensed first.
c. The ending inventory under LIFO will tend to approximate replacement cost.
d. In periods of declining costs, cost of goods sold using LIFO will produce a lower
cost of goods sold than FIFO.
Questions 7, 8, 9, and 10 are based on the following data:
Sanfillipo, Inc., had 800 units of inventory on hand at March 1, 2013, costing $20 each. Purchases
and sales of inventory during the month of March were as follows:
Date
March 8
15
22
27
Purchases
Sales
600 units
400 units @ $22 each
400 units @ $24 each
400 units
Sanfillipo uses the periodic inventory system. According to a physical count, 600 units were on
hand at the end of March.
7.
The cost of inventory at the end of March applying the FIFO method is:
a. $12,900
b. $14,400
c. $12,000
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d.
$14,000
8.
The cost of inventory at the end of March applying the LIFO method is:
a. $12,900
b. $14,400
c. $12,000
d. $14,000
9.
The cost of inventory at the end of March applying the average cost method is:
a. $12,900
b. $14,400
c. $12,000
d. $14,000
10. If Sanfillipo instead used the perpetual inventory system, cost of goods sold for the
month of March applying the LIFO inventory method would be:
a. $22,400
b. $21,500
c. $21,600
d. $24,000
11. In a period of declining costs, the use of which of the following inventory cost methods
would result in the highest ending inventory?
a. FIFO.
b. LIFO.
c. Average cost.
d. Weighted-average cost.
12. International Financial Reporting Standards allow companies to use each of the following
inventory valuation methods except:
a. FIFO.
b. LIFO.
c. Average cost.
d. All of the above methods are allowed.
13. LIFO liquidation profits occur when:
a. Costs are rising and inventory quantity increases.
b. Costs decline.
c. Costs increase.
d. Costs are rising and inventory quantity declines.
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14. For its 2013 fiscal year, the King Pharmaceutical Company reported sales of
$10,500,000, cost of goods sold of $6,300,000, and net income of $525,000. The
company's gross profit ratio for the year is:
a. 40%
b. 60%
c.
5%
d. 67%
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15. On December 31, 2013, the Charlie Company adopted the dollar-value LIFO inventory
method. Inventory at the end of 2013 for its only inventory pool was $500,000 under the
dollar-value LIFO method. At the end of 2014 inventory at year-end cost is $672,000
and the cost index is 1.05. Inventory at the end of 2014 at dollar-value LIFO cost is:
a. $625,000
b. $640,000
c. $647,000
d. $672,000
16. J.T. Rider and Sons uses the dollar-value LIFO inventory method. At the end of 2014 the
cost index is 1.25 and the ending inventory at base year cost is $360,000. If 2014
beginning inventory at base year cost was $300,000, 2014 ending inventory at dollarvalue LIFO cost is:
a. $300,000
b. $450,000
c. $360,000
d. $375,000
Answers:
1. b.
2. d.
3. c.
4. a.
5. b.
6.
7.
8.
9.
10.
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c.
d.
c.
a.
c.
11.
12.
13.
14.
15.
b.
b.
d.
a.
c.
16.
d.
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CPA Exam Questions
1. d.
2. c. Under the net method, purchases are recorded net of the discount:
$3,600 x 98% = $3,528
3. b. Average Cost = $4,950 / 140 units = $35.36 per unit
Ending Inventory = $35.36 x 5 = $176.79
4. a. 5 units x $30 = $150
5. c. 5 units x $50 = $250
6. b. If the inventory balance was lower using FIFO than LIFO, then prices during
the period were moving downward. By using FIFO during such a period, the
higher priced items are sold first with lower-priced goods remaining in the ending
inventory.
7. b.
Date
Inventory
At Base
Year cost
1/1/13
12/31/13
12/31/14
$100,000
$120,000
$128,000
Layer
At Base
Year Cost
Cost
Index
$20,000
$8,000
1.00
1.05
1.10
Layer at
Current year
Cost
Ending
Inventory
$21,000
$8,800
$100,000
$121,000
$129,800
8. a. IAS No. 2 does not permit the use of LIFO.
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CMA Exam Questions
1. c. The company began March with 3,200 units in inventory at $64.30 each.
The March 4 purchase added 3,400 additional units at $64.75 each. Under
FIFO, the 3,600 units sold on March 14 were the oldest units. That sale
eliminated all of the 3,200 units priced at $64.30 and 400 of the units priced
at $64.75, leaving an inventory of 3,000 units at $64.75 prior to the March
25 purchase. On March 25, 3,500 units were acquired at $66. The 3,450
units sold on March 28 were the 3,000 remaining units priced at $64.75 and
450 units priced at $66. The ending inventory consists of 3,050 units at $66
each, or $201,300. The answer would have been the same under the periodic
FIFO method.
2. a. The ending inventory consists of 3,050 units (beginning inventory plus
purchases, minus sales). Under the periodic LIFO method, those units are
valued at the oldest prices for the period, which is $64.30 of the beginning
inventory. Multiplying $64.30 times 3,050 units produces a total inventory
value of $196,115.
3. a. Under the perpetual LIFO method, the company begins with 3,200 units
at $64.30. Added to this is the March 4 purchase of 3,400 units at $64.75.
The March 14 sale uses all of the March 4 purchase and 200 of the original
inventory units. Thus, the firm is left with 3,000 units at $64.30. The March
25 purchase of 3,500 at $66 is added to the previous 3,000 units. The March
28 sale of 3,450 units comes entirely from the March 25 purchase, leaving
just 50 of those units at $66 each. Thus, at the end of the month, the
inventory consists of two layers: 3,000 units at $64.30 ($192,200), and 50
units at $66 ($3,300). Adding the two together produces a total ending inventory of
$196,200.
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