COURSE
6312 Accounting II
Unit C
ESSENTIAL
STANDARD
OBJECTIVE
6.00
C3
12%
6.01
B2
4%
ESSENTIAL
QUESTIONS
 What is inventory?
 What are the different types of inventory control systems?
 What are the different types of inventory control methods?
Inventory Control and Cost
Accounting
Apply inventory control methods.
Understand inventory control
methods.
UNPACKED CONTENT
I.
Inventory
A. Merchandise or stock offered for sale to customers by retail, wholesale and
distribution businesses; may also be made by a business for sale to customers
B. Merchandise inventory
1. Largest current asset of a business; requires management control
a. Control the size and variety of the inventories
(1) Amount of merchandise on hand
(2) Cost of that merchandise
(3) Which items are selling and which are not
b. Maintain inventory sufficient to satisfy customers’ needs
(1) Problems related to excess inventory
(a) Inadequate cash flow
(b) Requires storage space
(c) Items may become obsolete.
(2) Problems related to inventory shortage
(a) Lost sales due to insufficient stock
(b) Lost sales due to insufficient variety
2. Appears on the balance sheet as a current asset; appears on the income
statement as a cost of goods sold
3. Includes all costs necessary to purchase the item and get it to its intended
destination
4. Includes some Goods in Transit that have been purchased from suppliers
but not yet received
a. Free on Board (FOB) shipping point
(1) Title for the goods (ownership) passes to buyer when goods are
placed in the care of the transportation company.
(2) Buyer/business pays transportation charges
(3) Costs of these goods must be included in the Inventory account.
b. Free on Board (FOB) destination
(1) Title for the goods (ownership) STAYS with the seller until goods are
delivered to the buyer/business.
(2) Vendor/seller pays transportation charges
(3) Costs of these goods are NOT included in the Inventory account.
5. Goods on Consignment are goods that have been given to a business to
sell but do not belong to the business.
a. NOT included in inventory
b. Consignee often footnotes these goods on financial statements
(1) Consignee – the person or business receiving the goods to sell
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(2) Consignor – the person or business that gives the goods to sell
II.
Inventory Control Systems
A. Perpetual inventory
1. Inventory continuously updated
2. Used by a majority of businesses
3. When new merchandise is purchased, the Inventory account is updated
instead of the Purchases account.
4. Sales of merchandise to customers require two journal entries:
a. Debit Cash or Accounts Receivable and credit Sales
b. Debit Cost of Goods Sold and credit Inventory
5. Stock records – used to continuously update the quantity of goods on
hand
6. Companies that use a perpetual inventory system will also perform a
periodic inventory once per year to verify.
B. Periodic inventory
1. Also referred to as physical inventory
2. Determined by counting, weighing, or measuring all items of merchandise
on hand
3. When inventory is purchased throughout the year, a debit is made to the
Purchases account.
a. Shown as a cost of goods sold on the income statement
b. The Purchases account is closed to the Inventory account at the end of
the year.
4. Sales of merchandise to customers require one journal entry:
a. Debit Accounts Receivable or Cash and credit Sales.
b. No entry is made to Inventory or Cost of Goods Sold as these
adjustments will be made at the end of the accounting period.
5. At the end of the year, the Inventory account is adjusted to equal the
amount on hand per the periodic count.
6. Inventory records are used during a periodic inventory to record
information about each item of merchandise on hand.
7. For businesses with large amounts of inventory, taking an inventory count
is expensive. Therefore, inventory is physically counted only once a year.
III. Inventory Control Methods
A. Importance
1. Help businesses account for their ending inventory and determine the cost
of goods sold
2. Necessary when inventory consists of many items that are not specifically
identifiable, such as in a hardware store, and not as easily computed as
when inventory consists of large, identifiable items
3. Because of fluctuations in purchase prices, businesses must make
assumptions about which items have sold and which remain in inventory.
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B. Inventory control methods
1. Specific identification
a. Each item in the ending inventory is valued at its actual cost.
b. Primarily useable in firms that sell big ticket items such as cars,
appliances, or furniture
c. Rarely used in practice today
2. First-In First-Out – FIFO
a. Based on the assumption that the first items purchased are the first
items sold
b. Assumes the more recently acquired items remain in inventory
c. During periods of inflation, use of FIFO will result in the lowest estimate
of cost of goods sold and the highest net income among the three mostused approaches.
3. Last-In First-Out – LIFO
a. Assumes that the last items purchased are the first items sold
b. Assumes the earliest acquired items remain in inventory
c. During periods of inflation, use of LIFO will result in the highest estimate
of cost of goods sold and the lowest net income among the three mostused approaches.
4. Weighted average
a. Assigns an average cost to each unit in inventory
b. Results in a Cost of Goods sold amount that is between amounts
resulting with the FIFO and LIFO methods
C. Lower of cost or market value
1. Per GAAP, inventory is valued at historical cost. However, there are times
when the original cost of the ending inventory is greater than the
replacement cost.
2. Inventory is calculated using one of the inventory control methods above.
3. Then, the costs are compared to the current market value to determine if
an adjustment should be made.
4. If inventory has decreased in value below historical cost, then the inventory
value is reduced and the difference is charged to Cost of Goods Sold or
Loss account.
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KEY TERMS
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Inventory
Inventory account
Merchandise
Stock
Current asset
Cost of goods sold
Goods in transit
Free on Board (FOB) shipping point
Free on Board (FOB) destination
Goods on consignment
Consignee
 Consignor
 Perpetual inventory
 Purchases account
 Periodic inventory
 Inventory records
 Inventory control method
 Specific identification
 First-In First-Out (FIFO)
 Last-In First-Out (LIFO)
 Weighted average
 Lower of cost or market
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6312 Accounting II
Summer 2011 Version 2
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