8
Inventories:
Measurement
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
Recording and Measuring Inventory
Types of Inventory
Merchandise
Inventory
Goods acquired for
resale
8-2
Manufacturing
Inventory
•Raw Materials
•Work-in-Process
•Finished Goods
Manufacturing Inventories
Raw
Materials


Work in
Process

$XX
Finished
Goods
$XX

Direct
Labor


Cost of Goods Sold
$XX
Manufacturing
Overhead

8-3









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
Inventory Systems
Two accounting systems are used to record
transactions involving inventory:
8-4
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.
Perpetual Inventory System
Lothridge Wholesale Beverage Company (LWBC) begins
2011 with $120,000 in inventory. During the period it
purchases on account $600,000 of merchandise for resale
to customers.
2011
Inventory
Accounts payable
600,000
600,000
Purchase of merchandise inventory on account
Returns of inventory are credited to the inventory
account.
Discounts on inventory purchases can be recorded
using the gross or net method.
8-5
Perpetual Inventory System
During 2011, LWBC sold, on account, inventory with a retail
price of $820,000 and a cost basis of $540,000, to customers.
2011
Inventory
Accounts payable
600,000
600,000
Purchase of merchandise inventory on account.
2011
Accounts receivable
Sales revenue
820,000
820,000
Record sales on account.
Cost of goods sold
Inventory
Record cost of goods sold.
8-6
540,000
540,000
Periodic Inventory System
The periodic inventory system is not designed to track
either the quantity or cost of merchandise inventory. Cost
of goods sold is calculated, using the schedule below, after
the physical inventory count at the end of the period.
Beginning Inventory
+ Net Purchases
Cost of Goods Available for Sale
- Ending Inventory
= Cost of Goods Sold
8-7
Periodic Inventory System
Lothridge Wholesale Beverage Company (LWBC) begins
2011 with $120,000 in inventory. During the period it
purchases on account $600,000 of merchandise for resale
to customers.
2011
Purchases
Accounts payable
Purchase of merchandise inventory on account
8-8
600,000
600,000
Periodic Inventory System
During 2011, LWBC sold, on account, inventory with a retail
price of $820,000 to customers, and a cost basis of $540,000.
2011
Accounts receivable
Sales revenue
820,000
820,000
Record sales on account.
No entry is made to record Cost of Goods Sold. A physical count
of Ending Inventory shows a balance of $180,000. Let’s
calculate Cost of Goods Sold at the end of 2011.
8-9
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
We need the following adjusting entry to record cost of good sold.
December 31, 2011
Cost of goods sold
Inventory (ending)
Inventory (beginning)
Purchases
540,000
180,000
120,000
600,000
To adjust inventory, close purchases, and record cost of goods sold.
8 - 10
Comparison of Inventory Systems
Transaction or
Event
Routine purchases of
various inventory items
Costs debited to
purchases account
Costs debited to
inventory account
Sale of inventory
No accounting entries
made to inventory
Debit Cost of goods
sold and credit
inventory
End-of-period
accounting entries and
related activities
8 - 11
Periodic Inventory Perpetual Inventory
Physical count to
No separate
determine ending
determination of cost of
inventory and cost of
goods sold necessary
goods sold
What is Included in Inventory?
General Rule
All goods owned by the company on the inventory
date, regardless of their location.
Goods in Transit
Depends on FOB
shipping terms.
8 - 12
Goods on
Consignment
Expenditures Included in Inventory
Invoice Price
Purchase
Returns and
Allowances
+
Freight-in on
Purchases
8 - 13
Purchase
Discounts
Purchase Returns
On November 8, 2011, LWBC returns merchandise that had a cost
to LWBC of $2,000, and a cost basis to the seller of 1,600.
Periodic Inventory Method
November 8, 2011
Accounts payable
2,000
Purchase returns and allowances
2,000
Perpetual Inventory Method
Accounts payable
Inventory
2,000
Returns of inventory are credited to the Purchase Returns
and Allowances account when using the periodic
inventory method.
The returns are credited to Inventory using the perpetual
inventory method.
8 - 14
2,000
Purchase Discounts
Gross Method
October 5, 2011
Purchases
Accounts payable
20,000
20,000
October 14, 2011
Accounts payable
14,000
Purchase discounts
Cash
November 4, 2011
Accounts payable
Cash
Discount terms are
2/10, n/30.
$14,000
x 0.02
$ 280
8 - 15
Net Method
280
13,720
6,000
6,000
Partial payment not
made within the
discount period
Purchases
Accounts payable
19,600
Accounts payable
Cash
13,720
Accounts payable
Interest expense
Cash
5,880
120
19,600
13,720
6,000
$20,000
x 0.02
$ 400
-120
$ 280
Inventory Cost Flow Assumptions
• Specific identification
• Average cost
• First-in, first-out (FIFO)
• Last-in, first-out (LIFO)
8 - 16
Last-In, First-Out
Periodic Inventory System
Picture This, LLC
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for Sale
Ending Inventory
Cost of Goods Sold
8 - 17
Units
1,200
900
550
600
800
4,050
1,400
2,650
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 26,400.00
21,600.00
13,750.00
16,200.00
22,400.00
$ 100,350.00
35,774.50
$ 64,575.50
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
(1,400 units)
Beginning Inventory
(1,200 units)
Available
for Sale
(4,050 units)
Goods Sold
(2,650)
$100,350 ÷ 4,050 = $24.7778 weightedaverage per unit cost
8 - 18
Weighted-Average Periodic System
Picture This, LLC
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for Sale
Ending Inventory
Cost of Goods Sold
8 - 19
Units
1,200
900
550
600
800
4,050
(1,400)
2,650
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
$ 24.7778
$ 24.7778
Total
$ 26,400.00
21,600.00
13,750.00
16,200.00
22,400.00
$ 100,350.00
(34,688.92)
$ 65,661.08
First-In, First-Out (FIFO)
The FIFO
• The cost of the oldest
method
inventory items are
assumes that
charged to COGS
items are sold
when goods are sold.
in the
• The cost of the
chronological
newest inventory
order of their
items remain in
acquisition.
ending inventory.
8 - 20
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 - 21
First-In, First-Out (FIFO)
Periodic Inventory System
Picture This, LLC
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for Sale
Ending Inventory
Cost of Goods Sold
8 - 22
Units
1,200
900
550
600
800
4,050
1,400
2,650
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 26,400.00
21,600.00
13,750.00
16,200.00
22,400.00
$ 100,350.00
These are
the 1,400
38,600.00
most recently
$ 31,050.00
acquired
units.
First-In, First-Out (FIFO)
Periodic Inventory System
Picture This, LLC
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for Sale
Ending Inventory
Cost of Goods Sold
8 - 23
Units
1,200
900
550
600
800
4,050
1,400
2,650
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 26,400.00
21,600.00
13,750.00
16,200.00
22,400.00
$ 100,350.00
38,600.00
$ 61,750.00
First-In, First-Out (FIFO)
Periodic Inventory System
Picture This, LLC
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for Sale
Ending Inventory
Cost of Goods Sold
8 - 24
Units
1,200
900
550
600
800
4,050
1,400
2,650
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 26,400.00
21,600.00
13,750.00
16,200.00
22,400.00
$ 100,350.00
These are
the first
38,600.00
2,650 units
$ 61,750.00
acquired.
First-In, First-Out (FIFO)
Periodic Inventory System
Picture This, LLC
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for Sale
Ending Inventory
Cost of Goods Sold
8 - 25
Units
1,200
900
550
600
800
4,050
1,400
2,650
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 26,400.00
21,600.00
13,750.00
16,200.00
22,400.00
$ 100,350.00
38,600.00
$ 61,750.00
Last-In, First-Out (LIFO)
The LIFO
• The cost of the
method
newest inventory
assumes that
items are charged to
the newest
COGS when goods
items are sold
are sold.
first, leaving the • The cost of the oldest
older units in
inventory items
inventory.
remain in inventory.
8 - 26
Last-In, First-Out (LIFO)
Unlike FIFO, using
the LIFO method
may result in COGS
and Ending
Inventory Cost that
differ under the
periodic and
perpetual
approaches.
8 - 27
Last-In, First-Out
Date
9/15
9/22
9/30
Sales Units
1,000
700
950
2,650
Perpetual Inventory System
Picture This, LLC
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for Sale
Ending Inventory
Cost of Goods Sold
8 - 28
Units
1,200
900
550
600
800
4,050
1,400
2,650
$/Unit
Total
$ 22.00
$ 26,400.00
24.00
21,600.00
25.00
13,750.00
27.00
16,200.00
28.00
22,400.00
These are
the
100,350.00
oldest$units
in
inventory and are
most likely to
remain in inventory
when using LIFO.
Last-In, First-Out
Perpetual Inventory System
Date
Beg. Inv.
Purchased
1,200 x
22.00 =
9/3
900 x
24.00 =
9/15
550 x
25.00 =
2,650
Sold
Balance
$ 26,400.00
48,000.00
61,750.00
26,400
21,600
13,750
550 x
450 x
1,000
25.00 =
24.00 =
13,750.00
10,800.00
24,550.00
The Cost of Goods Sold for the September
15 sale is $24,550.
After this sale, there are 1,650 units in
inventory at various costs per unit.
8 - 29
37,200.00
Last-In, First-Out
Perpetual Inventory System
Date
Purchased
Beg. Inv.
1200 x 22.00 = 26,400
9/3 450 x 24.00 = 10,800
9/21 600 x 27.00 = 16,200
9/22
Sold
600 x
100 x
700
27.00 =
24.00 =
Balance
$ 26,400.00
37,200.00
53,400.00
16,200.00
2,400.00
18,600.00
The Cost of Goods Sold for the
September 15 sale is $18,600.
After this sale, there are 1,550 units in
inventory at various per unit cost.
8 - 30
34,800.00
Last-In, First-Out
Perpetual Inventory System
Date
Beg. Inv
9/3
9/29
9/30
Purchased
1,200 x 22.00 =
350 x 24.00 =
800 x 28.00 =
Sold
Balance
$ 26,400.00
34,800.00
57,200.00
26,400
8,400
22,400
800 x
150 x
950
28.00 =
24.00 =
22,400.00
3,600.00
26,000.00
31,200.00
The Cost of Goods Sold for the September
30 sale is $26,000.
After this sale, there are 1,400 units in
inventory (1,200 × $22.00) per unit
and (200 × $24.00) for a total cost of ending
inventory of $31,200.
8 - 31
Last-In, First-Out
Periodic Inventory System
Picture This, LLC
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for Sale
Ending Inventory
Cost of Goods Sold
8 - 32
Units
1,200
900
550
600
800
4,050
1,400
2,650
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 26,400.00
21,600.00
13,750.00
16,200.00
22,400.00
$ 100,350.00
Last-In, First-Out
Periodic Inventory System
Beginning inventory
Purchase of September 3
Cost of goods available for sale
Units Unit Cost Total Cost
1,200 $ 22.00 $ 26,400
200
24.00
4,800
1,400
31,200
Picture This, LLC
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for Sale
Ending Inventory
Cost of Goods Sold
8 - 33
Units
1,200
900
550
600
800
4,050
1,400
2,650
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 26,400.00
21,600.00
13,750.00
16,200.00
22,400.00
$ 100,350.00
31,200.00
$ 69,150.00
Last-In, First-Out
Perpetual Inventory System
Picture This, LLC
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for Sale
Ending Inventory
Cost of Goods Sold
8 - 34
Units
1,200
900
550
600
800
4,050
1,400
2,650
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 26,400.00
21,600.00
13,750.00
16,200.00
22,400.00
$ 100,350.00
31,200.00
$ 69,150.00
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.
8 - 35
LIFO
• Matches high (newer)
costs with current
(higher) sales.
• Inventory is valued
based on low (older)
cost basis.
• Results in lower
taxable income.
U. S. GAAP vs. IFRS
LIFO is an important issue for U.S. multinational
companies. Unless the U.S. Congress repeals the LIFO
conformity rule, in inability to use LIFO under IFRS will
impose a serious impediment to convergence.
• LIFO is permitted and used by
U.S. Companies.
• If used for income tax
reporting, the company must
use LIFO for financial
reporting.
• Conformity with IAS No. 2
would cause many U.S.
companies to lose a valuable
tax shelter.
8 - 36
• IAS No. 2, Inventories, does
not permit the use of LIFO.
• Because of this restriction,
many U.S. companies use
LIFO only for domestic
inventories.
Decision Makers’ Perspective
Factors Influencing Method Choice
How closely do
reported
costs reflect actual
flow of inventory?
How are income
taxes affected by
inventory method
choice?
8 - 37
How well are costs
matched against
related revenues?
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.
8 - 38
This LIFO
liquidation
results in
“paper profits.”