7-1
CHAPTER 7
MEASURING AND
REPORTING INVENTORIES
.
7-2
Inventory
“Inventory is often the largest and most
important asset owned by a
merchandising company.”
What is the biggest expense on the income
statement?
Cost of Goods Sold
What are the two major factors in
determining Cost of Goods Sold?
(Beg. Inventory + Purchases - End. Inventory)
7-3
Inventory
Inventory is where the action is!
 It’s a real can of worms.

7-4
Balance Sheet Amount
The inventory dollar amount on the
balance sheet is the product of what
two factors? (i.e., What? x What?)
Balance Sheet Amount = Quantity x Cost
“War stories” about
inventory observations
7-5
Inventory Costs Include
251

Invoice price

Insurance while in transit

Transportation

Handling costs to get the
inventory ready for sale
e.g., washing cars
(i.e., all costs to get the inventory into a
position and condition for resale.)
7-6
Impact of Inventory Errors
on Financial Statements
 Errors
in inventory may cause
misstatements in the following
areas:

Income Statement
COGS, Gross Margin,
Net Income

Balance Sheet
Inventory, Retained Earnings
7-7
Impact of Inventory Errors
on Financial Statements
Assume that the inventory at the end of
19A is misstated.
What is the impact of the error on the Income
Statements and Balance Sheets for 19A and 19B?
19A
12-31
19B
12-31
Error
Income Statement:
Year Ended 12-31-19A
Year Ended 12-31-19B
Balance Sheet:
12-31-19A
12-31-19B
Impact of Error?
Wrong End Inv, COGS, GM, Net Income
Wrong Beg Inv, COGS, GM, Net Income
Wrong Inventory and Retained Earnings
Nothing wrong! The error "washes out"
(i.e., counterbalances)
7-8
Impact of Inventory Errors
on Financial Statements
O.K.
O.K.
5k over
5k under
5k over
O.K.
5k over
O.K.
5k over
5k over
7-9
Impact of Inventory Errors
on Financial Statements
O.K.
5k over
O.K.
5k over
O.K.
5k over
5k under
O.K.
5k under
5k over
5k under
O.K.!!!
7-10
Impact of Inventory Errors
on Financial Statements
Additional proof that Retained
Earnings at the end of Year 2 are O.K.
Retained Earnings
As recorded
As recorded
120,000
55,000
86,500
261,500
Balance 1-1-98
Net Income - 1998 5,000 over
Net Income - 1999 5,000 under
Balance 12-31-99 O.K.!!!
Proof that sometimes, in fact, two
wrongs do make a right!
7-11
Impact of Inventory Errors
on Financial Statements
Here is a summary of the the material we
just finished.
Effects of Errors in Inventory
Ending Inventory
Understated
Overstated
Cost of
Goods Sold Overstated
Net Income Understated
Understated
Overstated
250
Beginning Inventory
Understated
Overstated
Understated
Overstated
Overstated
Understated
7-12
Impact of Inventory Errors
on Financial Statements
There is a much simpler way of getting the
effect of an error on net income.
I call it the “sneaky way” because it uses the
balance sheet equation.
 As before in ILL. 7.1, if inventory at 12-31-98
is overstated by $5,000, determine the effect
on 1998 net income as follows:
12-31-98
A = L + S/E

Overstated
by 5K
Overstated
by 5K
7-13
Methods of Determining
Inventory Cost
Perpetual Method
vs.
Periodic Method
7-14
Perpetual Inventory Procedure
The inventory account is continuously
updated for . . .
Inventory purchases
 Purchase returns
 Inventory sales
 Sales returns

7-15
Comparing Journal Entries
For comparison, let’s make the journal
entries for each of the following
transactions using both the periodic
and perpetual methods. Keep in mind
that sales under the perpetual method
require two journal entries.
7-16
Comparing Journal Entries
On September 5, Worley Co. purchased 100
units of inventory for $30 per unit.
GENERAL JOURNAL
Date Description
PERIODIC
PERPETUAL
PR Debit
Page 1
Credit
7-17
Comparing Journal Entries
On September 5, Worley Co. purchased 100
units of inventory for $30 per unit.
GENERAL JOURNAL
Date Description
9/5
9/5
PR Debit
PERIODIC
Purchases
Accounts Payable
3,000
PERPETUAL
Merchandise Inventory
Accounts Payable
3,000
Page 1
Credit
3,000
3,000
7-18
Comparing Journal Entries
On September 7, Worley Co. sold 10 of the
previously purchased units for $50 each.
GENERAL JOURNAL
Date Description
PERIODIC
PERPETUAL
Page 1
PR Debit Credit
7-19
Comparing Journal Entries
On September 7, Worley Co. sold 10 of the
previously purchased units for $50 each.
GENERAL JOURNAL
Date Description
Page 1
PR Debit Credit
PERIODIC
The Cost of Goods
Sold account is an expense
9/7
Accounts Receivable
500
account
and is closed to Income Summary
at the end
Sales
500
of the period just like all other expense accounts.
9/7
PERPETUAL
Accounts Receivable
500
AT SALES PRICE
Sales
500
Cost of Goods Sold
Merchandise Inventory
300
300
AT COST
7-20
Comparing Journal Entries
On Sept. 8, Worley Co. returned 2 of the
previously purchased units as defective.
GENERAL JOURNAL
Date Description
Page 1
PR Debit Credit
Periodic
Perpetual
7-21
Comparing Journal Entries
On Sept. 8, Worley Co. returned 2 of the
previously purchased units as defective.
GENERAL JOURNAL
Date Description
Page 1
PR Debit Credit
Periodic
9/8
Accounts Payable
60
Purchase Returns and Allowances
60
( 2 @ $30 per units = $60)
Perpetual
9/8
Accounts Payable
Merchandise Inventory
60
60
7-22
Inventory Cost Flow Methods
Specific identification
First-in, first-out
(FIFO)
Last-in, first-out
(LIFO)
Weighted average
7-23
7-24
7-25
Inventory Cost Flow Methods
Reminder from the “Saturday Night Page”
Calculation of Cost of Goods Sold
Beginning
Inventory
(The
top part
is not relevant to
this discussion.)
+ Purchases,
etc
Cost of Goods Available for Sale
- Ending Inventory
Cost of Goods Sold
So, GAS - EI = CGS
Or, GAS = EI + CGS
7-26
Inventory Cost Flow Methods
Cost of Goods Available for Sale
Ending Inventory
Cost of Goods Sold
7-27
Specific Identification



Attaches actual cost to an identifiable unit
of product
Used for relatively large inventory items
Frequently identified by serial number
7-28
First-In, First-Out
COST OF
GOODS
AVAILABLE
FOR SALE
7-29
First-In, First-Out
Oldest Costs
Cost of
Goods Sold
Newest Costs
Ending
Inventory
7-30
First-In, First-Out
Periodic Inventory Procedure
The following schedule shows the mouse pad
inventory for Computers, Inc. for September.
The physical inventory count shows 800
mouse pads in ending inventory.
Use the FIFO procedure to determine:
(1) Ending inventory
(2) Cost of goods sold
7-31
First-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Units
BI
1,000
9/3 Pur.
100
9/15 Pur.
150
9/21 Pur.
200
9/29 Pur.
100
Goods available
for sale
1,550
Ending inventory
800
Cost of goods sold
750
Unit Cost
$ 5.25
5.30
5.60
5.80
5.90
Total
$ 5,250.00
530.00
840.00
1,160.00
590.00
$ 8,370.00
7-32
First-In, First-Out
Periodic Inventory Procedure
Computer,
Inc.
Remember: FIFO
ending inventory
is calculatedMouse
usingPad
the Inventory
cost of the
newest purchases. Start with 9/29
Units
Unit
Cost
and then Date
add other purchases
until
BI
1,000
$ 5.25
you reach
the number
of units
in
9/3
100
5.30
ending inventory.
9/15
150
9/21 Pur.
200
9/29 Pur.
100
Goods available
for sale
1,550
Ending inventory
800
Cost of goods sold
750
5.60
5.80
5.90
Total
$ 5,250.00
530.00
840.00
1,160.00
590.00
$ 8,370.00
7-33
First-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
9/29
Units
Beg. Inv.
Purchases
100@$5.90
End Inv.
100@$5.90
100
Cost of
Goods Sold
7-34
First-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
9/21
9/29
Units
Beg. Inv.
Purchases
200@$5.80
100@$5.90
End Inv.
200@$5.80
100@$5.90
300
Cost of
Goods Sold
7-35
First-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
9/15
9/21
9/29
Units
Beg. Inv.
Purchases
150@$5.60
200@$5.80
100@$5.90
End Inv.
150@$5.60
200@$5.80
100@$5.90
450
Cost of
Goods Sold
7-36
First-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
9/3
9/15
9/21
9/29
Units
Beg. Inv.
Purchases
100@$5.30
150@$5.60
200@$5.80
100@$5.90
End Inv.
100@$5.30
150@$5.60
200@$5.80
100@$5.90
550
Cost of
Goods Sold
7-37
First-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
BI
9/3
9/15
9/21
9/29
Units
Beg. Inv.
1000@$5.25
Purchases
100@$5.30
150@$5.60
200@$5.80
100@$5.90
End Inv.
250@$5.25
100@$5.30
150@$5.60
200@$5.80
100@$5.90
800
Cost of
Goods Sold
7-38
First-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
BI
9/3
9/15
9/21
9/29
Units
Costs
Beg. Inv.
1000@$5.25
Purchases
100@$5.30
150@$5.60
200@$5.80
100@$5.90
Cost of Goods Available for Sale
End Inv.
250@$5.25
100@$5.30
150@$5.60
200@$5.80
100@$5.90
800
$ 4,432.50
Cost of
Goods Sold
750@$5.25
$
$8,370.00
750
3,937.50
7-39
First-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
BI
9/3
9/15
9/21
9/29
Units
Costs
Beg. Inv.
1000@$5.25
Purchases
100@$5.30
150@$5.60
200@$5.80
100@$5.90
Cost of Goods Available for Sale
End Inv.
250@$5.25
100@$5.30
150@$5.60
200@$5.80
100@$5.90
800
$ 4,432.50
Cost of
Goods Sold
750@$5.25
$
$8,370.00
750
3,937.50
7-40
Last-In, First-Out
7-41
Last-In, First-Out
Oldest Costs
Ending
Inventory
Newest Costs
Cost of
Goods Sold
7-42
Last-In, First-Out
Periodic Inventory Procedure
The following schedule shows the mouse pad
inventory for Computers, Inc. for September.
The physical inventory count shows 800
mouse pads in ending inventory.
Use the LIFO periodic procedure to determine:
(1) Ending inventory
(2) Cost of goods sold
7-43
Last-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Units
BI
1,000
9/3 Pur.
100
9/15 Pur.
150
9/21 Pur.
200
9/29 Pur.
100
Goods available
for sale
1,550
Ending inventory
800
Cost of goods sold
750
Unit Cost
$ 5.25
5.30
5.60
5.80
5.90
Total
$ 5,250.00
530.00
840.00
1,160.00
590.00
$ 8,370.00
7-44
Last-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Units
Unit Cost
BI
1,000
$ 5.25
9/3 Pur.
100
5.30
9/15 Pur.
150
5.60
9/21
200
5.80
Remember:
LIFO ending
inventory
is
9/29
100
5.90
calculated
using
the
cost
of
the
oldest
Goods available
purchases.
Start with
for sale
1,550beginning
inventory
and then800
add other
Ending
inventory
purchases
until you
Cost of goods
sold reach
750 the number
of units in ending inventory.
Total
$ 5,250.00
530.00
840.00
1,160.00
590.00
$ 8,370.00
7-45
Last-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Inv.
BI
1000@$5.25
Units
Purchases
End Inv.
800@$5.25
800
Cost of
Goods Sold
7-46
Last-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Inv.
BI
1000@$5.25
Purchases
End Inv.
800@$5.25
Cost of
Goods Sold
200@$5.25
Units
800
200
7-47
Last-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Inv.
BI
1000@$5.25
9/3
Purchases
End Inv.
800@$5.25
Cost of
Goods Sold
200@$5.25
100@$5.30
100@$5.30
800
300
7-48
Last-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Inv.
BI
1000@$5.25
9/3
9/15
9/21
9/29
Units
Purchases
End Inv.
800@$5.25
100@$5.30
150@$5.60
200@$5.80
100@$5.90
800
Cost of
Goods Sold
200@$5.25
100@$5.30
150@$5.60
200@$5.80
100@$5.90
750
7-49
Last-In, First-Out
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Inv.
BI
1000@$5.25
9/3
9/15
9/21
9/29
Units
Costs
Purchases
End Inv.
800@$5.25
100@$5.30
150@$5.60
200@$5.80
100@$5.90
Cost of goods available for sale
800
$ 4,200.00
Cost of
Goods Sold
200@$5.25
100@$5.30
150@$5.60
200@$5.80
100@$5.90
750
$ 4,170.00
$8,370.00
7-50
Weighted-Average
Periodic Inventory Procedure
7-51
Weighted-Average
Periodic Inventory Procedure
Cost per unit
Goods Available for Sale in $_
Goods Available for Sale in units
Ending Inventory
Ending Inv. = Cost per unit x No. Units in Ending Inv.
7-52
Weighted-Average
Periodic Inventory Procedure
The following schedule shows the mouse pad
inventory for Computers, Inc. for September.
The physical inventory count shows 800
mouse pads in ending inventory.
Use the weighted-average periodic
procedure to determine:
(1) Ending inventory
(2) Cost of goods sold
7-53
Weighted-Average
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Goods Sold
Units
1,000
100
150
200
100
1,550
- 800
750
$/Unit
$5.25
5.30
5.60
5.80
5.90
Total
$5,250.00
530.00
840.00
1,160.00
590.00
$8,370.00
7-54
Weighted-Average
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Units
$/Unit
Total
Beg. Inventory
1,000
$5.25
$5,250.00
9/3
100
5.30
530.00
9/15
150
5.60
840.00
9/21$8,370 ÷ 1,550
200= $5.40 weighted-average
5.80
1,160.00
9/29
100
5.90
590.00
Goods Available for
Sale
1,550
$8,370.00
Ending Inventory
- 800
Goods Sold
750
7-55
Weighted-Average
Periodic Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Units
$/Unit
Total
Beg. Inventory
1,000
$5.25
$5,250.00
9/3
100
5.30
530.00
9/15
150
5.60
840.00
9/21$8,370 ÷ 1,550
200= $5.40 weighted-average
5.80
1,160.00
9/29
100
5.90
590.00
Goods Available for
Sale
1,550
$8,370.00
Ending Inventory
- 800
× 5.40 = - 4,320.00
Goods Sold
750
$4,050.00
7-56
Effect of Different Cost Flow
Methods on Inventory and CGS
In the previous examples of the three cost flow
methods, what are the two possibilities for
what happened to GAS as of year end?
Became either: (1) Ending Inventory or
(2) Cost of Goods Sold
Computer, Inc.
Mouse Pad Inventory
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
FIFO
LIFO
Wtd. Avg.
$8,370.00
4,432.50
$3,937.50
$8,370.00
4,200.00
$4,170.00
$8,370.00
4,320.00
$4,050.00
7-57
Effect of Different Cost Flow
Methods on Inventory and CGS
255
Facts for all 4 Cost Flow Examples
Goods Available for Sale
Also see Illustrations 7.7, 7.8, 7.10 & 7.12
7-58
Effect of Different Cost Flow
Methods on Inventory and CGS
264
ILL. 7.18 (Periodic)
7-59
Effect of Different Cost Flow
Methods on Inventory and CGS
7-60
Perpetual Inventory Procedure
Now let’s turn our attention to the
perpetual inventory procedure.
7-61
FIFO
Perpetual Inventory Procedure
Let’s start with some fresh information.
Computers, Inc. has 1,200 units in inventory
on November 30. The company started the
month of November with 1,000 units on hand
at a cost of $5.25 per unit.
The company uses the FIFO perpetual
procedure to determine:
(1) Ending inventory
(2) Cost of goods sold
7-62
FIFO
Perpetual Inventory Procedure
To calculate the FIFO cost
for ending inventory and
cost of goods sold, we
must know when each
unit was sold. In this
example we will provide
information for
purchases and sales as it
is needed.
7-63
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
Purchases
On November 3rd, 300
units were purchased
at $5.30 per unit. We need
to update the inventory.
Balance
1,000@$5.25
Cost of
Goods Sold
7-64
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
Purchases
300@$5.30
Balance
1,000@$5.25
300@$5.30
Cost of
Goods Sold
7-65
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
Purchases
300@$5.30
On November 5th, 600
units were sold. We need
to update the inventory.
Balance
1,000@$5.25
300@$5.30
Cost of
Goods Sold
7-66
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
11/5
Purchases
300@$5.30
Balance
400@$5.25
300@$5.30
Cost of
Goods Sold
600@$5.25
7-67
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
11/5
Purchases
300@$5.30
Balance
400@$5.25
300@$5.30
On November 10th, 150
units were purchased
at $5.60 per unit. We need
to update the inventory.
Cost of
Goods Sold
600@$5.25
7-68
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
11/5
11/10
Purchases
300@$5.30
Balance
400@$5.25
300@$5.30
Cost of
Goods Sold
600@$5.25
150@$5.60
150@$5.60
7-69
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
11/5
11/10
Purchases
300@$5.30
Balance
400@$5.25
300@$5.30
Cost of
Goods Sold
600@$5.25
150@$5.60
150@$5.60
On November 14th, 200
units were purchased
at $5.80 per unit. We need
to update the inventory.
7-70
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
11/5
11/10
11/14
Purchases
300@$5.30
Balance
400@$5.25
300@$5.30
Cost of
Goods Sold
600@$5.25
150@$5.60
200@$5.80
150@$5.60
200@$5.80
7-71
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
11/5
11/10
11/14
Purchases
300@$5.30
Balance
400@$5.25
300@$5.30
Cost of
Goods Sold
600@$5.25
150@$5.60
200@$5.80
150@$5.60
200@$5.80
On November 17th, 500
units were sold. We need
to update the inventory.
7-72
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
11/5
11/10
11/14
11/17
Purchases
300@$5.30
Balance
Cost of
Goods Sold
200@$5.30
600@$5.25
150@$5.60
200@$5.80
150@$5.60
200@$5.80
400@$5.25
100@$5.30
7-73
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
11/5
11/10
11/14
11/17
Purchases
300@$5.30
Balance
Cost of
Goods Sold
200@$5.30
600@$5.25
150@$5.60
200@$5.80
150@$5.60
200@$5.80
400@$5.25
100@$5.30
On November 23rd, 400
units were sold. We need
to update the inventory.
7-74
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
11/5
11/10
11/14
11/17
11/23
Purchases
Balance
Cost of
Goods Sold
300@$5.30
600@$5.25
150@$5.60
200@$5.80
150@$5.80
400@$5.25
100@$5.30
200@$5.30
150@$5.60
50@$5.80
7-75
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
11/5
11/10
11/14
11/17
11/23
Purchases
Balance
Cost of
Goods Sold
300@$5.30
600@$5.25
150@$5.60
200@$5.80
150@$5.80
On November 30th, 150
units were purchased
at $5.90 per unit. We need
to update the inventory.
400@$5.25
100@$5.30
200@$5.30
150@$5.60
50@$5.80
7-76
FIFO
Perpetual Inventory Procedure
Computer, Inc.
Mouse Pad Inventory
Date
Beg. Bal.
BI
1,000@$5.25
11/3
11/5
11/10
11/14
11/17
Purchases
Balance
300@$5.30
600@$5.25
150@$5.60
200@$5.80
150@$5.80
400@$5.25
100@$5.30
200@$5.30
150@$5.60
50@$5.80
11/23
11/30
Cost of
Goods Sold
150@$5.90
150@$5.90
7-77
LIFO
Perpetual Inventory Procedure
You are not responsible for this method.
260
7-78
First-In, First-Out
Periodic
Inventory
System
Perpetual
Inventory
System
Cost of Goods Sold
Same
Cost of Goods Sold
Ending
Inventory
Same
Ending
Inventory
7-79
Last-In, First-Out
Periodic
Inventory
System
Perpetual
Inventory
System
Cost of Goods Sold
Different
Cost of Goods Sold
Ending
Inventory
Different
Ending Inventory
7-80
Weighted-Average
Perpetual Inventory Procedure
You are not responsible for this method.
261
7-81
Advantages and Disadvantages
of FIFO





Advantages
Easy to apply.
Inventory value
approximates current
cost.
Flow of costs tends to
be consistent with
usual physical flow of
goods.
Systematic and
objective.
Not subject to
manipulation.
7-82
Advantages and Disadvantages
of FIFO





Advantages
Easy to apply.
Inventory value
approximates current
cost.
Flow of costs tends to
be consistent with
usual physical flow of
goods.
Systematic and
objective.
Not subject to
manipulation.



Disadvantages
Does not match current
cost of goods sold with
current revenues.
Inventory (or paper)
profits.
In periods of rising
prices, pay higher
income taxes.
7-83
Advantages and Disadvantages
of LIFO


Advantages
In periods of rising
prices, pay less taxes.
Matches latest
inventory costs with
current revenues.



Disadvantages
LIFO conformity rule for
tax and book purposes.
Cost of record keeping
higher.
Inventory valuation is at
older costs.
7-84
In Periods of Rising Prices. . .



LIFO
Matches high
(newer) costs with
current (higher)
sales.
Values inventory on
low (older) cost
basis.
Results in lower
taxable income.



FIFO
Matches low (older)
costs with current
(higher) sales.
Values inventory
approximating
higher current
costs.
Results in higher
taxable income.
7-85
Departures From Cost Basis of
Inventory Valuation
GAAP requires inventory be valued at
the Lower of Cost or Market (LCM).



Cost refers to the invoice price and other costs
such as transportation. It is determined by one of
the four inventory cost flow methods previously
discussed.
Market generally refers to the replacement cost of
the inventory.
LCM is called the inventory “valuation method”
7-86
Departures From Cost Basis of
Inventory Valuation
Lower-of-Cost-or-Market Method (LCM)
Item
Mouse pad
Diskettes
Keyboard
Quantity
800
1,000
75
Unit Cost
$
5.75
2.19
27.00
Unit
Market
$ 4.50
2.25
29.00
Total
Cost
$ 4,600
2,190
2,025
$ 8,815
**LCM applied on an item-by-item basis.
Total
Market
$ 3,600
2,250
2,175
$ 8,025
LCM**
$ 3,600
2,190
2,025
$ 7,815
7-87
Estimating Inventory
Necessary due to fire, theft, and
interim reporting, primarily when
using the periodic inventory method.
Methods for Estimating
Gross Margin Method
 Retail Inventory Method

Not responsible for this one
7-88
Gross Margin Method
To use this method we must know
the following:
Net sales for the period.
Cost of beginning inventory.
Net purchases for the period.
The historical gross margin rate.

 

7-89
Gross Margin Method
Because of a May 31st fire at its warehouse,
DonCo, Inc. must use the gross margin method
to estimate the value of its lost inventory. The
controller develops the following information:
gross profit 43% of sales; Inventory at May 1
$237,400; net purchases for May $728,300; net
sales for May $1,213,000.
Let’s estimate inventory at May 31.
7-90
Gross Margin Method
Beginning inventory, May 1
Net purchases for May
Cost of goods available for sale
$
$
237,400
728,300
965,700
7-91
Gross Margin Method
Beginning inventory, May 1
Net purchases for May
Cost of goods available for sale
$
Net sales for May
Estimated gross profit percentage
Estimated gross profit
$ 1,213,000
43%
$
521,590
$
237,400
728,300
965,700
7-92
Gross Margin Method
Beginning inventory, May 1
Net purchases for May
Cost of goods available for sale
$
Net sales for May
Estimated gross profit percentage
Estimated gross profit
$ 1,213,000
43%
$
521,590
Net sales for May
Estimated gross profit
Estimated cost of goods sold
$ 1,213,000
521,590
$
691,410
$
237,400
728,300
965,700
7-93
Gross Margin Method
Beginning inventory, May 1
Net purchases for May
Cost of goods available for sale
$
Net sales for May
Estimated gross profit percentage
Estimated gross profit
$ 1,213,000
43%
$
521,590
Net sales for May
Estimated gross profit
Estimated cost of goods sold
$ 1,213,000
521,590
$
691,410
Cost of goods available for sale
Less: Estimated cost of goods sold
Estimated inventory, May 31
$
$
$
237,400
728,300
965,700
965,700
691,410
274,290
7-94
Gross Margin Method
Proof of Estimate
Sales for May
Cost of goods sold:
Beginning inventory
Net purchases
Cost of goods available for sale
Estimated ending inventory
Cost of goods sold
Gross profit for May
$ 1,213,000
$ 237,400
728,300
965,700
274,290
$
691,410
521,590
269
7-95
THE
END
(Almost)