Chapter 6
Acquisitions/Payment:
Inventory and Liabilities
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Prentice Hall Publishing
1
Inventory
 Inventory is tangible property that is
held for resale or will be part of goods
held for resale.
 Inventory is reported on the balance
sheet as a current asset.
 Types of inventory:




merchandise inventory
Raw materials inventory
Work in process inventory
Finished goods inventory
Copyright 2003
These 3 will
be studied
in managerial
accounting.
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2
Inventory Cost

The amount recorded for inventory
should include:

Invoice price, freight charges, inspection
costs, and preparation costs.
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3
Terms of Sale and Purchases
 2/10, n/30 (for example)
2% discount if invoice paid in ten days
 tells when and how much must be paid
 high interest cost of not taking purchase
discounts

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Shipping Terms
(Sales & Purchases)
 F.O.B. shipping point or destination
 tells who pays shipping
 and who includes the inventory on the
Balance Sheet when in-transit.
 F.O.B shipping indicates that the title to
the goods changes hands at shipping.
 F.O.B. destination indicates that the title
to the goods changes hands at
destination.
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Shipping Costs
 Whoever owns the goods
while they are in-transit
pays for the shipping.
 Shipping costs to get the
inventory IN are included
as part of the cost of the
inventory.
 Shipping costs for a sale
are part of operating
expenses.
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6
Alternative Inventory Cost Flow Methods
FIFO
LIFO
Weighted
Average
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7
Inventory Cost Flow Methods
These four inventory costing methods
are used to assign the total dollar
amount of goods available for sale
between ending inventory and cost of
goods sold.
Ending
inventory
or CGS??
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8
First-In, First-Out

The cost of the oldest inventory items
are charged to cost of goods sold when
goods are sold.

The cost of the newest inventory items
remain in ending inventory.

The actual physical flow of inventory
items may differ from the FIFO cost flow
assumptions.
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9
Last-In, First-Out

The cost of the newest inventory items
are charged to cost of goods sold when
goods are sold.

The cost of the oldest inventory items
remain in ending inventory.

The actual physical flow of inventory
items may differ from the LIFO cost flow
assumptions.
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10
Weighted-Average
Take the average cost of all goods
available for sale to value both COGS and
Ending Inventory.
 BE SURE IT’S WEIGHTED!

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11
Specific Identification

Specific cost of each inventory item
is known.

Used with small volume, high dollar
inventory.
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12
Perpetual Inventory Systems
 The inventory account is continuously updated for the
following items:
 Purchases
 Returns & Allowances
 Sales
 Detailed record-keeping has become much easier with
current technology.
 A physical count of the inventory is still required at the
end of the accounting period to assure accurate
inventory records in case of errors or theft.
Periodic Inventory Systems
 The ending inventory is determined at
the end of the period by taking a
physical count of the goods remaining
on hand.
 Cost of goods sold is calculated at the
end of the accounting period using the
ending inventory count.
Cost of Goods Sold
Beginning inventory
Add: Purchases (net)
Goods available for sale
Deduct: Ending inventory
Cost of goods sold
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Periodic Inventory Systems


Because entries are not made to the
inventory account during the
accounting period, the amount of
inventory is not known until the end of
the period, when the inventory count
is done.
This system is being used less and
less due to advancements in
technology.
Financial Statements:
Income Statement:
FIFO
LIFO
Sales
CGS
GM
Balance Sheet:
Inventory
Wt. Avg.
$236
116
120
$236
146
90
$ 236
131
105
$122
$ 92
$ 107
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17
Comparison of Methods

Each of the four methods is acceptable,
and an argument can be made for using
each.

The choice of an inventory method will
depend on management’s incentives,
the tax laws, and the reporting
company’s particular economic
circumstances.
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18
Consistency Principle
Because the choice of an
inventory method can
significantly affect the
financial statements, a
company might be inclined
to select a new method
each year that would result
in the most favorable
financial statements.
However . . .
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19
Errors in Measuring Ending Inventory

Misstatements in inventory may cause errors
in the following areas:
 Income Statement
» Cost of Goods Sold, Gross Profit, Net Income

Balance Sheet
» Inventory, Payables, Retained Earnings

Because the ending inventory of one period
becomes the beginning inventory of the next
period, ending inventory errors affect two
accounting periods.
Gross Profit Method of
Estimating Inventory
Provides an estimate
 Not acceptable for GAAP
 When to use

for interim reporting purposes
 when physical inventory not possible

Lower of Cost or Market

Ending inventory is reported at the
lower of cost or market (LCM).

Market refers to the replacement cost
of the merchandise.

An example of conservatism in
accounting