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Intermediate Accounting 11th edition
Nikolai Bazley Jones
An electronic presentation
By Norman Sunderman and Kenneth Buchanan
Angelo State University
COPYRIGHT © 2010 South-Western/Cengage Learning

Flow of Inventory Costs
Accounts Payable
(or Cash)
Merchandising Company
Merchandise
Inventory
Cost of
Goods Sold
2
Goods
Purchased
Goods
Sold

Flow of Inventory Costs
Accounts Payable
(or Cash)
Manufacturing Company
Raw Materials
Inventory
To Work in Process
Inventory
Materials
Purchased
Materials
Used in
Production
3
Continued

Flow of Inventory Costs
Direct Labor
Actual
Direct
Labor
Manufacturing Company
Labor Charged to Production Manufacturing
(Factory)
Overhead
Actual
Mfg.
Overhead
Overhead Applied to Production
To Work in Process
Inventory
To Work in Process
Inventory
Continued
4

Flow of Inventory Costs
Manufacturing Company
Materials Used
Direct Labor
Overhead Applied
Work in Process
Inventory
Finished Goods
Goods Finished
(Manufactured)
Inventory
Goods Sold to
Cost of Goods Sold
5

A company using a perpetual system maintains a continuous record of the physical quantities in its inventory.
6

A company using a periodic system does not maintain a continuous record of the physical quantities of inventory on hand.
7

Purchases
+ Freight-in
– Purchases Returns and
Allowances
– Purchases Discounts Taken
= Net Purchases
8

Comparison of Systems
Perpetual
Inventory System
Beginning Inventory
+ Purchases (net)
– Goods Sold
= Ending Inventory
Periodic
Inventory System
Beginning Inventory
+ Purchases (net)
– Ending Inventory
= Goods Sold
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
Price paid or consideration given

Freight-in

Receiving

Unpacking

Inspecting

Storage

Insurance

Applicable taxes
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Purchases Discounts
Under the gross price method , a company records the purchase at the gross price and records the amount of the discount in the accounting system only if the discount is taken.
Under the net price method , a company records the purchase at its net price and records the amount of the discount in the accounting system only if the discount is not taken.
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Annual Rate on Discounts
A company purchases $1,000 of goods under terms of 2/10, n/30. What is the annual discount rate?
If the company does not pay promptly, it is forfeiting
2% in order to keep the money for an additional 20 days.
The company can forfeit this discount 18 times during a year. (360 days/20 additional each time =
18)
2% forfeited 18 times equals an annual interest rate of 36%
12

Specific Identification
Apr. 1
Apr. 10
Apr. 20
100 units @ $10 per unit
80 units @ $11 per unit
70 units @ $12 per unit
On April 27, 90 units were sold from the beginning inventory and 50 units from the
April 10 purchase.
13

Specific Identification
Apr. 1
Apr. 10
Apr. 20
Apr. 1
Apr. 10
Apr. 20
= Sold 90
=
=
Ending Inventory………… $1,270
90 units @ $10 per unit = $ 900
50 units @ $11 per unit = 550
0 units @ $12 per unit = 0
Cost of Goods Sold……….
$1,450
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Specific Identification
Apr. 1
Apr. 10
Apr. 20
Apr. 1
Apr. 10
Apr. 20
100 units @ $10 per unit =
80 units @ $11 per unit =
70 units @ $12 per unit =
Goods Available for Sale…
$ 1,000
880
840
$2,720
10 units @ $10 per unit =
30 units @ $11 per unit =
70 units @ $12 per unit =
Ending Inventory…………
$ 100
330
840
$1,270
$1,480
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First-In, First-Out (FIFO)
Apr. 1
Apr. 10
Apr. 20 70 units @ $12 per unit
Sold all
Sold 40
Sold 0
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Sold 140 units during April

First-In, First-Out (FIFO)
Apr. 1
Apr. 10
Apr. 20
= $ 0
=
70 units @ $12 per unit =
Ending Inventory…………
440
840
$1,280
Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold
$1,000 + $1,720 – $1,280 = $1,440
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First-In, First-Out (FIFO)
The ending inventory and the cost of goods sold under perpetual and periodic FIFO are identical.
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Average Cost
Apr. 1 100 units @ $10 per unit = $1,000
Apr. 10 80 units @ $11 per unit = 880
Apr. 20 70 units @ $12 per unit
250 units
$2,720

250 units = $10.88
= 840
$2,720
$10.88 × 110 units = Ending Inventory of $1,197
Sold 140 units during April
Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold
$1,000 + $1,720 – $1,197 = $1,523
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Moving Average
Apr. 1 Beginning Inventory 100 units @ $10
Apr. 10 Purchases 80 units @ $11
Apr. 10 Balance
$1,880

180
Apr. 18 Sales
Apr. 18 Balance
Apr. 20 Purchases
Apr. 20 Balance
Apr. 27 Sales
180 units @ $10.44
(90) units @ $10.44
$1,000
880
$1,880
(940)
90 units @ $10.44
$ 940
70 units @ $12 840
160 units @ $11.125
$1,780
(50) units @ $11.125
(556)
Apr. 30 Balance 110 units @ $11.125
$1,224
Cost of Goods Sold (140 units) $940 + $556
Ending Inventory (110 units @ $11.125)
$1,780

160
$1,496
$1,224
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Last-In, First-Out (LIFO)
Apr. 1
Apr. 10
Apr. 20
Periodic Inventory System
100 units @ $10 per unit Sold 0
Sold 70
Sold all
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Sold 140 units during April

Last-In, First-Out (LIFO)
Apr. 1
Apr. 10
Apr. 20
Periodic Inventory System
100 units @ $10 per unit = $1,000
=
=
Ending Inventory…………
110
0
$1,110
Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold
$1,000 + $1,720 – $1,110 = $1,610
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Apr. 1
Apr. 10
Apr. 20
Last-In, First Out (LIFO)
Perpetual Inventory System
70 units @ $12 per unit
Sold 10
Purchased
Sold 80
Purchased
70
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Sold 90 units during April

Apr. 1
Apr. 10
Apr. 20
Last-In, First Out (LIFO)
Perpetual Inventory System
90 units @ $10 per unit
0 units @ $11 per unit =
20 units @ $12 per unit =
Ending Inventory…………
= $ 900
0
240
$1,140
Beginning Inventory + Purchases – Ending Inventory = Cost of Goods Sold
$1,000 + $1,720 – $1,140 = $1,580
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Cost Flow
Assumption and Method
FIFO, periodic
FIFO, perpetual
Weighted average
Moving average
LIFO, periodic
LIFO, perpetual
Cost of Goods Cost of
Available Goods Ending for Sale Sold Inventory
$2,720
2,720
2,720
2,720
2,720
2,720
$1,440
1,440
1,523
1,496
1,610
1,580
$1,280
1,280
1,197
1,224
1,110
1,140
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Holding Gains Comparisons
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FIFO matches the oldest cost with revenue.
LIFO matches the most recent cost with revenue.

Liquidation of LIFO Layers
2006:
2007:
2008:
2009:
10,000 units @ $20 per unit = $200,000
6,000 units @ $22 per unit = 132,000
8,000 units @ $24 per unit = 192,000
4,000 units @ $30 per unit =
Inventory, Jan. 1, 2010…..
120,000
$644,000
In 2010 the company purchases 50,000 units at $35 per unit but sells 60,000 units.
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Liquidation of LIFO Layers
2006:
2007:
2008:
2009:
2010:
10,000 units @ $20 per unit
6,000 units @ $22 per unit
= $ 200,000
= 132,000
= 192,000
= 120,000
In 2010 the company purchases 50,000 units at $35 per unit and sells 60,000 units.
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Liquidation of LIFO Layers
2006:
2007:
2008:
10,000 units @ $20 per unit
6,000 units @ $22 per unit
2,000 units @ $24 per unit
2008:
2009:
2010:
6,000 units @ $24 per unit = $ 144,000
4,000 units @ $30 per unit = 120,000
50,000 units @ $35 per unit = 1,750,000
Cost of Goods Sold………..
$2,014,000
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1.
The LIFO method requires a company to keep numerous detailed records.
2.
Fluctuations in the physical quantities of similar inventory items may occur.
3.
As technological changes take place, inventory made up with one material is replaced by inventory made with substitute materials, or an outdated design is replaced by a newer design.
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Dollar-Value LIFO
Step 1: Value the total ending inventory at current-year costs.
01/01/09
12/31/09
12/31/10
12/31/11
12/31/12
$10,000
$12,100
$13,125
$16,800
$12,360
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Dollar-Value LIFO
Step 2: Convert the ending inventory cost to base-year costs.
12/31/09 $12,100 × 100/110 = $11,000
12/31/10
12/31/11
$13,125
$16,800
12/31/12 $12,360
12/31/09
Ending
Inventory at
Current Costs
×
Base-Year
Cost Index
Current
Cost Index
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Dollar-Value LIFO
Step 3: Compute the change in the inventory level for the year at base-year costs.
12/31/09
12/31/10
12/31/11
12/31/12
$11,000
$10,500
$12,000
$10,300
$11,000 – $10,000
$1,000
Base year, $10,000
1/1/09
12/31/09
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Dollar-Value LIFO
Step 4a: If there is an increase in the inventory levels at base-year costs, convert this increase to current-year costs.
$1,000
× 110/100 = $ 1,100
Base year, $10,000
× 100/100 = 10,000
$11,100
12/31/09
Ending inventory,
12/31/09
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Dollar-Value LIFO
Step 2: Convert the ending inventory cost to base-year costs.
12/31/09
12/31/10
$12,100
$13,125
× 100/110 = $11,000
× 100/125 = $10,500
12/31/11 $16,800
12/31/12 $12,360
12/31/10
Ending
Inventory at
Current Costs
×
Base-Year
Cost Index
Current
Cost Index
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Dollar-Value LIFO
Step 3: Compute the change in the inventory level for the year at base-year costs.
12/31/09
12/31/10
12/31/11
12/31/12
$11,000
$10,500
$12,000
$10,300
$11,000 – $10,500
$1,000
Base year, $10,000
12/31/10
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Dollar-Value LIFO
Step 3: Compute the change in the inventory level for the year at base-year costs.
12/31/09
12/31/10
12/31/11
12/31/12
$11,000
$10,500
$12,000
$10,300
$500
Base year, $10,000
12/31/10
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Dollar-Value LIFO
Step 4b: If there is a decrease in the inventory levels at base-year costs, this decrease reduces the inventory.
$500 × 110/100 = $ 550
Base year, $10,000 × 100/100 = 10,000
$10,550
12/31/10
Ending inventory,
12/31/10
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Dollar-Value LIFO
Step 2: Convert the ending inventory cost to base-year costs.
12/31/09
12/31/10
12/31/11
$12,100
$13,125
$16,800
× 110/100 = $11,000
× 100/125 = $10,500
× 100/140 = $12,000
12/31/12 $12,360
12/31/11
Ending
Inventory at
Current Costs
×
Base-Year
Cost Index
Current
Cost Index
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Dollar-Value LIFO
Step 3: Compute the change in the inventory level for the year at base-year costs.
12/31/09
12/31/10
12/31/11
12/31/12
$11,000
$10,500
$12,000
$10,300
$500
Base year, $10,000
12/31/11
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Dollar-Value LIFO
Step 3: Compute the change in the inventory level for the year at base-year costs.
12/31/09
12/31/10
12/31/11
12/31/12
$11,000
$10,500
$12,000
$10,300
$1,500
$500
Base year, $10,000
12/31/11
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Dollar-Value LIFO
Step 4a: If there is an increase in inventory levels at base-year costs, convert this increase to current-year costs.
$1,500
$500
× 140/100 = $ 2,100
× 110/100 =
550
Base year, $10,000
12/31/11
× 100/100 = 10,000
$12,650
Ending inventory,
12/31/11
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Dollar-Value LIFO
Step 2: Convert the ending inventory cost to base-year costs.
12/31/09
12/31/10
12/31/11
12/31/12
12/31/12
$12,100
$13,125
× 110/100 = $11,000
× 100/125 = $10,500
$16,800 × 100/140 = $12,000
$12,360
Ending
Inventory at
Current Costs
×
×
100/120 = $10,300
Base-Year
Cost Index
Current
Cost Index
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Dollar-Value LIFO
12/31/09
12/31/10
12/31/11
12/31/12
$11,000
$10,500
$12,000
$10,300
$1,500
$500
Base year, $10,000
12/31/12
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Dollar-Value LIFO
12/31/09
12/31/10
12/31/11
12/31/12
$11,000
$10,500
$12,000
$10,300
$500
Base year, $10,000
12/31/12
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Dollar-Value LIFO
12/31/09
12/31/10
12/31/11
12/31/12
$11,000
$10,500
$12,000
$10,300
$300
Base year, $10,000
12/31/12
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Dollar-Value LIFO
Step 4a: If there is an increase in the inventory levels at base-year costs, convert this increase to current-year costs.
$300 × 110/100 = $ 330
Base year, $10,000 × 100/100 = 10,000
$10,330
12/31/12
Ending inventory,
12/31/12
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Determination of Cost Index
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Cost Index =
Sample of Ending Inventory at Current-Year Costs
× 100
Sample of Ending Inventory at Base-Year Costs
Double-Extension Method

Determination of Cost Index
49
Cost Index =
Sample of Ending Inventory at Current -Year Costs
Sample of Ending Inventory at Previous-Year Costs
×
Previous-
Year Cost
Index
Link-Chain Method

A company may use inventory pools in conjunction with dollar-value LIFO. The purpose of the pools is to maintain the benefits from using
LIFO when fluctuations in the physical quantities or similar inventory items occur and when technological change takes place.
50


Life Valuation Adjustment - Frequently, a company uses LIFO for external financial reporting and income tax purposes but uses another method for internal management.
51


Interim Statements Using LIFO – If a company uses LIFO for annual reporting purposes, it must use LIFO for interim reporting purposes.
GAAP states that if a company using LIFO has an inventory liquidation at an interim date that it expects to replace by the end of the annual period, it does not include the LIFO liquidation in its inventory, and its cost of sales includes the expected cost of replacement of the liquidated LIFO inventory.
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
Change to or from LIFO - A company may occasionally change its inventory cost flow assumption.
 To – Usually, the effect on the results of prior periods is not determinable. Then GAAP requires that the company apply the change prospectively, as of the earliest date practicable.

From – Retroactively restate the results of prior periods and treat the change as a retrospective adjustment.
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IFRS vs. U.S. GAAP

IFRS do not allow the use of LIFO for both financial and tax purposes.

While both U.S. GAAP and IFRS allow the use of multiple acceptable cost flow assumptions,
IFRS require that the same assumption be used for all inventories that have a similar nature and use. No such requirement exists under U.S. GAAP.
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Appendix: Foreign Currency Transactions Involving Inventory
When exchange rates are stated in terms of $ per unit of foreign currency, exchange gains and losses occur for purchases or sales on account as follows:
1.
An exchange gain occurs when the exchange rate declines between the date a payable is recorded as a result of a purchase of inventory and the date of the cash payment.
2.
An exchange gain occurs when the exchange rate increases between the date a receivable is recorded as a result of a sale of inventory and the date of the cash receipt.
Continued
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Appendix: Foreign Currency Transactions Involving Inventory
3.
An exchange loss occurs when the exchange rate increases between the date a payable is recorded as a result of a purchase of inventory and the date of the cash payment.
4.
An exchange loss occurs when the exchange rate declines between the date a receivable is recorded as a result of a sale of inventory and the date of the cash receipt.
RMB
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Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.
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