Chapter 15
Accounting for Merchandise
Inventory
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Practical Approach, 11e by Slater
Learning Objective 1
Understanding and journalizing
transactions using the perpetual inventory
system and explaining the difference
between perpetual and periodic inventory
systems
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Perpetual Inventory System
Two key accounts
 Merchandise Inventory
◦ Asset
◦ Current balance of Inventory at all times
◦ Entries are recorded for each purchase and each sale
of Inventory

Cost of Goods Sold
◦ Cumulative total cost of all merchandise sold to
customers during accounting period

Both accounts provide current info to mgmt
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Perpetual vs. Periodic System
Perpetual system
 Value of Inventory is known after every
purchase & sale
 Cost of goods sold is known after every sale
 Purchases, purchase returns & allowances, and
freight accounts don’t exist
Periodic system
 Does not give accurate info about Merchandise
Inventory or C.O.G.S. until ending Inventory is
done
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LO-1
Perpetual Inventory System
We will use Problem 15B-1 to illustrate the journal
entries involved with the perpetual inventory
system.
Transactions for March:
15-Purchased merchandise on acct. totaling $1,800, terms n/30.
16- Sold merchandise costing $71 on acct. for $92 to B. Hackett.
18- Returned $120 of defective merchandise purchased Mar. 15.
19- Sold $230 of merchandise for cash. It costs $175.
19- Allowed merchandise sold on Mar. 16 return for credit -$14. It
costs $11.
20- Bought $900 merchandise on acct. from JT Supply; terms n/30.
22- Received pmt from B. Hackett for Mar. 16 sale less return.
23- Sold $410 of merchandise costing $320 for cash.
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Problem 15B-1
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Problem 15B-1
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Problem 15B-1
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Problem 15B-1
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LO-1
Learning Objective 2
Maintaining a subsidiary ledger for
inventory
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Inventory Subsidiary Ledger
A business with a variety of products in
Inventory will use Inventory subsidiary
ledger
 Maintain an individual record for each
different product
 Companies like Wal-Mart and Target use
this ledger

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Practical Approach, 11e by Slater
LO-2
Merchandise Inventory
Subsidiary Accounts
ITEM: Product A
PURCHASED
SOLD
BALANCE
DATE
Controlling Account
Merchandise Inventory
Sep. 1
6 @ $30=$180
ITEM: Product B
PURCHASED
SOLD
BALANCE
DATE
Bal. 292
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Sep. 1
8 @ $14 =$112
LO-2
Merchandise Inventory
Controlling Account
Subsidiary Accounts
ITEM: Product A
Merchandise Inventory
PURCHASED
SOLD
DATE
Sep. 1
Sep. 4 5 @ $30
Bal. 292
BALANCE
6 @ $30=$180
11 @ $30=$330
Sep. 4 150
Bal. 442
Bal. 442
ITEM: Product B
PURCHASED
SOLD
BALANCE
DATE
Purchased 5 units of
Product A for $30 on Sep. 4.
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Sep. 1
8 @ $14 =$112
LO-2
Merchandise Inventory
Controlling Account
Subsidiary Accounts
ITEM: Product A
PURCHASED
Merchandise Inventory
Bal. 292
210 Sep. 8
SOLD
BALANCE
DATE
Sep. 1
Sep. 4 5 @ $30
Sep. 8
7 @ $30
6 @ $30=$180
11 @ $30=$330
4 @ $30 =$120
Sep. 4 150
Bal. 232
Bal. 232
ITEM: Product B
PURCHASED
SOLD
BALANCE
DATE
Sep. 1
8 @ $14 =$112
Sold 7 units of
Product A on Sep. 8.
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Practical Approach, 11e by Slater
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Learning Objective 3
Understanding periodic methods of
determining the value of the ending
inventory
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Inventory Valuation MethodsPeriodic Inventory System
Specific Invoice
 First In, First Out (FIFO)
 Last In, First Out (LIFO)
 Weighted Average

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Inventory Valuation MethodsPeriodic Inventory System

Method used will have effect on
◦ Ending Inventory
◦ Cost of goods sold
◦ Gross profit
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Specific Invoice Method
Identify each item in ending Inventory by
a specific purchase price and invoice
number
 Also known as specific identification
method
 Would be used with cars, boats, and
antiques.

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Specific Invoice Method
Pros
Simple if small
amounts of high-cost
goods
Flow of goods and
flow of cost are same
Costs are exactly
matched with Sales
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Cons
 Difficult if large unit
volume and small
unit prices
First In, First Out Method
Assume that the oldest goods are sold
first
 Ending Inventory valued at costs shown
on most recent invoices
 Refer to Problem 15B-4

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First In, First Out Method
At end of year, 400 units unsold
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First In, First Out Method
Cost of Goods Available for Sale
Less Cost of Ending Inventory
Cost of Goods Sold
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$43,800
22,000
$21,800
LO-3
First In, First Out Method
Pros
Cost flow tends to
follow physical flow
Ending Inventory
valuation is made up of
current costs on
balance sheet
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Cons
 During inflationary
periods, FIFO
produces higher net
income, thus more
taxes to be paid
 Recent costs are not
matched with recent
Sales
LO-3
Last In, First Out Method
Assume that the goods most recently
acquired are sold first
 Ending Inventory valued at earliest invoice
costs
 Refer again to Problem 15B-4

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Last In, First Out Method
At end of year, 400 units unsold
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Last In, First Out Method
Cost of Goods Available for Sale
Less Cost of Ending Inventory
Cost of Goods Sold
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$43,800
11,300
$32,500
LO-3
Last In, First Out Method
Pros
Cost of goods sold is near
current costs
Matches current costs with
current selling price
During inflationary periods,
LIFO produces lowest net
income, a tax advantage
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Practical Approach, 11e by Slater


Cons
Ending Inventory is
valued at old prices
Does not match physical
flow of goods
LO-3
Weighted-Average Method
Average unit cost =
Total cost of goods available for sale
Total units of goods available for sale
 Usually falls between FIFO & LIFO
amounts
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Weighted-Average Method
Average Unit Cost = $43,800 / 1,010 = $43.37
Ending Inventory = 400 units x $43.37 = $17,348
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Practical Approach, 11e by Slater
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Weighted-Average Method
Cost of Goods Available for Sale
Less Cost of Ending Inventory
Cost of Goods Sold
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$43,800
17,348
$26,452
LO-3
Weighted Average Method
Pros
Good for products sold in
large volume
An equal unit cost is assigned
to each unit in Inventory



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Practical Approach, 11e by Slater
Cons
Current prices have no
more significance than
older prices
Most recent costs are not
matched with current
Sales
Cost of ending Inventory is
not most recent costs
LO-3
When Can An Inventory Method Be
Changed?


Consistency Principle – requires companies to
follow the same accounting methods or
procedures from period to period
Full Disclosure Principle – requires companies
to disclose on their financial reports changes in
accounting procedures and methods along with
effect of the change as well as justification for
change
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Items That Should be Included in
the Cost of Inventory
Goods in Transit
F.O.B. shipping point – buyer becomes
owner when merchandise is placed on
carrier at shipping point
F.O.B. destination – seller maintains
ownership until merchandise reaches the
destination
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Items That Should Not be Included
in the Cost of Inventory
Merchandise on consignment - merchandise
sold through agent (consignee) who does not
own it, but has possession
 Damaged or obsolete merchandise - if not
saleable, should not be added to cost of
Inventory.
◦ If saleable at lower cost, value should be
conservatively estimated & added to
Inventory

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Items That Should be Included in
the Cost of Inventory

Goods in Transit - When inventory is taken, add
only if ownership of inventory has been
transferred to buyer.
◦ Only use with F.O.B. - shipping point

Damaged or Obsolete Merchandise - only
if saleable, estimate value at conservative
cost.
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Learning Objective 4
Estimating ending inventory using the
retail method and gross profit method
and understanding how the ending
inventory amount affects financial reports
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Methods of Estimating Ending
Inventory

Retail Method

Gross Profit Method
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Retail Method

Must know
◦ Beginning Inventory at cost and at retail
◦ Cost of net purchases at cost and at retail
◦ Net Sales at retail
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Retail Method – Problem 15B-5
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Retail Method – Problem 15B-5
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Retail Method – Problem 15B-5
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Retail Method – Problem 15B-5
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Gross Profit Method

Develops relationship among Sales, Cost of
Goods Sold, and gross profit

Can also be used to determine amount of
Inventory on hand at time of a fire

Can verify accuracy of physical Inventory at
year’s end
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Gross Profit Method

Helps prepare financial statements

Must know
◦ Average gross profit rate
◦ Net Sales, beginning Inventory, net purchases
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Gross Profit Method
Step 1: Compute cost of goods available for
sale
Step 2: Estimate Cost of Goods Sold by
multiplying cost percentage times
Net Sales
Step 3: Subtract Cost of Goods Sold from
cost of goods available for sale
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Problem 15B-6
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Effects of Inventory Errors
Error in ending Inventory in Year 1 affects
income statement for two years
 Year 1 ending Inventory becomes Year 2
beginning Inventory.

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Practical Approach, 11e by Slater
LO-4
Effects of Inventory Errors
If the item is:
Overstated
Understated
Beginning
Inventory
Profit is
understated
Profit is
overstated
Ending Inventory
Profit is
overstated
Profit is
understated
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Publishing, College Accounting: A
Practical Approach, 11e by Slater
LO-4
End of Chapter 15
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Publishing, College Accounting: A
Practical Approach, 11e by Slater