Inventories ACG 2021: Chapter 6 Created by: M. Mari Fall 2007

Inventories is used to indicate:  Merchandise held for sale in the normal course of business  Materials in the process of production or held for production.

What is included in the cost of inventory? Costs Transportation Import duties Insurance against losses in transit

Effect of Inventory Errors on Financial Statements Any errors in the inventory count will affect both the balance sheet and the income statement. Inventory could be overstated or understated

Inventory Cost Flow Assumptions A major accounting issue arises with identical units of merchandise are acquired at different unit costs during a period. First in, first out method – cost flow is in the order in which the costs were incurred. Last in, first out method – cost flow is in the reverse order in which the costs are incurred. Average cost – cost flow is an average of the costs

Inventory Costing Methods under a Perpetual Inventory System All merchandise increases and decreases are recorded in a manner similar to the recording or increases and decreases in cash. The merchandise inventory account at the beginning of an accounting period indicates the merchandise in stock on that date. Purchases are recorded by debiting Merchandise Inventory and crediting Cash or Accounts payable. On the date of each sale, the cost of the merchandise sold is recorded by debiting Cost of Merchandise Sold and crediting Merchandise Inventory.

First in, First out Method Most businesses dispose of goods in the order in which the goods are purchased. Especially true of perishables and goods whose styles or models often change. The FIFO method is often consistent with the physical flow or movement of merchandise.

First in, First out Method DateActivityUnitsCost per unit Jan 1Inventory100$20 Jan 4Sale70 Jan 10Purchase80$21 Jan 22Sale40 Jan 28Sale20 Jan 30Purchase100$22

Example 1: FIFO Questions: 1.What is cost of merchandise sold in January under FIFO? DateUnitsCost per unit Total Cost Jan 470$20$1400 Jan $20 $21 $810 Jan 2820$21$420 Total cost$2630 What is value of Ending inventory 50 $21 per unit $ $22 per unit 2200 Total 3250

Last in First Out When the LIFO method is used in a perpetual inventory system, the cost of units sold is the cost of the most recent purchases. Purchased in January 200 units Purchased in December 150 units. Sold 100 units 100 units come from December Purchase

Last in First Out Information below from last year’s activity DateActivityUnitsCost per unit Jan 1Inventory100$20 Jan 4Sale70 Jan 10Purchase80$21 Jan 22Sale40 Jan 28Sale20 Jan 30Purchase100$22

Example 2: LIFO Questions: 1.What is cost of merchandise sold in January under LIFO ? DateUnitsCost per unit Total Cost Jan 470$20$1400 Jan 2240$21840 Jan 2820$21$420 Total cost What is the value of ending inventory on January 30? 30 $20 per unit$ $21 per unit $22 per unit 2200 Total 3220

Average Cost Method When the average cost method is used in a perpetual inventory system, an average unit cost for each type of item is computed each time a purchase is made.

Inventory Costing Methods under a Periodic Inventory System When the periodic inventory system is used, only revenue is recorded each time a sale is made. No entry is made at the time of the sale to record the cost of the merchandise sold.

Computation of Cost of merchandise sold Merchandise inventory 1/1$59,700 Purchases$521,980 Less purchases returns$9,100 Purchases discounts 2,525 11,625 Net purchases 510,355 Add transportation in 17,400 Cost of merchandise purchased527,755 Merchandise available for sale587,455 Less merchandise inventory 12/31 62,150 Cost of merchandise sold525,305

First in, First out Method A physical inventory is conducted at the end of the year. Start at the beginning of year to calculate cost of merchandise sold At end of year: 300 units still in inventory. DateUnitsUnit cost Total Cost Jan 1Inventory200$9$1800 Mar 10Purchase300$10$3000 Sept 21Purchase400$11$4400 Nov 13Purchase100$12$1200 TOTAL1000$10,400

First In, First Out Method Jan 1 Inventory200$9$1,800 Mar 10Purchase ,000 Sept ,200 Nov 18 Cost of merchandise sold 700$7,000 Cost of merchandise sold: Total available for sale1,000 Ending inventory 300 Units sold 700 Units Cost/unit Total Cost We start allocating units sold from the beginning of the year to the end

First In, First Out Method Value of ending inventory = Total cost – Cost of merchandise sold = $10,400 – $7,000 = $3,400 Comprised of: Sept: 200 $11 = $2,200 Nov: $12 = $1,200 $3,400

Example for Students Jan 1Inventory150$5750 Mar 10Purchase Sept Nov Total available for sale Units in ending inventory 120. Compute Cost of merchandise under FIFO.

Last in, First out Method A physical inventory is conducted at the end of the year. Calculate the cost of merchandise sold by starting at the end of the year and working forward

Last in, First Out Method Jan 1Inventory200$9$1,800 Mar 10Purchase300103,000 Sept ,400 Nov ,200 Total available for sale 1,000$10,400 Suppose that ending inventory is 100 units, compute under FIFO: Cost of merchandise sold Ending inventory value

Last in, First Out Method Cost of merchandise sold: Total available for sale1,000 Ending inventory 300 Units sold 700

Last in, First Out Method Nov 18Purchase100$12$1,200 Sept Purchase ,400 Mar ,000 Cost of merchandise sold 700$7,600

Last in, First Out Method Value of ending inventory = Total cost – Cost of merchandise sold = $10,400 – 7,600 = $2,800 Comprised of: Mar: $10 = $1,000 Jan: $ 9 = $1,800 TOTAL $2,800

Example for Students Jan 1Inventory150$5750 Mar 10Purchase Sept Nov Total available for sale Units in ending inventory 120. Compute Cost of merchandise under LIFO.

Average Cost Method A physical inventory is conducted at the end of the year. Calculate the cost of merchandise sold by getting an average of the cost and multiplying by the number of units in ending inventory Average costs = Total cost/Total units Cost of merchandise sold: = Average cost X units sold

Average Cost Method Jan 1Inventory200$9$1,800 Mar 10Purchase300103,000 Sept ,400 Nov ,200 Total available for sale1,000$10,400 Ending inventory is 300 units, compute cost of goods sold under Average cost method.

Average Cost Method What is cost of merchandise sold in January under Average cost? Average costs  = Total cost / Total units  = $10,400/1000  = $10.40 per unit Cost of merchandise sold = Average costs X units sold = $10.4 per unit X 700 units = $7,200 Ending inventory = Average costs x units in ending inventory = $10.40 per unit x 300 units = $3200

Example for Students Jan 1Inventory150$5750 Mar 10Purchase Sept Nov Total available for sale Units in ending inventory 120. Compute Cost of merchandise under Average cost method.

Retail Method of Inventory Costing Estimates inventory cost based on the relationship of the cost of merchandise available for sale to the retail price of the same merchandise.

Retail Method of Inventory Costing CostRetail Merchandise inventory 1/1 $19,400$36,000 Purchases 42,600 64,000 Merchandise available for sale 62,000100,000

Retail Method of Inventory Costing Ratio of cost to retail price = $62,000/$100,000 = 62% Sales for January $70,000 Merchandise inventory January1st at retail: $30,000 Merchandise inventory at cost $30,000 x 62% = $18,600

Lower of Cost or Market Used for commodities Minerals

Lower of Cost or Market CommodityQuantityUnit CostUnit Market CostMarketLower A400$10.25$9.50$4,100$3,800 B ,7002,8922,700 C ,650 D ,9204,1303,920 15,53015,47215,070