Chapter 9 Inventories Accounting, 21st Edition Warren Reeve Fess © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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After studying this chapter, you should be able to: Objectives 1. Summarize and provide examples of internal control procedures that apply to inventories. 2. Describe the effect of inventory errors on the financial statement. 3. Describe the three inventory cost flow assumptions and how they impact the income statement and balance sheet. 4. Compute the cost of inventory under the perpetual inventory system, using the following cost methods: first-in, first-out; last-in, first-out; average cost. After studying this chapter, you should be able to:

Objectives 5. Compute the cost of inventory under the periodic inventory system, using the following costing methods: first-in, first-out; last-in, first-out; average cost. 6. Compare and contrast the use of the three inventory costing methods. 7. Compute the proper valuation of inventory at other than cost, using the lower-of-cost-or-market and net realization value concepts. 8. Prepare a balance sheet presentation of merchandise inventory.

Objectives 9. Estimate the cost of inventory, using the retail method and the gross profit method. 10. Compute the interpret the inventory turnover ratio and number of days’ sales in inventory.

Why is Inventory Control Important? Inventory is a significant asset and for many companies the largest asset. Inventory is central to the main activity of merchandising and manufacturing companies. Mistakes in determining inventory cost can cause critical errors in financial statements. Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.

AGREE AGREE AGREE Receiving report Purchase order Invoice JOURNAL Date Description Post. Ref. Nov. 9 Inventory 1 222 00 Accounts Payable--XYZ Co. 1 222 00 Purchased merchandise on account.

Effect of Inventory Errors on Financial Statements LIABILITIES Merchandise Inventory ASSETS OWNER’S EQUITY Net Income Cost of Merchandise Sold COSTS & EXPENSES REVENUES If merchandise inventory is . . . . . . . Cost of merchandise sold is . . . . . . Gross profit and net income are . . . Ending owner’s equity is . . . . . . . . . overstated understated

Effect of Inventory Errors on Financial Statements If merchandise inventory is . . . . . . . Cost of merchandise sold is . . . . . . Gross profit and net income are . . . Ending owner’s equity is . . . . . . . . . understated overstated

Inventory Cost Flow Assumptions Purchased goods FIFO Sold goods

Inventory Cost Flow Assumptions Sold goods Purchased goods LIFO

Inventory Cost Flow Assumptions Purchased goods Sold goods Average Cost

Inventory Costing Methods 43% 40% 30% 20% 10% 0% 34% 19% 4% Fifo Lifo Average Other

Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Item 127B Units Cost Price Jan. 1 Inventory 10 $20 4 Sale 7 $30 10 Purchase 8 21 22 Sale 4 31 28 Sale 2 32 30 Purchase 10 22 Cost of Mdse. Sold

Fifo Perpetual

FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

FIFO Perpetual Inventory Account Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Item 127B Units Cost Price Jan. 1 Inventory 10 $20 4 Sale 7 $30 10 Purchase 8 21 22 Sale 4 31 28 Sale 2 32 30 Purchase 10 22 Cost of Mdse. Sold On January 4, 7 units of Item 127B are sold at $30 each.

FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 Jan. 1 10 20 200 4 7 20 140 3 20 60 The sale of 7 units leaves a balance of 3 units. On January 4, 7 units of Item 127B are sold at $30 each.

FIFO Perpetual Inventory Account Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Item 127B Units Cost Price Jan. 1 Inventory 10 $20 4 Sale 7 $30 10 Purchase 8 21 22 Sale 4 31 28 Sale 2 32 30 Purchase 10 22 Cost of Mdse. Sold On January 10, the firm purchased eight units at $21 each.

FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 Because the purchase price of $21 is different than the cost of the previous 3 units on hand, the inventory balance of 11 units is accounted for separately. On January 10, the firm purchased eight units at $21 each.

FIFO Perpetual Inventory Account Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Cost of Mdse. Sold Item 127B Units Cost Price Jan. 1 Inventory 10 $20 4 Sale 7 $30 10 Purchase 8 21 22 Sale 4 31 28 Sale 2 32 30 Purchase 10 22 On January 22, the firm sold four units for $31 each.