Inventories – Part II Chapter 8 1

Using FIFO, the earliest batch purchased is considered the first batch of merchandise sold. The physical flow does not have to match the accounting method chosen. First-In, First-Out Method 2

= $2,000 = 1,680 =2,200 Cost of merchandise available for sale 100 $20 80 $ $ units available for sale during year Jan. 1 Jan. 10 Jan. 30 $5,880 FIFO Method 3

The physical count on January 31 shows that 150 units are on hand (conclusion: 130 units were sold). What is the cost of the ending inventory? = $ 0 = 1,050 = 2, $20 80 $ $22 Jan. 1 Jan. 10 Jan. 30 Sold these Sold 30 of the $ $22 Ending inventory$3,250 4

Now we can calculate the cost of goods sold as follows: Beginning inventory, January 1 $2,000 Purchases ($1,680 + $2,200) 3,880 Cost of merchandise available for sale$5,880 Ending inventory, January 31 3,250 Cost of merchandise sold $2,630 5

Exhibit 5 First-In, First-Out Flow of Costs 6

Using LIFO, the most recent batch purchased is considered the first batch of merchandise sold. The actual flow of goods does not have to be LIFO. For example, a store selling fresh fish would want to sell the oldest fish first (which is FIFO) even though LIFO is used for accounting purposes. Last-In, First-Out Method 7

=$2,000 = 1,680 =2,200 Cost of merchandise available for sale 100 $20 80 $ $ units available for sale during year Jan. 1 Jan. 10 Jan. 30 $5,880 LIFO Method 8

Assume again that the physical count on January 31 is 150 units (and that 130 units were sold). What is the cost of the ending inventory? = $2,000 = 1, 680 = 2, $20 80 $ $22 Jan. 1 Jan. 10 Jan. 30 Sold these Sold 30 of the $21 =0=0 = 1,050 Ending inventory$3,050 9

Now we can calculate the cost of goods sold as follows: Beginning inventory, January 1 $2,000 Purchases ($1,680 + $2,200) 3,880 Cost of merchandise available for sale$5,880 Ending inventory, January 31 3,050 Cost of merchandise sold $2,830 10

Exhibit 5 11

The average cost method is sometimes called the weighted average method. It uses the average unit cost for determining cost of merchandise sold and the ending merchandise inventory. Average Cost Method 12

The weighted average unit cost is determined as follows: Average Unit Cost = Total Cost of Units Available for Sale Units Available for Sale 13

$5,880 =$2,000 = 1,680 =2, $20 80 $ $ Jan. 1 Jan. 10 Jan. 30 Average unit cost: $5,880 ÷ 280 = $21 Cost of merchandise sold: 130 units at $21 = $2,730 Ending merchandise inventory: 150 units at $21= $3,150 14

Now we can calculate the cost of goods sold as follows: Beginning inventory, January 1 $2,000 Purchases ($1,680 + $2,200) 3,880 Cost of merchandise available for sale$5,880 Ending inventory, January 31 3,150 Cost of merchandise sold $2,730 15

Example Exercise 7-4 Periodic Inventory Using FIFO, LIFO, Average Cost Methods The units of an item available for sale during the year were as follows: $50$ 300 Mar. $55770 $62 1,240 Available for sale40units$2,310 There are 16 units of the item in the physical inventory at December 31. The periodic inventory system is used. Determine the inventory cost by (a) the first-in, first-out (FIFO) method, (b) the last-in, first-out (LIFO) method, and (c) the average cost method. 16

Example Exercise 7-4 (continued) a)First-in, first-out (FIFO) method: $992 (16 units × $62) c)Average method: $924 (16 units × $57.75) where average cost = $57.75 ($2,310 ÷ 40 units) b)Last-in, first-out (LIFO) method: $850 (6 units × $50) + (10 units × $55) 17

Partial Income Statements Net sales$3,900 Cost of merchandise sold: Beginning inventory$2,000 Purchases 3,880 Merchandise available for sale$5,880 Less ending inventory 3,250 Cost of merchandise sold 2,630 Gross profit$1,270 First-In, First-Out 18

Partial Income Statements Net sales$3,900 Cost of merchandise sold: Beginning inventory$2,000 Purchases 3,880 Merchandise available for sale$5,880 Less ending inventory 3,150 Cost of merchandise sold 2,730 Gross profit$1,170 Average Cost 19

Net sales$3,900 Cost of merchandise sold: Beginning inventory$2,000 Purchases 3,880 Merchandise available for sale$5,880 Less ending inventory 3,050 Cost of merchandise sold 2,830 Gross profit$1,070 Last-In, First-Out Partial Income Statements 20

Effects of Changing Costs (Prices): FIFO and LIFO Cost Methods Exhibit 7 21

Weighted FIFO Average LIFO Ending inventory$3,250$3,150$3,050 Cost of merchandise sold$2,630$2,730$2,830 Gross profit$1,270$1,170$1,070 Recap 22

Cost is the primary basis for valuing and reporting inventories in the financial statements. However, inventory may be valued at other than cost in the following cases: Cost (continued) 23

1.The cost of replacing items in inventory is below the recorded cost. 2.The inventory cannot be sold at normal prices due to imperfections, style changes, or other causes. 24

Market, as used in lower of cost or market, is the cost to replace the merchandise on the inventory date. Market 25

Cost and replacement cost can be determined for the following: 1.Each item in the inventory. 2.Each major class or category of inventory. 3.Total inventory as a whole. 26

Determining Inventory at Lower of Cost or Market Exhibit 8 27

Example Exercise 7-5 Lower-of-Cost-or-Market Method On the basis of the following data, determine the value of the inventory at the lower of cost or market. Apply lower of cost or market to each inventory item as shown in Exhibit 8. Inventory Unit Unit Commodity Quantity Cost Price Market Price C17Y10$ 39$40 B

Example Exercise 7-5 (continued) 29

Merchandise that is out of date, spoiled, or damaged should be written down to its net realizable value. This is the estimated selling price less any direct cost of disposal, such as sales commissions. Net Realizable Value 30

Merchandise inventory is usually presented in the Current Assets section of the balance sheet, following receivables. Merchandise Inventory on the Balance Sheet 31

The method of determining the cost of inventory (FIFO, LIFO, or weighted average) and the method of valuing the inventory (cost or the lower of cost or market) should be shown. Merchandise Inventory on the Balance Sheet 32

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Effect of Inventory Errors on the Financial Statements Some reasons causing inventory errors to occur include the following: 1.Physical inventory on hand was miscounted. 2.Costs were incorrectly assigned to inventory. 3.Inventory in transit was incorrectly included or excluded from inventory. 4.Consigned inventory was incorrectly included or excluded from inventory. 34

Effect of Inventory Errors on Current Period’s Income Statement Exhibit 9 35

Effect of Inventory Errors on Two Years’ Income Statements 7-91 Exhibit 10 36

Effect of Inventory Errors on Current Period’s Balance Sheet Exhibit 11 37

Example Exercise 7-6 Effect of Inventory Errors Zula Repair Shop incorrectly counted its December 31, 2010 inventory as $250,000 instead of the correct amount of $220,000. Indicate the effect of the misstatement on Zula’s December 31, 2010 balance sheet and income statement for the year ended December 31,

Example Exercise 7-6 (continued) Amount of Misstatement Overstatement (Understatement) Balance Sheet: Merchandise inventory overstated$30,000 Current assets overstated30,000 Total assets overstated30,000 Owner’s equity overstated30,000 Income Statement: Cost of merchandise sold understated$(30,000) Gross profit overstated30,000 Net income overstated30,000 39