1. Inventories
Chapter 7

2. CH1 Types of businesses:
Manufacturing Business e.g. Ford.
Merchandising Business e.g. Debenhams
Servicing Business e.g. Saudi Airlines
Manufacturing Businesses use Raw material to make product and the ending inventory from this kind of business is the unsold goods or items.
Merchandising Businesses: buy & Hold inventory for resale - Do not make goods

3. CH6 Inventory:
The raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for sale

4. 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.

5. Learning Objective 1
Describe the importance of control over inventory.

6. Control of Inventory
Two primary objectives of control over inventory are:
Safeguarding the inventory from damage or theft.
Reporting inventory in the financial statements.
Inventory must be protected from external risks ( such as fire or damage and theft) and internal fraud by employees.
Controls for safeguarding inventory should include security measures to prevent damage and theft such as:
storing inventory in areas that are restricted to only authorized employees
Locking high-priced inventory in cabinets
using cameras and security tags.

7. Safeguarding Inventory
Controls for safeguarding inventory begin as soon as the inventory is ordered, the following documents are often used for inventory control:
The purchase order authorizes the purchase of the inventory from an approved vendor.
The receiving report establishes an initial record of the receipt of the inventory.
Vendor’s Invoice
Recording inventory using a perpetual inventory system is also an effective means of control. The amount of inventory is always available in the subsidiary inventory ledger.

8. Safeguarding Inventory
Controls for safeguarding inventory should include security measures to prevent damage and customer or employee theft.
examples :
Storing inventory in areas that are restricted to only authorized employees.
Locking high-priced inventory in cabinets.
Using two-way mirrors, cameras, security tags, and guards.

9. Reporting Inventory
A physical inventory or count of inventory should be taken near year-end to make sure that the quantity of inventory reported in the financial statements is accurate.

10. Learning Objective 2
Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet.

11. INVENTORY COST FLOW ASSUMPTIONS
An accounting issue arises when identical units of goods are acquired at different unit costs during a period. In such cases, when an item is sold, it’s necessary to determine its cost using a cost flow Assumptions and method.

12. Inventory Cost Flow Assumptions
Purchased goods 4 3 2 1
Under FIFO, the first goods purchased are assumed to be the first goods sold
FIFO
Therefore, the ending inventory is made of the most recent purchases. 3 2
Sold goods 1

13. Inventory Cost Flow Assumptions
Purchased goods 3
Under LIFO, the last goods purchased are assumed to be the first goods sold 2 1
LIFO
The ending inventory is made up of the first/old purchases. 1 2
Sold goods 3

14. Inventory Cost Flow Assumptions
Purchased goods 3 2 1
Sold goods
Average
Cost
The cost of the units sold and the ending inventory is an average of the purchase costs.
Small exercise

15. Inventory Cost Flow Assumptions
To illustrate, assume that three identical units of merchandise are purchased during May, as follows:
Assume that one unit is sold on may 30 for $20. Depending upon which unit was sold, the gross profit varies from $11 to $6.

16. Inventory Cost Flow Assumptions
Assume that one unit is sold on May 30 for $20. Depending upon which unit was sold, the gross profit varies from $11 to $6 as shown below:

17. Inventory Cost Flow Assumptions
Under the specific identification inventory cost flow method, the unit sold is identified with a specific purchase.

18. INVENTORY COST FLOW ASSUMPTIONS
(continued)

19. Inventory Cost Flow Assumptions
Under the first-in, first out (FIFO) inventory cost flow method, the first units purchased are assumed to be sold first and the ending inventory is made up of the most recent purchases.
FIFO — Milk (or any perishable item). When shelves are restocked, the “older” milk is moved to the front, and the “newer” milk is placed in back to encourage customers to buy the older milk first.

20. INVENTORY COST FLOW ASSUMPTIONS
(continued)

21. Inventory Cost Flow Assumptions
Under the last-in, first out (LIFO) inventory cost flow method, the last units purchased are assumed to be sold first and the ending inventory is made up of the first units purchased.
LIFO — Packages of nails or screws at a hardware store. When shelves are restocked, the older packages are slid to the back of the shelf or rack and the newer packages placed in front. Customers buy the newest hardware first.

22. Items in Ending Inventory
Summary:
Method
Items Sold
Items in Ending Inventory
First-in, first-out
First items purchased
Last items purchased
Last-in, first-out

23. INVENTORY COST FLOW ASSUMPTIONS
(concluded)

24. Inventory Cost Flow Assumptions
Under the weighted average inventory cost flow method, the cost of the units sold and in ending inventory is a weighted average of the purchase costs.
Average — Gasoline. When new gasoline is delivered to a gas station, it is dumped into the tank with any old gas that has not been sold. Therefore, the customer is buying a mixture of old and new gas.

25. Learning Objective 3
Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and weighted average cost methods.

26. 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
Two inventory systems is used : 1. Perpetual 2. Periodic
Under all methods: ending inventory (15 units) units sold (13 units) *** the quantities are the same but the costs are different.

27. Fifo
Perpetual

28. 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
The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

29. 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.

30. 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
Jan
The sale of 7 units leaves a balance of 3 units.
On January 4, 7 units of Item 127B are sold at $30 each.

31. 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.

32. 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
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.

33. 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.

34. FIFO Perpetual Inventory Account
Item 127B
Purchases Cost of Mdse. Sold Inventory Balance
On January 22, the firm sold four units for $31 each.
Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan
Of the four units sold, three are from the first units in (fifo) at a cost of $20.

35. 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 28, the firm sold two units at $32.

36. On January 28, the firm sold two units at $32.
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
On January 28, the firm sold two units at $32.

37. 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 30, purchased ten additional units of Item 127B at $22 each.

38. 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
On January 30, purchased ten additional units of Item 127B at $22 each.
Totals 18 $ $ $325

39. FIFO CMS: Income Statement
LG 4
FIFO CMS: Income Statement
JAN
SOLD UNITS
COST
TOTAL 4 7 20
$140 22 3 1 21 60 28 2 42 31
CMS
$263
I/S

40. FIFO INVENTORY: Balance Sheet
LG 4
FIFO INVENTORY: Balance Sheet
Ending Inventory
COST
TOTAL 5 21
$105 10 22
220 15
$325
B/S

41. = $360 EXERCISE LG 3 Ending inventory is 11 units. 1/1 Inventory
2/4 Purchase
7/20 Purchase
12/30 Purchase
Calculate the cost of ending inventory using FIFO.
6 $28
12 $30
14 $32
8 $33
= $360

42. Lifo
Perpetual

43. LIFO 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
The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

44. On January 4, the firm sold 7 units at $30 each.
LIFO 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
On January 4, the firm sold 7 units at $30 each.

45. On January 10, the firm purchased eight units at $21 each.
LIFO 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
Note that a new layer is formed.
On January 10, the firm purchased eight units at $21 each.

46. On January 22, the firm sells four units at $31 each.
LIFO 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
Of the 4 units sold, all come from the most recent purchase at a cost of $21 each.
On January 22, the firm sells four units at $31 each.

47. On January 28, sold two units at $32 each.
LIFO 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
On January 28, sold two units at $32 each.

48. On January 30, purchase 10 units at $22 each.
LIFO 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
On January 30, purchase 10 units at $22 each.

49. LIFO 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
Three layers
Totals 18 $ $ $322

50. LIFO CMS: Income Statement
LG 4
LIFO CMS: Income Statement
JAN
SOLD UNITS
COST
TOTAL 4 7 20
$140 2 21 84 28 42 31
CMS
$266
I/S

51. LIFO INVENTORY: Balance Sheet
LG 4
LIFO INVENTORY: Balance Sheet
Ending Inventory
COST
TOTAL 3 20
$60 2 21 42 10 22
220 15
$322
B/S

52. = $318 EXERCISE LG 3 Ending inventory is 11 units. 1/1 Inventory
2/4 Purchase
7/20 Purchase
12/30 Purchase
Calculate the cost of ending inventory using LIFO.
6 $28
12 $30
14 $32
8 $33
= $318

53. Cost of Merchandise Available for Sale Units Available for Sale
Average Cost method
Cost of Merchandise Available for Sale
= Average Unit Cost
Units Available for Sale
With Average cost, an average unit cost for each item is computed each time a purchase is made.
Inventory data using the perpetual inventory system can be used in evaluating advertising campaigns and sales promotions.

54. Average cost-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
Three layers
Totals 18 $ $ $323

55. Inventory Costing Methods
For purposes of illustration, the data for Item 127B are used, as shown below. We will examine the perpetual inventory system first.

56. FIRST-IN, FIRST-OUT METHOD
(continued)

57. FIRST-IN, FIRST-OUT METHOD
(continued)

58. FIRST-IN, FIRST-OUT METHOD
(continued)

59. FIRST-IN, FIRST-OUT METHOD
(continued)

60. FIRST-IN, FIRST-OUT METHOD
(continued)

61. FIRST-IN, FIRST-OUT METHOD
(continued)

62. FIRST-IN, FIRST-OUT METHOD
(continued)

64. LAST-IN, FIRST-OUT METHOD
(continued)

65. LAST-IN, FIRST-OUT METHOD
(continued)

66. LAST-IN, FIRST-OUT METHOD
(continued)

67. LAST-IN, FIRST-OUT METHOD
(continued)

68. LAST-IN, FIRST-OUT METHOD
(continued)

69. LAST-IN, FIRST-OUT METHOD

70. LAST-IN, FIRST-OUT METHOD
(continued)

72. Weighted Average Cost Method
When the weighted average cost method is used in a perpetual system, an average unit cost for each item is computed each time a purchase is made.
This unit cost is then used to determine the cost of each sale until another purchase is made and a new average is computed. This averaging technique is called a moving average.

73. WEIGHTED AVERAGE COST METHOD

75. ONLY 5 Learning Objective
Compare and contrast the use of the three inventory costing methods.
ONLY

76. COMPARING INVENTORY COST METHODS
Inflation Deflation

77. Comparing Inventory Cost Methods
When the FIFO method is used during a period of inflation or rising prices, FIFO will show a larger profit than the other two inventory costing methods.

78. Comparing Inventory Cost Methods
When the LIFO method is used during a period of inflation or rising prices, LIFO will show a lower profit than the other two inventory costing methods.
During a period of rising prices, using LIFO offers an income tax savings compared to the other two inventory costing methods.

79. Comparing Inventory Cost Methods
The weighted average cost method of inventory costing is a compromise between FIFO and LIFO. Net income for the weighted average cost method is somewhere between the net incomes of LIFO and FIFO.

80. Learning Objective 6
Describe and illustrate the reporting of merchandise inventory in the financial statements.

81. Reporting Merchandise Inventory
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:
The cost of replacing items in inventory is below the recorded cost.
The inventory cannot be sold at normal prices due to imperfections, style changes, or other causes.

82. Valuation at Lower of Cost or Market
Market, as used in lower-of-cost-or-market method, is the cost to replace the merchandise on the inventory date.

83. Valuation at Lower of Cost or Market
Cost and replacement cost can be determined for the following:
Each item in the inventory.
Each major class or category of inventory.
Total inventory as a whole.

84. VALUATION AT LOWER OF COST OR MARKET
>
< >
<
The market decline based on individual items
($15,520 – $15,070) = $450

85. Valuation at Net Realizable Value
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 costs of disposal, such as sales commissions or special advertising.

86. Valuation at Net Realizable Value
Assume the following data about an item of damaged merchandise:
The merchandise should be valued at its net realizable value of $650 ($800 – $150).
Original cost $1,000
Estimated selling price 800
Selling expenses 150

87. Merchandise Inventory on the Balance Sheet
Merchandise inventory is usually presented in the Current Assets section of the balance sheet, following receivables.
The method of determining the cost of the inventory (FIFO, LIFO, or weighted average) and the method of valuing the inventory (cost or the lower of cost or market) should be shown.

88. MERCHANDISE INVENTORY ON THE BALANCE SHEET

89. + more WAC exercises from E25
H.W:
PE 7-1 A
PE 7-1 B
PE 7-2 A
PE 7-2 B
PE 7-3 A
PE 7-3 B
PE 7-5 A
PE 7-5 B
EX 7-3
EX 7-4
+ more WAC exercises from E25

90. Inventories
The End