1. Inventory of Wholesalers and Retailers
Purchased in finished form
Resold without transformation
Classified as “Merchandise Inventory” on balance sheet
LO1

2. Inventory of Manufacturers
Balance Sheet
Classifications
Costs Included
in Inventory
Direct
materials
Raw
materials
Manufacture
products
Direct
labor
Work in
process
Manufacturing
overhead
Finished
goods

3. Condensed Income Statement for a Merchandiser
Net sales $100,000
Cost of goods sold ,000
Gross profit $ 40,000
Selling and administrative expenses ,300
Net income before tax $ 10,700
Income tax expense ,280
Net income $ 6,420
LO2

4. Net Sales and Contra-Sales Accounts
Sales revenue
The inflow of either cash or accounts
receivable from the sale of a product
Normal
balance
Two deductions from sales:
sales returns and allowances
sales discounts
normal
debit
balance
normal
debit
balance

5. Sales Returns and Allowances
records inventory returned by customers
who are not completely satisfied
a customer may be given an allowance for
spoiled or damaged merchandise
single account used to record both
returns and allowances
Normal
balance
normal
debit
balance

6. Credit Terms and Sales Discounts
n/30 Payment due 30 days from invoice
1/10, n/30 Deduct 1% of invoice amount if paid within 10 days; otherwise full invoice amount is due in 30 days
2/10, n/30 Deduct 2% of invoice amount if paid within 10 days; otherwise full invoice amount is due in 30 days

7. The Cost of Goods Sold Model
Beginning
inventory
Purchases of
merchandise + =
Goods Available
for Sale
Less: Ending inventory
Cost
of goods
sold =
LO3

8. The Cost of Goods Sold Model
Beginning inventory $ 15,000
+ Cost of goods purchased ,000
= Cost of goods available for sale 78,000
– Ending inventory (18,000)
= Cost of goods sold $ 60,000
An increase in ending
inventory means more
was bought than sold
“Pool” of goods
available to sell
during the period

9. Perpetual Inventory Systems
Inventory records are updated after each purchase or sale
Point-of-sale terminals have improved the ability of mass merchandisers to maintain perpetual systems

10. Periodic Inventory Systems
Inventory records are updated periodically based on physical inventory counts
Reduces record keeping but also decreases the ability to track theft, breakage, etc., and prepare interim financial statements

11. Cost of Goods Purchased
Cost of inventory purchased (invoice price):
Less:
Purchase returns and allowances
Purchase discounts
Plus:
Transportation-in

12. Title passes at destination
FOB Destination Point
Title passes at destination
No sale or purchase until inventory reaches its destination
Seller responsible for inventory while in transit

13. Title passes when shipped
FOB Shipping Point
Both sale and purchase recorded upon shipment
Buyer responsible for inventory while in transit
Title passes when shipped

14. Analysis of Profitability
particular
interest
to current and
potential
investors
Gross
Profit %
LO4 14 14

15. Inventory Valuation and Income Measurement
Value
assigned to
inventory
on balance
sheet
Value
expensed
as cost of
goods sold
on income
statement
When Sold =
LO5

16. Inventory Costs Included
Any freight costs incurred by buyer
Cost of insurance for inventory in transit
Cost of storing inventory before selling
Excise and sales taxes

17. Inventory Costing Methods
Four costing methods available:
Specific
Identification
Weighted
Average
First-in, First-out
(FIFO)
Last-in, First-out
(LIFO)
LO6

18. Detailed Costing Method Example
Beginning inventory, Jan. 1: 500 units (unit cost $10)
Inventory purchases:
Date Units Unit Cost
1/ $ 11 4/ 9/
12/
Total purchases 1,000 units
Ending inventory, Dec. 31: 600 units
Calculate the Cost of Goods Sold and Ending Inventory under each cost flow method

19. Specific Identification Method
Step 1: Identify the specific units in
inventory at the end of the year
and their costs.
Step 2: Identify the units sold and calculate the cost of goods sold.

20. Specific Identification Method Units × Cost = Total cost
Date purchased Units Cost Total Cost
Beg. inventory $10 $5,000
1/ ,200
4/ ,200
12/ ,400
Cost of goods sold $9,800
Units × Cost = Total cost

21. Weighted Average Method
Step 1: Calculate the cost of goods
available for sale.
Step 2: Divide the cost of goods available
for sale by the total units to
determine the weighted average
cost per unit.

22. Weighted Average Method
Cost of Goods Available for Sale
Units Available for Sale
$17,100
1,500
= $11.40/unit

23. Weighted Average Method
Step 3: Calculate ending inventory and cost of goods sold by multiplying the weighted average cost per unit by the number of units in ending inventory and the number of units sold. ×
Avg.
Cost
# of
Units

24. Weighted Average Method
ALLOCATE TO
Ending Cost of
Inventory Goods Sold
Units on hand
Units sold
Weighted average cost × $ $ 11.40
Total cost of goods
available of $17,100 allocated: $6, $10,260

25. First-in, First-out (FIFO) Method
Step 1: Assign the cost of the beginning
inventory to cost of goods sold.
Step 2: Continue to work forward until you assign the total number of units sold during the period to cost of goods sold Allocate the remaining costs to ending inventory.

26. First-in, First-out (FIFO) Method
ALLOCATE TO
Ending Cost of
Units Cost Inventory Goods Sold
1/ $ $5,000
1/ $ ,300
4/ / 100 $ $3, ,200
9/ $ ,600
12/ $ ,400
TOTALS $7, $9,500

27. Last-in, First-out (LIFO) Method
Step 1: Assign the cost of the last units purchased to cost of goods sold.
Step 2: Work backwards until you assign the total number of units sold during the period to cost of goods sold (allocate the remaining costs to ending inventory).

28. Last-in, First-out (LIFO) Method
ALLOCATE TO
Ending Cost of
Units Cost Inventory Goods Sold
1/ $ $5,000
1/ /200 $ , $ 2,200
4/ $ ,800
9/ $ ,600
12/ $ ,400
TOTALS $6, $11,000

29. LIFO Issues LIFO liquidation
Liquidation can result in high gross profit (and large tax bill)
LIFO conformity rule
If used for tax, LIFO must also be used for books
LIFO reserve
Difference between inventory value stated at FIFO and value stated at LIFO

30. International Inventory Valuation Methods
Acceptable methods of costing inventory in the United States may not be acceptable in other countries
LIFO is generally accepted in the United States
IASB (international standards) prohibit the use of LIFO by companies that follow international standards
It is uncertain whether LIFO will survive as an acceptable inventory valuation method

31. Reasons for Inventory Errors
Mathematical mistakes
Physical inventory counting errors
Cutoff problems – in-transit
Goods on consignment
LO8

32. Effect of Inventory Errors on the Income Statement, 2012
Reported Corrected Effect
Sales $1, $1,000
Beginning inventory $ $ 200
Add: Purchases
Goods available for sale $ $ 900
Less: Ending inventory $50 OS
Cost of goods sold $ $ US
Gross margin $ $ OS
Operating expenses
Net income $ $ OS
OS = overstatement
US = understatement

33. Effect of Inventory Errors on the Income Statement, 2013
Reported Corrected Effect
Sales $1, $1,500
Beginning inventory $ $ $50 OS
Add: Purchases , ,100
Goods available for sale $1, $1, OS
Less: Ending inventory
Cost of goods sold $1, $1, OS
Gross margin $ $ US
Operating expenses
Net income $ $ US
OS = overstatement
US = understatement

34. Counterbalancing Errors
The 2012 error reverses in 2013 (but 2012 inventory
both 2012 and 2013 profits are misstated by 50):
Beginning inventory $xxx $+50
Add: Purchases xxx xxx
= Goods available for sale xxx
Less: Ending inventory xxx
= Cost of goods sold –

35. Report loss in year market falls below cost…
Lower of Cost or Market
Before After
Price Price Change Change
Cost $100, $85,000
Report loss in year market falls below cost…
LO9

36. normal gross profit % when sold
Lower of Cost or Market
Before After
Price Price Change Change
Selling price $ $ 80
Cost
Gross profit $ $ 20
…to maintain
normal gross profit % when sold
Gross profit % % %

37. Lower of Cost or Market Market = replacement cost (not retail value)
Cost determined under one of the costing methods
Justified on basis of conservatism
Can be applied to:
Entire inventory
Individual items
Groups of items

38. Lower of Cost or Market under International Standards
Both U.S. GAAP and international financial reporting standards (IFRS) require lower-of-cost-or-market
Differences between U.S. GAAP and IFRS
How market value is defined
Recording changes in market value in future periods

39. Inventory Turnover Ratio
Cost of Goods Sold
Average Inventory
The number of times per period inventory is turned over (i.e., sold)
LO10

40. Number of Days’ Sales in Inventory
Number of Days in the Period
Inventory Turnover Ratio
The average number of days
inventory is on hand before its sold

41. Statement of Cash Flows
Cash Flows from Operating Activities:
Net income xxx
Increase in inventory –
Decrease in inventory
Increase in accounts payable
Decrease in accounts payable –
Indirect
Method
LO11

42. Inventory Costing Methods with the Use of a Perpetual Inventory System
Appendix
Accounting Tools:
Inventory Costing Methods with the Use of a Perpetual Inventory System

43. FIFO Costing with a Perpetual System
FIFO applied at time of sale
Same FIFO inventory total under periodic
and perpetual systems

44. LIFO Costing with a Perpetual System
LIFO applied at time of sale
Different LIFO inventory total under periodic and perpetual systems because of pricing gap

45. Moving Average with a Perpetual System
New weighted average cost is computed for each purchase
Different inventory total under weighted average (periodic) and moving average (perpetual)

46. End of Chapter 5