1. INVENTORIES AND THE COST OF GOODS SOLD
CHAPTER:3
Aman Khan
MBA-Finance
INVENTORIES AND THE
COST OF GOODS SOLD 2

2. Goods owned and held for sale to customers
Inventory Defined
Inventory
Goods owned and held for sale to customers
Current
asset

3. The Flow of Inventory Costs
BALANCE SHEET
Current assets:
Inventory
Purchase cost (or manufacturing costs)
as goods are sold
as incurred
INCOME STATEMENT
Revenue
Cost of goods sold
Gross profit
Expenses
Net income
Sale Price
Purchase Price

4. Inventory SYSTEMs There are two systems for inventory recording.
Perpetual System: In this system inventory record is updated after each sale.
Periodic System.
In this system inventory will be updated at the end of accounting period.

5. The Flow of Inventory Costs
In a perpetual inventory system, inventory entries parallel the flow of costs.

6. Which Unit Did We Sell?
When identical units of inventory have different unit costs, a question naturally arises as to which of these costs should be used in recording a sale of inventory. 4

7. Inventory Subsidiary Ledger
A separate subsidiary account is maintained for each item in inventory.
Purchases
Sold
Cost Of Goods sold
Date
Units
Unit Cost
Total
Unit
Jan 1 20 10
200
Jan 3 15
225
Jan 7
400
Jan 12 30
300 ?
How can we determine the unit cost for the Jan. 12 sale?

8. Specific identification
Inventory Cost Flows
We use one of these inventory valuation methods to determine cost of inventory sold.
Specific identification
LIFO
Average cost
FIFO 4

9. First-In First-Out
The First-In, First-Out method often called FIFO is based on the assumption that the first merchandise purchased is the first merchandise sold.

10. fifo 1st 1st 2nd 2nd 3rd 4th January , sold two items FIFO Sold items
Purchase item on 1st January Purchase item on 2nd January Purchase item on 3rd January
4th January ,
sold two items
Sold items
1st
1st
FIFO
2nd
2nd
3rd

11. First-In, First-Out Method (FIFO)
Oldest Costs
Recent Costs
Costs of Goods Sold
Ending Inventory

12. Information for the Following Inventory Examples
The Bike Company (TBC)

13. On August 14, TBC sold 20 bikes for $130 each.
FIFO – Example
The Cost of Goods Sold for the August 14 sale is $1,970, leaving $530 and 5 units in inventory.
On August 14, TBC sold 20 bikes for $130 each.
Continue

14. A similar entry is made after each sale.
FIFO – Example
Retail
Cost
A similar entry is made after each sale.
Continue

15. FIFO – Example Cost of Goods Sold for August 31 = $2,600
Additional purchases were made on Aug. 17 and Aug. 28.
On August 31, an additional 23 units were sold.
Cost of Goods Sold for August 31 = $2,600
Continue

16. FIFO – Example Income Statement Balance Sheet COGS = $4,570
Inventory = $1,420

17. FIFO-Q1 DATE DESCRIPTION UNITS JAN. 1 Beginning Inventory 900 10 9,000
COST
TOTAL COST
JAN. 1
Beginning Inventory
900 10
9,000
Feb.23
Purchases
1,200 11
13,200
Apr. 20
3,000 12
36,000
May.4
4,000 13
52,000
Nov.30
Sales
2,000 15
30,000

18. Fifo-Q2 DATE DESCRIPTION UNIT S UNIT COST TOTAL COST SEP.1
Beginning balance 15 60
900
SEP.4
Purchases 20 65
1300
SEP.8
SALES 25
100
2500
SEP.9 40 70
2800
SEP.20 10 80
800
SEP.25 50
110
5500

19. LAST-In First-Out
The Last-In, First-Out method often called LIFO is based on the assumption that the Last merchandise Purchased is the first merchandise Sold.

20. Lifo 1st 2nd 2nd 3rd 3rd 4th January , sold two items LIFO Sold items
Purchase item on 1st January Purchase item on 2nd January Purchase item on 3rd January
4th January ,
sold two items
Sold items
1st
LIFO
2nd
2nd
3rd
3rd

21. Last-In, First-Out Method (LIFO)
Recent Costs
Oldest Costs
Costs of Goods Sold
Ending Inventory

22. On August 14, TBC sold 20 bikes for $130 each.
LIFO – Example
The Cost of Goods Sold for the August 14 sale is $2,045, leaving $455 and 5 units in inventory.
On August 14, TBC sold 20 bikes for $130 each.
Continue

23. A similar entry is made after each sale.
LIFO – Example
Retail
Cost
A similar entry is made after each sale.
Continue

24. LIFO – Example Cost of Goods Sold for August 31 = $2,685
Additional purchases were made on Aug. 17 and Aug. 28.
On Aug. 31, an additional 23 units were sold.
Continue

25. LIFO – Example Income Statement Balance Sheet COGS = $4,730
Inventory = $1,260

26. LIFO-EXAMPLE DATE DESCRIPTION UNITS JAN. 1 Beginning Inventory 900 10
COST
TOTAL COST
JAN. 1
Beginning Inventory
900 10
9,000
Feb.23
Purchases
1,200 11
13,200
Apr. 20
3,000 12
36,000
May.4
4,000 13
52,000
Nov.30
Sales
2,000 15
30,000

27. Lifo - exAmple DATE DESCRIPTION UNIT S UNIT COST TOTAL COST SEP.1
Beginning balance 15 60
900
SEP.4
Purchases 20 65
1300
SEP.8
SALES 25
100
2500
SEP.9 40 70
2800
SEP.20 10 80
800
SEP.25 50
110
5500

28. Average-Cost Method
When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold.
Cost of Goods Available for Sale
Units on hand on the date of sale ÷

29. Average-Cost Method – Example
The average cost per unit must be computed prior to each sale.
$100 = $2,500  25
On August 14, TBC sold 20 bikes for $130 each.
Continue

30. Average-Cost Method – Example
The average cost per unit is $100.
$100 = $2,500  25
Let’s look at the entries for the Aug. 14 sale.
Continue

31. Average-Cost Method – Example
Retail
Cost
A similar entry is made after each sale.
Continue

32. Average-Cost Method – Example
Additional purchases were made on August 17 and August 28.
On August 31, an additional 23 units were sold.
Continue

33. Average-Cost Method – Example
$114 = $3,990  35

34. Average-Cost Method – Example
The average cost per unit is $114.
$114 = $3,990  35

35. Average-Cost Method – Example
Income Statement
COGS = $4,622
Balance Sheet
Inventory = $1,368
$114 × 12 = $1,368

36. Specific Identification
When a unit is sold, the specific cost of the unit sold is added to cost of goods sold.

37. Specific Identification – Example
On August 14, TBC sold 20 bikes for $130 each.
Nine bikes originally cost $91 and 11 bikes originally cost $106.
Continue

38. Specific Identification – Example
The Cost of Goods Sold for the August 14 sale is $1,985, leaving $515 and 5 units in inventory.
Let’s look at the entries for the Aug. 14 sale.
Continue

39. Specific Identification – Example
Retail
Cost
A similar entry is made after each sale.
Continue

40. Not really. Specific identification is hard to use when we sell a lot of inventory that has lots of different costs.
Since specific identification is so easy, can’t we use it all the time?

41. Taking a Physical Inventory
The primary reason for taking a physical inventory is to adjust the perpetual inventory records for unrecorded shrinkage losses, such as theft, spoilage, or breakage.

42. Periodic Inventory Systems
In a periodic inventory system, inventory entries are as follows.
Note that an entry is not made to inventory. 4

43. Periodic Inventory Systems
In a periodic inventory system, inventory entries are as follows. 4

44. CLASS ACTIVITY DATE DESCRIPTION TOTAL UNITS UNIT RATE TOTAL AMOUNT
Jan.1
Beginning balance 10
$ 500
$ 5,000
Feb.5
Purchased 15
$ 550
$ 8,250
March.2 25
$ 570
$ 14,250
April.4
Sold 35
$ 600
$ 21,000
May 10 20
$ 580
$ 11,600
June 3 30
$ 590
$ 17,700
July 7 60
$ 600
$ 36,000
Calculate:
Cost of Goods Sold (2 ) Ending Balance (3) Pass journal entries
According to:
FIFO
LIFO
AVERAGE
Specific Identification:
For 1st sale ,10 units each from jan.1 and feb.5
and units from March 2 purchases,
For 2nd sale All units from June 3 & May 10 and remaining from
March 2 purchases.

45. End of Chapter 8 4