1. Chapter 9 Inventories Accounting, 24th Edition Warren Reeve Fess
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PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

2. Objectives Summarize the objective of control over inventory.
Describe the three inventory cost flow assumptions and how they impact the income statement and balance sheet.
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.
Compute the proper valuation of inventory at other than cost, using the lower-of-cost-or-market and net realization value concepts.
Prepare a balance sheet presentation of merchandise inventory.
After studying this chapter, you should be able to:

3. 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

4. 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

5. 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.

6. The main aims of control of inventory?
Safeguarding the inventory from damage or theft.
Reporting inventory in the financial statement.
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. Example of Safeguarding inventory
Controls for safeguarding inventory begin as soon as the inventory is ordered, the following documents are often used for inventory control:
Purchase order (from an approved vendor/seller)
Receiving report:(when receiving the inventory)
Vendor’s invoice

8. 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 statement is accurate.

9. 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.
Three methods to calculate cost:
First - In - First- Out (FIFO).
Last - In - First- Out (LIFO).
Average Cost method.

10. 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

11. 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

12. 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

13. 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.

14. Specific identification inventory method
Under this cost flow method, the unit sold is identified with a specific purchase.
The specific identification method is normally used by automobile dealerships, jewelry stores, and art galleries.

15. 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 (150 units) units sold (130 units) *** the quantities are the same but the costs are different.

16. Fifo
Perpetual

17. 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.

18. 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.

19. 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.

20. 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.

21. 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.

22. 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.

23. 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.

24. 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.

25. 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.

26. 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.

27. 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

28. 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

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

30. = $360 EXERCISE Ending inventory is 11 units. 1/1 Inventory
LG 3
EXERCISE
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

31. Lifo
Perpetual

32. 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.

33. 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.

34. 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.

35. 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.

36. 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.

37. 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.

38. 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

39. 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

40. 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

41. = $318 EXERCISE Ending inventory is 11 units. 1/1 Inventory
LG 3
EXERCISE
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

42. 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.

43. 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

44. Reporting Merchandise Inventory in the financial statements4
Reporting Merchandise Inventory in the financial statements
Cost is the primary basis for valuing and reporting inventories in the financial statements.
However, the inventory may be valued at other than cost in two 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 cases.

45. LOWER-OF-COST-OR MARKET
If the cost of replacing inventory is lower than its recorded purchase cost, the lower-of-cost-or-market (LCM) method is used to value the inventory.
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.

46. LOWER-OF-COST-OR MARKET
LG 7
LOWER-OF-COST-OR MARKET
Exercise7-5 p.325:
Item
Quantity
Unit
Cost
Unit Market A
400
$10.25
$ 9.50 B
120
22.50
24.10 C
600
8.00
7.75 D
280
14.00
14.75

47. LOWER-OF-COST-OR MARKET (Slide 2 of 3)
LG 7
LOWER-OF-COST-OR MARKET (Slide 2 of 3)
Item
Cost
Market
LCM A
$4,100
$3,800 B
2,700
2,892 C
4,800
4,650 D
3,920
4,130
It used to ensure that the inventory is not reported at a cost higher than its replacement cost*

48. Valuation of Inventory at Lower-of-Cost-or-Market
Unit Unit
Inventory Cost Market Total Total Lower
Item Quantity Price Price Cost Market C or M
A 400 $10.25 $ $ 4,100 $ 3,800
B ,700 2,892
C ,800 4,650
D ,920 4,130
$ 3,800
2,700
4,650
3,920
Total $15,520 $15,472 $15,070
Can be for one item or all items of the inventory
The market decline based on individual items
($15,520 – $15,070) = $450

49. Net realizable value
Merchandise that is out of date, spoiled, or damaged can often be sold only at a price below its original cost. Such merchandise should be valued at its realizable value.
Net realizable value =
Estimated selling price- Direct cost of proposal
Exercise: Assume the following data about an item of damaged merchandise:
Original cost ,000
Estimated selling price 800
Selling expenses
Net realizable value = 800 – 150= 650

50. Metro-Arts Balance Sheet December 31, 2012
Presentation of Merchandise Inventory on the Balance Sheet
Metro-Arts Balance Sheet December 31, 2012
Assets Current assets: Cash $ Accounts receivable $ Merchandise inventory at lower of cost (first-in, first-out method) or market
The following are reported:
The method of determining the inventory cost (FIFO, LIFO & Average)
The method of valuing the inventory (cost or the lower of cost or market)
Additionally, if the company decides to change the inventory costing method, the effect of the change and the reason for the change are disclosed in the financial statement.

51. Chapter 9
The End