1. Electronic Presentation by Douglas Cloud Pepperdine University
Chapter 8
Inventories
Electronic Presentation by Douglas Cloud Pepperdine University

2. After studying this chapter, you should be able to:
Learning Goals
1. Identify the types of inventory used by merchandisers and manufacturers.
2. Summarize and provide examples of internal control procedures that apply to inventory.
3. Describe three inventory cost flow assumptions and how they impact the income statement and the balance sheet.
After studying this chapter, you should be able to:
Continued

3. Learning Goals
4. Determine the cost of inventory under the perpetual inventory system, using the first-in, first-out; last-in, first-out; and average cost methods.
5. Determine the cost of inventory under the periodic inventory system, using the first-in, first-out; last-in, first-out; and average cost methods.
6. Compare and contrast the use of the three inventory costing methods.
Continued

4. Learning Goals
7. Determine the proper valuation of inventory at other than cost, using the lower-of-cost-or-market and net realizable value concepts.
8. Describe how inventories are being reduced through quick response.
9. Determine and interpret the inventory turnover ratio, the number of days’ sales in inventory, and lifo reserve adjustments.

5. Learning Goal 1
Identify the types of inventory used by merchandisers and manufacturers.

6. Materials inventory consists of the cost of raw materials used in manufacturing a product.
Work in process inventory consists of the costs for partially completed products.
Direct materials
Direct labor costs
Factory overhead

7. Finished goods inventory consists of the costs of direct materials, direct labor, and factory overhead for completed products.
When the merchandise is sold, the costs are transferred to Cost of Goods Sold

8. Learning Goal 2
Summarize and provide examples of internal control procedures that apply to inventories.

9. 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.
Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.

10. Using a perpetual inventory system, the amount of each type of merchandise is always readily available in a subsidiary inventory ledger.

11. To ensure the accuracy of the amount of inventory reported in the financial statements, a merchandising should take a physical count. This is true even though a firm uses a perpetual inventory system.

12. Learning Goal 3
Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet.

13. Three identical units of Item X are purchased during May.
One unit is sold on May 30 for $20, the unit that was purchased on May 18.
Three identical units of Item X are purchased during May.
Item X Units Cost
May 10 Purchase 1 $ 9
18 Purchase 1 13
24 Purchase
Total 3 $36
Average cost per unit $12
Specific Identification

14. The gross profit from this sale would be $7, which is the selling price of $20 less the May 18th cost of $13.

15. Fifo Method
Purchased goods
FIFO
Sold goods

16. Fifo Method Item X Units Cost May 10 Purchase 1 $ 9 18 Purchase 1 13
Total 3 $36
Average cost per unit $12

17. Effect of Inventory Costing Methods on Financial Statements
Fifo Method
Effect of Inventory Costing Methods on Financial Statements
$14 13
Balance Sheet
Merchandise
inventory $27
Income Statement
Sales $20
Cost of merchandise
sold 9
Gross profit $11

18. Lifo Method
Sold goods
Purchased goods
LIFO

19. Lifo Method Item X Units Cost May 10 Purchase 1 $ 9 18 Purchase 1 13
Total 3 $36
Average cost per unit $12

20. Effect of Inventory Costing Methods on Financial Statements
Lifo Method
Effect of Inventory Costing Methods on Financial Statements
Income Statement
Sales $20
Cost of merchandise
sold 14
Gross profit $ 6
$13 9
Balance Sheet
Merchandise
inventory $22

21. Average Cost Method
Purchased goods
Sold goods
Average
Cost

22. Average Cost Method Item X Units Cost May 10 Purchase 1 $ 9
Total 3 $36
Average cost per unit $12

23. Effect of Inventory Costing Methods on Financial Statements
Average Cost Method
Effect of Inventory Costing Methods on Financial Statements
$12 12
Income Statement
Sales $20
Cost of merchandise
sold 12
Gross profit $ 8
Balance Sheet
Merchandise
inventory $24

24. Inventory Costing Methods
600
500
400
300
200
100
Number of firms (> $1Billion Sales)
FIFO
LIFO
Average cost

25. Learning Goal 4
Determine the cost of inventory under the perpetual inventory system, using the first-in, first-out; last-in, first-out; and average cost methods.

26. Perpetual Inventory System
Inventory Cost Data
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
Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

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
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. The sale of 7 units leaves a balance of 3 units.
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 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
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
On January 10, the firm purchased eight units at $21 each.
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 three units on hand, the inventory balance of 11 units is accounted for at two prices.

33. FIFO Perpetual Inventory Account
Inventory Cost Data
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 22, the firm sold four units for $31 each.

34. 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 22, the firm sold four units for $31 each.
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
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 28, the firm sold two units at $32.

36. FIFO Perpetual Inventory Account
Item 127B
Purchases Cost of Mdse. Sold Inventory Balance
On January 28, the firm sold two units at $32.
Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan

37. FIFO Perpetual Inventory Account
Inventory Cost Data
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 30, purchased ten additional units of Item 127B at $22 each.

38. FIFO Perpetual Inventory Account
Item 127B
On January 30, purchased ten additional units of Item 127B at $22 each.
Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan

39. FIFO Perpetual Inventory Accounting
Inventory Cost Data
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
Let’s record this sale of Item 127B on January 4.

40. FIFO Perpetual Inventory Accounting
Jan. 4 Accounts Receivable 210
Sales 210
4 Cost of Merchandise Sold 140
Merchandise Inventory 140

41. LIFO Perpetual

42. 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.

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

44. 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.

45. 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 four 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.

46. 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.

47. LIFO Perpetual Inventory Account
Item 127B
Purchases Cost of Mdse. Sold Inventory Balance
On January 30, purchase 10 units at $22 each.
Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan

48. Learning Goal 5
Determine the cost of inventory under the periodic inventory system, using the first-in, first-out; last-in, first-out; and average cost methods.

49. Note: These amounts are not from the textbook.
Fifo Periodic
200 $9
Jan. 1 Beginning Inventory
300 $10
Mar. 10 Purchase
400 $11
Sept. 21 Purchase
100 $12
Nov. 18 Purchase
Note: These amounts are not from the textbook.
1,000 units available for sale during year

50. Cost of merchandise available for sale
Fifo Periodic
200 $9
= $1,800 Jan. 1
= 3,000 Mar. 10
= 4,400 Sept. 21
= 1,200 Nov. 18
300 $10
400 $11
100 $12
1,000 units available for sale during year
$10,400
Cost of merchandise available for sale

51. Fifo Periodic
A physical count on December 31 reveals that 700 of the 1,000 units have been sold.

52. Fifo Periodic
Using fifo, the first units purchased are theoretically the first units sold. Let’s count starting with January 1.

53. Fifo Periodic 200 units @ $9 Sold these 200 = $1,800 Jan. 1
= 0 Mar. 10
= 3,000 Mar. 10
Sold 200 of these
200 $11
400 $11
= 2,200 Sept. 21
= 4,400 Sept. 21
100 $12
= 1,200 Nov. 18
1,000 units available for sale during year
$10,400
$ 3,400
Ending inventory

54. Fifo Periodic Cost of merchandise available for sale $10,400
Less ending inventory 3,400
Cost of merchandise sold $ 7,000

55. Summary of Fifo Periodic
Cost of
Merchandise
Sold
Merchandise
Available
for Sale
Purchases
$1,800
200 units at $9
Jan. 1
200 units at $9
$1,800
$3,000
300 units at $10
Mar. 10
300 units at $10
$3,000
$2,200
200 units at $11
Sep. 21
400 units at $11
$7,000
700 units
$4,400
Merchandise
Inventory
Nov. 18
100 units at $12
$1,200
$2,200
200 units at $11
1,000 units
$10,400
$1,200
100 units at $12
$3,400
300 units

56. Lifo Periodic Jan. 1 Beginning Inventory 200 units @ $9
Mar. 10 Purchase
400 $11
Sept. 21 Purchase
100 $12
Nov. 18 Purchase
1,000 units available for sale during year
Using lifo, the most recent batch purchased is considered the first batch of merchandise sold.

57. Assume again that 700 units were sold during the year.
Lifo Periodic
Assume again that 700 units were sold during the year.
200 $9
Jan. 1 Beginning Inventory
300 $10
Mar. 10 Purchase
400 $11
Sept. 21 Purchase
100 $12
Nov. 18 Purchase
1,000 units available for sale during year

58. Lifo Periodic 200 units @ $9 = $1,800 Jan. 1 = 3,000 Mar. 10
= 4,400 Sept. 21
= 1,200 Nov. 18
100 $10
Sold 200 of these
300 $10
1,000
400 $11
Sold these 400
Sold these 100
100 $12
1,000 units available for sale during year
$2,800

59. Lifo Periodic Cost of merchandise available for sale $10,400
Less ending inventory 2,800
Cost of merchandise sold $ 7,600

60. Summary of Lifo Periodic
Merchandise
Inventory
Merchandise
Available
for Sale
Purchases
$1,800
200 units at $9
Jan. 1
200 units at $9
$1,000
100 units at $10
$1,800
$2,800
300 units
Mar. 10
300 units at $10
$3,000
Cost of
Merchandise
Sold
Sep. 21
400 units at $11
$4,400
$2,000
200 units at $10
Nov. 18
100 units at $12
$1,200
$4,400
400 units at $11
1,000 units
$10,400
$1,200
100 units at $12
$7,600
700 units

61. Average Cost Periodic
200 $9
Jan. 1 Beginning Inventory
The average cost periodic method is based on the average cost of identical units.
300 $10
Mar. 10 Purchase
400 $11
Sept. 21 Purchase
100 $12
Nov. 18 Purchase
1,000 units available for sale during year

62. Average Cost Periodic 200 units @ $9 = $ 1,800
1,000 units available for sale during year
$10,400 Cost of merchandise available for sale

63. Average Cost Periodic Cost of Merchandise Available for Sale
= Average Unit Cost
Units Available for Sale During Year
$10,400
1,000 Units
= $10.40 per Unit

64. …or, 700 units sold times $10.40 equals $7,280.
Average Cost Periodic
Cost of merchandise available for sale $10,400
Less ending inventory ($10.40 x 300) 3,120
Cost of merchandise sold $ 7,280
…or, 700 units sold times $10.40 equals $7,280.

65. Learning Goal 6
Compare and contrast the use of the three inventory costing methods.

66. First-In, First-Out Net sales $15,000 Cost of merchandise sold:
Beginning inventory $ 1,800
Purchases 8,600
Merchandise available for sale $10,400
Less ending inventory 3,400
Cost of merchandise sold ,000
Gross profit $ 8,000

67. Average Cost Net sales $15,000 Cost of merchandise sold:
Beginning inventory $ 1,800
Purchases 8,600
Merchandise available for sale $10,400
Less ending inventory 3,120
Cost of merchandise sold ,280
Gross profit $ 7,720

68. Last-In, First-Out Net sales $15,000 Cost of merchandise sold:
Beginning inventory $ 1,800
Purchases 8,600
Merchandise available for sale $10,400
Less ending inventory 2,800
Cost of merchandise sold ,600
Gross profit $ 7,400

69. Learning Goal 7
Determine the proper valuation of inventory at other than cost, using the lower-of-cost-or-market and net realizable value concepts.

70. In the lower-of-cost-or-market method, market is the cost to replace the merchandise on the inventory date.

71. 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
$ 3,800
2,700
4,650
3,920
Total $15,520 $15,472 $15,070
A 400 $10.25 $ $ 4,100 $ 3,800
B ,700 2,892
C ,800 4,650
D ,920 4,130
The market decline is either:
1. Based on total inventory ($15,520 – $15,472) = $48
2. Based on individual items ($15,520 – $15,070) = $450

72. Learning Goal 8
Describe how inventories are being reduced through quick response.

73. To satisfy customer demand with the least amount of inventory and inefficiency, merchandisers and manufacturers are embracing quick response.
Quick response is used to optimize inventory levels by electronically sharing common forecast, inventory, sales, and payment information between manufacturers and merchandisers, using the Internet or other electronic means.

74. Learning Goal 9
Determine and interpret the inventory turnover ratio, the number of days’ sales in inventory, and lifo reserve adjustments.

75. Inventory Turnover Ratios
Safeway Inc. Zale
Cost of merchandise sold $22,482,400,000 $920,003,000
Inventories:
Beginning of year $2,444,900,000 $571,669,000
End of year $2,508,000,000 $630,450,000
Average $2,476,450,000 $601,059,500
Inventory turnover 9.1 times 1.5 times
Cost of merchandise sold
Average inventory
Use: To assess the efficiency in the management of inventory

76. Number of Days’ Sales in Inventory
Safeway Inc. Zale
Average daily cost of
merchandise sold:
$22,482,400,000/365 $61,595,616
$920,003,000/365 $2,520,556
Ending inventory $2,508,000,000 $630,450,000
Average selling period 41 days 250 days
Inventory, end of year
Average daily cost of merchandise sold
Generally, the lower number of days’ sales in inventory, the better.

77. Chapter 8
The End