1. 16–1 McQuaig Bille 1 College Accounting 10 th Edition McQuaig Bille Nobles © 2011 Cengage Learning PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University Chapter 16 Ending Merchandise Inventory

2. 16–2 Accounting Language  Merchandise inventory is defined as goods purchased by the company and held for resale to customers in the ordinary course of business.  The Merchandise Inventory account requires two adjusting entries: 1.The first entry removes or “reverses out” the value of the beginning merchandise inventory. 2.The second entry adds in the value of the ending merchandise inventory.

3. 16–3 Merchandise Inventory and Related T Accounts

4. 16–4 Merchandise Inventory and Related T Accounts

5. 16–5 Accounting Language Assume that a firm has a beginning merchandise inventory amounting to $275,000. The cost of the ending merchandise inventory is $283,000. The adjustment is described by T accounts as follows:

6. 16–6 The Importance of Inventory Valuation  Merchandise Inventory is the only account that can appear on both major financial statements.  If the ending merchandise inventory is overstated, the cost of goods sold will also be understated and net income will be overstated.  If the beginning merchandise inventory is overstated, net income will be understated.  The problem is ongoing when the understated ending inventory of year 1 becomes the beginning inventory for year 2.

7. 16–7 Summary

8. 16–8 Merchandise inventory turnover is the number of times a firm’s average inventory is sold during a given year. Merchandise Inventory Turnover

9. 16–9 Assume the following information for 2011 and 2010 for Southern Furniture. Beginning Merchandise Inventory (from the Cost of Goods Sold section of the income statement)$ 46,000$ 64,000 Ending Merchandise Inventory (from the Cost of Goods Sold Section of income statement or the balance sheet)58,00046,000 Cost of Goods Sold (from the Cost of Goods Sold section of the income statement)278,000248,000 2011 2010 Merchandise Inventory Turnover

10. 16–10 Merchandise Inventory Turnover

11. 16–11 Taking Inventories  Care should be taken to count all goods belonging to the firm.  Sometimes goods may not be physically present. 1.From the seller’s position, merchandise sold FOB destination should be included in the seller’s inventory. 2.From the buyer’s position, merchandise purchased FOB shipping point should be included in the buyer’s inventory.

12. 16–12 Periodic Inventory System Whitewater Raft Supply keeps an inventory of Draco life vests (#931). The following activity took place for this inventory item during the year: Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 Total available109units$6,897 Note: These data will be repeated several times to demonstrated the different inventory methods.

13. 16–13 Specific Identification Method When Whitewater Raft Supply takes inventory at the end of the year, it finds that there are 29 life vests in stock; 7 of those were bought in March, 10 were bought in July, and 12 were bought in November. Costs are assigned to the ending inventory as follows: Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 7 $ 441 Sold all but 7 of these Sold all of these

14. 16–14 Specific Identification Method When Whitewater Raft Supply takes inventory at the end of the year, it finds that there are 29 life vests in stock; 7 of those were bought in March, 10 were bought in July, and 12 were bought in November. Costs are assigned to the ending inventory as follows: Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 7 $ 441 Sold all of these 10 Sold all but 10 of these 650

15. 16–15 Specific Identification Method When Whitewater Raft Supply takes inventory at the end of the year, it finds that there are 29 life vests in stock; 7 of those were bought in March, 10 were bought in July, and 12 were bought in November. Costs are assigned to the ending inventory as follows: Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 7 $ 441 Sold all of these 10 650 12 Sold all but 12 of these 804

16. 16–16 When Whitewater Raft Supply takes inventory at the end of the year, it finds that there are 29 life vests in stock; 7 of those were bought in March, 10 were bought in July, and 12 were bought in November. Costs are assigned to the ending inventory as follows: Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 7 $ 441 Sold all of these 10 650 12 804 Specific Identification Method Total29units$1,895

17. 16–17 Specific Identification Method Whitewater Raft Supply determines the cost of goods sold by subtracting the value of the ending inventory from the total cost of goods available for sale. Total life vests available (109 units)$6,897 Less ending inventory (29 units) 1,895 Cost of goods sold (80 units)$5,002

18. 16–18 Weighted-Average-Cost Method Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 Total available109units$6,897 STEP 1. STEP 2.$6,897 ÷ 109 = $63.28 STEP 3. 29 units x $63.28 = $1,835.12 Value of Ending Inventory (29 units) STEP 4. Cost of goods sold (80 units) $6,897.00 – $1,835.12 = $5,061.88

19. 16–19 First-In, First-Out Method (FIFO) Method The first-in, first-out (FIFO) method is based on the flow- of-cost assumption that costs of merchandise sold should be charged against revenue in the order in which the costs were incurred. Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 Total available109units$6,897

20. 16–20 First-In, First-Out Method (FIFO) Method Whitewater Raft Supply sold 80 units. Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 Sold all 24 Sold all 30 80 56 26 Sold 26 of 35 0 9 units @ $65 each = $ 585

21. 16–21 First-In, First-Out Method (FIFO) Method Whitewater Raft Supply sold 80 units. Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 Sold all 24 Sold all 30 Sold 26 of 35 9 units @ $65 each = $ 585 Total29units $1,925 Cost of Goods Sold = Total Available – Ending Inventory $4,972 = $6,897– $1,925

22. 16–22 Last-In, First-Out Method (LIFO) Method The last-in, first-out (LIFO) method is based on the flow- of-cost assumption that the most recently purchased articles are sold first and the articles remaining in the ending inventory are the oldest. Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 Total available109units$6,897

23. 16–23 Last-In, First-Out Method (LIFO) Method Whitewater Raft Supply sold 80 units. Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 Sold all 20 Sold 25 of 30 80 60 25 Sold all 35 0 5 units @ $63 each = 315

24. 16–24 Last-In, First-Out Method (LIFO) Method Whitewater Raft Supply sold 80 units. Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 Sold all 20 Sold 25 of 30 Sold all 35 5 units @ $63 each = 315 Total 29 units$1,707 Cost of Goods Sold = Total Available – Ending Inventory $5,190 = $6,897– $1,707

25. 16–25 Comparison of Methods Whitewater Raft Supply sells the 80 life vests for $110 apiece, for a total of $8,800. The four methods yield the following gross profits.

26. 16–26 The effects of the methods are as follows: 1.Specific identification matches costs exactly with revenues. 2.Weighted-average-cost is a compromise between LIFO and FIFO. 3.FIFO provides the most realistic amount for the ending inventory. 4.LIFO provides the most realistic amount for the Cost of Goods Sold section of the income statement. Comparison of Methods

27. 16–27 Tax Effect of LIFO  In periods of rising prices, LIFO yields the lowest gross profit and hence the lowest income taxes because the most recent costs are assigned to the cost of goods sold.  When prices fall, companies using LIFO are at a disadvantage from the standpoint of income taxes.  The cost figure determined by the different methods may have nothing to do with the physical flow of goods.

28. 16–28 Lower-of-Cost-or-Market Rule  Sometimes the replacement cost of items in stock is less than the original market cost.  Market refers to the current price charged in the market.  The lower-of-cost-or-market (LCM) rule says that, under certain conditions, when the replacement or market cost is lower than the original cost, the inventory should be valued at the lower cost.

29. 16–29 Perpetual Inventory System Whitewater Raft Supply keeps an inventory of Draco life vests (#931). The following activity took place for this inventory item during the year: Jan.1Beginning inventory24units @ $58 each =$1,392 Mar.16Purchase30units @ $63 each =1,890 July29Purchase35units @ $65 each =2,275 Nov. 18Purchase20units @ $67 each =1,340 Total available109units$6,897

30. 16–30 Whitewater Raft Supply sold 80 units on the following dates: Feb. 2815 units Apr. 317 units June 2116 units Dec. 232 units 80 units Perpetual Inventory System This information will be used in the next section.

31. 16–31 To calculate the moving average cost per unit, Whitewater Raft Supply divides the total cost at time of sale by the total units at time of sale. Moving Average Cost per Unit = Total Cost at time of sale ÷ Total Units at time of sale Moving-Average-Cost Method

32. 16–32 Moving-Average-Cost Method

33. 16–33 *Rounded Moving-Average-Cost Method

34. 16–34

35. 16–35 Last-In, First-Out (LIFO) Method Whitewater Raft Supply’s accountant now verifies the total cost of the 80 life vests sold: Cost of Goods Sold = Total Available – Ending Inventory $5,054 = $6,897 – $1,843

36. 16–36 Comparison of Methods

37. 16–37 Perpetual Inventory Record  When a firm uses the perpetual inventory system, Merchandise Inventory is a controlling account.  The firm maintains an individual record for each kind of product in the subsidiary ledger.  The firm records the remaining balance after each receipt or sale.

38. 16–38 Perpetual Inventory Record  Whitewater Raft Supply maintains a perpetual inventory of rafting paddles on a LIFO basis.  The ending balance of 30 units amounts to $2,223. Nineteen paddles were sold at $115 each, for total sales of $2,185. The cost of goods sold was $1,410 to generate a gross profit of $775.