This document discusses inventory valuation methods. It covers perpetual and periodic inventory systems, as well as classifications like raw materials, work in process, and finished goods. Cost flow methods like FIFO, average cost, and specific identification are explained. The document also discusses lower of cost or market, inventory errors, and presentation of inventory balances. Alternative methods for estimating inventory balances like the gross profit method and retail inventory method are presented through examples.

1. Slide
6-1
Inventories

2. Slide
6-2

3. Slide
6-3

4. Slide
6-4
Perpetual Inventory Method
Date Account Debit Credit
Inventory
Accounts Payable
$$$
$$$
Accounts Receivable
Sales
COGS
Inventory
$$$
SSS
SSS
SSS
Ordering
Inventory
Selling
Inventory
Periodic Inventory Method
Date Account Debit Credit
Purchases
Accounts Payable
$$$
$$$
Accounts Receivable
Sales
$$$
SSS

5. Slide
6-5

6. Slide
6-6
One Classification:
Merchandise Inventory
Three Classifications:
Raw Materials
Work in Process
Finished Goods
Merchandising
Company
Manufacturing
Company
Regardless of the classification, companies report all inventories
under Current Assets on the statement of financial position.

7. Slide
6-7
Physical Inventory taken for two reasons:
Perpetual System
1. Check accuracy of inventory records.
2. Determine amount of inventory lost (wasted raw
materials, shoplifting, or employee theft).
Periodic System
1. Determine the inventory on hand
2. Determine the cost of goods sold for the period.

8. Slide
6-8
Involves counting, weighing, or measuring each kind of
inventory on hand.
Taken,
when the business is closed or when business is
slow.
at end of the accounting period.
Taking a Physical Inventory

9. Slide
6-9
Goods in Transit
Purchased goods not yet received.
Sold goods not yet delivered.
Determining Ownership of Goods
Goods in transit should be included in the inventory of the
company that has legal title to the goods. Legal title is
determined by the terms of sale.

10. Slide
6-10
Illustration 6-1
Ownership of the goods
passes to the buyer when
the public carrier accepts
the goods from the seller.
Ownership of the goods
remains with the seller until
the goods reach the buyer.
Goods in Transit

11. Slide
6-11
Consigned Goods
In some lines of business, it is common to hold the
goods of other parties and try to sell the goods for
them for a fee, but without taking ownership of
goods.
These are called consigned goods.
Determining Ownership of Goods

12. Slide
6-12
Unit costs can be applied to quantities on hand
using the following costing methods:
Specific Identification
First-in, first-out (FIFO)
Average-cost
Cost Flow
Assumptions

13. Slide
6-13
An actual physical flow costing method in which items
still in inventory are specifically costed to arrive at the
total cost of the ending inventory.
Practice is relatively rare.
Most companies make assumptions (Cost Flow
Assumptions) about which units were sold.
Specific Identification Method

14. Slide
6-14
Here is information about the mountain bike inventory of Trekking
for the month of August.

15. Slide
6-15

16. Slide
6-16
P1
Balance Sheet Inventory
Income Statement
Cost of Goods Sold

17. Slide
6-17
Earliest goods purchased are first to be sold.
Often parallels actual physical flow of merchandise.
Generally good business practice to sell oldest units
first.
“First-In-First-Out (FIFO)”

18. Slide
6-18
P1

19. Slide
6-19
P1

20. Slide
6-20
Allocates cost of goods available for sale on the
basis of weighted average unit cost incurred.
Assumes goods are similar in nature.
Applies weighted average unit cost to the units on
hand to determine cost of the ending inventory.
“Average-Cost”

21. Slide
6-21
Cost of Goods
Available for
Sale
Units on hand
on the date of
sale
÷
P1

22. Slide
6-22
P1

23. Slide
6-23
P1

24. Slide
6-24
Illustration 6-9
Financial Statement and Tax Effects
Income
Statement
Effects

25. Slide
6-25
Statement of Financial Statement Effects
Ø A major advantage of the FIFO method is that in a period
of inflation, the costs allocated to ending inventory will
approximate their current cost.
Ø A shortcoming of the average-cost method is that in a
period of inflation, the costs allocated to ending inventory
may be understated in terms of current cost.

26. Slide
6-26
Tax Effects
In a period of inflation:
Ø FIFO - inventory and net income higher.
Ø AVERAGE Cost - lower income taxes.

27. Slide
6-27
Using Cost Flow Methods Consistently
Method should be used consistently, enhances
comparability.
Although consistency is preferred, a company may
change its inventory costing method.

28. Slide
6-28
Lower-of-Cost-or-Net Realizable Value
When the value of inventory is lower than its cost
Companies can “write down” the inventory to its net
realizable value in the period in which the price
decline occurs.
Net realizable value refers to the net amount that a
company expects to realize (receive) from the sale of
inventory.
It is the estimated selling price in the ordinary course of
business, less the estimated costs of completion and
estimated selling expenses.

29. Slide
6-29
Illustration: Assume that Ken Tuckie TV has the following
lines of merchandise with costs and market values as
indicated.
Illustration 6-10
Lower-of-Cost-or-Net Realizable Value

30. Slide
6-30
Common Cause:
Failure to count or price inventory correctly.
Not properly recognizing the transfer of legal title to
goods in transit.
Errors affect both the income statement and
statement of financial position.

31. Slide
6-31
Inventory errors affect the computation of cost of goods
sold and net income.
Income Statement Effects
Illustration 6-12
Illustration 6-11

32. Slide
6-32
Inventory errors affect the computation of cost of goods sold
and net income in two periods.
An error in ending inventory of the current period will
have a reverse effect on net income of the next
accounting period.
Over the two years, the total net income is correct
because the errors offset each other.
The ending inventory depends entirely on the accuracy
of taking and costing the inventory.
Income Statement Effects

33. Slide
6-33
($3,000)
Net Income
understated
$3,000
Net Income
overstated
Combined income for 2-
year period is correct.
Illustration 6-13

34. Slide
6-34
Effect of inventory errors on the statement of financial
position is determined by using the accounting equation:
Statement of Financial Position Effects
Illustration 6-11
Illustration 6-14

35. Slide
6-35

36. Slide
6-36

37. Slide
6-37
Ending inventory understated by
$1,500
Correct
COGS Overstated by $1,500
Net Income Understated by
$1,500
COGS Understated by $1,500
Net Income Overstated by
$1,500

38. Slide
6-38
Statement of Financial Position - Inventory classified as
current asset.
Income Statement - Cost of goods sold.
There also should be disclosure of
1) major inventory classifications,
2) basis of accounting (cost, or lower-of-cost-or-net
realizable value), and
3) Cost method (specific identification, FIFO, or average-
cost).
Presentation

39. Slide
6-39
The gross profit method estimates the cost of ending
inventory by applying a gross profit rate to net sales.
Gross Profit Method
Illustration 6B-1

40. Slide
6-40
Illustration: Kishwaukee Company’s records for January show net
sales of $200,000, beginning inventory $40,000, and cost of goods
purchased $120,000. The company expects to earn a 30% gross
profit rate. Compute the estimated cost of the ending inventory at
January 31 under the gross profit method.
Illustration 6B-2

41. Slide
6-41
Company applies the cost-to-retail percentage to ending
inventory at retail prices to determine inventory at cost.
Retail Inventory Method
Illustration 6B-3

42. Slide
6-42
Note that it is not necessary to take a physical inventory to determine
the estimated cost of goods on hand at any given time.
Illustration 6B-4
Illustration: