This document discusses accounting for inventories. It covers classifying inventory, determining inventory quantities through physical counts and ownership rules, inventory costing methods including specific identification, FIFO, LIFO, and average cost, and the financial statement effects of using different cost flow assumptions. The key points are determining inventory ownership, applying cost flow assumptions like FIFO and LIFO to value ending inventory balances, and how the choice of assumptions like LIFO can impact reported income during inflationary periods by reducing taxable income.

1. Chapter 6-
1

2. Chapter 6-
2
Chapter 3
Inventories
Accounting Principles, Ninth Edition

3. Chapter 6-
3
Study Objectives
1. Describe the steps in determining inventory
quantities.
2. Explain the accounting for inventories and apply the
inventory cost flow methods.
3. Explain the financial effects of the inventory cost
flow assumptions.
4. Explain the lower-of-cost-or-market basis of
accounting for inventories.

4. Chapter 6-
4
5. Indicate the effects of inventory errors on the
financial statements.
6. Compute and interpret the inventory turnover ratio.

5. •
•
Work in
process Raw
materials
• inventory
Determining
ownership of
goods
•
•
•
•
Cost flow
assumptions
Financial
statement
and tax
effects
Consistent
use Lower-
ofcost-
ormarket
• effects
Balance
sheet
effects
Chapter 6-
4

6. • Specific
identification
Statement
Presentation
and Analysis
Reporting and Analyzing Inventory
• Taking a
physical
Classifying
Inventory
Determining
Inventory
Quantities
Inventory
Costing
Inventory
Errors
• Finished
goods
• Income
statement
• Presentation
• Analysis

7. Classifying Inventory
Merchandising
Company
One Classification:
• Merchandise Inventory
Manufacturing
Company
Three Classifications:
• Raw Materials
• Work in Process
• Finished Goods

8. Regardless of the classification, companies report all
inventories under Current Assets on the balance
sheet.
Chapter
6-5

10. Chapter 6-
6

11. Determining Inventory Quantities
Chapter6-
11 SO 1 Describe the steps in determining inventory quantities.
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.

12. Determining Inventory Quantities
Chapter6-
12 SO 1 Describe the steps in determining inventory quantities.
Taking a Physical Inventory
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.

13. Determining Inventory Quantities
Chapter6-
13 SO 1 Describe the steps in determining inventory quantities.
Determining Ownership of Goods
Goods in Transit
• Purchased goods not yet received.
• Sold goods not yet delivered.
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.
Illustration 6-1

14. Determining Inventory Quantities
Chapter6-
14 SO 1 Describe the steps in determining inventory quantities.
Terms of Sale
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.

15. Determining Inventory Quantities
Chapter6-
15 SO 1 Describe the steps in determining inventory quantities.
Review Question
Goods in transit should be included in the
inventory of the buyer when the:
a. public carrier accepts the goods from the
seller.
b. goods reach the buyer.
c. terms of sale are FOB destination.

16. Determining Inventory Quantities
Chapter6-
16 SO 1 Describe the steps in determining inventory quantities.
d. terms of sale are FOB shipping point.
Determining Ownership of Goods
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.

17. Inventory Costing
Chapter SO 2 Explain the accounting for inventories 6-17
and apply the
inventory cost flow thd
Unit costs can be applied to quantities on
hand using the following costing methods:
• Specific Identification
• First-in, first-out (FIFO)
• Last-in, first-out (LIFO)
• Average-cost
Cost Flow
Assumptions

18. Inventory Costing
Chapter SO 2 Explain the accounting for inventories 6-18
and apply the
inventory cost flow thd
Specific Identification Method
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.
Illustration: Assume that Crivitz TV Company purchases
three identical 46-inch TVs on different dates at costs

19. Inventory Costing
Chapter SO 2 Explain the accounting for inventories 6-19
and apply the
inventory cost flow thd
of $700, $750, and $800. During the year Crivitz sold
two sets at $1,200 each.
Illustration: If Crivitz sold the TVs it purchased on
February 3 and May 22, then its cost of goods sold is
Illustration 6-2

20. Inventory Costing
Chapter SO 2 Explain the accounting for inventories 6-20
and apply the
inventory cost flow thd
$1,500 ($700 $800), and its ending inventory is $750.
Illustration 6-3

21. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-21
and apply the inventory
cost flow thd
Illustration 6-11

22. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-22
and apply the inventory
cost flow thd
Use of cost flow methods in
major U.S. companies

23. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-23
and apply the inventory
cost flow thd
Cost Flow Assumption does not need to

24. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-24
and apply the inventory
cost flow thd
equal
Physical Movement of
Goods
Illustration: Assume that Houston Electronics uses a
periodic inventory system.

25. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-25
and apply the inventory
cost flow thd
A physical inventory at the end of the year determined that
during the year Houston sold 550 units and had 450 units in
inventory at December 31.
Illustration 6-4

26. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-26
and apply the inventory
cost flow thd
“First-In-First-Out (FIFO)”
• Earliest goods purchased are first to be sold.
• Often parallels actual physical flow of
merchandise.
• Generally good business practice to sell oldest
units first.

27. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-27
and apply the inventory
cost flow thd
“First-In-First-Out (FIFO)”

28. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-28
and apply the inventory
cost flow thd
Illustration 6-5

29. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-29
and apply the inventory
cost flow thd
“First-In-First-Out (FIFO)”

30. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-30
and apply the inventory
cost flow thd
Illustration 6-5

31. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-31
and apply the inventory
cost flow thd
“Last-In-First-Out (LIFO)”
• Latest goods purchased are first to be sold.
• Seldom coincides with actual physical flow of
merchandise.
• Exceptions include goods stored in piles, such as
coal or hay.

32. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-32
and apply the inventory
cost flow thd
“Last-In-First-Out (LIFO)”

33. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-33
and apply the inventory
cost flow thd
Illustration 6-7

34. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-34
and apply the inventory
cost flow thd
“Last-In-First-Out (LIFO)”

35. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-35
and apply the inventory
cost flow thd
Illustration 6-7

36. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-36
and apply the inventory
cost flow thd
“Average-Cost”
• 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.

37. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-37
and apply the inventory
cost flow thd
“Average Cost”

38. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-38
and apply the inventory
cost flow thd
Illustration 6-10

39. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-39
and apply the inventory
cost flow thd
“Average Cost”

40. Inventory Costing – Cost Flow
Assumptions
Chapter SO 2 Explain the accounting for inventories 6-40
and apply the inventory
cost flow thd
Illustration 6-10

41. Inventory Costing – Cost Flow Assumptions
Financial Statement and Tax Effects
Illustration 6-12

42. Inventory Costing – Cost Flow Assumptions
Chapter6-
42SO 3 Explain the financial effects of the inventory cost flow assumptions.

43. Inventory Costing – Cost Flow Assumptions
Review Question
The cost flow method that often parallels the
actual physical flow of merchandise is the:
a. FIFO method.
b. LIFO method.
c. average cost method.
d. gross profit method.

44. Inventory Costing – Cost Flow Assumptions
Chapter6-
44SO 3 Explain the financial effects of the inventory cost flow assumptions.
Chapter SO 2 Explain the accounting for inventories
6-29
and apply the inventory cost flow
Review Question
In a period of inflation, the cost flow method
that results in the lowest income taxes is the:
a. FIFO method.
b. LIFO method.
c. average cost method.

45. Inventory Costing – Cost Flow Assumptions
d. gross profit method.

46. Inventory Costing – Cost Flow Assumptions
Chapter6-
46 SO 3 Explain the financial effects of the inventory cost flow assumptions.
Discussion Question
Q6-12 Casey Company has been using the
FIFO cost flow method during a prolonged
period of rising prices. During the same time
period, Casey has been paying out all of its
net income as dividends. What adverse
effects may result from this policy?
See notes page for discussion

47. Chapter 6-
47
Using Cost Flow Methods Consistently
• Method should be used consistently, enhances
comparability.
• Although consistency is preferred, a company may
change its inventory costing method.
Illustration 6-14
Disclosure of change in cost flow method

48. Inventory Costing
Chapter6-
48 SO 3 Explain the financial effects of the inventory cost flow assumptions.

49. Inventory
Chapter 6-
49
Costing
Lower-of-Cost-or-Market
When the value of inventory is lower than its cost
• Companies can “write down” the
inventory to its market value in the
period in which the price decline occurs.
• Market value = Replacement Cost •
Example of conservatism.

50. Inventory Errors
Chapter6-
50 SO 5 Indicate the effects of inventory errors on the financial
statements.
SO 4 Explain the lower-of-cost-
ormarket basis of accounting for
Costing
Lower-of-Cost-or-Market
Illustration: Assume that Ken Tuckie TV has the
following lines of merchandise with costs and market
values as indicated.

51. Inventory
Chapter 6-
51
SO 4 Explain the lower-of-cost-
ormarket basis of accounting for
Common Cause:
Illustration 6-15

52. Inventory Errors
Chapter6-
52 SO 5 Indicate the effects of inventory errors on the financial
statements.
• 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 balance sheet.

53. Inventory Errors
Chapter6-
53 SO 5 Indicate the effects of inventory errors on the financial
statements.
Income Statement Effects
Inventory errors affect the computation of cost of
goods sold and net income. Illustration 6-16
Illustration 6-17

54. Inventory Errors
Chapter6-
54 SO 5 Indicate the effects of inventory errors on the financial
statements.
Income Statement Effects
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.

55. Inventory Errors
Chapter6-
55 SO 5 Indicate the effects of inventory errors on the financial
statements.
Illustration 6-18

56. Inventory Errors
Chapter6-
56 SO 5 Indicate the effects of inventory errors on the financial
statements.
Combined income for
2-year period is correct.
($3,000)
Net Income
understated
$3,000
Net
Income
overstated
Review Question
Understating ending inventory will overstate:
a. assets.
b. cost of goods sold.
c. net income.

57. Inventory Errors
Chapter6-
57 SO 5 Indicate the effects of inventory errors on the financial
statements.
d. owner's equity.
Balance Sheet Effects
Effect of inventory errors on the balance sheet is
determined by using the basic accounting equation:.

58. Inventory Errors
Chapter6-
58 SO 5 Indicate the effects of inventory errors on the financial
statements.
Illustration 6-16
Illustration 6-19

59. Statement Presentation and Analysis
Presentation
Balance Sheet - Inventory classified as current asset.
Income Statement - Cost of goods sold subtracted
from sales.
There also should be disclosure of
1) major inventory classifications, 2) basis
of accounting (cost or LCM), and
3) costing method (FIFO, LIFO, or average).
Chapter

60. Statement Presentation and Analysis
Chapter6-
60 SO 6 Compute and interpret the inventory turnover ratio.
6-42
Analysis
Inventory management is a double-edged sword
1. High Inventory Levels - may incur high carrying
costs (e.g., investment, storage, insurance,
obsolescence, and damage).
2. Low Inventory Levels – may lead to stockouts and
lost sales.
Inventory turnover measures the number of times on
average the inventory is sold during the period.

61. Statement Presentation and Analysis
Chapter6-
61 SO 6 Compute and interpret the inventory turnover ratio.
Inventory = Cost of Goods Sold
Turnover
Average Inventory
Days in inventory measures the average number of
days inventory is held.
Days in = Days in Year (365)
Inventory
Inventory Turnover

62. Statement Presentation and Analysis
Chapter6-
62 SO 6 Compute and interpret the inventory turnover ratio.
Illustration: Wal-Mart reported in its 2008 annual report
a beginning inventory of $33,685 million, an ending
inventory of $35,180 million, and cost of goods sold for the
year ended January 31, 2008, of $286,515 million. The
inventory turnover formula and computation for Wal-Mart
are shown below.
Illustration 6-21

63. Statement Presentation and Analysis
Chapter6-
63 SO 6 Compute and interpret the inventory turnover ratio.
Days in Inventory: Inventory turnover of 8.3 times divided
into 365 is approximately 44 days. This is the approximate
time that it takes a company to sell the inventory.

64. Chapter6-
64 SO 7 Apply the inventory cost flow methods to perpetual inventory records.
Assuming the Perpetual Inventory System, compute Cost of Goods
Sold and Ending Inventory under FIFO, LIFO, and Average cost.
Example
Cost Flow Methods in Perpetual Systems
Appendix 6A

65. Cost Flow Methods in Perpetual Systems
Chapter6-
65 SO 7 Apply the inventory cost flow methods to perpetual inventory records.
“First-In-First-Out (FIFO)”
Illustration 6A-2

66. Cost Flow Methods in Perpetual Systems
Chapter6-
66 SO 7 Apply the inventory cost flow methods to perpetual inventory records.

67. Cost Flow Methods in Perpetual Systems
Chapter6-
67 SO 7 Apply the inventory cost flow methods to perpetual inventory records.
“Last-In-First-Out (LIFO)”
Illustration 6A-3

68. Cost Flow Methods in Perpetual Systems
Chapter6-
68 SO 7 Apply the inventory cost flow methods to perpetual inventory records.
“Average Cost” (Moving-Average System)
Illustration 6A-4

69. Cost Flow Methods in Perpetual Systems
Chapter6-
69 SO 7 Apply the inventory cost flow methods to perpetual inventory records.

70. Estimating Inventories
Chapter6-
70 SO 8 Describe the two methods of estimating inventories.
Gross Profit Method
The gross profit method estimates the cost of ending
inventory by applying a gross profit rate to net sales.
Illustration 6B-1
Illustration: Kishwaukee Company’s records for January show
net sales of $200,000, beginning inventory $40,000, and cost of

71. Estimating Inventories
Chapter6-
71 SO 8 Describe the two methods of estimating inventories.
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

72. Estimating Inventories
Chapter6-
72 SO 8 Describe the two methods of estimating inventories.
Retail Inventory Method
Company applies the cost-to-retail percentage to ending
inventory at retail prices to determine inventory at cost.
Illustration 6B-3

73. Estimating Inventories
Chapter6-
73 SO 8 Describe the two methods of estimating inventories.
Illustration:
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

74. Copyright
“Copyright © 2009 John Wiley & Sons, Inc. All rights
reserved. Reproduction or translation of this work beyond that
permitted in Section 117 of the 1976 United States Copyright
Act without the express written permission of the copyright
owner is unlawful. Request for further information should be
addressed to the Permissions Department, John Wiley & Sons,
Inc. The purchaser may make back-up copies for his/her own
use only and not for distribution or resale. The Publisher
assumes no responsibility for errors, omissions, or damages,

75. caused by the use of these programs or from the use of the
information contained herein.”
Chapter
6-54