Chapter 7 Inventory Fill Ins

1. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Inventories
Inventories
Chapter 7
Chapter 7

2. Learning ObjectivesLearning Objectives
1.1. Describe the importance of control overDescribe the importance of control over
inventory.inventory.
2.2. Describe three inventory cost flow assumptionsDescribe three inventory cost flow assumptions
and how they impact the income statement andand how they impact the income statement and
balance sheet.balance sheet.
3.3. Determine the cost of inventory under theDetermine the cost of inventory under the
perpetual inventory system, using the FIFO, LIFO,perpetual inventory system, using the FIFO, LIFO,
and weighted average cost methods.and weighted average cost methods.
4.4. Determine the cost of inventory under theDetermine the cost of inventory under the
periodic inventory system, using the FIFO, LIFO,periodic inventory system, using the FIFO, LIFO,
and weighted average cost methods.and weighted average cost methods.

3. Learning ObjectivesLearning Objectives
5.5. Compare and contrast the use of the threeCompare and contrast the use of the three
inventory costing method.inventory costing method.
6.6. Describe and illustrate the reporting ofDescribe and illustrate the reporting of
merchandise inventory in the financialmerchandise inventory in the financial
statements.statements.
7.7. Describe and illustrate the inventory turnoverDescribe and illustrate the inventory turnover
and the number of days’ sales in inventory inand the number of days’ sales in inventory in
analyzing the efficiency and effectiveness ofanalyzing the efficiency and effectiveness of
inventory management.inventory management.

4. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objective
Learning ObjectiveDescribe the importance of control
Describe the importance of controlover inventory.
over inventory.
11

5. Control of InventoryControl of Inventory
o Two primary objectives of control overTwo primary objectives of control over
inventory are:inventory are:
 Safeguarding the inventory from damage or theft.Safeguarding the inventory from damage or theft.
 Reporting inventory in the financial statements.Reporting inventory in the financial statements.

6. Safeguarding InventorySafeguarding Inventory
o TheThe purchase orderpurchase order authorizes the purchase ofauthorizes the purchase of
the inventory from an approved vendor.the inventory from an approved vendor.

7. Safeguarding InventorySafeguarding Inventory
o TheThe receiving reportreceiving report establishes an initialestablishes an initial
record of the receipt of the inventory.record of the receipt of the inventory.

8. Safeguarding InventorySafeguarding Inventory
o Recording inventory using a perpetualRecording inventory using a perpetual
inventory system is also an effective means ofinventory system is also an effective means of
control.The amount of inventory is alwayscontrol.The amount of inventory is always
available in theavailable in the subsidiary inventory ledgersubsidiary inventory ledger..

9. Safeguarding InventorySafeguarding Inventory
o Controls for safeguarding inventory shouldControls for safeguarding inventory should
include security measures to prevent damageinclude security measures to prevent damage
and customer or employee theft. Someand customer or employee theft. Some
examples of security measures include theexamples of security measures include the
following:following:
 Storing inventory in areas that are restricted to onlyStoring inventory in areas that are restricted to only
authorized employees.authorized employees.
 Locking high-priced inventory in cabinets.Locking high-priced inventory in cabinets.
 Using two-way mirrors, cameras, security tags, andUsing two-way mirrors, cameras, security tags, and
guards.guards.

10. Reporting InventoryReporting Inventory
o AA physical inventoryphysical inventory or count of inventoryor count of inventory
should be taken near year-end to make sureshould be taken near year-end to make sure
that the quantity of inventory reported in thethat the quantity of inventory reported in the
financial statements is accurate.financial statements is accurate.

11. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objective
Learning Objective
Describe three inventory cost flow
Describe three inventory cost flow
assumptions and how they impact
assumptions and how they impact
the income statement and balance
the income statement and balance
sheet.
sheet.
22

12. INVENTORYINVENTORY
COST FLOWCOST FLOW
ASSUMPTIONSASSUMPTIONS

13. Inventory Cost Flow AssumptionsInventory Cost Flow Assumptions

14. Inventory Cost Flow AssumptionsInventory Cost Flow Assumptions
o Assume that one unit is sold on May 30 for $20.Assume that one unit is sold on May 30 for $20.
Depending upon which unit was sold, the grossDepending upon which unit was sold, the gross
profit varies from $11 to $6 as shown below:profit varies from $11 to $6 as shown below:

15. Inventory Cost Flow AssumptionsInventory Cost Flow Assumptions
o Under the specific identification inventory costUnder the specific identification inventory cost
flow method, the unit sold is identified with aflow method, the unit sold is identified with a
specific purchase.specific purchase.

16. Inventory Cost Flow AssumptionsInventory Cost Flow Assumptions
o Under theUnder the first-in, first out (FIFO) inventoryfirst-in, first out (FIFO) inventory
cost flow methodcost flow method, the first units purchased are, the first units purchased are
assumed to be sold first and the endingassumed to be sold first and the ending
inventory is made up of the most recentinventory is made up of the most recent
purchases.purchases.

17. Inventory Cost Flow AssumptionsInventory Cost Flow Assumptions
o Under theUnder the last-in, first out (LIFO) inventorylast-in, first out (LIFO) inventory
cost flow methodcost flow method, the last units purchased are, the last units purchased are
assumed to be sold first and the endingassumed to be sold first and the ending
inventory is made up of the first unitsinventory is made up of the first units
purchased.purchased.

18. Inventory Cost Flow AssumptionsInventory Cost Flow Assumptions
o Under theUnder the weighted average inventory costweighted average inventory cost
flowflow methodmethod, the cost of the units sold and in, the cost of the units sold and in
ending inventory is a weighted average of theending inventory is a weighted average of the
purchase costs.purchase costs.

19. INVENTORYINVENTORY
COST FLOWCOST FLOW
ASSUMPTIONSASSUMPTIONS
(continued)

20. INVENTORYINVENTORY
COST FLOWCOST FLOW
ASSUMPTIONSASSUMPTIONS
(continued)

21. INVENTORYINVENTORY
COST FLOWCOST FLOW
ASSUMPTIONSASSUMPTIONS
(concluded)

22. EXAMPLEEXAMPLE
EXERCISEEXERCISE

23. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objective
Learning ObjectiveDetermine the cost of inventory
Determine the cost of inventory
under the perpetual inventory
under the perpetual inventory
system, using the FIFO, LIFO, and
system, using the FIFO, LIFO, and
weighted average cost methods.
weighted average cost methods.
33

24. Inventory Costing MethodsInventory Costing Methods
o For purposes of illustration, the data for ItemFor purposes of illustration, the data for Item
127B are used, as shown below.We will127B are used, as shown below.We will
examine theexamine the perpetual inventory systemperpetual inventory system first.first.

25. FIRST-IN, FIRST-FIRST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

26. FIRST-IN, FIRST-FIRST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

27. FIRST-IN, FIRST-FIRST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

28. FIRST-IN, FIRST-FIRST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

29. FIRST-IN, FIRST-FIRST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

30. FIRST-IN, FIRST-FIRST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

31. FIRST-IN, FIRST-FIRST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

32. LAST-IN, FIRST-LAST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

33. LAST-IN, FIRST-LAST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

34. LAST-IN, FIRST-LAST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

35. LAST-IN, FIRST-LAST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

36. LAST-IN, FIRST-LAST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

37. LAST-IN, FIRST-LAST-IN, FIRST-
OUT METHODOUT METHOD

38. LAST-IN, FIRST-LAST-IN, FIRST-
OUT METHODOUT METHOD
(continued)

39. Weighted Average Cost MethodWeighted Average Cost Method
o When the weighted average cost method isWhen the weighted average cost method is
used in a perpetual system, an average unitused in a perpetual system, an average unit
cost for each item is computed each time acost for each item is computed each time a
purchase is made.purchase is made.
o This unit cost is then used to determine theThis unit cost is then used to determine the
cost of each sale until another purchase iscost of each sale until another purchase is
made and a new average is computed.Thismade and a new average is computed.This
averaging technique is called aaveraging technique is called a movingmoving
averageaverage..

40. WEIGHTEDWEIGHTED
AVERAGE COSTAVERAGE COST
METHODMETHOD

41. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objective
Learning ObjectiveDetermine the cost of inventory
Determine the cost of inventory
under the periodic inventory
under the periodic inventory
system, using the FIFO, LIFO, and
system, using the FIFO, LIFO, and
weighted average cost methods.
weighted average cost methods.
44

42. First-In, First-Out MethodFirst-In, First-Out Method
o Using FIFO, the earliest batch purchased isUsing FIFO, the earliest batch purchased is
considered the first batch of merchandiseconsidered the first batch of merchandise
sold.The physical flow does not have to matchsold.The physical flow does not have to match
the accounting method chosen.This time wethe accounting method chosen.This time we
will be examining thewill be examining the periodic inventoryperiodic inventory
systemsystem..

43. Cost of merchandiseCost of merchandise
available for saleavailable for sale
First-In, First-Out MethodFirst-In, First-Out Method
o Beginning inventory and purchases of ItemBeginning inventory and purchases of Item
127B in January are as follows:127B in January are as follows:

44. First-In, First-Out MethodFirst-In, First-Out Method
o The physical count on January 31 shows thatThe physical count on January 31 shows that
800 units are on hand. (Conclusion: 1,300 units800 units are on hand. (Conclusion: 1,300 units
were sold.) What is the cost of the endingwere sold.) What is the cost of the ending
inventory?inventory?

45. First-In, First-Out MethodFirst-In, First-Out Method
o Now we can calculate the cost of merchandiseNow we can calculate the cost of merchandise
sold as follows:sold as follows:

46. FIRST-IN, FIRST-FIRST-IN, FIRST-
OUT METHODOUT METHOD

47. Last-In, First-Out MethodLast-In, First-Out Method
o Using LIFO, the most recent batch purchasedUsing LIFO, the most recent batch purchased
is considered the first batch of merchandiseis considered the first batch of merchandise
sold.The actual flow of goods does not have tosold.The actual flow of goods does not have to
be LIFO. For example, a store selling fresh fishbe LIFO. For example, a store selling fresh fish
would want to sell the oldest fish first (which iswould want to sell the oldest fish first (which is
FIFO), even though LIFO is used forFIFO), even though LIFO is used for
accounting purposes.accounting purposes.

48. Last-In, First-Out MethodLast-In, First-Out Method
o Assume again that the physical count onAssume again that the physical count on
January 31 is 800 units (and that 1,300 unitsJanuary 31 is 800 units (and that 1,300 units
were sold). What is the cost of thewere sold). What is the cost of the
merchandise sold?merchandise sold?

49. LAST-IN, FIRST-LAST-IN, FIRST-
OUT METHODOUT METHOD

50. Weighted Average Cost MethodWeighted Average Cost Method
o TheThe weighted average cost methodweighted average cost method uses theuses the
weighted average unit cost for determiningweighted average unit cost for determining
cost of merchandise sold and the endingcost of merchandise sold and the ending
merchandise inventory.merchandise inventory.

51. Average costAverage cost
per unitper unit
EndingEnding
InventoryInventory
Weighted Average Cost MethodWeighted Average Cost Method

52. Weighted Average Cost MethodWeighted Average Cost Method

53. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objective
Learning Objective
Compare and contrast the use of the
Compare and contrast the use of the
three inventory costing methods.
three inventory costing methods.
55

54. Comparing Inventory Cost MethodsComparing Inventory Cost Methods
o Using the perpetual inventory systemUsing the perpetual inventory system
illustration with sales of $39,000 (1,300 units xillustration with sales of $39,000 (1,300 units x
$30), the differences in ending inventory, cost$30), the differences in ending inventory, cost
of merchandise sold, and gross profit areof merchandise sold, and gross profit are
illustrated in the next three slides.illustrated in the next three slides.

55. PARTIALPARTIAL
INCOMEINCOME
STATEMENTSSTATEMENTS
(FIFO)(FIFO)

56. PARTIAL INCOMEPARTIAL INCOME
STATEMENTSSTATEMENTS
(WEIGHTED AVERAGE(WEIGHTED AVERAGE
COST)COST)

57. PARTIALPARTIAL
INCOMEINCOME
STATEMENTSSTATEMENTS
(LIFO)(LIFO)

58. COMPARINGCOMPARING
INVENTORYINVENTORY
COST METHODSCOST METHODS

59. Comparing Inventory Cost MethodsComparing Inventory Cost Methods
o When the FIFO method is used during aWhen the FIFO method is used during a
period of inflation or rising prices, FIFO willperiod of inflation or rising prices, FIFO will
show a larger profit than the other twoshow a larger profit than the other two
inventory costing methods.inventory costing methods.

60. Comparing Inventory Cost MethodsComparing Inventory Cost Methods
o When the LIFO method is used during aWhen the LIFO method is used during a
period of inflation or rising prices, LIFO willperiod of inflation or rising prices, LIFO will
show a lower profit than the other twoshow a lower profit than the other two
inventory costing methods.inventory costing methods.
o During a period of rising prices, using LIFODuring a period of rising prices, using LIFO
offers an income tax savings compared to theoffers an income tax savings compared to the
other two inventory costing methods.other two inventory costing methods.

61. Comparing Inventory Cost MethodsComparing Inventory Cost Methods
o The weighted average cost method ofThe weighted average cost method of
inventory costing is a compromise betweeninventory costing is a compromise between
FIFO and LIFO. Net income for the weightedFIFO and LIFO. Net income for the weighted
average cost method is somewhere betweenaverage cost method is somewhere between
the net incomes of LIFO and FIFO.the net incomes of LIFO and FIFO.

62. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objective
Learning ObjectiveDescribe and illustrate the
Describe and illustrate the
reporting of merchandise inventory
reporting of merchandise inventory
in the financial statements.
in the financial statements.
66

63. Reporting Merchandise InventoryReporting Merchandise Inventory
o Cost is the primary basis for valuing andCost is the primary basis for valuing and
reporting inventories in the financialreporting inventories in the financial
statements. However, inventory may be valuedstatements. However, inventory may be valued
at other than cost in the following cases:at other than cost in the following cases:
 The cost of replacing items in inventory is below theThe cost of replacing items in inventory is below the
recorded cost.recorded cost.
 The inventory cannot be sold at normal prices dueThe inventory cannot be sold at normal prices due
to imperfections, style changes, or other causes.to imperfections, style changes, or other causes.

64. Valuation at Lower of Cost or MarketValuation at Lower of Cost or Market
o MarketMarket, as used in, as used in lower-of-cost-or-marketlower-of-cost-or-market
methodmethod, is the cost to replace the merchandise, is the cost to replace the merchandise
on the inventory date.on the inventory date.

65. Valuation at Lower of Cost or MarketValuation at Lower of Cost or Market
o Cost and replacement cost can be determinedCost and replacement cost can be determined
for the following:for the following:
 Each item in the inventory.Each item in the inventory.
 Each major class or category of inventory.Each major class or category of inventory.
 Total inventory as a whole.Total inventory as a whole.

66. VALUATION ATVALUATION AT
LOWER OF COSTLOWER OF COST
OR MARKETOR MARKET

67. Valuation at Net Realizable ValueValuation at Net Realizable Value
o Merchandise that is out of date, spoiled, orMerchandise that is out of date, spoiled, or
damaged should be written down to itsdamaged should be written down to its netnet
realizable valuerealizable value.This is the estimated selling.This is the estimated selling
price less any direct costs of disposal, such asprice less any direct costs of disposal, such as
sales commissions or special advertising.sales commissions or special advertising.

68. Original costOriginal cost $1,000$1,000
Estimated selling priceEstimated selling price 800800
Selling expensesSelling expenses 150150
Valuation at Net Realizable ValueValuation at Net Realizable Value
o Assume the following data about an item ofAssume the following data about an item of
damaged merchandise:damaged merchandise:
o The merchandise should be valued at its netThe merchandise should be valued at its net
realizable value of $650 ($800 – $150).realizable value of $650 ($800 – $150).

69. Merchandise Inventory on the Balance SheetMerchandise Inventory on the Balance Sheet
o Merchandise inventory is usually presented inMerchandise inventory is usually presented in
the Current Assets section of the balancethe Current Assets section of the balance
sheet, following receivables.sheet, following receivables.

70. Merchandise Inventory on the Balance SheetMerchandise Inventory on the Balance Sheet
o The method of determining the cost of theThe method of determining the cost of the
inventory (FIFO, LIFO, or weighted average)inventory (FIFO, LIFO, or weighted average)
and the method of valuing the inventory (costand the method of valuing the inventory (cost
or the lower of cost or market) should beor the lower of cost or market) should be
shown.shown.

71. MERCHANDISEMERCHANDISE
INVENTORY ONINVENTORY ON
THE BALANCETHE BALANCE
SHEETSHEET

72. Inventory ErrorsInventory Errors
o Some reasons that inventory errors may occurSome reasons that inventory errors may occur
include the following:include the following:
 Physical inventory on hand was miscounted.Physical inventory on hand was miscounted.
 Costs were incorrectly assigned to inventory.Costs were incorrectly assigned to inventory.
 Inventory in transit was incorrectly included orInventory in transit was incorrectly included or
excluded from inventory.excluded from inventory.
 Consigned inventory was incorrectly included orConsigned inventory was incorrectly included or
excluded from inventory.excluded from inventory.

73. Inventory ErrorsInventory Errors
o Inventory errors often arise fromInventory errors often arise from consignedconsigned
inventoryinventory. Manufacturers sometimes ship. Manufacturers sometimes ship
merchandise to retailers who act as themerchandise to retailers who act as the
manufacturer’s agent.manufacturer’s agent.

74. Inventory ErrorsInventory Errors
o The manufacturer, called theThe manufacturer, called the consignorconsignor, retains, retains
title until the goods are sold. Such merchandisetitle until the goods are sold. Such merchandise
is said to be shipped on consignment to theis said to be shipped on consignment to the
retailer, called theretailer, called the consigneeconsignee..

75. INVENTORYINVENTORY
ERRORSERRORS

76. LO 6LO 6

77. BALANCE SHEETBALANCE SHEET
EFFECTSEFFECTS

78. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objective
Learning Objective
Describe and illustrate the inventory
Describe and illustrate the inventory
turnover and the number of days’ sales
turnover and the number of days’ sales
in inventory in analyzing the efficiency
in inventory in analyzing the efficiency
and effectiveness of inventory
and effectiveness of inventory
management.
management.
77

79. Inventory TurnoverInventory Turnover
o Inventory turnoverInventory turnover measures the relationshipmeasures the relationship
between cost of merchandise sold and thebetween cost of merchandise sold and the
amount of inventory carried during theamount of inventory carried during the
period. It is calculated as follows:period. It is calculated as follows:
Inventory Turnover =
Cost of Merchandise Sold
Average Inventory

80. Inventory TurnoverInventory Turnover
o Inventory turnover for Best Buy is shown belowInventory turnover for Best Buy is shown below
(in millions).(in millions).

81. Number of Days’
Sales in Inventory
Average Inventory
Average Daily Cost of
Merchandise Sold
=
Inventory TurnoverInventory Turnover
o The number of days’ sales in inventoryThe number of days’ sales in inventory
measures the length of time it takes to acquire,measures the length of time it takes to acquire,
sell, and replace the inventory. It is computedsell, and replace the inventory. It is computed
as follows:as follows:

82. Inventory TurnoverInventory Turnover
o The number of days’ sales in inventory for BestThe number of days’ sales in inventory for Best
Buy is computed below (in millions).Buy is computed below (in millions).

83. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Appendix
Appendix
Estimating
Estimating
Inventory Cost
Inventory Cost

84. Retail Method of Inventory CostingRetail Method of Inventory Costing
o TheThe retail inventory methodretail inventory method of estimatingof estimating
inventory cost requires costs and retail pricesinventory cost requires costs and retail prices
to be maintained for the merchandiseto be maintained for the merchandise
available for sale.available for sale.
o A ratio of cost to retail price is then used toA ratio of cost to retail price is then used to
convert ending inventory at retail to estimateconvert ending inventory at retail to estimate
the ending inventory cost.the ending inventory cost.

85. RETAIL METHODRETAIL METHOD
OF INVENTORYOF INVENTORY
COSTINGCOSTING

86. Gross Profit Method of Inventory CostingGross Profit Method of Inventory Costing
o TheThe gross profit methodgross profit method uses the estimateduses the estimated
gross profit for the period to estimate thegross profit for the period to estimate the
inventory at the end of the period.inventory at the end of the period.

87. GROSS PROFITGROSS PROFIT
METHOD OFMETHOD OF
INVENTORYINVENTORY
COSTINGCOSTING

88. c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Inventories
Inventories
The End
The End