This document discusses inventory valuation methods including specific identification, average cost, FIFO, and LIFO. Examples are provided to illustrate how inventory and cost of goods sold transactions are recorded under each method. The key inventory accounting principles of consistency, physical inventory counts, obsolescence, and lower of cost or market are also overviewed.

1. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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INVENTORIES AND THE
COST OF GOODS SOLD
Chapter
8

2. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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InventoryInventory
Goods owned
and held for sale
to customers
Goods owned
and held for sale
to customers
Current
asset
Current
asset
Inventory DefinedInventory Defined

3. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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INCOME STATEMENT
Revenue
Cost of goods sold
Gross profit
Expenses
Net income
As purchase costs
(or manufacturing
costs) are incurred
as goods
are sold
BALANCE SHEET
Current assets:
Inventory
$ $
$
The Flow of Inventory CostsThe Flow of Inventory Costs

4. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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GENERAL JOURNAL
Date Account Titles and Explanation
P
R Debit Credit
Entry on Purchase Date
Inventory $$$$
Accounts Payable $$$$
Entry on Sale Date
Cost of Goods Sold $$$$
Inventory $$$$
In a perpetual inventory system, inventory entries
parallel the flow of costs.
The Flow of Inventory CostsThe Flow of Inventory Costs

5. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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When identical units of inventory have
different unit costs, a question naturally
arises as to which of these costs should be
used in recording a sale of inventory.
Which Unit Did We Sell?Which Unit Did We Sell?

6. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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A separate subsidiary account is maintained
for each item in inventory.
A separate subsidiary account is maintained
for each item in inventory.
How can we determine the unit cost for the Sept. 10 sale?
Item LL002 Primary supplier Electronic City
Description Laser Light Secondary supplier Electric Company
Location Storeroom 2 Inventory level: Min: 25 Max: 200
Purchased Sold Balance
Date Units
Unit
Cost Total Units
Unit
Cost
Cost of
Goods
Sold Units
Unit
Cost Total
Sept. 5 100 30$ 3,000$ 100 30$ 3,000$
Sept. 9 75 50 3,750 100 30 3,000
75 50 3,750
Sept. 10 10 ? ? ? ? ?
? ? ?
Inventory Subsidiary LedgerInventory Subsidiary Ledger

7. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Specific
identification
LIFO
Average
cost
FIFO
We use one of these inventory valuation
methods to determine cost of inventory sold.
Inventory Cost FlowsInventory Cost Flows

8. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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The Bike Company (TBC)
Information for the Following
Inventory Examples
Information for the Following
Inventory Examples

9. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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8-9
Specific IdentificationSpecific Identification
When a unit
is sold, the
specific cost of
the unit sold is
added to cost
of goods sold.

10. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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8-10
On August 14, TBC sold 20 bikes for $130 each.
Nine bikes originally cost $91 and 11 bikes
originally cost $106.
On August 14, TBC sold 20 bikes for $130 each.
Nine bikes originally cost $91 and 11 bikes
originally cost $106.
Continue
Specific Identification – ExampleSpecific Identification – Example

11. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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The Cost of Goods Sold for the August 14 sale is
$1,985, leaving $515 and 5 units in inventory.
The Cost of Goods Sold for the August 14 sale is
$1,985, leaving $515 and 5 units in inventory.
Continue
Let’s look at the entries for
the Aug. 14 sale.
Specific Identification – ExampleSpecific Identification – Example

12. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Continue
RetailRetail
CostCost
A similar entry is
made after each sale.
A similar entry is
made after each sale.
Specific Identification – ExampleSpecific Identification – Example

13. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Additional purchases were made on August 17 and 28.
Costs associated with sales on August 31 were as follows: 1 @ $91,
3 @ $106, 15 @ $115, & 4 @ $119.
Additional purchases were made on August 17 and 28.
Costs associated with sales on August 31 were as follows: 1 @ $91,
3 @ $106, 15 @ $115, & 4 @ $119.
Continue
Specific Identification – ExampleSpecific Identification – Example
Cost of Goods
Sold for
August 31 =
$2,610
Cost of Goods
Sold for
August 31 =
$2,610

14. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Balance Sheet
Inventory = $1,395
Income Statement
COGS = $4,595
1 @ 106$ = 106$
5 @ 115$ = 575
6 @ 119$ = 714
End. Inv. 1,395$
Specific Identification – ExampleSpecific Identification – Example

15. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Since specific
identification is so
easy, can’t we use it
all the time?
Not really. Specific
identification is hard to use
when we sell a lot of
inventory that has lots of
different costs.

16. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Cost of Goods
Available for
Sale
Units on hand
on the date of
sale
÷
Average-Cost MethodAverage-Cost Method
When a unit is sold,
the average cost of each unit
in inventory is assigned to
cost
of goods sold.
When a unit is sold,
the average cost of each unit
in inventory is assigned to
cost
of goods sold.

17. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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8-17
On August 14, TBC sold 20 bikes for $130 each.On August 14, TBC sold 20 bikes for $130 each.
Continue
The average cost per unit
must be computed prior
to each sale.
The average cost per unit
must be computed prior
to each sale.
Average-Cost Method – ExampleAverage-Cost Method – Example
$100 = $2,500 ÷ 25$100 = $2,500 ÷ 25

18. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Continue
The average cost per
unit is $100.
The average cost per
unit is $100.
Let’s look at the entries
for the Aug. 14 sale.
Average-Cost Method – ExampleAverage-Cost Method – Example
$100 = $2,500 ÷ 25$100 = $2,500 ÷ 25

19. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Continue
RetailRetail
CostCost
A similar entry is
made after each sale.
A similar entry is
made after each sale.
Average-Cost Method – ExampleAverage-Cost Method – Example

20. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Additional purchases were made on August 17 and
August 28.
On August 31, an additional 23 units were sold.
Additional purchases were made on August 17 and
August 28.
On August 31, an additional 23 units were sold.
Continue
Average-Cost Method – ExampleAverage-Cost Method – Example

21. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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$114 = $3,990 ÷ 35$114 = $3,990 ÷ 35
Average-Cost Method – ExampleAverage-Cost Method – Example

22. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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$114 = $3,990 ÷ 35$114 = $3,990 ÷ 35The average cost per
unit is $114.
The average cost per
unit is $114.
Average-Cost Method – ExampleAverage-Cost Method – Example

23. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Income Statement
COGS = $4,622
Balance Sheet
Inventory = $1,368
$114 × 12 = $1,368$114 × 12 = $1,368
Average-Cost Method – ExampleAverage-Cost Method – Example

24. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Costs of
Goods Sold
Costs of
Goods Sold
Ending
Inventory
Ending
Inventory
Oldest
Costs
Oldest
Costs
Recent
Costs
Recent
Costs
First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)

25. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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8-25
On August 14, TBC sold 20 bikes for $130 each.On August 14, TBC sold 20 bikes for $130 each.
Continue
The Cost of Goods Sold for the August 14 sale is $1,970,
leaving $530 and 5 units in inventory.
The Cost of Goods Sold for the August 14 sale is $1,970,
leaving $530 and 5 units in inventory.
FIFO – ExampleFIFO – Example

26. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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RetailRetail
CostCost
Continue
A similar entry is
made after each sale.
A similar entry is
made after each sale.
FIFO – ExampleFIFO – Example

27. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Additional purchases were made on Aug. 17 and Aug. 28.
On August 31, an additional 23 units were sold.
Additional purchases were made on Aug. 17 and Aug. 28.
On August 31, an additional 23 units were sold.
Continue
FIFO – ExampleFIFO – Example
Cost of Goods Sold for August 31 = $2,600Cost of Goods Sold for August 31 = $2,600

28. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Balance Sheet
Inventory = $1,420
Income Statement
COGS = $4,570
2 @ 115$ = 230$
10 @ 119$ = 1,190
End. Inv. 1,420$
FIFO – ExampleFIFO – Example

29. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Costs of
Goods Sold
Costs of
Goods Sold
Ending
Inventory
Ending
Inventory
Recent
Costs
Recent
Costs
Oldest
Costs
Oldest
Costs
Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

30. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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On August 14, TBC sold 20 bikes for $130 each.On August 14, TBC sold 20 bikes for $130 each.
Continue
LIFO – ExampleLIFO – Example
The Cost of Goods Sold for the August 14 sale is
$2,045, leaving $455 and 5 units in inventory.
The Cost of Goods Sold for the August 14 sale is
$2,045, leaving $455 and 5 units in inventory.

31. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Continue
RetailRetail
CostCost
A similar entry is
made after each sale.
A similar entry is
made after each sale.
LIFO – ExampleLIFO – Example

32. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Continue
LIFO – ExampleLIFO – Example
Additional purchases were made on Aug. 17 and Aug. 28.
On Aug. 31, an additional 23 units were sold.
Additional purchases were made on Aug. 17 and Aug. 28.
On Aug. 31, an additional 23 units were sold.Cost of Goods Sold for August 31 = $2,685Cost of Goods Sold for August 31 = $2,685

33. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Balance Sheet
Inventory = $1,260
Income Statement
COGS = $4,730
LIFO – ExampleLIFO – Example
5 @ 91$ = 455$
7 @ 115$ = 805
End. Inv. 1,260$

34. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Inventory Valuation Methods: A Summary
Costs Allocated to:
Valuation
Method
Cost of Goods
Sold Inventory Comments
Specific Actual cost of Actual cost of units Parallels physical flow
identification the units sold remaining Logical method when units
are unique
May be misleading for
identical units
Average cost Number of units
sold times the
Number of units on
hand times the
Assigns all units the same
average unit cost
average unit cost average unit cost Current costs are averaged
in with older costs
First-in, First-out
(FIFO)
Cost of earliest
purchases on
Cost of most
recently
Cost of goods sold is based
on older costs
hand prior to the
sale
purchased units Inventory valued at current
costs
May overstate income during
periods of rising prices; may
increase income taxes due
Last-in, First-out
(LIFO)
Cost of most
recently
Cost of earliest
purchases
Cost of goods sold shown at
recent prices
purchased units (assumed still in
inventory)
Inventory shown at old (and
perhaps out of date) costs
Most conservative method
during periods of rising
prices; often results in lower
income taxes

35. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Once a company has
adopted a particular
accounting method, it
should follow that
method consistently,
rather than switch
methods from one
year to the next.
The Principle of ConsistencyThe Principle of Consistency

36. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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This inventory arrived
just in time for us to use
in the manufacturing
process.
Just-In-Time (JIT) Inventory
Systems
Just-In-Time (JIT) Inventory
Systems

37. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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The primary reason for taking a physical inventory
is to adjust the perpetual inventory records for
unrecorded shrinkage losses, such as theft,
spoilage, or breakage.
The primary reason for taking a physical inventory
is to adjust the perpetual inventory records for
unrecorded shrinkage losses, such as theft,
spoilage, or breakage.
Taking a Physical InventoryTaking a Physical Inventory

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Reduces the value
of the inventory.
Reduces the value
of the inventory.
Adjust inventory
value to the lower
of historical cost or
current
replacement cost
(market).
Adjust inventory
value to the lower
of historical cost or
current
replacement cost
(market).
ObsolescenceObsolescence
Lower of Cost
or Market
(LCM)
Lower of Cost
or Market
(LCM)
LCM and Other Write-Downs
of Inventory
LCM and Other Write-Downs
of Inventory

39. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Year
End
A sale should be recorded when title
to the merchandise passes to the
buyer.
A sale should be recorded when title
to the merchandise passes to the
buyer.
F.O.B.
shipping
point  title
passes to
buyer at the
point of
shipment.
F.O.B.
shipping
point  title
passes to
buyer at the
point of
shipment.
F.O.B.
destination
point  title
passes to
buyer at the
point of
destination.
F.O.B.
destination
point  title
passes to
buyer at the
point of
destination.
Goods In TransitGoods In Transit

40. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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In a periodic inventory system, inventory entries are
as follows.
Note that an entry is not
made to inventory.
Note that an entry is not
made to inventory.
Periodic Inventory SystemsPeriodic Inventory Systems

41. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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In a periodic inventory system, inventory entries are
as follows.
Periodic Inventory SystemsPeriodic Inventory Systems

42. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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The inventory on
hand and the
cost of goods
sold for the year
are not
determined until
year-end.
Periodic Inventory SystemsPeriodic Inventory Systems

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Specific
identification
LIFO
Average
cost
FIFO
We use one of these inventory valuation
methods in a periodic inventory system.
Periodic Inventory SystemsPeriodic Inventory Systems

44. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 5.25$ 5,250.00$
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 9,725.00$
Ending
Inventory 1,200 ?
Cost of
Goods Sold 600 ?
Information for the Following
Inventory Examples
Information for the Following
Inventory Examples

45. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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By reviewing actual
purchase invoices,
Computers, Inc. determines
that the 1,200 mouse pads
on hand at year-end have
an actual total cost of
$6,400.
Determine the cost of
goods sold for the year.
Specific Identification – ExampleSpecific Identification – Example

46. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 5.25$ 5,250.00$
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 9,725.00$
Ending
Inventory 1,200 6,400.00$
Cost of
Goods Sold 600 3,325.00$
Cost of Goods Sold
$9,725 - $6,400 = $3,325
Cost of Goods Sold
$9,725 - $6,400 = $3,325
Specific Identification – ExampleSpecific Identification – Example

47. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Total Cost of
Goods
Available for
Sale
Total Number
of Units
Available for
Sale
÷
The average cost is
calculated at year-
end as follows:
The average cost is
calculated at year-
end as follows:
Average-Cost MethodAverage-Cost Method

48. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 5.25$ 5,250.00$
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 9,725.00$
Ending
Inventory 1,200 ?
Cost of
Goods Sold 600 ?
Avg. Cost $9,725 ÷ 1,800
= $5.40278
Avg. Cost $9,725 ÷ 1,800
= $5.40278
Average-Cost Method – ExampleAverage-Cost Method – Example
Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 5.25$ 5,250.00$
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 9,725.00$
Ending
Inventory 1,200 6,483.00$
Cost of
Goods Sold 600 3,242.00$
Ending Inventory
Avg. Cost $5.40278 × 1,200 =
$6,483
Ending Inventory
Avg. Cost $5.40278 × 1,200 =
$6,483
Cost of Goods Sold
Avg. Cost $5.40278 × 600 =
$3,242
Cost of Goods Sold
Avg. Cost $5.40278 × 600 =
$3,242

49. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Costs of
Goods Sold
Costs of
Goods Sold
Ending
Inventory
Ending
Inventory
Oldest
Costs
Oldest
Costs
Recent
Costs
Recent
Costs
First-In, First-Out Method (FIFO)First-In, First-Out Method (FIFO)

50. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Remember: Start
with the 11/29
purchase and then
add other purchases
until you reach the
number of units in
ending inventory.
FIFO – ExampleFIFO – Example
Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 5.25$ 5,250.00$
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 9,725.00$
Ending
Inventory 1,200 ?
Cost of
Goods Sold 600 ?

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Date Beg. Inv. Purchases End. Inv.
Cost of
Goods Sold
Nov. 29 150@$5.90 150@$5.90
Units 150
Now, let’s complete the
table.
Now, let’s complete the
table.
FIFO – ExampleFIFO – Example
Date Beg. Inv. Purchases End. Inv.
Cost of
Goods Sold
1,000@$5.25 600@$5.25
400@$5.25
Jan. 3 300@$5.30 300@$5.30
June 20 150@$5.60 150@$5.60
Sept. 15 200@$5.80 200@$5.80
Nov. 29 150@$5.90 150@$5.90
Units 1,200 600
Now, we have allocated
the cost to all 1,200 units
in ending inventory.
Date Beg. Inv. Purchases End. Inv.
Cost of
Goods Sold
1,000@$5.25 600@$5.25
400@$5.25
Jan. 3 300@$5.30 300@$5.30
June 20 150@$5.60 150@$5.60
Sept. 15 200@$5.80 200@$5.80
Nov. 29 150@$5.90 150@$5.90
Units 1,200 600
Costs $6,575 $3,150
Cost of Goods Available for Sale $9,725

52. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Completing the table
summarizes the
computations just
made.
FIFO – ExampleFIFO – Example
Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 5.25$ 5,250.00$
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 9,725.00$
Ending
Inventory 1,200 6,575.00$
Cost of
Goods Sold 600 3,150.00$

53. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Costs of
Goods Sold
Costs of
Goods Sold
Ending
Inventory
Ending
Inventory
Recent
Costs
Recent
Costs
Oldest
Costs
Oldest
Costs
Last-In, First-Out Method (LIFO)Last-In, First-Out Method (LIFO)

54. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Remember: Start with
beginning inventory
and then add other
purchases until you
reach the number of
units in ending
inventory.
LIFO – ExampleLIFO – Example
Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 5.25$ 5,250.00$
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 9,725.00$
Ending
Inventory 1,200 ?
Cost of
Goods Sold 600 ?

55. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Date Beg. Inv. Purchases End. Inv.
Cost of
Goods Sold
1,000@$5.25 1,000@$5.25
Units 1,000
LIFO – ExampleLIFO – Example
Date Beg. Inv. Purchases End. Inv.
Cost of
Goods Sold
1,000@$5.25 1,000@$5.25
Jan. 3 300@$5.30 200@$5.30
100@$5.30
Units 1,200 100
Now, we have allocated
the cost to all 1,200 units
in ending inventory.
Next, let’s
complete the
table.
Next, let’s
complete the
table.
Date Beg. Inv. Purchases End. Inv.
Cost of
Goods Sold
1,000@$5.25 1,000@$5.25
Jan. 3 300@$5.30 200@$5.30
100@$5.30
June 20 150@$5.60 150@$5.60
Sept. 15 200@$5.80 200@$5.80
Nov. 29 150@$5.90 150@$5.90
Units 1,200 600
Costs $6,310 $3,415
Cost of Goods Available for Sale $9,725

56. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Completing the table
summarizes the
computations just
made.
LIFO – ExampleLIFO – Example
Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 5.25$ 5,250.00$
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 9,725.00$
Ending
Inventory 1,200 6,310.00$
Cost of
Goods Sold 600 3,415.00$

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Errors in Measuring Inventory
Beginning Inventory Ending Inventory
Effect on Income Statement Overstated Understated Overstated Understated
Goods Available for Sale + - 0 0
Cost of Goods Sold + - - +
Gross Profit - + + -
Net Income - + + -
Effect on Balance Sheet
Ending Inventory 0 0 + -
Retained Earnings - + + -
An error in ending inventory in a year will result in the
same error in the beginning inventory of the next year.
An error in ending inventory in a year will result in the
same error in the beginning inventory of the next year.
Importance of an Accurate
Valuation of Inventory
Importance of an Accurate
Valuation of Inventory

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For interim financialstatements, we may needto estimate endinginventory and cost of
goods sold.

59. © The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
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Determine cost of goods
available for sale.
Estimate cost of goods sold
by multiplying the net sales
by the cost ratio.
Deduct cost of goods sold
from cost of goods available
for sale to determine ending
inventory.
Determine cost of goods
available for sale.
Estimate cost of goods sold
by multiplying the net sales
by the cost ratio.
Deduct cost of goods sold
from cost of goods available
for sale to determine ending
inventory.
The Gross Profit MethodThe Gross Profit Method

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In March of 2003, Chemico’s inventory was
destroyed by fire. Chemico’s normal gross profit
ratio is 30% of net sales. At the time of the fire,
Chemico showed the following balances:
In March of 2003, Chemico’s inventory was
destroyed by fire. Chemico’s normal gross profit
ratio is 30% of net sales. At the time of the fire,
Chemico showed the following balances:
Sales 31,500$
Sales returns 1,500
Beginning Inventory 12,000
Net cost of goods purchased 20,500
Gross Profit Method – ExampleGross Profit Method – Example

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Gross Profit Method – ExampleGross Profit Method – Example
× 70%




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Measures how quickly a company
sells its merchandise inventory.
Measures how quickly a company
sells its merchandise inventory.
A ratio that is low compared to competitors
suggests inefficient use of assets.
A ratio that is low compared to competitors
suggests inefficient use of assets.
Average Inventory = (Beg. Inv. + End. Inv.) ÷ 2Average Inventory = (Beg. Inv. + End. Inv.) ÷ 2
Inventory Turnover RateInventory Turnover Rate

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Remember that identical
companies that use different
inventory methods (e.g.,
FIFO and LIFO) will have
different inventory turnover
ratios.
Accounting Methods Can Affect
Analytical Ratios
Accounting Methods Can Affect
Analytical Ratios

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Careful! If you
drop the inventory
we will have another
write down.
End of Chapter 8End of Chapter 8