Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Inventories:Measurement
8
8-2
Inventory
Those assets that a company:
2. Has in production (work in process) for future sale.
2. Has in production (work in process) for future sale.
1. Intends to sell in the normalcourse of business.
1. Intends to sell in the normalcourse of business.
3. Uses currently in the productionof goods to be sold (raw materials).
3. Uses currently in the productionof goods to be sold (raw materials).
8-3
Types of Inventories
Merchandise Inventory
Merchandise Inventory
Goods acquired for resale
Goods acquired for resale
Manufacturing Inventory
Manufacturing Inventory
•Raw Materials•Work-in-Process•Finished Goods
•Raw Materials•Work-in-Process•Finished Goods
Types of InventoryTypes of Inventory
8-4
Inventory Cost FlowsRaw
Materials
(1) $XX $XX (4)
Work inProcess
FinishedGoods
Cost of GoodSold
DirectLabor
ManufacturingOverhead
$XX $XX (7) $XX $XX (8)
$XX
(2) $XX $XX (5)
(3) $XX $XX (6)
(1) Raw materials purchased
(2) Direct labor incurred
(3) Manufacturing overhead incurred
(4) Raw materials used
(5) Direct labor applied
(6) Manufacturing overhead applied
(7) Work in process transferred to finished goods
(8) Finished goods sold
(1) Raw materials purchased
(2) Direct labor incurred
(3) Manufacturing overhead incurred
(4) Raw materials used
(5) Direct labor applied
(6) Manufacturing overhead applied
(7) Work in process transferred to finished goods
(8) Finished goods sold
8-5
Learning Objective
Explain the difference between aperpetual inventory system and a
periodic inventory system.
8-6
Inventory Methods
Perpetual Inventory System
Perpetual Inventory System
The inventory account is
continuously updated as
purchases and sales are made.
The inventory account is
continuously updated as
purchases and sales are made.
Periodic Inventory System
Periodic Inventory System
The inventory The inventory account is adjusted account is adjusted
at the end of a at the end of a reporting cycle.reporting cycle.
The inventory The inventory account is adjusted account is adjusted
at the end of a at the end of a reporting cycle.reporting cycle.
Two accounting systems are used to record transactions involving inventory:
8-7
Perpetual Inventory System
Matrix, Inc. purchases on account $600,000 of merchandise for resale to customers.
GENERAL JOURNALDate Description Debit Credit
Inventory 600,000
Accounts Payable 600,000
2006
Returns of inventory are credited to the inventory account.
Discounts on inventory purchases can be recorded using the gross or net method.
Returns of inventory are credited to the inventory account.
Discounts on inventory purchases can be recorded using the gross or net method.
8-8
Perpetual Inventory System
Matrix, Inc. sold, on account, inventory with aretail price of $820,000 and a cost basisof $540,000, to a customer.
GENERAL JOURNALDate Description Debit Credit
Accounts Receivable 820,000
Sales
Cost of Goods Sold 540,000
Inventory
820,000
540,000
2006
8-9
Periodic Cost of Goods Sold Equation
Beginning Inventory+ Net Purchases
Cost of Goods Available for Sale
- Ending Inventory= Cost of Goods Sold
8-10
Periodic Inventory System
Matrix, Inc. purchases on account $600,000 of merchandise for resale to customers.
GENERAL JOURNALDate Description Debit Credit
Purchases 600,000
Accounts Payable 600,000
2006
Returns of inventory are credited to the Purchase Returns and Purchase Returns and AllowancesAllowances account.
Discounts on inventory purchases can be recorded using the gross or net method.
Returns of inventory are credited to the Purchase Returns and Purchase Returns and AllowancesAllowances account.
Discounts on inventory purchases can be recorded using the gross or net method.
8-11
Periodic Inventory System
Matrix, Inc. sold on account, inventory with aretail price of $820,000 and a cost basisof $540,000, to a customer.
GENERAL JOURNALDate Description Debit Credit
Accounts Receivable 820,000
Sales 820,000
2006
No entry is made to record Cost of Good Sold. Assuming BeginningInventory of $120,000. A physical count of Ending Inventory shows
a balance of $180,000. Let’s calculate Cost of Goods Sold atthe end of the accounting period.
No entry is made to record Cost of Good Sold. Assuming BeginningInventory of $120,000. A physical count of Ending Inventory shows
a balance of $180,000. Let’s calculate Cost of Goods Sold atthe end of the accounting period.
8-12
Periodic Inventory System
Beginning inventory 120,000$ Plus: Purchases 600,000 Cost of goods available for sale 720,000 Less: Ending inventory (180,000) Cost of goods sold 540,000$
Calculation of Cost of Goods Sold
Date Description Debit Credit
12/31/06 Cost of goods sold 540,000 Inventory (ending) 180,000 Inventory (beginning) 120,000 Purchases 600,000
Adjusting entry to determine Cost of Goods Sold
8-13
Comparison of Inventory Systems
8-14
Learning Objective
Explain which physical quantities of goods should be included in inventory.
8-15
What is Included in Inventory?
General RuleAll goods owned by the company on the inventory All goods owned by the company on the inventory
date, regardless of their location.date, regardless of their location.
General RuleAll goods owned by the company on the inventory All goods owned by the company on the inventory
date, regardless of their location.date, regardless of their location.
Goods in TransitGoods in Transit Goods on Consignment
Goods on Consignment
Depends on FOB shipping terms.
Depends on FOB shipping terms.
8-16
Learning Objective
Determine the expenditures that shouldbe included in the cost of inventory.
8-17
Expenditures Included in Inventory
Invoice Price
Invoice Price
Freight-in on
Purchases
Freight-in on
Purchases
+
Purchase Returns
Purchase Returns
Purchase Discounts
Purchase Discounts
8-18
Purchase Discounts
Date Description Debit Credit
10/5/06 Purchases 20,000 Accounts payable 20,000
10/14/06 Accounts payable 14,000 Purchase discounts 280 Cash 13,720
11/4/06 Accounts payable 6,000 Cash 6,000
10/5/06 Purchases 19,600 Accounts payable 19,600
10/14/06 Accounts payable 13,720 Cash 13,720
11/4/06 Accounts payable 5,880 Interest expense 120 Cash 6,000
Net Method
Gross Method
Discount terms are 2/10, n/30.
$14,000x 0.02$ 280
Partial payment not made within the discount period
8-19
Net Method Using Perpetual and Periodic
Matrix, Inc. purchased on account $6,000 of merchandise for resale to customers. The merchandise was purchased subject to a cash discount of 2/10, n/30.
The company incurred $160 in freight-in on the merchandise. Upon inspection, the company found that
$200 of merchandise was damaged and the seller agreed to accept the merchandise return and credit the
account of the company. The inventory was sold for $8,300 on account. Let’s look at the journal entries under both the perpetual and periodic accounting
system assuming Matrix uses the net method to record merchandise purchases.
8-20
Net Method Using Perpetual and PeriodicDescription Debit Credit
Inventory 5,880 Accounts payable 5,880
Inventory 160 Cash 160
Accounts payable 200 Inventory 200
Accounts receivable 8,300 Sales revenue 8,300
Cost of goods sold 5,840 Inventory 5,840
Purchases 5,880 Accounts payable 5,880
Freight-in 160 Cash 160
Accounts payable 200 Purchase returns 200
Accounts receivable 8,300 Sales revenue 8,300
Periodic Inventory Method
Perpetual Inventory Method
Beginning inventory -$ Purchases 5,880$ Less: Returns (200) Plus: Freight-in 160 Net purchases 5,840 Cost of goods available for sale 5,840 Less: Ending inventory - Cost of goods sold 5,840$
8-21
Learning Objective
Differentiate between the specific identification, FIFO, LIFO, and average cost methods used to determine the cost of ending inventory and
cost of goods sold.
8-22
Inventory Cost Flow Methods
Specific cost identification
Average cost
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
Specific cost identification
Average cost
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
8-23
The specific cost of each inventory item must be known.
By selecting specific items from inventory at the time of sale, income can be manipulated.
The specific cost of each inventory item must be known.
By selecting specific items from inventory at the time of sale, income can be manipulated.
Specific Cost Identification
Items are added to inventory at cost when they are purchased.
COGS for each sale is based on the specific cost of the item sold.
Items are added to inventory at cost when they are purchased.
COGS for each sale is based on the specific cost of the item sold.
8-24
Average Cost Method
8-25
Weighted-Average Periodic System
The following schedule shows the frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the periodic weighted-average method to weighted-average method to determine:determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
The following schedule shows the frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the periodic weighted-average method to weighted-average method to determine:determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
8-26
Weighted-Average Periodic System
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 ?Cost of Goods Sold 1,350 ?
8-27
Weighted-Average Periodic System
Now, we have to assign costs to ending inventory and cost of goods sold.
Beginning Inventory (800 units)
Purchases (1,150 units)
Beginning Inventory (800 units)
Purchases (1,150 units)
Available for Sale
(1,950 units)
Available for Sale
(1,950 units)
Ending Inventory(600 units)
Ending Inventory(600 units)
Goods Sold(1,350)
Goods Sold(1,350)
$47,650 ÷ 1,950 = $24.4359 weighted-average per unit cost
$47,650 ÷ 1,950 = $24.4359 weighted-average per unit cost
8-28
Weighted-Average Periodic System
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 24.4359 14,661.54 Cost of Goods Sold 1,350 24.4359 32,988.46$
8-29
Moving-Average Perpetual System
The following schedule shows the Frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the perpetual weighted-average method to weighted-average method to determine:determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
The following schedule shows the Frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the perpetual weighted-average method to weighted-average method to determine:determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
8-30
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 Ending Inventory 600 Cost of Goods Sold 1,350
Moving-Average Perpetual System
8-31
Moving-Average Perpetual System
8-32
Moving-Average Perpetual System
$11,600.00 ÷ (800-600+300) = $23.200
8-33
Moving-Average Perpetual System
$27,490.00 ÷ (800-600+300-300+250+200+400) = $26.181
8-34
Moving-Average Perpetual System
Su
m
8-35
First-In, First-Out
The cost of the oldest inventory items are charged to COGS when goods are sold.
The cost of the newest inventory items remain in ending inventory.
The cost of the oldest inventory items are charged to COGS when goods are sold.
The cost of the newest inventory items remain in ending inventory.
The FIFO method
assumes that items are sold
in the chronological order of their acquisition.
8-36
First-In, First-Out
Even though the periodic and the perpetual
approaches differ in the timing of adjustments to
inventory . . .
. . . COGS and Ending Inventory Cost are the same under both
approaches.
Even though the periodic and the perpetual
approaches differ in the timing of adjustments to
inventory . . .
. . . COGS and Ending Inventory Cost are the same under both
approaches.
8-37
FIFO - Periodic System
The following schedule shows the frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the periodic FIFO method to determine:FIFO method to determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
The following schedule shows the frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the periodic FIFO method to determine:FIFO method to determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
8-38
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 Cost of Goods Sold 1,350
FIFO - Periodic System
These are the 600 most recently
acquired units.
These are the 600 most recently
acquired units.
8-39
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 Cost of Goods Sold 1,350
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 16,600.00 Cost of Goods Sold 1,350
FIFO - Periodic System
8-40
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 16,600.00 Cost of Goods Sold 1,350
FIFO - Periodic System
These are the first 1,350 units acquired.
These are the first 1,350 units acquired.
8-41
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 16,600.00 Cost of Goods Sold 1,350
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 16,600.00 Cost of Goods Sold 1,350 31,050.00$
FIFO - Periodic System
8-42
FIFO - Perpetual System
The following schedule shows the frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the perpetual FIFO method to determine:FIFO method to determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
The following schedule shows the frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the perpetual FIFO method to determine:FIFO method to determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
8-43
FIFO - Perpetual System
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 Ending Inventory 600 Cost of Goods Sold 1,350
8-44
FIFO - Perpetual System
200
The ending inventory on 9/1 consists of:The ending inventory on 9/1 consists of: 200 units from beginning inventory @ $22.00200 units from beginning inventory @ $22.00
The ending inventory on 9/1 consists of:The ending inventory on 9/1 consists of: 200 units from beginning inventory @ $22.00200 units from beginning inventory @ $22.00
8-45
FIFO - Perpetual System
200
The ending inventory on 9/3 consists of:The ending inventory on 9/3 consists of: 200 units from beginning inventory @ $22.00200 units from beginning inventory @ $22.00
300 units from the 9/3 purchase @ $24.00300 units from the 9/3 purchase @ $24.00
The ending inventory on 9/3 consists of:The ending inventory on 9/3 consists of: 200 units from beginning inventory @ $22.00200 units from beginning inventory @ $22.00
300 units from the 9/3 purchase @ $24.00300 units from the 9/3 purchase @ $24.00
8-46
FIFO - Perpetual System
200
The ending inventory on 9/10 consists of:The ending inventory on 9/10 consists of:200 units from the 9/3 purchase @ $24.00200 units from the 9/3 purchase @ $24.00
The ending inventory on 9/10 consists of:The ending inventory on 9/10 consists of:200 units from the 9/3 purchase @ $24.00200 units from the 9/3 purchase @ $24.00
8-47
FIFO - Perpetual System
The ending inventory on 9/15 consists of:The ending inventory on 9/15 consists of:200 units from the 9/3 purchase @ $24.00200 units from the 9/3 purchase @ $24.00
250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00
The ending inventory on 9/15 consists of:The ending inventory on 9/15 consists of:200 units from the 9/3 purchase @ $24.00200 units from the 9/3 purchase @ $24.00
250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00
200
8-48
FIFO - Perpetual System
The ending inventory on 9/21 consists of:The ending inventory on 9/21 consists of:200 units from the 9/3 purchase @ $24.00200 units from the 9/3 purchase @ $24.00
250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00
The ending inventory on 9/21 consists of:The ending inventory on 9/21 consists of:200 units from the 9/3 purchase @ $24.00200 units from the 9/3 purchase @ $24.00
250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00
200
8-49
FIFO - Perpetual System
The ending inventory on 9/29 consists of:The ending inventory on 9/29 consists of:200 units from the 9/3 purchase @ $24.00200 units from the 9/3 purchase @ $24.00
250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00400 units from the 9/29 purchase @ $28.00400 units from the 9/29 purchase @ $28.00
The ending inventory on 9/29 consists of:The ending inventory on 9/29 consists of:200 units from the 9/3 purchase @ $24.00200 units from the 9/3 purchase @ $24.00
250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00400 units from the 9/29 purchase @ $28.00400 units from the 9/29 purchase @ $28.00
200
8-50
FIFO - Perpetual System
The ending inventory on 9/30 consists of:The ending inventory on 9/30 consists of: 200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00
400 units from the 9/29 purchase @ $28.00.400 units from the 9/29 purchase @ $28.00.
The ending inventory on 9/30 consists of:The ending inventory on 9/30 consists of: 200 units from the 9/21 purchase @ $27.00200 units from the 9/21 purchase @ $27.00
400 units from the 9/29 purchase @ $28.00.400 units from the 9/29 purchase @ $28.00.
8-51
FIFO - Perpetual System
Note that this is the same COGS computed using the Periodic
approach.
8-52
Last-In, First-Out
Any questions before we run into
LIFO?
8-53
Last-In, First-Out
The cost of the newest inventory items are charged to COGS when goods are sold.
The cost of the oldest inventory items remain in inventory.
The cost of the newest inventory items are charged to COGS when goods are sold.
The cost of the oldest inventory items remain in inventory.
The LIFO method
assumes that the newest
items are sold first, leaving the
older units in inventory.
8-54
Last-In, First-Out
Unlike FIFO, using the LIFO method may
result in COGS and Ending Inventory Cost that differ
under the periodic and perpetual approaches.
Unlike FIFO, using the LIFO method may
result in COGS and Ending Inventory Cost that differ
under the periodic and perpetual approaches.
8-55
The following schedule shows the frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the periodic LIFO method to determine:LIFO method to determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
The following schedule shows the frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the periodic LIFO method to determine:LIFO method to determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
LIFO - Periodic System
8-56
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 Cost of Goods Sold 1,350
LIFO - Periodic System
These are the 600 oldest units in
inventory.
These are the 600 oldest units in
inventory.
8-57
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 13,200.00 Cost of Goods Sold 1,350
LIFO - Periodic System
200
600 x $22.00
8-58
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 13,200.00 Cost of Goods Sold 1,350
LIFO - Periodic System
600 x $22.00
These are the most recently acquired 1,350
units.
These are the most recently acquired 1,350
units.
200
8-59
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 47,650.00$ Ending Inventory 600 13,200.00 Cost of Goods Sold 1,350 34,450.00$
LIFO - Periodic System
$4,400$4,400 + $30,050
200 x $22.00
200
8-60
LIFO - Perpetual System
The following schedule shows the frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the perpetual LIFO method to determine:LIFO method to determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
The following schedule shows the frame inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30 shows 600 frames in ending inventory.
Use theUse the perpetual LIFO method to determine:LIFO method to determine:
(1) Ending inventory cost.(1) Ending inventory cost.
(2) Cost of goods sold.(2) Cost of goods sold.
8-61
LIFO - Perpetual System
Yore Frame, Inc.Frame Inventory
Date Units $/Unit TotalBeg. Inventory 800 22.00$ 17,600.00$
9/3 300 24.00 7,200.00 9/15 250 25.00 6,250.00 9/21 200 27.00 5,400.00 9/29 400 28.00 11,200.00
Goods Available for Sale 1,950 Ending Inventory 600 Cost of Goods Sold 1,350
8-62
LIFO - Perpetual System
In LIFO, we assume that we sell the newest units in inventory first.
In this case, the 600 “newest” units come from beginning inventory,
leaving 200 units in the beginning inventory layer.
In LIFO, we assume that we sell the newest units in inventory first.
In this case, the 600 “newest” units come from beginning inventory,
leaving 200 units in the beginning inventory layer.
200
8-63
LIFO - Perpetual System
The ending inventory on 9/3 consists of: 200 units from beginning inventory @ $22.00
300 units from the 9/3 purchase @ $24.00
The ending inventory on 9/3 consists of: 200 units from beginning inventory @ $22.00
300 units from the 9/3 purchase @ $24.00
200
8-64
LIFO - Perpetual System
For the 9/10 sale, we must identify the 300 newest units. They all come from the September 3
purchase.
Note that all of the 9/3 units have been “sold” and Note that all of the 9/3 units have been “sold” and only 200 of the beginning inventory units remain.only 200 of the beginning inventory units remain.
For the 9/10 sale, we must identify the 300 newest units. They all come from the September 3
purchase.
Note that all of the 9/3 units have been “sold” and Note that all of the 9/3 units have been “sold” and only 200 of the beginning inventory units remain.only 200 of the beginning inventory units remain.
200
8-65
LIFO - Perpetual System
The ending inventory on 9/15 consists of: 200 units from beginning inventory @ $22.00250 units from the 9/15 purchase @ $25.00
The ending inventory on 9/15 consists of: 200 units from beginning inventory @ $22.00250 units from the 9/15 purchase @ $25.00
200
8-66
LIFO - Perpetual System
The ending inventory on 9/21 consists of: 200 units from beginning inventory @ $22.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00
The ending inventory on 9/21 consists of: 200 units from beginning inventory @ $22.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00
200
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LIFO - Perpetual System
The ending inventory on 9/29 consists of: 200 units from beginning inventory @ $22.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00
400 units from the 9/29 purchase @ $28.00.
The ending inventory on 9/29 consists of: 200 units from beginning inventory @ $22.00250 units from the 9/15 purchase @ $25.00200 units from the 9/21 purchase @ $27.00
400 units from the 9/29 purchase @ $28.00.
200
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LIFO - Perpetual System
150
For the 9/30 sale, we must identify the 450 newest For the 9/30 sale, we must identify the 450 newest units. 400 of them come from the 9/29 purchase. units. 400 of them come from the 9/29 purchase.
The other 50 come from the 9/21 purchase. The other 50 come from the 9/21 purchase.
For the 9/30 sale, we must identify the 450 newest For the 9/30 sale, we must identify the 450 newest units. 400 of them come from the 9/29 purchase. units. 400 of them come from the 9/29 purchase.
The other 50 come from the 9/21 purchase. The other 50 come from the 9/21 purchase.
200
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LIFO - Perpetual System
150
200
The ending inventory on 9/30 consists of:The ending inventory on 9/30 consists of: 200 units from beginning inventory @ $22.00200 units from beginning inventory @ $22.00
250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00
150 units from the 9/21 purchase @ $27.00.150 units from the 9/21 purchase @ $27.00.
The ending inventory on 9/30 consists of:The ending inventory on 9/30 consists of: 200 units from beginning inventory @ $22.00200 units from beginning inventory @ $22.00
250 units from the 9/15 purchase @ $25.00250 units from the 9/15 purchase @ $25.00
150 units from the 9/21 purchase @ $27.00.150 units from the 9/21 purchase @ $27.00.
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When Prices Are Rising . . .
LIFO Matches high (newer)
costs with current (higher) sales.
Inventory is valued based on low (older) cost basis.
Results in lower taxable income.
Is not officially endorsed by the IASC.
LIFO Matches high (newer)
costs with current (higher) sales.
Inventory is valued based on low (older) cost basis.
Results in lower taxable income.
Is not officially endorsed by the IASC.
FIFO Matches low (older) costs
with current (higher) sales.
Inventory is valued at approximate replacement cost.
Results in higher taxable income.
FIFO Matches low (older) costs
with current (higher) sales.
Inventory is valued at approximate replacement cost.
Results in higher taxable income.
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Comparison of Cost Flow Methods
Average Cost FIFO LIFO
Cost of goods sold 31,941$ 31,050$ 32,950$ Ending inventory 15,709 16,600 14,700 Total 47,650$ 47,650$ 47,650$
Perpetual Inventory System
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Comparison of Cost Flow Methods
# of Companies
% of Companies
# of Companies
% of Companies
FIFO 384 46% 394 43%LIFO 251 30% 150 16%Average 167 20% 235 25%Other 31 4% 148 16%Total 833 100% 927 100%
Inventory Method Used by Major Companies
2003 1973
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Learning Objective
Discuss the factors affecting a company’s choice of inventory method.
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Decision Makers’ Perspective
What factors motivate companies to select one inventory method over another?
How accurate is the timing of reported
incomeand income taxes?
How closely do reported
costs reflect actualflow of inventory?
How well are costs matched against
related revenues?
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Learning Objective
Understand supplemental LIFO disclosures and the effect of LIFO liquidations on net
income.
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LIFO Liquidation
LIFO inventory costs on the balance sheet are “out of date” because they reflect
old purchase transactions.
LIFO inventory costs on the balance sheet are “out of date” because they reflect
old purchase transactions.
When prices rise . . .
If inventory declines, these “out of date” costs
may be charged to current earnings.
If inventory declines, these “out of date” costs
may be charged to current earnings.
This LIFOliquidation results in
“paper profits.”
This LIFOliquidation results in
“paper profits.”
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LIFO Reserves
Many companies use LIFO for external reporting and income tax purposes but maintain internal records using FIFO or
average cost.
The conversion from FIFO or average cost The conversion from FIFO or average cost to LIFO takes place at the end of the to LIFO takes place at the end of the
period. The conversion may look like this:period. The conversion may look like this:
The conversion from FIFO or average cost The conversion from FIFO or average cost to LIFO takes place at the end of the to LIFO takes place at the end of the
period. The conversion may look like this:period. The conversion may look like this:
2003 2002
Total inventories at FIFO 12,541$ 11,544$ Less: LIFO allowance 1,581 1,807 Inventories, at LIFO cost 10,960$ 9,737$
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Learning Objective
Calculate the key ratios used by analysts to monitor a company’s investment in inventories.
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Gross Profit Ratio
Gross profitratio
Gross profit Net sales
=
This measure indicates how muchof each sales dollar is left after
deducting the cost of goods sold to cover expenses and provide a profit.
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Inventory Turnover Ratio
Cost of goods sold Average inventory
Inventoryturnover ratio
=
This ratio measures how many times a company’s inventory has been sold
and replaced during the year.
This ratio measures how many times a company’s inventory has been sold
and replaced during the year.
If a company’s inventory If a company’s inventory turnover Is less than its turnover Is less than its
industry average, it either industry average, it either has excessive inventory or has excessive inventory or
the wrong sorts of inventory.the wrong sorts of inventory.
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Earnings Quality
Many believe that manipulating income reduces earnings quality because it can mask permanent earnings. Inventory write-downs and changes in inventory method are two additional inventory-
related techniques a company could use to manipulate earnings.
Many believe that manipulating income reduces earnings quality because it can mask permanent earnings. Inventory write-downs and changes in inventory method are two additional inventory-
related techniques a company could use to manipulate earnings.
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Learning Objective
Determine ending inventory using thedollar-value LIFO inventory method.
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LIFO Inventory Pools
Inventory Pools consist of inventory units grouped according to similarities.
Inventory Pools consist of inventory units grouped according to similarities.
For example, all similar units
purchased at the same time can be “pooled”
and assigned an average unit cost.
For example, all similar units
purchased at the same time can be “pooled”
and assigned an average unit cost.
Using Inventory Pools with LIFO simplifies
record keeping.
Using Inventory Pools with LIFO simplifies
record keeping.
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Example
The replacement inventory differs from the old inventory on
hand. We just create a new layer.
Example
The replacement inventory differs from the old inventory on
hand. We just create a new layer.
Dollar-Value LIFO (DVL)
DVL inventory pools are viewed as layers of value, rather than layers of similar units.DVL inventory pools are viewed as layers
of value, rather than layers of similar units.
DVL simplifies LIFO record-keeping.
DVL simplifies LIFO record-keeping.
DVL minimizes the probability of layer
liquidation.
DVL minimizes the probability of layer
liquidation.
At the end of the period, we determine if a new inventory layer
was added by comparing ending
inventory to beginning inventory.
At the end of the period, we determine if a new inventory layer
was added by comparing ending
inventory to beginning inventory.
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Dollar-Value LIFO (DVL)
We need to determine if the increase in ending inventory over beginning inventory was due to a price increase or an increase
in inventory.
We need to determine if the increase in ending inventory over beginning inventory was due to a price increase or an increase
in inventory.
1a. Compute a Cost Index for the
year.
1a. Compute a Cost Index for the
year.
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Dollar-Value LIFO (DVL)
1b. Deflate the ending
inventory value using
the cost index.
1b. Deflate the ending
inventory value using
the cost index.
1c. Compare ending
inventory (at base year cost) to
beginning inventory.
1c. Compare ending
inventory (at base year cost) to
beginning inventory.
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Dollar-Value LIFO (DVL)
Next, identify the layers in ending inventory and the years they were created.
Next, identify the layers in ending inventory and the years they were created.
Sum all the layers to arrive at Ending Inventory at DVL
cost.
Sum all the layers to arrive at Ending Inventory at DVL
cost.
Convert each layer’s base year cost to layer
year cost by multiplying times the
cost index.
Convert each layer’s base year cost to layer
year cost by multiplying times the
cost index.
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End of Chapter 8
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