16–1McQuaig Bille

11College Accounting10th Edition

McQuaig Bille Nobles

© 2011 Cengage Learning

PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University

Chapter 16Ending Merchandise Inventory

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Accounting LanguageAccounting Language

Merchandise inventory is defined as goods purchased by the company and held for resale to customers in the ordinary course of business.

The Merchandise Inventory account requires two adjusting entries:1. The first entry removes or “reverses out” the

value of the beginning merchandise inventory.

2. The second entry adds in the value of the ending merchandise inventory.

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Merchandise Inventory and Related T AccountsMerchandise Inventory

and Related T Accounts

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Merchandise Inventory and Related T AccountsMerchandise Inventory

and Related T Accounts

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Accounting LanguageAccounting Language

Assume that a firm has a beginning merchandise inventory amounting to $275,000. The cost of the ending merchandise inventory is $283,000. The adjustment is described by T accounts as follows:

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The Importance of Inventory ValuationThe Importance of Inventory Valuation

Merchandise Inventory is the only account that can appear on both major financial statements.

If the ending merchandise inventory is overstated, the cost of goods sold will also be understated and net income will be overstated.

If the beginning merchandise inventory is overstated, net income will be understated.

The problem is ongoing when the understated ending inventory of year 1 becomes the beginning inventory for year 2.

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SummarySummary

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Merchandise inventory turnover is the number of times a firm’s average inventory is sold during a given year.

Merchandise Inventory TurnoverMerchandise Inventory Turnover

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Assume the following information for 2011 and 2010 for Southern Furniture.

Beginning Merchandise Inventory (from the Cost of Goods Sold section of the income statement) $ 46,000 $ 64,000Ending Merchandise Inventory (from the Cost of Goods Sold Section of income statement or the balance sheet) 58,000 46,000Cost of Goods Sold (from the Cost of Goods Sold section of the income statement) 278,000 248,000

2011 2010

Merchandise Inventory TurnoverMerchandise Inventory Turnover

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Merchandise Inventory TurnoverMerchandise Inventory Turnover

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Taking InventoriesTaking Inventories

Care should be taken to count all goods belonging to the firm.

Sometimes goods may not be physically present.1. From the seller’s position, merchandise sold FOB

destination should be included in the seller’s inventory.

2. From the buyer’s position, merchandise purchased FOB shipping point should be included in the buyer’s inventory.

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Periodic Inventory SystemPeriodic Inventory System

Whitewater Raft Supply keeps an inventory of Draco life vests (#931). The following activity took place for this inventory item during the year:

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each =1,340

Total available 109 units $6,897

Note: These data will be repeated several times to demonstrated the different inventory methods.

Note: These data will be repeated several times to demonstrated the different inventory methods.

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Specific Identification MethodSpecific Identification Method

When Whitewater Raft Supply takes inventory at the end of the year, it finds that there are 29 life vests in stock; 7 of those were bought in March, 10 were bought in July, and 12 were bought in November. Costs are assigned to the ending inventory as follows:

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each =1,340

7 $ 441

Sold all but 7of these

Sold all of these

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Specific Identification MethodSpecific Identification Method

When Whitewater Raft Supply takes inventory at the end of the year, it finds that there are 29 life vests in stock; 7 of those were bought in March, 10 were bought in July, and 12 were bought in November. Costs are assigned to the ending inventory as follows:

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each =1,340

7 $ 441Sold all of these

10

Sold all but 10of these

650

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Specific Identification MethodSpecific Identification Method

When Whitewater Raft Supply takes inventory at the end of the year, it finds that there are 29 life vests in stock; 7 of those were bought in March, 10 were bought in July, and 12 were bought in November. Costs are assigned to the ending inventory as follows:

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each =1,340

7 $ 441Sold all of these

10 650 12

Sold all but 12of these

804

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When Whitewater Raft Supply takes inventory at the end of the year, it finds that there are 29 life vests in stock; 7 of those were bought in March, 10 were bought in July, and 12 were bought in November. Costs are assigned to the ending inventory as follows:

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each =1,340

7 $ 441Sold all of these

10 650 12 804

Specific Identification MethodSpecific Identification Method

Total 29 units $1,895

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Specific Identification MethodSpecific Identification Method

Whitewater Raft Supply determines the cost of goods sold by subtracting the value of the ending inventory from the total cost of goods available for sale.

Total life vests available (109 units) $6,897Less ending inventory (29 units) 1,895Cost of goods sold (80 units) $5,002

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Weighted-Average-Cost MethodWeighted-Average-Cost Method

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each =1,340

Total available 109 units $6,897

STEP 1.

STEP 2. $6,897 ÷ 109 = $63.28

STEP 3.29 units x $63.28 = $1,835.12Value of Ending Inventory (29 units)

STEP 4. Cost of goods sold (80 units) $6,897.00 – $1,835.12 = $5,061.88

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First-In, First-Out Method (FIFO) Method

First-In, First-Out Method (FIFO) Method

The first-in, first-out (FIFO) method is based on the flow-of-cost assumption that costs of merchandise sold should be charged against revenue in the order in which the costs were incurred.

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each =1,340

Total available 109 units $6,897

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First-In, First-Out Method (FIFO) Method

First-In, First-Out Method (FIFO) Method

Whitewater Raft Supply sold 80 units.

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each =1,340

Sold all 24Sold all 30

805626

Sold 26 of 35

0

9 units @ $65 each = $ 585

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First-In, First-Out Method (FIFO) Method

First-In, First-Out Method (FIFO) Method

Whitewater Raft Supply sold 80 units.

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each =1,340

Sold all 24Sold all 30Sold 26 of 35 9 units @ $65 each = $ 585

Total 29 units $1,925

Cost of Goods Sold = Total Available – Ending Inventory $4,972 = $6,897 – $1,925

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Last-In, First-Out Method (LIFO) Method

Last-In, First-Out Method (LIFO) Method

The last-in, first-out (LIFO) method is based on the flow-of-cost assumption that the most recently purchased articles are sold first and the articles remaining in the ending inventory are the oldest.

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each =1,340

Total available 109 units $6,897

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Last-In, First-Out Method (LIFO) Method

Last-In, First-Out Method (LIFO) Method

Whitewater Raft Supply sold 80 units.

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each = 1,340Sold all 20

Sold 25 of 30

806025

Sold all 35

0

5 units @ $63 each = 315

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Last-In, First-Out Method (LIFO) Method

Last-In, First-Out Method (LIFO) Method

Whitewater Raft Supply sold 80 units.

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each = 1,340Sold all 20

Sold 25 of 30Sold all 35

5 units @ $63 each = 315

Total 29 units $1,707

Cost of Goods Sold = Total Available – Ending Inventory $5,190 = $6,897 – $1,707

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Comparison of MethodsComparison of Methods

Whitewater Raft Supply sells the 80 life vests for $110 apiece, for a total of $8,800. The four methods yield the following gross profits.

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The effects of the methods are as follows:

1. Specific identification matches costs exactly with revenues.

2. Weighted-average-cost is a compromise between LIFO and FIFO.

3. FIFO provides the most realistic amount for the ending inventory.

4. LIFO provides the most realistic amount for the Cost of Goods Sold section of the income statement.

Comparison of MethodsComparison of Methods

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Tax Effect of LIFOTax Effect of LIFO

In periods of rising prices, LIFO yields the lowest gross profit and hence the lowest income taxes because the most recent costs are assigned to the cost of goods sold.

When prices fall, companies using LIFO are at a disadvantage from the standpoint of income taxes.

The cost figure determined by the different methods may have nothing to do with the physical flow of goods.

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Lower-of-Cost-or-Market RuleLower-of-Cost-or-Market Rule

Sometimes the replacement cost of items in stock is less than the original market cost.

Market refers to the current price charged in the market.

The lower-of-cost-or-market (LCM) rule says that, under certain conditions, when the replacement or market cost is lower than the original cost, the inventory should be valued at the lower cost.

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Perpetual Inventory SystemPerpetual Inventory System

Whitewater Raft Supply keeps an inventory of Draco life vests (#931). The following activity took place for this inventory item during the year:

Jan. 1 Beginning inventory 24 units @ $58 each = $1,392Mar. 16 Purchase 30 units @ $63 each = 1,890July 29 Purchase 35 units @ $65 each = 2,275Nov. 18 Purchase 20 units @ $67 each =1,340

Total available 109 units $6,897

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Whitewater Raft Supply sold 80 units on the following dates:

Feb. 28 15 unitsApr. 3 17 unitsJune 21 16 unitsDec. 2 32 units

80 units

Perpetual Inventory SystemPerpetual Inventory System

This information will be used in the next section.

This information will be used in the next section.

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To calculate the moving average cost per unit, Whitewater Raft Supply divides the total cost at time of sale by the total units at time of sale.

Moving Average Cost

per Unit=

Total Cost at time of sale ÷

Total Units at time of sale

Moving-Average-Cost MethodMoving-Average-Cost Method

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Moving-Average-Cost MethodMoving-Average-Cost Method

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*Rounded

Moving-Average-Cost MethodMoving-Average-Cost Method

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Last-In, First-Out (LIFO) Method

Last-In, First-Out (LIFO) Method

Whitewater Raft Supply’s accountant now verifies the total cost of the 80 life vests sold:

Cost of Goods Sold = Total Available – Ending Inventory

$5,054 = $6,897 – $1,843

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Comparison of MethodsComparison of Methods

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Perpetual Inventory Record

Perpetual Inventory Record

When a firm uses the perpetual inventory system, Merchandise Inventory is a controlling account.

The firm maintains an individual record for each kind of product in the subsidiary ledger.

The firm records the remaining balance after each receipt or sale.

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Perpetual Inventory RecordPerpetual Inventory Record Whitewater Raft Supply maintains a perpetual inventory of

rafting paddles on a LIFO basis. The ending balance of 30 units amounts to $2,223.

Nineteen paddles were sold at $115 each, for total sales of $2,185. The cost of goods sold was $1,410 to generate a gross profit of $775.