Accounting for InventoriesAccounting for Inventories

• Inventory Systems:Inventory Systems:– Perpetual—Maintains a moving inventory Perpetual—Maintains a moving inventory

balance (i.e., Merchandise inventory balance (i.e., Merchandise inventory increases as merchandise is purchased increases as merchandise is purchased and decreases as it soldand decreases as it sold

– Periodic—A physical inventory is taken and Periodic—A physical inventory is taken and priced at the end of an accounting period priced at the end of an accounting period and adjusted into the merchandise and adjusted into the merchandise inventory account at the end of the period inventory account at the end of the period to obtain cost of goods sold in the current to obtain cost of goods sold in the current periodperiod

Inventory Valuation Inventory Valuation MethodsMethods

• CostCost– Inventory is valued at what the business Inventory is valued at what the business

paid for it (includes cash discounts, paid for it (includes cash discounts, freight-in, and returns allowed)freight-in, and returns allowed)

• Lower of Cost or MarketLower of Cost or Market– Current replacement cost is compared Current replacement cost is compared

with the purchase price of each item in with the purchase price of each item in inventory; then the lower of the amount inventory; then the lower of the amount on an aggregate basis is used for on an aggregate basis is used for inventory valuationinventory valuation

Flow of Cost ConsiderationsFlow of Cost Considerations• Specific Identification—Cost of specific items Specific Identification—Cost of specific items

purchased follow those items as they are soldpurchased follow those items as they are sold• First-in; first-out (applies to cost of goods sold)First-in; first-out (applies to cost of goods sold)

– First purchase prices apply to first goods sold; Most First purchase prices apply to first goods sold; Most recent purchase prices apply to what is left in ending recent purchase prices apply to what is left in ending inventoryinventory

• Last-in; first-out (applies to cost of goods sold)Last-in; first-out (applies to cost of goods sold)– First purchase prices apply to ending inventory; Most First purchase prices apply to ending inventory; Most

recent purchase prices apply to first goods soldrecent purchase prices apply to first goods sold

• Weighted average Weighted average – Average cost of purchases is determined and the Average cost of purchases is determined and the

same price per unit is applied to both cost of goods same price per unit is applied to both cost of goods sold and ending inventorysold and ending inventory

Example of Cost FlowsExample of Cost Flows

• Specific IdentificationSpecific Identification– 11stst purchase item A @ $50; 2 purchase item A @ $50; 2ndnd purchase purchase

item A @ $100item A @ $100– 11stst sale is item A is the second purchase; sale is item A is the second purchase;

CGS would be $100 and ending CGS would be $100 and ending inventory would be $50inventory would be $50

• First-In, First-Out same exampleFirst-In, First-Out same example– Cost of goods sold would be $50 and Cost of goods sold would be $50 and

ending inventory would be $100ending inventory would be $100

Example of Cost Flows, Example of Cost Flows, ContinuedContinued• Last-In, First-OutLast-In, First-Out

– Cost of goods sold would be $100 and Cost of goods sold would be $100 and ending inventory would be $50ending inventory would be $50

• Weighted AverageWeighted Average– ($50 + 100)/2 = $75 average cost($50 + 100)/2 = $75 average cost– Cost of goods sold would be $75 (one Cost of goods sold would be $75 (one

item @ $75)item @ $75)– Ending inventory would be $75 (one Ending inventory would be $75 (one

item @ $75item @ $75

Inventory And Profit Inventory And Profit DeterminationDetermination

• An important equation in this pricing An important equation in this pricing process is—process is—– Beginning inventory + purchases = Beginning inventory + purchases = Total Total

available for saleavailable for sale– Total available for saleTotal available for sale = Cost of Goods = Cost of Goods

Sold + Ending InventorySold + Ending Inventory

•So one can calculate the cost of So one can calculate the cost of goods sold first or the ending goods sold first or the ending inventory first and subtract from inventory first and subtract from total available for sale to get the total available for sale to get the other amount other amount