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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Inventory
CHAPTER F IVE
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
LEARNING OBJECTIVES
Describe the four different inventory costing methods
Compute inventory costs using first-in, first-out (FIFO); last-in, first-out (LIFO); and average cost methods and journalize inventory transactions
Compare the effects of the different costing methods on the financial statements
Value inventory using the lower-of-cost-or-market (LCM) rule
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
LEARNING OBJECTIVES
Illustrate the reporting of inventory in the financial statements
Determine the effect of inventory errors on the financial statements
Use the gross profit method to estimate ending inventory
Compute the inventory turnover rate and the days-sales-in-inventory ratio
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Descr ibe the four d iff erent inventory cost ing methods
LEARNING OBJECTIVE ONE
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Inventory Costing Methods
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Specific- Identification First-in, first-out (FIFO)
Last-in, first-out (LIFO) Average Cost
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Specific-Identification
◘ Cost assigned to inventory item when sold is the actual cost paid for item
◘ Cost flow through accounting records exactly matches physical flow of goods
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
FIRST-IN, FIRST-OUT (FIFO)
◘ Assumes earliest inventory costs are assigned to items when sold
◘ Cost flow through accounting records will closely match physical flow of goods
LAST-IN, FIRST-OUT (LIFO)
◘ Assumes most recent inventory costs are assigned to items when sold
◘ Cost flow through accounting records will be nearly opposite of physical flow of goods
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FIFO and LIFO
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Average Cost
◘ Assumes a weighted-average cost per item is assigned to items as sold
◘ Cost of goods sold and ending inventory will fall between amounts determined by FIFO and LIFO
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Cost Flow vs. Physical Flow
◘ Cost Flow How accounting records reflect cost of goods sold
using inventory costing method business has chosen
◘ Physical Flow How goods are stocked and how they are removed
when sold
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
LEARNING OBJECTIVE TWO
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Compute inventory costs us ing fi rst- in , fi rst-out (FIFO); last- in , fi rst-out (L IFO); and average cost methods and journal ize inventory transact ions
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Inventory Account
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Inventory
Beginning Balance
Purchases
Shipping
Ending Balance
Sales
Purchase Discounts
Purchase Returns and Allowances
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Ending InventoryUnits on hand
Cost of Goods Sold
Units sold
Inventory Cost Flows
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Cost of Goods
Available for Sale
Purchases
Beginning Inventory
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
FIFO Illustrated (1 of 2)
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$10$10
Beginning Inventory:2 units @ $10/ea.
$12
$12
$12$12
$12$12
$12
$12
Purchases:8 units @ $12/ea.
10 units on hand,Company sells 7 unitsCompany sold 7 units,3 units remain on hand
Ending Inventory
$36• 3 units @
12/ea.
Cost of Goods Sold$80
• 2 units @ $10/ea.• 5 units @ $12/ea.
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
FIFO Illustrated (2 of 2)
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Purchases Cost of Goods Sold
Inventory on Hand
Date Qty Unit Cost
TotalCost
Qty UnitCost
TotalCost
Qty UnitCost
TotalCost
Apr 1
2 $10 $20
Apr 9
8 $12 $96 2 $10 $20
8 $12 $96
Apr 15
2 $10 $20
5 $12 $60 3 $12 $36
Apr 30
8 $96 7 $80 3 $36
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
FIFO Journal Entries
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GENERAL JOURNAL
DATE ACCOUNTS DEBIT CREDIT
Apr. 9 Inventory (8 x $12) 96
Accounts Payable 96
Apr.15
Accounts Receivable 175
Sales Revenue 175
Cost of Goods Sold 80
Inventory 80
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
10 units on hand,Company sells 7 unitsCompany sold 7 units,3 units remain on hand
LIFO Illustrated
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$10$10
Beginning Inventory:2 units @ $10/ea.
$12
$12
$12$12
$12$12
$12
$12
Purchases:8 units @ $12/ea.
Ending Inventory
$32• 1 unit @ 12/ea.• 2 units @
10/ea.
Cost of Goods Sold$84
• 7 units @ $12/ea.
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
LIFO Illustrated (2 of 2)
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Purchases Cost of Goods Sold
Inventory on Hand
Date Qty Unit Cost
TotalCost
Qty UnitCost
TotalCost
Qty UnitCost
TotalCost
Apr 1
2 $10 $20
Apr 9
8 $12 $96 2 $10 $20
8 $12 $96
Apr 15
7 $12 $84 2 $10 $20
1 $12 $12
Apr 30
8 $96 7 $84 3 $32
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
LIFO Journal Entries
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GENERAL JOURNAL
DATE ACCOUNTS DEBIT CREDIT
Apr. 9 Inventory (8 x $12) 96
Accounts Payable 96
Apr.15
Accounts Receivable 175
Sales Revenue 175
Cost of Goods Sold 84
Inventory 84
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
$10$10
Beginning Inventory:2 units @ $10/ea.
$12
$12
$12$12
$12$12
$12
$12
Purchases:8 units @ $12/ea.
Units
UnitCost
TotalCost
Beginning Inventory
2 $10 $20
Purchases 8 12 96
10 $116
Company sold 7 units,3 units remain on hand
Average Cost Illustrated (1 of 2)
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10 units on hand,Company sells 7 units
Ending Inventory
$34.80• 3 units @
11.60/ea.
Cost of Goods Sold
$81.20• 7 units @
$11.60/ea
Available for Sale10 units @ $11.60/ea.
$11.60
$11.60
$11.60
$11.60
$11.60
$11.60
$11.60
$11.60
$11.60
$11.60
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Average Cost Illustrated (2 of 2)
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Purchases Cost of Goods Sold
Inventory on Hand
Date Qty
Unit Cost
Total
Cost
Qty
UnitCost
TotalCost
Qty UnitCost
TotalCost
Apr 1
2 $10 $20
Apr 9
8 $12 $96 2 $10 $20
8 $12 $96
10 $11.60
$116
Apr 15
7 $11.60
$81.20
3 $11.60
$34.80
Apr 30
8 $96 7 $81.20
3 $34.80
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Average Cost Journal Entries
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GENERAL JOURNAL
DATE ACCOUNTS DEBIT CREDIT
Apr. 9 Inventory (8 x $12) 96
Accounts Payable 96
Apr.15
Accounts Receivable 175
Sales Revenue 175
Cost of Goods Sold 81.20
Inventory 81.20
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Compare the eff ects of the d iff erent cost ing methods on the fi nancia l statements
LEARNING OBJECTIVE
THREE04/13/2023
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Comparison of Inventory Methods(under assumption prices are increasing)
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Inventory
Costing Method Description Benefit
First-in, First-out(FIFO)
Cost of Goods Sold has older, lower costs;Ending Inventory has newer, higher costs
Most closely matches actual flow of goods;Maximizes net income which attracts investors and creditors
Last-in, First-out(LIFO)
Cost of Goods Sold has newer, higher costs;Ending Inventory has older, lower costs
Minimizes net income, income taxes, and ending inventory;Reduces cash needed to pay taxes
Average Cost
Averages costs in Cost of Goods Sold and Ending Inventory
A “middle-ground” solution for reporting net income, ending inventory, and paying taxes
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Consistency Principle
◘ Companies should use same accounting methods from period to period
◘ If a company does change methods, it must be justified and disclosed in the financial statements
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Value inventory us ing the lower-of-cost-or-market (LCM) ru le
LEARNING OBJECTIVE FOUR
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Lower-of-Cost-or-Market (LCM)
◘ Inventory is recorded at the lesser of: Historical cost Current replacement cost (market value)
◘ If market value is less than cost: Record a loss and reduce inventory
◘ If cost is less than market: No entry needed
◘ Application of conservatism principle
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Problem P5-44A (1 of 3)
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Ending Inventory (unadjusted)
$163,300
Decrease in market value (15,900)
Current replacement cost (adj.)
$147,400
Inventory amount on Balance Sheet
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Problem P5-44A (2 of 3)
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Cost of Goods Sold (unadjusted)
$614,000
Loss on inventory value 15,900
Cost of Goods Sold (adjusted)
$629,900
Cost of Goods Sold amount
on Income Statement
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Problem P5-44A (3 of 3)
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GENERAL JOURNAL Page 3
DATE ACCOUNTS DEBIT CREDIT
Oct.31
Cost of Goods Sold 15,900
Inventory 15,900
To write down inventory to market
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
I l lustrate the report ing of inventory in the fi nancia l statements
LEARNING OBJECTIVE FIVE
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Inventory on the Balance Sheet
◘ Reported as a current asset
◘ Financial statement footnotes describe inventory costing method and whether valued at LCM
Full-disclosure principle
Sample footnote:
NOTE 2: Statement of Significant Accounting Policies:
Inventory: Inventory is carried at lower-of-cost-or-market. Cost is determined by using the first-in, first-out method.
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Inventory Shrinkage
◘ Loss due to employee or customer theft, damage, and spoilage
◘ Physical inventory count taken to adjust inventory records
Inventory account is debited or credited as needed Cost of Goods Sold account is corresponding offset
account
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Determine the eff ect of inventory errors on the fi nancia l statements
LEARNING OBJECTIVE SIX
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Causes of Inventory Errors
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Improper Counting
Double-counting
Not counting some items
Ignoring obsolete or damaged
goods
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Impact of Inventory Errors
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Period One Period Two
Ending Inventory
Cost of Goods Sold
Gross Profit
& Net
Income
Cost of Goods Sold
Gross Profit &
Net Income
Overstated → Understated
Overstated
Overstated
Understated
Understated→
Overstated
Understated
Understated
Overstated
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Use the gross profi t method to est imate ending inventory
LEARNING OBJECTIVE
SEVEN04/13/2023
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Gross Profit Method
◘ Estimates the value of ending inventory
◘ Based on format for Cost of Goods Sold:
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Cost of Goods Sold Modified for Gross Profit Method
Beginning Inventory Beginning Inventory
+ Purchases + Purchases
(net of purchase discounts, returns & allowances plus shipping costs)
= Cost of Goods Available for Sale
= Cost of Goods Available for Sale
- Ending Inventory - Cost of Goods Sold (estimated)
= Cost of Goods Sold = Ending Inventory (estimated)
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Gross Profit Method Illustrated
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Gross Profit Method of estimating Ending Inventory
Step 1 Beginning Inventory $14,000
+ Purchases (net) 66,000
= Cost of Goods Available for Sale 80,000
Step 2 Estimated Cost of Goods Sold:
Net Sales Revenue $100,000
- Estimated Gross Profit of 40% ($100,000 x 40%) 40,000
= Estimated Cost of Goods Sold
(60,000)
Step 3 Estimated Ending Inventory $20,000
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
LEARNING OBJECTIVE
EIGHT04/13/2023
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Compute the inventory turnover rate and the days-sales- in- inventory rat io
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
How Much Inventory Does a Business Need?
◘ Too little inventory may result in lost sales and profits
A customer may go elsewhere if merchandise not in-stock
◘ Too much inventory is expensive to maintain
Uses space in warehouse Must pay for or finance inventory that isn’t
generating cash May become obsolete or lose value
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Inventory Ratios
◘ Inventory Turnover How many times in a year the inventory was
purchased and then sold
◘ Days-Sales-in-Inventory Compares inventory sold during a day with the
average amount of inventory held by a business during the year
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C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Beginning Inventory + Ending Inventory
2
Inventory Turnover
◘ Usually computed for an annual period
◘ Average inventory is
◘ Result described as number of “times per year”
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Average Inventory
Inventory Turnover
Cost of Goods Sold
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Days-Sales-in-Inventory
◘ Cost of Goods Sold / 365 approximates the amount of inventory sold each day
◘ Result described as number of “days”
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Average Inventory
Days-Sales-in-Inventory
Cost of Goods Sold 365
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Exercise E5-27A (1 of 2)
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White Water Kayak, Inc.Income Statement
For the Year Ended December 31, 2012
Sales Revenue $1,752,300
Cost of Goods Sold:
Beginning Inventory $ 35,000
Net Purchases 750,600
Cost of Goods Available 785,600
Ending Inventory 48,700
Cost of Goods Sold 736,900
Gross Profit 1,015,400
Operating Expenses 66,000
Net Income $ 949,400
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
Cost of Goods Sold
$35,000 + $48,7002
Exercise E5-27A (2 of 2)
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Average Inventory
$41,850
Inventory Turnover
Inventory Turnover
17.61 times per year
Cost of Goods Sold$736,900
C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L
CHAPTER SUMMARY
Four inventory costing methods are permitted by GAAP. The costing method chosen by a business impacts their Cost of Goods Sold on the Income Statement and Inventory balance on the Balance Sheet and must be consistent from period to period.
Adjustments for Lower-of-Cost-or-Market, shrinkage, and inventory counting errors may be made to ensure conservatism and accuracy in reporting inventory.
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?C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S
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Questions
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