Professional Documents
Culture Documents
1 compiled by Merkeb.T
INTRODUCTION
2 compiled by Merkeb.T
Inventory: Cost Measurement and Flow Assumption
Inventories: is especially significant because the acquisition manufacture and sale
of products are important to the profitability of many companies the cost (carrying
value) of the inventory usually has a material impact on a company’s balance sheet
since the ending inventory of one period is the beginning inventory of the next
period the cost of the inventory on the balance sheet will have an impact on the
next periods cost of goods sold and net income. In this chapter we shall discuss.
The determinations of inventory quantities and costs and alternative inventory cost
flow assumptions.
3 compiled by Merkeb.T
Under the specific identification inventory cost flow assumption, a company
identifies each unit sold and each unit remaining in the ending inventory and
includes the actual costs of those units in cost of goods sold and ending inventory,
respectively.
The specific identification method can be applied in either a perpetual or a periodic
inventory system but it is more reasonable to use it with a perpetual system in
which: - each unit is identifies as it is sold and the appropriate cost attached.
Illustration 7-4 Inventory inflows and out flows for ABC Company
4 compiled by Merkeb.T
Inventory, April 1 --------------------- 100 units at $10 per unit -------------- $ 1,000
Purchases, April 10 ------------------- 80 units at $11 per unit ------------------ $ 880
Purchases, April 20 ------------------- 70 units at $12 per unit ------------------ $ 840
Goods available for sale --------------250 units --------------------------------- $ 2,720
Sales, April 18 ---------------------------- (90) units
140 units
Sales, April 27 ---------------------------- (50) units
Inventory, April 30 --------------------110 units
5 compiled by Merkeb.T
(Periodic inventory system)
Cost of goods sold (140 units):
April 18:90 units at $10 -------------------------------------------- $900
April 27: 50 units: 10 units at $10 --------------------------------- 100
: 40 units at $ 11 ------------------------------- 440
Total ---------------------------------------------------------$1,440
Ending inventory (110 units)
40 units at $11=$440
70 units at $12= 840
Total-------------------- $1,280
Note that the ending inventory and the cost of goods sold under both the perpetual
and the periodic systems are equal this always is true for the FIFO cost flow
assumption because the most recent costs incurred are included in the ending
inventory.
6 compiled by Merkeb.T
April 20:70 units at $12 -------------------------------------------- $ 840
20 units at $ 11 ----------------------------------------------- 220
April 27: 50 units at $11 --------------------------------------------- 550
Total --------------------------------------------------------- $ 1,610
Ending inventory (110 units)
100 units at $10=$1000
10 units at $11 = 110
Total------------------- $1,110
7 compiled by Merkeb.T
calculated after each purchase. The new weighted average is computed in the same
way as in the weighted average method. That is under the moving average method,
the average cost per unit is the cost of the units available for sale after the purchase
divided by the number of units available for sale at that time.
This available cost is used to determine the cost each sale made until the next
purchase, at which time a new average cost must be calculated. The illustration for
both systems as follows:
8 compiled by Merkeb.T
April 10, Purchases --------------------------------- 80 units at $11 ----------$880
April 10, Balance ---------------------------------- 180 units at $10.44 -----$1,880
April 18, Sales --------------------------------- (90) units at $10.44 ---------$(940)
April 18, Balance ---------------------------------- 90 units at $10.44 ---------$940
April 20, Purchases --------------------------------- 70 units at $12.00 -------$840
April 20, Purchases --------------------------------- 160 units at $11.125 --$1,780
April 27, Sales -------------------------------------- (50) units at $11.125 ----$(556)
April 30, Balance ------------------------------ ---- 110 units at $11.125 ----$1,224
Cost of goods sold (140 units at $11.125) ----------------------------------- $1,224
9 compiled by Merkeb.T
Lo2:- . Record inventory flows
Accounting for and reporting inventory under a perpetual system
In perpetual inventory system, all merchandise increase and decrease are recorded
in manner similar to the recording of increase and decrease in cash. The
merchandise inventories account at the beginning of an accounting period
indicated the merchandise in stock on that date. Purchase is recorded by debiting
merchandise inventory and crediting cash or account payable, on the data of each
sale. The cost of merchandise sold is recorded by debiting cost of merchandise sold
and crediting merchandise inventory.
Example:-The following units of item K are available for sale
Item K units cost
Jan.1 Inventory 20 $ 20
4 Sale 14
10 Purchase 16 21
22 Sale 8
28 Sale 4
30 Purchase 20 22
The firm used a perpetual inventory system, and there are 30 units of one item on
hand at end of the year. What is the total cost of goods sold and ending inventory
according to:-
A.FIFO B.LIFO C. average cost method.
10 compiled by Merkeb.T
FIFO method
Using cost, costs are included in the merchandise sold in the order in which they
were incurred.
Date Quant Unit Total Quanti Unit Total Quanti Unit Total
ity cost cost ty cost cost ty cost cost
1 20 20 400
4 14 20 280 6 20 120
10 16 21 336 6 20 120
16 21 336
22 6 20 120 14 21 294
2 21 42
28 4 21 84 10 21 210
30 20 22 440 10 21 210
20 22 440
11 compiled by Merkeb.T
LIFO method
When the LIFO method is used in a perpetual inventory system the cost of the
units sold is the cost of the most recent purchase
Date Quant Unit Total Quanti Unit Total Quanti Unit Total
1 20 20 400
4 14 20 280 6 20 120
10 16 21 336 6 20 120
22 8 21 168 16
6 21
20 336
120
8 21 168
28 4 21 84 6 20 120
4 21 84
30 20 22 440 6 20 120
4 21 84
20 22 440
12 compiled by Merkeb.T
Total 26 $532 30 $644
average.
Date Quant Unit Total Quanti Unit Total Quanti Unit Total
1 20 20 400
4 14 20 280 6 20 120
13 compiled by Merkeb.T
Estimating Inventory cost
In practical an inventory amount may be need in order to prepare an income
statement when it is impractical or impossible to take a physical inventory or to
maintain perpetual inventory records the amount of inventory on hand can be
estimated.
The two commonly used methods of estimating inventory cost are:-
1. The retail method
2. The gross profit method
1. Retail Methods
The retail method of estimating the cost of inventories is used primary by retailing
enterprises. Under the periodic inventory system, the cost of the ending inventory
is subtracted from the total cost of goods available for sale to compute the cost of
goods sold. Under the retail method, a record of goods available for sale at selling
prices is kept separate at selling prices. The ending inventories valued at selling
prices then are reduced to estimated cost by multiplying the inventories at selling
price by the cost percentage computed for the accounting period.
ABC Company
Estimate of Inventories by Retail Method
End of current year
14 compiled by Merkeb.T
Cost Retail
Beginning inventories ---------------------------- $ 40,000 $50,000
Net Purchases -------------------------------------- $ 150,000 200,000
Goods available for sale ------------------------- $ 190,000 250,000
Cost percentage ($190,000 $250, 00) -------- $ 76%
Less: Sales and normal shrinkage ---------------------------------------------
220,000
Ending inventories at retail--------------------------------------------------- $30,000
Ending inventories at
Cost ($30,000x0.76) ---------------------------------- $22,800
15 compiled by Merkeb.T
profit and cost of good sold percentage are obtained from prior year’s financial
statements, which presumably are available.
Lo4:- Prepare inventory schedules and ad hoc reports
Illustration
The following data are given for ABC Company for the year ended Dec 31, year 3.
Beginning inventories ------------------------------------------- $ 40,000
Net Purchases ----------------------------------------------------- 200,000
Net sales ------------------------------------------------------------- 225,000
Average cost percentage for the past two years ----------- 80%
Then by assuming that the cost percentage for year 4 remained at 80% the cost of
the inventories on Dec 31, year 3 is estimated as follows
ABC Corporation
Estimate of cost of inventories by gross profit method
December 31, year 3
Beginning inventories, at cost ------------------------------------ $ 40,000
Add: Net purchases ------------------------------------------------- 200,000
16 compiled by Merkeb.T
Cost of goods available for sale ---------------------------------- $240,000
Less: Estimated cost of goods sold:
17 compiled by Merkeb.T