Inventories: Measurement

Inventory

Those assets that a company:

1. Intends to sell in the normal

course of business.

2. Has in production for future sale.

3. Uses currently in the production

of goods to be sold.

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 Types of Inventories

Merchandise Manufacturing
Inventory Inventory
Goods acquired for •Raw Materials
resale •Work-in-process
•Finished Goods

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 Inventory Methods

Perpetual Periodic Inventory

Inventory System System
The inventory
The inventory
account is
continuously account is
adjusted at the end
updated as
of a reporting
purchases and
sales are made. cycle.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Accounting Entries in a
Perpetual System
When a purchase of inventory is made:

GENERAL JOURNAL Page ##

Date Description Debit Credit
Inventory $$$$
Accounts Payable (or Cash) $$$$

Returns of inventory are credited to the inventory account.

Discounts on inventory purchases can be recorded using the
gross or net method.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Accounting Entries in a
Perpetual System
When a sale is made, the seller must make two
separate entries:
GENERAL JOURNAL Page ##
Date Description Debit Credit
1 Accounts Receivable (or Cash) $$$$
Sales $$$$

2 Cost of Goods Sold $$$

Inventory $$$

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Cost of Goods Sold Equation

Beginning Inventory
+ Purchases
Cost of Goods
Available for Sale
- Ending Inventory
= Cost of Goods Sold

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 What is Included in Inventory?
General Rule
All goods owned by the company on the
inventory date, regardless of their location.

Goods in Transit Goods on

Consignment

Depends on FOB
shipping terms.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Expenditures Included in
Inventory
Invoice Purchase
Price Returns

+
Freight-in
Purchase
on
Discounts
Purchases

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Inventory Cost Flow Methods

u Specific cost identification

u Average cost
u First-in, first-out (FIFO)
u Last-in, first-out (LIFO)

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Specific Cost Identification
u Items are added to u Thespecific cost of
inventory at cost each inventory item
when they are must be known.
purchased.
u Byselecting
u COGS for each sale specific items from
is based on the inventory at the
specific cost of the time of sale,
item sold. income can be
manipulated.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Weighted-Average
Periodic Example
The following schedule shows the mouse pad
inventory for Computers, Inc. for September.
The physical inventory count at September 30
shows 800 mouse pads in ending inventory.
Use the periodic weighted-average method to
determine:
(1) Ending inventory cost.
(2) Cost of goods sold.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Weighted-Average
Periodic Example
Computer, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beg. Inventory 1,000 $5.25 $5,250.00
9/3 100 5.30 530.00
9/15 150 5.60 840.00
9/21 200 5.80 1,160.00
9/29 100 5.90 590.00
Goods Available for
Sale 1,550 $8,370.00
Ending Inventory 800 ?
Cost of Goods Sold 750 ?

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Weighted-Average
Periodic Example
Now, we have to assign costs to ending inventory and
cost of goods sold.
Ending Inventory
(800 units)
Beginning Inventory
Available
(1,000 units)
for Sale
Purchases (1,550 units)
(550 units)
Goods Sold
(750)

$8,370 ÷ 1,550 = $5.40 weighted-average

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Weighted-Average
Periodic Example
Computer, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beg. Inventory 1,000 $5.25 $5,250.00
9/3 100 5.30 530.00
9/15 150 5.60 840.00
9/21 200 5.80 1,160.00
9/29 100 5.90 590.00
Goods Available for
Sale 1,550 $8,370.00
Ending Inventory 800 x 5.40 = 4,320.00
Cost of Goods Sold 750 x 5.40 = $ 4,050.00

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 First-In, First-Out

The FIFO u The cost of the oldest

method inventory items are
assumes that charged to COGS
items are sold when goods are sold.
in the u The cost of the
chronological newest inventory
order of their items remain in
acquisition. ending inventory.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 First-In, First-Out
Even though the periodic
approach and the perpetual
approach differ in the
timing of adjustments to
inventory . . .
. . . COGS and Ending
Inventory Cost are the
same under both
approaches.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 FIFO - Perpetual Example
The following schedule shows the mouse pad
inventory for Computers, Inc. for September.
The physical inventory count at September 30
shows 800 mouse pads in ending inventory.
Use the perpetual FIFO method to determine:
(1) Ending inventory cost.
(2) Cost of goods sold.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 FIFO - Perpetual Example
Computer, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beg. Inventory 1,000 $5.25 $5,250.00
9/3 100 5.30 530.00
9/15 150 5.60 840.00
9/21 200 5.80 1,160.00
9/29 100 5.90 590.00
Goods Available for
Date Sales Units
Sale 1,550
9/1 300
Ending Inventory 800 9/10 200
Cost of Goods Sold 750 9/30 250

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 FIFO - Perpetual Example
Date Purchased Sold Balance
Beg. Inv. 1000 x 5.25 = 5,250 $ 5,250.00
1-Sep 300 x 5.25 = 1,575.00 3,675.00
3-Sep 100 x 5.30 = 530 4,205.00
10-Sep 200 x 5.25 = 1,050.00 3,155.00
15-Sep 150 x 5.60 = 840 3,995.00
21-Sep 200 x 5.80 = 1,160 5,155.00
29-Sep 100 x 5.90 = 590 5,745.00
30-Sep 250 x 5.25 = 1,312.50 4,432.50

Cost of Goods Sold = 3,937.50

Note that this is the same COGS

computed using the Periodic
approach.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Last-In, First-Out
Any questions
before we run into
LIFO?

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 Last-In, First-Out

The LIFO u The cost of the

method newest inventory
assumes that items are charged to
the newest COGS when goods
items are sold are sold.
first, leaving the u The cost of the oldest
older units in inventory items
inventory. remain in inventory.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 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.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 LIFO - Perpetual Example
The following schedule shows the mouse pad
inventory for Computers, Inc. for September.
The physical inventory count at September 30
shows 800 mouse pads in ending inventory.
Use the perpetual LIFO method to determine:
(1) Ending inventory cost.
(2) Cost of goods sold.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 LIFO - Perpetual Example
Computer, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beg. Inventory 1,000 $5.25 $5,250.00
9/3 100 5.30 530.00
9/15 150 5.60 840.00
9/21 200 5.80 1,160.00
9/29 100 5.90 590.00
Goods Available for
Date Sales Units
Sale 1,550
9/1 300
Ending Inventory 800 9/10 200
Cost of Goods Sold 750 9/30 250

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 LIFO - Perpetual Example
Date 700 Purchased Sold Balance
Beg. Inv. 1000 x 5.25 = 5,250 $ 5,250
1-Sep 300 x 5.25 = 1,575 3,675

In LIFO, we assume that we sell the

newest units in inventory first.
In this case, the 300 “newest” units
come from beginning inventory,
leaving 700 units in the beginning
inventory layer.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 LIFO - Perpetual Example
600
Date 700 Purchased Sold Balance
Beg. Inv. 1000 x 5.25 = 5,250 $ 5,250
1-Sep 300 x 5.25 = 1,575 3,675
3-Sep 100 x 5.30 = 530 4,205
10-Sep 100 x 5.30 = 530 3,675
100 x 5.25 = 525 3,150

For the September 10 sale, we must identify the 200

newest units.
100 of them come from the September 3 purchase.
The other 100 come from beginning inventory.
Note that all of the 9/3 units have been “sold” and
only 600 of the beginning inventory units remain.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 LIFO - Perpetual Example
600
Date 700 Purchased Sold Balance
Beg. Inv. 1000 x 5.25 = 5,250 $ 5,250
1-Sep 300 x 5.25 = 1,575 3,675
3-Sep 100 x 5.30 = 530 4,205
10-Sep 100 x 5.30 = 530 3,675
100 x 5.25 = 525 3,150
15-Sep 150 x 5.60 = 840 3,990
21-Sep 50 200 x 5.80 = 1,160 5,150
29-Sep 100 x 5.90 = 590 5,740
30-Sep 100 x 5.90 = 590 5,150
150 x 5.80 = 870 4,280

Cost of Goods Sold = 4,090

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 When Prices Are Rising . . .
FIFO LIFO
u Matches low (older) u Matches high (newer)
costs with current costs with current
(higher) sales. (higher) sales.
u Inventory is valued u Inventory is valued
approximates based on low (older)
replacement cost. cost basis.
u Results in higher u Results in lower
taxable income. taxable income.
u Is not officially
endorsed by the
IASC.

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001

 Decision Makers’ Perspective
What factors motivate companies to
select one inventory method over another?

How closely do
How well are costs
reported
matched against
costs reflect actual
related revenues?
flow of inventory?

How accurate are

the timing of
reported income
and income taxes?
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001