CHAPTER 7

INVENTORIES
Learning Objectives
Control of Inventory

Reporting
Safeguarding the
inventory in the
inventory from
financial
damage or theft.
statements
Safeguarding Inventory (slide 1 of 3)

 Controls for safeguarding inventory begin as soon as the

inventory is ordered.
 The following documents are often used for inventory control:

Purchase Receivin Vendor’s

order g report invoice
Safeguarding Inventory (slide 2 of 3)

The purchase order

The receiving report
authorizes the
establishes an initial
purchase of the
record of the receipt
inventory from an
of the inventory.
approved vendor.
Safeguarding Inventory (slide 3 of 3)

 Security measures to prevent damage and customer or

employee theft.

Storing Locking high-

inventory in priced inventory
restricted area in cabinets.

Using two-way
mirrors, cameras,
security tags, and
guards.
Reporting Inventory

A physical inventory or count of inventory should

be taken near year-end

Make sure that the quantity of inventory reported

in the financial statements is accurate

The cost of the inventory is assigned for reporting

in the financial statements, using one of two
inventory cost flow assumptions.
Inventory Cost Flow Assumptions
(slide 1 of 2)

 An accounting issue arises when identical units of

merchandise are acquired at different unit costs during a
period.
 When an item is sold, it is necessary to determine its cost
using a cost flow assumption and related inventory costing
method.
Inventory Cost Flow Assumptions
(slide 2 of 2)
Illustration of Inventory Cost Flow
Assumptions (slide 1 of 2)
 Assume that three identical units of merchandise are
purchased during May, as follows:
Illustration of Inventory Cost Flow
Assumptions (slide 2 of 2)
 Assume that one unit is sold on May 30 for Rp20,000, the
gross profit will varies from Rp11.000 to Rp6.000, depends
on which unit is sold (if only we can identify the unit sold
specifically) it can’t be applied in identical units (have
same appearrance)
Specific Identification Inventory
Cost Method
 The unit sold is identified with a specific purchase.
 The ending inventory is made up of the remaining units on
hand.
 For example, if the May 18 unit was sold,
• The cost of merchandise sold is Rp13,000
• The gross profit is Rp7,000, and
• The ending inventory is Rp23,000.
First-In, First-Out (FIFO) Inventory
Cost Flow Method

The ending
The first units
inventory is
purchased are
made up of the
assumed to be
most recent
sold
purchases.
Weighted Average Inventory
Cost Flow Method

The cost of the units sold

and in ending inventory is
a weighted average of the
purchase costs.
Inventory Costing Methods
Inventory Costing Methods Under
Perpetual Inventory System
 For purposes of illustration, the data for Item 127B are used,
as shown below.
First-In, First-Out Method

 Costs are included in the cost of merchandise sold in the order

in which they were purchased.
 It is often the same as the physical flow of the merchandise.
 It often provides results that are about the same using the
specific identification method.
Exhibit 4: Entries and Perpetual
Inventory Account (FIFO)
Weighted Average Cost Method

 Under a perpetual inventory system, a unit cost for each item

is computed each time a purchase is made.
 To determine the cost of each sale until another purchase is
made and a new average is computed.
 This technique is called a moving average.
Exhibit 5: Entries and Perpetual Inventory
Account (Weighted Average)
Inventory Costing Methods Under
a Periodic Inventory System
 Only revenue is recorded each time a sale is made.
 No entry is made at the time of the sale to record the cost of
the merchandise sold.
 A physical inventory is taken to determine the cost of the
inventory and the cost of the merchandise sold.
First-In, First-Out Method (slide 1 of 3)

 We use the same data for Item 127B as in the perpetual

inventory example.
 The beginning inventory and purchases of Item 127B in
January are as follows:
First-In, First-Out Method (slide 2 of 3)

 The physical count on January 31 shows that 800 units are on

hand.
 The cost of the 800 units in the ending inventory on January
31 is determined as follows:
First-In, First-Out Method (slide 3 of 3)

 The cost of merchandise sold of Rp26,720,000, as shown

below.
Exhibit 6: First-In, First-Out
Flow of Costs
Weighted Average Cost Method
(slide 1 of 2)

 The weighted average unit cost is determined as follows:

Weighted Average Cost Method
(slide 2 of 2)

 The data for Item 127B is used as follows:

 The cost of the January 31 ending inventory:

Comparing Inventory Costing Methods
(slide 1 of 2)

 FIFO and weighted average inventory normally yield different

amounts for the following:
1. Cost of merchandise sold
2. Gross profit
3. Net income
4. Ending merchandise inventory
Comparing Inventory Costing Methods
(slide 2 of 2)

 Using the perpetual inventory system

Exhibit 7: Effects of Changing Costs (Prices):
FIFO and WA Cost Methods
Reporting Merchandise Inventory
in the Financial Statements
 Cost is the primary basis for valuing and reporting inventories
in the financial statements.
 Inventory may be valued at other than cost in the following
cases:
1. The cost of replacing items in inventory is below the
recorded cost.
2. The inventory cannot be sold at normal prices due to
imperfections, style changes, spoilage, damage,
obselence, or other causes.
Valuation at Lower of Cost or Market
(slide 1 of 3)

 If the market is lower than the purchase cost, lower-of-cost-

or-market (LCM) method is used to value the inventory.
 Market, as used in lower of cost or market, is the net
realizable value of the merchandise. Net realizable value is
determined as follows:
Net Realizable Value = Estimated Selling Price – Direct Costs of
Disposal
• Direct costs of disposal include selling expenses such as
special advertising or sales commissions.
Valuation at Lower of Cost or Market
(slide 2 of 3)

 Assume the following data about an item of damaged merchandise:

 In applying LCM, the market value of the merchandise is

Rp650,000, computed as follows:

 Thus, the merchandise would be valued at Rp650,000, which is the

lower of its cost of Rp1,000,000 and its market value of
Rp650,000.
Valuation at Lower of Cost or Market
(slide 3 of 3)

 The lower-of-cost-or-market method can be applied in one of

three ways. The cost, market price, and any declines could be
determined for the following:
1. Each item in the inventory

2. Each major class or category of inventory

3. Total inventory as a whole

Merchandise Inventory on the Statement
of Financial Position (slide 1 of 2)

 Merchandise inventory is usually reported in the Current

Assets section of the statement of financial position.
 The following are also reported:
1. The method of determining the cost of the inventory
(FIFO or weighted average)
2. The method of valuing the inventory (cost or the lower of
cost or market)
Merchandise Inventory on the Statement
of Financial Position (slide 2 of 2)
Exhibit 9: Effect of Inventor Errors on
Current Period’s Income Statement
Exhibit 10: Effects of Inventory Errors on
Two Years’ Income Statements
Exhibit 11: Effect of Inventor Errors on Current
Period’s Statement of financial Position
Financial Analysis and Interpretation

Inventory should be kept enough on hand to meet its

customers’ needs to prevent lost in sales.

Too much inventory ties up funds that could be used to

improve operations.

Excess inventory increases storage and property taxes.

Excess inventory increases the risk of losses due to

price declines, damage, or changes in customer tastes.
Inventory Turnover (slide 1 of 2)

 Measures the relationship between the cost of merchandise

sold and the amount of inventory carried during the period
 The larger the inventory turnover the more efficient and
effective in managing inventory.
Inventory Turnover (slide 2 of 2)

 Inventory turnover for PT Matahari Dept. Store Tbk.

Number of Day’s Sales in Inventory
(slide 1 of 2)

 Measures the length of time it takes to acquire, sell, and

replace the inventory.
 The average daily cost of merchandise sold is determined by
dividing the cost of merchandise sold by 365.
Number of Day’s Sales in Inventory
(slide 2 of 2)

 The number of days’ sales in inventory for Matahari, is

computed as follows (in millions):
Matahari versus PT Sepatu Bata Tbk.