Chapter 6

INVENTORIES AND
COST OF SALES

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Winston Kwok, Ph.D., CPA

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
 6-2

C1

DETERMINING INVENTORY ITEMS

Merchandise inventory includes all goods that a
company owns and holds for sale, regardless of where
the goods are located when inventory is counted.

Items
Items requiring
requiring special
special attention
attention include:
include:
Goods
Goods in
Damaged or
Transit
Goods on Obsolete
Consignment
 6-3

C1

GOODS IN TRANSIT
FOB Shipping Point
Public
Carrier

Seller Buyer

Ownership passes
to the buyer here.

Public
Carrier

Seller FOB Destination Point Buyer

 6-4

C1

GOODS ON CONSIGNMENT
Merchandise is included in the inventory of the
consignor, the owner of the inventory.
Thanks for selling my
inventory in your
store.
Consignee

Consignor
 6-5

C1

GOODS DAMAGED OR OBSOLETE

Damaged or obsolete goods are not counted in

inventory if they cannot be sold.
Cost should be reduced to net realizable
value if they can be sold.
Net realizable value is the estimated
selling price in the ordinary course of
business less the estimated costs of
completion and the estimated costs
necessary to make the sale.
 6-6

C2

DETERMINING INVENTORY COSTS

Include all expenditures necessary to bring an item to
a salable condition and location.

Minus
Minus
Discounts
Discounts Invoice Plus
Plus
Insurance
and
and
Allowances
Allowances
Cost Insurance

Plus
Plus Import
Import Plus
Plus
Duties
Duties Plus
Plus Storage
Storage
Freight
Freight
 6-7

C2
INTERNAL CONTROLS AND TAKING A
PHYSICAL COUNT
 Most companies take a  When the physical count
physical count of does not match the
inventory at least once Merchandise Inventory
each year. account, an adjustment
must be made.

Good internal controls over count include:

1.Pre-numbered inventory tickets.
2.Counters have no inventory responsibility.
3.Counts confirm existence, amount, and
quality of inventory item.
4.Second count is taken.
5.Manager confirms all items counted.
 6-8

C2 INVENTORY COSTING UNDER

A PERPETUAL SYSTEM
Inventory
affects . . .
Balance Income
Sheet Statement

The matching
principle requires
matching costs
with sales.
 6-9

C2 INVENTORY COST FLOW

ASSUMPTIONS

Management decisions in accounting for inventory

involve the following:
1.Items included in inventory and their costs.
2.Costing method (specific identification, FIFO, LIFO,
or weighted average).
3.Inventory system (perpetual or periodic).
4.Use of market values or other estimates.
 6 - 10

P1 INVENTORY COST FLOW

ASSUMPTIONS
First-In, First-Out Assumes costs flow in the order
(FIFO) incurred.

Last-In, First-Out Assumes costs flow in the

(LIFO) reverse order incurred.

Weighted Assumes costs flow at an

Average average of the costs available.
 6 - 11

P1

INVENTORY COSTING ILLUSTRATION

Here is information about the mountain bike inventory of
Trekking for the month of August.
 6 - 12

P1

SPECIFIC IDENTIFICATION
 6 - 13

P1 SPECIFIC IDENTIFICATION

Income
Income Statement
Statement
Cost
Cost of
of Goods
Goods Sold
Sold Balance
Balance Sheet
Sheet Inventory
Inventory
 6 - 14

P1

SPECIFIC IDENTIFICATION
Here are the entries to record the purchases and sales. The
numbers in red are determined by the cost flow assumption used.

All purchases and sales are made on credit.

The selling price of inventory was as follows:
8/14 $130
8/31 150
 6 - 15

P1

FIRST-IN, FIRST-OUT (FIFO)

Oldest Cost of
Costs Goods Sold

Recent Ending
Costs Inventory
 6 - 16

P1

FIRST-IN, FIRST-OUT (FIFO)

 6 - 17

P1

FIRST-IN, FIRST-OUT (FIFO)

 6 - 18

P1

FIRST-IN, FIRST-OUT (FIFO)

Here are the entries to record the purchases and sales entries. The
numbers in red are determined by the cost flow assumption used.

All purchases and sales are made on credit.

The selling price of inventory was as follows:
8/14 $130
8/31 150
 6 - 19

P1

LAST-IN, FIRST-OUT (LIFO)

Recent Cost of
Costs Goods Sold

Oldest
Costs
 6 - 20

P1

LAST-IN, FIRST-OUT (LIFO)

 6 - 21

P1

LAST-IN, FIRST-OUT (LIFO)

 6 - 22

P1

LAST-IN, FIRST-OUT (LIFO)

Here are the entries to record the purchases and sales entries. The
numbers in red are determined by the cost flow assumption used.

All purchases and sales are made on credit.

The selling price of inventory was as follows:
8/14 $130
8/31 150
 6 - 23

P1

WEIGHTED AVERAGE
When a unit is sold, the average
cost of each unit in inventory is
assigned to cost of goods sold.
Cost of Goods Units on hand
Available for ÷ on the date of
Sale sale
 6 - 24

P1

WEIGHTED AVERAGE
 6 - 25

P1

WEIGHTED AVERAGE
 6 - 26

P1

WEIGHTED AVERAGE
 6 - 27

P1

WEIGHTED AVERAGE
Here are the entries to record the purchases and sales entries for Trekking.
The numbers in red are determined by the cost flow assumption used.

All purchases and sales are made on credit.

The selling price of inventory was as follows:
8/14 $130
8/31 150
 6 - 28

A1
FINANCIAL STATEMENT EFFECTS
OF COSTING METHODS
Because prices change, inventory methods nearly always
assign different cost amounts.
 6 - 29

A1 FINANCIAL STATEMENT EFFECTS

OF COSTING METHODS
Advantages
Advantages of
of Methods
Methods

Weighted First-In, Last-In,

Average First-Out First-Out

Ending inventory Better matches

Smoothes out approximates current costs in cost
price changes. current of goods sold with
replacement cost. revenues.
 6 - 30

A1 CONSISTENCY IN USING COSTING

METHODS

The consistency principle requires a

company to use the same accounting
methods period after period so that financial
statements are comparable across periods.
 6 - 31

P2
LOWER OF COST AND NET REALIZABLE
VALUE
Inventory must be reported at NRV when
NRV is lower than cost.

Can be applied two ways:

(1) separately to each
individual item.
(2) to major categories of
assets.
 6 - 32

P2

LOWER OF COST AND NRV

A motor sports retailer has the following
items in inventory:
 6 - 33

P2

LOWER OF COST AND NRV

Here is how to compute lower of cost and
NRV for individual inventory items.
 6 - 34

A2 FINANCIAL STATEMENT EFFECTS OF

INVENTORY ERRORS
Income Statement Effects
 6 - 35

A2 FINANCIAL STATEMENT EFFECTS

OF INVENTORY ERRORS

Balance Sheet Effects

 6 - 36

A3

INVENTORY TURNOVER
Shows how many times a company turns over its inventory
during a period. Indicator of how well management is
controlling the amount of inventory available.

Inventory Cost of goods sold

Turnover = Avg. inventory

Average
Inventory = (Beg. Inv. + End Inv.) ÷ 2
 
 6 - 37

A3

DAYS’ SALES IN INVENTORY

Reveals
Reveals how
how much
much inventory
inventory is
is available
available in
in
terms
terms of
of the
the number
number of
of days
days’’ sales.
sales.
 6 - 38

P3 APPENDIX 6A: INVENTORY COSTING

UNDER A PERIODIC SYSTEM

LIFO computation of COGS

and ending inventory under
a periodic system.
 6 - 39

P4 APPENDIX 6B:
INVENTORY ESTIMATION METHODS
Inventory sometimes requires estimation for interim statements or
if some casualty such as fire or flood makes taking a physical
count impossible.

Retail Inventory Method Gross Profit Method

 6 - 40

END OF CHAPTER 6