LECTURE 8

INVENTORY

6-1
 CHAPTER

8 Inventories
LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Discuss how to classify and determine inventory.

2. Explain the accounting for inventories and apply the inventory cost flow
methods.
3. Explain the financial effects of the inventory cost flow assumptions.
4. Explain the lower-of-cost-or-net realizable value basis of accounting for
inventories.
5. Indicate the effects of inventory errors on the financial statements.
6. Discuss the presentation and analysis of inventory.
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 Classifying and Determining Inventory
Learning Objective 1
Discuss how to classify and
Classifying Inventory determine inventory.

Merchandising Manufacturing
Company Company

One Classification: Three Classifications:

 Inventory  Raw Materials
 Work in Process
• HELPFUL HINT
Regardless of the classification,
 Finished Goods
companies report all inventories
under Current Assets on the
statement of financial position.

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 Determining Inventory Quantities

Physical Inventory taken for two reasons:

Perpetual System
1. Check accuracy of inventory records.
2. Determine amount of inventory lost due to wasted
raw materials, shoplifting, or employee theft.
Periodic System
3. Determine the inventory on hand.
4. Determine the cost of goods sold for the period.

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 Determining Inventory Quantities

TAKING A PHYSICAL INVENTORY

Involves counting, weighing, or measuring each kind of
inventory on hand.
Companies often “take inventory”
 when the business is closed or
business is slow.
 at the end of the accounting period.

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 Classifying and Determining Inventory
Learning Objective 2
Explain the accounting for
Inventory is accounted for at cost. inventories and apply the
inventory cost flow methods.
 Cost includes all expenditures necessary
to acquire goods and place them in a condition ready for
sale.
 Unit costs are applied to quantities to compute the total
cost of the inventory and the cost of goods sold using
the following costing methods:
► Specific identification
► First-in, first-out (FIFO) Cost Flow
Assumptions
► Last-in, first-out (LIFO)
► Average-cost
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 Cost Flow Assumptions

There are three assumed cost flow methods:

1. First-in, first-out (FIFO)

2. Last-in, first-out (LIFO)

3. Average-cost

Cost flow does not need be consistent with the physical

movement of the goods.

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 Cost Flow Assumptions- Periodic
Inventory
Illustration 6-5

Data for Lin Electronics’ Astro condensers.

(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold

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 Cost Flow Assumptions

FIRST-IN, FIRST-OUT (FIFO)

 Costs of the earliest goods purchased are the
first to be recognized in determining cost of goods
sold.

 Often parallels actual physical flow of merchandise.

 Companies obtain the cost of the ending inventory

by taking the unit cost of the most recent purchase
and working backward until all units of inventory
have been costed.
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 FIRST-IN, FIRST-OUT (FIFO)

Illustration 6-6
Allocation of costs—FIFO method
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 FIRST-IN, FIRST-OUT (FIFO)

• HELPFUL HINT
Another way of thinking about
the calculation of FIFO ending
inventory is the LISH
assumption—last in still here.
Illustration 6-6
Allocation of costs—FIFO method

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 LAST-IN, FIRST-OUT (LIFO)

 Under IFRS, LIFO is not permitted for financial

reporting purposes.

 Assumes latest goods purchased are first to be

sold.

 Seldom coincides with actual physical flow of

merchandise, except for goods stored in piles,
such as coal or hay.

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 LAST-IN, FIRST-OUT (LIFO)
Illustration 6C-1
Allocation of costs—LIFO method

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 LAST-IN, FIRST-OUT (LIFO)
Illustration 6C-1
Allocation of costs—LIFO method

Illustration 6C-2
Proof of COGS
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 AVERAGE-COST

 Allocates cost of goods available for sale on the

basis of weighted-average unit cost incurred.

 Applies weighted-average unit cost to the units

on hand to determine cost of the ending
inventory.

Illustration 6-8
Formula for weighted-average unit cost

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 AVERAGE-COST

Illustration 6-9
Allocation of costs—average-cost method

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 AVERAGE-COST

Illustration 6-11

Illustration 6-9
Allocation of costs—average-cost method

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 INCOME STATEMENT EFFECTS

Illustration 6-10
6-18 Comparative effects of cost flow methods LO 3
 Perpetual Inventory System
Learning Objective 7
Apply the inventory cost
Illustration 6A-1 flow methods to perpetual
Inventoriable units and costs inventory records.

Assuming the Perpetual Inventory System, compute Cost of

Goods Sold and Ending Inventory under FIFO and average-
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cost. LO 7
 First-In-First-Out (FIFO)

Illustration 6A-2
Perpetual system—FIFO Cost of Goods
Ending Inventory
Sold

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 Average-Cost

Illustration 6A-3
Perpetual system— Cost of Goods Ending Inventory
average-cost method
Sold

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 > DO IT!
The accounting records of Shumway Ag Implement show the following.
Beginning inventory 4,000 units at £ 3
Purchases 6,000 units at £ 4
Sales 7,000 units at £12
Determine the cost of goods sold during the period under a periodic
inventory system using (a) the FIFO method and (b) the average-
cost method.
Solution
Cost of goods available for sale = (4,000 × £3) + (6,000 × £4) = £36,000
Ending inventory = 10,000 − 7,000 = 3,000 units
(a) FIFO: £36,000 − (3,000 × £4) = £24,000
(b) Average cost per unit: [(4,000 × £3) + (6,000 × £4)] ÷ 10,000 = £3.60
Average-cost: £36,000 − (3,000 × £3.60) = £25,200
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 Cost Flow Assumptions

Question
In periods of rising prices, average-cost will produce:
a. higher net income than FIFO.
b. the same net income as FIFO.
c. lower net income than FIFO.
d. net income equal to the specific identification method.

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