8-1

Chapter

8
INVENTORIES AND
COST OF GOODS SOLD

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-2

Inventory
Inventory Defined
Defined

Inventory
Inventory

Goods
Goods owned
owned Current
Current
and
and held
held for
for sale
sale asset
asset
to
to customers
customers

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-3

The
The Flow
Flow of
of Inventory
Inventory Costs
Costs
BALANCE SHEET

Purchase costs (or

Asset
manufacturing Inventory
costs)

as goods
INCOME STATEMENT are sold
Revenue
Cost of goods sold
Gross profit
Expenses
Net income
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-4

The
The Flow
Flow of
of Inventory
Inventory Costs
Costs
In a perpetual inventory system, inventory entries
parallel the flow of costs.

GENERAL JOURNAL
P
Date Account Titles and Explanation R Debit Credit
Entry on Purchase Date
Inventory $$$$
Accounts Payable $$$$

Entry on Sale Date

Cost of Goods Sold $$$$
Inventory $$$$
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-5

Which
Which Unit
Unit Did
Did We
We Sell?
Sell?
When identical units of inventory have
different unit costs, a question naturally
arises as to which of these costs should be
used in recording a sale of inventory.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-6

Inventory
Inventory Subsidiary
Subsidiary Ledger
Ledger
AA separate
separate subsidiary
subsidiary account
account isis maintained
maintained
for
for each
each item
item in
in inventory.
inventory.
Item LL002 Primary supplier Electronic City
Description Laser Light Secondary supplier Electric Company
Location Storeroom 2 Inventory level: Min: 25 Max: 200
Purchased Sold Balance
Cost of
Unit Unit Goods Unit
Date Units Cost Total Units Cost Sold Units Cost Total
Sept. 5 100 $ 30 $ 3,000 100 $ 30 $ 3,000
Sept. 9 75 50 3,750 100 30 3,000
75 50 3,750
Sept. 10 10 ? ? ? ? ?
? ? ?

How can we determine the unit cost for the Sept. 10 sale?
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-7

Inventory
Inventory Cost
Cost Flows
Flows
We use one of these inventory valuation
methods to determine cost of inventory sold.

r age
Ave st
Co
FIFO

LIFO
Specific
Identification

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-8

Data
Data for
for an
an Illustration
Illustration

The Bike Company (TBC)

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-9

Specific
Specific Identification
Identification

When
When aa unit
unit
is
is sold,
sold, its
its
specific
specific cost
cost isis
added
added to to cost
cost ofof
goods
goods sold.
sold.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-10

Specific
Specific Identification
Identification

On
On August
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.
Of
Of the
the bikes
bikes sold
sold 99 originally
originally cost
cost $91
$91 and
and
11
11 cost
cost $106.
$106.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-11

Specific
Specific Identification
Identification

The
The Cost
Cost of
of Goods
Goods Sold
Sold for
for the
the August
August 14 14 sale
sale is
is
$1,985,
$1,985, leaving
leaving $515
$515 and
and 55 units
units in
in inventory.
inventory.

Let’s look at the entries for the Aug. 14 sale.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-12

Specific
Specific Identification
Identification

Retail
Retail (20
(20 ×× $103)
$103)

Cost
Cost

A
A similar
similar entry
entry is
is made
made after
after each
each sale.
sale.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-13

Specific
Specific Identification
Identification

Cost
Cost of
of Goods
Goods
Sold
Sold for
for
August
August 3131 ==
$2,610
$2,610
Additional
Additionalpurchases
purchaseswere
weremade
madeon
onAugust
August17
17and
and28.
28.
Costs
Costsassociated
associatedwith
withsales
saleson
onAugust
August31
31were
wereas
asfollows:
follows:11@
@$91,
$91,
33@@$106,
$106,15
15@
@$115,
$115,&&44@
@$119.
$119.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-14

Specific
Specific Identification
Identification

Income Statement
COGS = $4,595

Balance Sheet
Inventory = $1,395 11 @@ $$ 106
106 == $$ 106 106
55 @@ $$ 115
115 == 575
575
66 @@ $$ 119
119 == 714
714
End.
End. Inv.
Inv. © The$$1,395
1,395 Companies, Inc., 2008
McGraw-Hill
McGraw-Hill/Irwin
 8-15

Specific
Specific Identification
Identification
Since specific
identification is so
easy, can’t we use it
Not really. Specific all the time?
identification is hard to use
when we sell a lot of inventory
that has lots of different costs.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-16

Average-Cost
Average-Cost Method
Method

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-17

Average-Cost
Average-Cost Method
Method

The
Theaverage
averagecost
cost per
perunit
unit
must
must be
becomputed
computedprior
prior
to
toeach
eachsale.
sale. $2,500  25
$2,500 25 == $100
$100

On
On August
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-18

Average-Cost
Average-Cost Method
Method

The
The average
average costcost per
per
unit
unit is
is $100.
$100. $100 $2,500  25
$100 == $2,500 25

Let’s look at the entries

for the Aug. 14 sale.
© The McGraw-Hill Companies, Inc., 2008
McGraw-Hill/Irwin
 8-19

Average-Cost
Average-Cost Method
Method

Retail
Retail

Cost
Cost

A
A similar
similar entry
entry is
is made
made after
after each
each sale.
sale.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-20

Average-Cost
Average-Cost Method
Method

Additional
Additional purchases
purchases were
were made
made on
on August
August 17
17
and
and August
August 28.
28.
On
On August
August 31,
31, an
an additional
additional 23
23 units
units were
were sold.
sold.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-21

Average-Cost
Average-Cost Method
Method

$114 $3,990  35
$114 == $3,990 35

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-22

Average-Cost
Average-Cost Method
Method

The
The average
average cost
cost per
per $114 $3,990  35
$114 == $3,990 35
unit
unit is
is $114.
$114.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-23

Average-Cost
Average-Cost Method
Method

Income Statement
COGS = $4,622

Balance Sheet
Inventory = $1,368
$114
$114 ×× 12
12 == $1,368
$1,368
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-24

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)

Oldest
Oldest Costs
Costs of
of
Costs
Costs Goods
Goods Sold
Sold

Recent
Recent Ending
Ending
Costs
Costs Inventory
Inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-25

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)

The
The Cost
Cost of
of Goods
Goods Sold
Sold for
for the
the August
August 14 14 sale
sale is
is $1,970,
$1,970,
leaving
leaving $530
$530 and
and 55 units
units in
in inventory.
inventory.

On
On August
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-26

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)

Retail
Retail

Cost
Cost

A
A similar
similar entry
entry is
is made
made after
after each
each sale.
sale.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-27

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)

Additional
Additionalpurchases
purchaseswere
weremade
madeon onAug.
Aug.17
17and
andAug.
Aug.28.
28.
Cost
Cost of
of
On Goods
Goods
August Sold
31, Sold
an for
for August
August
additional 23 units 31
31
were == $2,600
$2,600
sold.
On August 31, an additional 23 units were sold.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-28

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)

Income Statement
COGS = $4,570

Balance Sheet
22 @
@ $$115
115 == $$ 230
230
10
10 @@ $$119
119 == 1,190
1,190
Inventory = $1,420
End.
End. Inv.
Inv. $$1,420
1,420

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-29

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)

Recent
Recent Costs
Costs of
of
Costs
Costs Goods
Goods Sold
Sold

Oldest
Oldest Ending
Ending
Costs
Costs Inventory
Inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-30

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)

The
The Cost
Cost ofof Goods
Goods Sold
Sold for
for the
the August
August 14 14 sale
sale is
is
$2,045,
$2,045, leaving
leaving $455
$455 and
and 55 units
units in
in inventory.
inventory.
On
On August
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-31

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)

Retail
Retail

Cost
Cost

A similar entry is made after each sale.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-32

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)

Additional
Additional purchases
purchases were
were made
made on
on Aug.
Aug. 17
17 and
and Aug.
Aug. 28.
28.
On
On Aug.
Aug. 31,
31, an
an additional
additional 23
23 units
units were
were sold.
sold.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-33

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)

Cost
Cost of
of Goods
Goods Sold
Sold for
for August
August 31
31 == $2,685
$2,685

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-34

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)

Income Statement
COGS = $4,730

Balance Sheet 55 @
@ $$ 9191 == $$ 455
455
Inventory = $1,260 77 @
@ $$115
115 == 805
805
End.
End. Inv.
Inv. $$1,260
1,260

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Inventory Valuation Methods: A Summary 8-35
Costs Allocated to:
Valuation Cost of Goods
Method Sold Inventory Comments
Specific Actual cost of Actual cost of units Parallels physical flow
identification the units sold remaining Logical method when units
are unique
May be misleading for
identical units
Average cost Number of units Number of units on Assigns all units the same
sold times the hand times the average unit cost
average unit cost average unit cost Current costs are averaged
in with older costs
First-in, First-out Cost of earliest Cost of most Cost of goods sold is based
(FIFO) purchases on recently on older costs
hand prior to the purchased units Inventory valued at current
sale costs
May overstate income during
periods of rising prices; may
increase income taxes due
Last-in, First-out Cost of most Cost of earliest Cost of goods sold shown at
(LIFO) recently purchases recent prices
purchased units (assumed still in Inventory shown at old (and
inventory) perhaps out of date) costs
Most conservative method
during periods of rising
prices; often results in lower
McGraw-Hill/Irwin © The McGraw-Hill
income taxes Companies, Inc., 2008
 8-36

The
The Principle
Principle of
of Consistency
Consistency

Once a company has

adopted a particular
accounting method, it
should follow that
method consistently
rather than switch
methods from one year
to the next.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-37

Just-In-Time
Just-In-Time (JIT)
(JIT) Inventory
Inventory
Systems
Systems

This inventory arrived just

in time for us to use it in
the manufacturing
process.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-38

Taking
Taking aa Physical
Physical Inventory
Inventory

The
The primary
primary reason
reason for
for taking
taking aa physical
physical inventory
inventory
is
is to
to adjust
adjust the
the perpetual
perpetual inventory
inventory records
records for
for
unrecorded
unrecorded shrinkage
shrinkage losses,
losses, such
such as
as theft,
theft,
spoilage,
spoilage, or
or breakage.
breakage.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-39

LCM
LCM and
and Other
Other Write-Downs
Write-Downs
of
of Inventory
Inventory

Reduces
Reduces the the value
value
Obsolescence
Obsolescence of
of the
the inventory.
inventory.

Lower
Lower of
of Cost
Cost Adjust
Adjust inventory
inventory
or
or Market
Market value
value toto the
the lower
lower
(LCM)
(LCM) of
of historical
historical cost
cost or
or
current
current
replacement
replacement cost cost
(market).
(market).
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-40

LCM
LCM and
and Other
Other Write-Downs
Write-Downs
of
of Inventory
Inventory
LCM Applied on the Basis of . . .
Individual Inventory Total
Cost Market Items Category Inventory
Bicycles:
Boy's bicycles $ 4,200 $ 4,600 4,200
Girls bicycles 3,800 3,100 3,100
Junior bicycle 5,700 5,000 5,000
Total $ 13,700 $ 12,700 12,700
Bicycle accessories:
Training wheels $ 485 $ 525 485
Headlamps 312 400 312
Protective helmets 700 600 600
Gloves 245 212 212
Kneepads 195 145 145
Total $ 1,937 $ 1,882 1,882
Total inventory $ 15,637 $ 14,582 $ 14,054 $ 14,582 $ 14,582

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-41

Goods
Goods In
In Transit
Transit

A
A sale
sale should
should be
be recorded
recorded when
when title
title to
to
the
the merchandise
merchandise passes
passes to
to the
the buyer.
buyer.

F.O.B.
F.O.B. F.O.B.
F.O.B.
shipping
shipping destination
destination
point 
point  title
title point 
point  title
title
passes
passes to to passes
passes toto
buyer
buyer at
at the
the Year buyer
buyer at
at the
the
point
point of
of End point
point of
of
shipment.
shipment. destination.
destination.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-42

Periodic
Periodic Inventory
Inventory Systems
Systems
In a periodic inventory system, inventory entries
are as follows.

Note
Note that
that an
an entry
entry is
is not
not
made
made toto inventory.
inventory.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-43

Periodic
Periodic Inventory
Inventory Systems
Systems
In a periodic inventory system, inventory entries
are as follows.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-44

Periodic
Periodic Inventory
Inventory Systems
Systems

The inventory on
hand and the cost
of goods sold for
the year are not
determined until
year-end.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-45

Periodic
Periodic Inventory
Inventory Systems
Systems
We use one of these inventory valuation
methods in a periodic inventory system.

Specific Average
identification cost

FIFO LIFO
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-46

Information
Information for
for the
the Following
Following
Inventory
Inventory Examples
Examples
Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 $ 5.25 $ 5,250.00
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200 ?
Cost of
Goods Sold
McGraw-Hill/Irwin 600 ?
© The McGraw-Hill Companies, Inc., 2008
 8-47

Specific
Specific Identification
Identification

By reviewing actual
purchase invoices,
Computers, Inc. determines
that the 1,200 mouse pads
on hand at year-end have
an actual total cost of
$6,400.
Determine the cost of
goods sold for the year.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-48

Specific
Specific Identification
Identification
Computers, Inc.
Mouse Pad Inventory
Date Units $/Unit Total
Beginning
Inventory 1,000 $ 5.25 $ 5,250.00
Purchases:
Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Sept.
Cost15
of Goods 200
Sold 5.80 1,160.00
Cost
Nov. 29
of Goods Sold
150 5.90 885.00
$9,725
$9,725 --
Goods $6,400
$6,400 == $3,325
$3,325
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200 $ 6,400.00
Cost of
Goods Sold 600 $ 3,325.00
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-49

Average-Cost
Average-Cost Method
Method

The
The average
average cost
cost is
is
calculated
calculated at
at year-
year-
end
end as
as follows:
follows:

Total Cost of Total Number

Goods of Units
Available for
÷ Available for
Sale Sale

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-50

Average-Cost
Average-Cost Method
Method
Computers, Inc.
Mouse Pad Inventory
Avg.
Avg.Cost $9,7251,800
Cost $9,725 1,800== Date Units $/Unit Total
$5.40278
$5.40278 Beginning
Ending
EndingInventory
Inventory Inventory 1,000 $ 5.25 $ 5,250.00
Avg.
Avg.Cost $5.402781,200
Cost $5.40278 1,200== Purchases:
$6,483
$6,483 Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
Cost
Costof
ofGoods
GoodsSold
Sold Sept. 15 200 5.80 1,160.00
Avg.
Avg.Cost $5.40278600
Cost $5.40278 600== Nov. 29 150 5.90 885.00
$3,242
$3,242 Goods
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200
1,200 $ 6,483.00
?
Cost of
Goods Sold 600 $ 3,242.00
?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-51

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)

Oldest
Oldest Costs
Costs of
of
Costs
Costs Goods
Goods Sold
Sold

Recent
Recent Ending
Ending
Costs
Costs Inventory
Inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-52

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)
Computers, Inc.
Remember: Mouse Pad Inventory
Start with the Date Units $/Unit Total
11/29 purchase Beginning
Inventory 1,000 $ 5.25 $ 5,250.00
and then add Purchases:
other purchases Jan. 3 300 5.30 1,590.00
June 20 150 5.60 840.00
until you reach Sept. 15 200 5.80 1,160.00
the number of Nov. 29 150 5.90 885.00
units in ending Goods
Available
inventory. for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200 ?
Cost of
Goods Sold 600 ?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-53

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)
Cost of
Date Beg. Inv. Purchases End. Inv. Goods Sold
1,000@$5.25 600@$5.25
400@$5.25
Jan. 3 300@$5.30 300@$5.30
June 20 150@$5.60 150@$5.60
Sept. 15 200@$5.80 200@$5.80
Nov. 29 150@$5.90 150@$5.90
Units 1,200
150 600

Now, we have allocated

Costs $6,575 $3,150
the cost to allNow,
1,200 let’s
Now, let’s complete
units complete the
the
Cost in
of ending inventory.
Goods Available table.
table.
for Sale $9,725

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-54

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)
Computers, Inc.
Completing Mouse Pad Inventory
the table Date
Beginning
Units $/Unit Total

summarizes Inventory 1,000 $ 5.25 $ 5,250.00

Purchases:
the Jan. 3 300 5.30 1,590.00
computations June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
just made. Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200 $ 6,575.00
Cost of
Goods Sold 600 $ 3,150.00

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-55

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)

Recent
Recent Costs
Costs of
of
Costs
Costs Goods
Goods Sold
Sold

Oldest
Oldest Ending
Ending
Costs
Costs Inventory
Inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-56

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)
Computers, Inc.
Remember: Start Mouse Pad Inventory
with beginning Date
Beginning
Units $/Unit Total

inventory and Inventory 1,000 $ 5.25 $ 5,250.00

Purchases:
then add other Jan. 3 300 5.30 1,590.00
purchases until June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
you reach the Nov. 29 150 5.90 885.00
number of units Goods
Available
in ending for Sale 1,800 $ 9,725.00

inventory. Ending
Inventory 1,200 ?
Cost of
Goods Sold 600 ?

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 8-57

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)
Cost of
Date Beg. Inv. Purchases End. Inv. Goods Sold
1,000@$5.25 1,000@$5.25
Jan. 3 300@$5.30 200@$5.30
100@$5.30
June 20 150@$5.60 150@$5.60
Sept. 15 200@$5.80 200@$5.80
Nov. 29 150@$5.90 150@$5.90
Units 1,000
1,200 100
600

Now, we have allocated

Costs $6,310
Next, $3,415
Next, let’s
let’s
the cost to all 1,200 units complete
completethethe
Cost in
of ending inventory.
Goods Available for Sale $9,725
table.
table.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-58

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)
Completing the Computers, Inc.
Mouse Pad Inventory
table Date Units $/Unit Total
Beginning
summarizes the Inventory 1,000 $ 5.25 $ 5,250.00
computations Purchases:
Jan. 3 300 5.30 1,590.00
just made. June 20 150 5.60 840.00
Sept. 15 200 5.80 1,160.00
Nov. 29 150 5.90 885.00
Goods
Available
for Sale 1,800 $ 9,725.00
Ending
Inventory 1,200 $ 6,310.00
Cost of
Goods Sold 600 $ 3,415.00

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 8-59

Importance
Importance of
of an
an Accurate
Accurate Valuation
Valuation
of
of Inventory
Inventory
Errors in Measuring Inventory
Beginning Inventory Ending Inventory
Effect on Income Statement Overstated Understated Overstated Understated
Goods Available for Sale + - NE NE
Cost of Goods Sold + - - +
Gross Profit - + + -
Net Income - + + -
Effect on Balance Sheet
Ending Inventory NE NE + -
Retained Earnings - + + -

An
An error
error in
in ending
ending inventory
inventory in
in aa year
year will
will result
result in
in the
the
same
same error
error in
in the
the beginning
beginning inventory
inventory ofof the
the next
next year.
year.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-60

For interim financial

statements, we may
need to estimate ending
inventory and cost of
goods sold.

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 8-61

The
The Gross
Gross Profit
Profit Method
Method

 Determine
 Determine cost
cost of
of goods
goods
available
available for
for sale.
sale.
 Estimate
 Estimate cost
cost ofof goods
goods sold
sold byby
multiplying
multiplying thethe net
net sales
sales by
by the
the
cost
cost ratio.
ratio.
 Deduct
 Deduct cost
cost ofof goods
goods sold
sold
from
from cost
cost ofof goods
goods available
available
for
for sale
sale to
to determine
determine ending
ending
inventory.
inventory.

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 8-62

The
The Gross
Gross Profit
Profit Method
Method
In
In March
March ofof 2007,
2007, Matrix
Matrix Company’s
Company’s
inventory
inventory was
was destroyed
destroyed by by fire.
fire. Matrix
Matrix
normal
normal gross
gross profit
profit ratio
ratio is
is 30%
30% of of net
net
sales.
sales. At
At the
the time
time of
of the
the fire,
fire, Matrix
Matrix
showed
showed the the following
following balances:
balances:

Sales
Sales $$ 31,500
31,500
Sales
Salesreturns
returns 1,500
1,500
Beginning
Beginning Inventory
Inventory 12,000
12,000
Net
Net cost
cost of
of goods
goodspurchased
purchased 20,500
20,500

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 8-63

The
The Gross
Gross Profit
Profit Method
Method
Estimating Inventory
The Gross Profit Method
Goods Available for Sale:
Step 1 Beginning Inventory $ 12,000
Net cost of goods purchased 20,500
Goods available for sale $ 32,500
Less estimated cost of goods sold:
Sales $ 31,500
Step 2 × 70%
Less sales returns (1,500)
Net sales $ 30,000
Estimated
Estimated
cost
cost
ofof
goods
goodssold
sold (21,000)
Step 3 Estimated March inventory loss $ 11,500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 8-64

The
The Retail
Retail Method
Method
The
The retail
retail method
method of
of estimating
estimating inventory
inventory requires
requires
that
that management
management determine
determine the the value
value of
of ending
ending
inventory
inventory at
at retail
retail prices.
prices.
In
In March
March of
of 2007,
2007, Matrix
Matrix Company’s
Company’s inventory
inventory waswas
destroyed
destroyed by
by fire.
fire. At
At the
the time
time of
of the
the fire,
fire, Matrix’s
Matrix’s
management
management collected
collected the
the following
following information:
information:
Information for Matrix Company
The Retail Method
Goods available for sale at cost $ 32,500
Goods available for sale at retail 50,000
Physical count of ending inventory priced at retail 22,000

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 8-65

The
The Retail
Retail Method
Method

Matrix
Matrix would
would follow
follow the
the steps
steps below
below to
to estimate
estimate
their
their ending
ending inventory
inventory using
using the
the retail
retail method.
method.
Estimating Inventory
The Retail Method
a Goods available for sale at cost $ 32,500
b Goods available for sale at retail 50,000
c Cost ratio [a b] 65%
d Physical count of ending inventory priced at retail 22,000
e Estimated ending inventory at cost [ c d] $ 14,300

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 8-66

Financial
Financial Analysis
Analysis

Measures
Measures howhow quickly
quickly aa company
company
sells
sells its
its merchandise
merchandise inventory.
inventory.

Average
Average Inventory
Inventory == (Beginning
(Beginning Inventory
Inventory ++ Ending
Ending Inventory)
Inventory) ÷÷ 22

A
A ratio
ratio that
that is
is low
low compared
compared to to competitors
competitors
suggests
suggests inefficient
inefficient use
use of
of assets.
assets.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 8-67

Financial
Financial Analysis
Analysis

Measures
Measures how
how manymany days
days onon
average
average itit takes
takes to
to sell
sell its
its
inventory.
inventory.

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 8-68

Accounting
Accounting Methods
Methods Can
Can Affect
Affect
Financial
Financial Ratios
Ratios

Remember that identical

companies that use different
inventory methods (e.g., FIFO
and LIFO) will have different
inventory turnover ratios.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008