Reporting and Analyzing

Inventories
 Determining Inventory Items
MFRS 102
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 requiring special attention include:
Goods
Goods in
Damaged or
Transit Goods on Obsolete
Consignment

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Goods in Transit
FOB Shipping Point
Public
Carrier

Seller Buyer

Ownership passes
to the buyer here.

Public
Carrier

Seller FOB Destination Point Buyer

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 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
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 Determining Inventory Costs

Include all expenditures necessary to bring an

item to a salable condition and location.

Minus
Discounts Invoice Plus
and
Allowances Cost Insurance

Plus Import Plus

Duties Plus Storage
Freight
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 Internal Controls and Taking a Physical
Count

Most
 Most companies
companies take
take aa physical
physical
count
count of
of inventory
inventory at
at least
least once
once
each
each year.
year.

When
 When the
the physical
physical count
count does
does
not Inv
not match
match the
the Merchandise
Merchandise e
Cou ntory
Inventory
Inventory account,
account, an
an nt
Qua Ta g
nt
adjustment
adjustment must
must be
be made.
made. Cou ity
nte
Cou d_
n __
by te
___ d
___
_

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Inventory Costing Under a Perpetual
System

Inventory
affects . . .
Balance Income
Sheet Statement

The matching
principle requires
matching cost of
sales with sales.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 Inventory Costing Under a Perpetual
System

Accounting for
inventory
Inventory
 Inventory System
System
requires several
Perpetual
 Perpetual or
or Periodic
Periodic
decisions . . .

Costing
 Costing Method
Method
Specific
 Specific Identification,
Identification, FIFO,
FIFO,
LIFO,
LIFO, or
or Weighted
Weighted Average
Average

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Inventory Costing Illustration

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Specific Identification

When
When units
units are
are sold,
sold, the
the specific
specific
cost
cost of
of the
the unit
unit sold
sold isis added
added to
to
cost
cost of
of goods
goods sold.
sold.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Specific Identification

The
The above
above purchases
purchases were
were
made
made inin August.
August. OnOn August
August 14,
14,
aa company
company sold
sold eight
eight bikes
bikes
originally
originally costing
costing $91
$91 and
and 12
12
bikes
bikes originally
originally costing
costing $106.
$106.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Specific Identification

The
TheCost
CostofofGoods
GoodsSold
Soldfor
forthe
theAugust
August14
14sale
sale
is
is$2,000.
$2,000.
88bikes
bikes@@91
91 == $$ 728
728
12
12bikes
bikes@@106
106== $1,272
$1,272
After
Afterthis
thissale,
sale,there
thereare
arefive
fiveunits
unitsin
ininventory
inventory
at
at$500:
$500:
22bikes
bikes@ @$91
$91 == $$182
182
33bikes
bikes@ @$106
$106== $$318
318

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Specific Identification

Additional
Additionalpurchases
purchaseswere
weremade
madeon
onAugust
August17
17and
and28.
28.
The
Thecost
costof
ofthe
the23
23items
itemssold
soldon
onAugust
August31
31were
wereas
asfollows:
follows:
22@
@$91
$91
33@
@$106
$106
15
15@@$115
$115
33@
@$119
$119
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 Specific Identification

Cost
Cost of
of Goods
Goods Sold
Sold for
for
August
August 31
31 == $2,582
$2,582
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 Specific Identification

After
Afterthe theAugust
August3131sale,
sale,there
thereare
are
12
12units
unitsinininventory
inventoryat
at$1,408:
$1,408:
55@
@$115
$115
McGraw-Hill/Irwin 77@@$119
$119 © The McGraw-Hill Companies, Inc., 2010
 Specific Identification

Income
Statement COGS
= $4,582

Balance Sheet
McGraw-Hill/Irwin
Inventory = $1,408
© The McGraw-Hill Companies, Inc., 2010
 Specific Identification
Here are the entries to record the purchases and sales. The
numbers in red are determined by the cost flow assumption
used.

Aug. 3 Merchandise inventory 1,590

All purchases Accounts payable 1,590
and sales are Aug. 14 Accounts receivable 2,600
made on Sales 2,600
Aug. 14 Cost of goods sold 2,000
credit.
Merchandise inventory 2,000
The selling Aug. 17 Merchandise inventory 2,300
price of Accounts payable 2,300
inventory was Aug. 28 Merchandise inventory 1,190
as follows: Accounts payable 1,190
Aug. 31 Accounts receivable 3,450
8/14 $130 Sales 3,450
8/31 150 Aug. 31 Cost of goods sold 2,582
Merchandise inventory 2,582
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 First-In, First-Out (FIFO)

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

Recent
Recent Ending
Ending
Costs
Costs Inventory
Inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 First-In, First-Out (FIFO)

The
The above
above purchases
purchases were
were
made
made in
in August.
August.
On
On August
August 14,
14, the
the company
company
sold
sold 20
20 bikes.
bikes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 First-In, First-Out (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.
After
After this
this sale,
sale, there
there are
are five
five units
units in
in
inventory
inventory at at $530:
$530:
55 @
@ $106
$106
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 First-In, First-Out (FIFO)

Additional
Additionalpurchases
purchaseswere
weremade
madeon
onAugust
August 17
17and
and28.
28.
Twenty-three
Twenty-threebikes
bikeswere
weresold
soldon
onAugust
August31.
31.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 First-In, First-Out (FIFO)

Cost
Cost of
of Goods
Goods Sold
Sold for
for
August
August 31
31 == $2,600
$2,600
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 First-In, First-Out (FIFO)

After
Afterthe
theAugust
August31 31sale,
sale,there
thereare
are
12
12units
unitsin
ininventory
inventoryat
at$1,420:
$1,420:
22@
@$115
$115
10
10@@$119
$119
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 First-In, First-Out (FIFO)

Income Statement
COGS = $4,570

Balance Sheet
Inventory = $1,420
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 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 Aug. 3 Merchandise inventory 1,590

and sales are Accounts payable 1,590
Aug. 14 Accounts receivable 2,600
made on
Sales 2,600
credit. Aug. 14 Cost of goods sold 1,970
The selling Merchandise inventory 1,970
price of Aug. 17 Merchandise inventory 2,300
inventory was Accounts payable 2,300
Aug. 28 Merchandise inventory 1,190
as follows: Accounts payable 1,190
8/14 $130 Aug. 31 Accounts receivable 3,450
Sales 3,450
8/31 150 Aug. 31 Cost of goods sold 2,600
McGraw-Hill/Irwin Merchandise inventory 2,600
© The McGraw-Hill Companies, Inc., 2010
 Last-In, First-Out (LIFO)

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

Oldest
Oldest Ending
Ending
Costs
Costs Inventory
Inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Last-In, First-Out (LIFO)

The
The above
above purchases
purchases were
were
made
made in
in August.
August.
On
On August
August 14,
14, the
the company
company
sold
sold 20
20 bikes.
bikes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Last-In, First-Out (LIFO)

The
The Cost
Cost of
of Goods
Goods Sold
Sold for
for the
the
August
August 14
14 sale
sale is
is $2,045.
$2,045.
After
After this
this sale,
sale, there
there are
are five
five units
units in
in
inventory
inventory at
at $455:
$455:
55 @@ $91
$91
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 Last-In, First-Out (LIFO)

Additional
Additionalpurchases
purchaseswere
weremade
madeon
onAugust
August 17
17and
and28.
28.
Twenty-three
Twenty-threebikes
bikeswere
weresold
soldon
onAugust
August31.
31.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Last-In, First-Out (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., 2010
 Last-In, First-Out (LIFO)

After
Afterthe
theAugust
August31 31sale,
sale,there
thereare
are
12
12units
unitsin
ininventory
inventoryatat$1,260:
$1,260:
55@
@$91
$91
77@@$115
$115
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 Last-In, First-Out (LIFO)

Income
Statement COGS
= $4,730

Balance Sheet
Inventory = $1,260
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 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.

Aug. 3 Merchandise inventory 1,590

All purchases Accounts payable 1,590
and sales are Aug. 14 Accounts receivable 2,600
made on Sales 2,600
credit. Aug. 14 Cost of goods sold 2,045
The selling Merchandise inventory 2,045
Aug. 17 Merchandise inventory 2,300
price of Accounts payable 2,300
inventory was Aug. 28 Merchandise inventory 1,190
as follows: Accounts payable 1,190
Aug. 31 Accounts receivable 3,450
8/14 $130 Sales 3,450
8/31 150 Aug. 31 Cost of goods sold 2,685
Merchandise inventory 2,685
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 Weighted Average

When
When aa unit
unit is
is sold,
sold, the
the
average
average cost
cost of
of each
each unit
unit
in
in inventory
inventory is
is assigned
assigned to
to
cost
cost of
of goods
goods sold.
sold.

Cost of Goods Units on hand

Available for ÷ on the date of
Sale sale

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Weighted Average

The
The above
above purchases
purchases were
were
made
made in
in August.
August.
On
On August
August 14,
14, 20
20 bikes
bikes were
were
sold.
sold.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Weighted Average

First, we need to compute the weighted

average cost per unit of items in inventory.

Cost of goods available for sale $ 2,500

Total units in inventory ÷ 25
Weighted average cost per unit $ 100

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Weighted Average

The
TheCost
Costof
of Goods
GoodsSold
Sold for
forthe
theAugust
August14
14
sale
saleis
is$2,000.
$2,000.
After
Afterthis
thissale,
sale,there
thereare
arefive
fiveunits
unitsin
in
inventory
inventoryatat $500:
$500:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Weighted Average

Additional
Additionalpurchases
purchaseswere
weremade
madeon
onAugust
August 17
17and
and28.
28.
Twenty-three
Twenty-threebikes
bikeswere
weresold
soldon
onAugust
August31.
31.

What is the weighted average cost per unit

of items in inventory?
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 Weighted Average

Units
Units
Inventory
Inventory 8/14
8/14 55 Cost of goods available for sale $ 3,990
Purchase
Purchase 8/17
8/17 20
20 Total units in inventory ÷ 35
Purchase
Purchase 8/28
8/28 10
10
Units
Weighted average cost per unit $ 114
Units available
available for
for sale
sale 35
35

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Weighted Average

Cost
Cost of
of Goods
Goods Sold
Sold for
for
August
August 31
31 == $2,622
$2,622

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Weighted Average

After
Afterthe
theAugust
August31 31sale,
sale,there
thereare
are
12
12units
unitsin
ininventory
inventoryat
at$1,368:
$1,368:
12
12@@$114
$114

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Weighted Average

Income
Statement COGS
= $4,622

Balance Sheet
Inventory = $1,368

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 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 Aug. 3 Merchandise inventory 1,590

and sales are Accounts payable 1,590
Aug. 14 Accounts receivable 2,600
made on
Sales 2,600
credit. Aug. 14 Cost of goods sold 2,000
The selling Merchandise inventory 2,000
price of Aug. 17 Merchandise inventory 2,300
inventory was Accounts payable 2,300
Aug. 28 Merchandise inventory 1,190
as follows: Accounts payable 1,190
8/14 $130 Aug. 31 Accounts receivable 3,450
Sales 3,450
8/31 150 Aug. 31 Cost of goods sold 2,622
McGraw-Hill/Irwin Merchandise inventory 2,622
© The McGraw-Hill Companies, Inc., 2010
 Financial Statement Effects of Costing
Methods
Because
Because prices
prices change,
change, inventory
inventory methods
methods nearly
nearly always
always
assign
assign different
different cost
cost amounts.
amounts.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Financial Statement Effects of Costing
Methods

Advantages
Advantages of
of Methods
Methods

Weighted First-In, Last-In,

Average First-Out First-Out

Ending
Ending inventory
inventory Better
Better matches
matches
Smoothes
Smoothes out
out approximates
approximates current
current costs
costs in
in cost
cost
price
price changes.
changes. current
current of
of goods
goods sold
sold with
with
replacement
replacement cost.
cost. revenues.
revenues.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 Use of LIFO
LIFO not permitted under IFRS.
Some countries such as U.S. and
Canada allow LIFO.

The reason why many countries do not

permit LIFO as it may reduce tax receipts
for the tax authorities.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Lower of Cost or Market
According
According to
to MFRS
MFRS 102,
102, inventories
inventories shall
shall be
be measured
measured at
at
the
the lower
lower of
of cost
cost and
and net
net realizable
realizable value.
value.
Inventory
Inventory must
must be
be reported
reported atat market
market value
value when
when market
market is
is
lower
lower than
than cost.
cost.

Defined
Defined asas net
net
realizable
realizable value
value
(sales
(sales price
price minus
minus Can
Can be
be applied
applied two
two ways:
ways:
the
the cost
cost of
of making
making (1)
(1) separately
separately to to each
each
the
the sale).
sale). individual
individual item.
item.
Consistent
Consistent with
with (2)
(2) to
to major
major categories
categories ofof
the assets.
assets.
the conservatism
conservatism
principle.
principle.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
 Lower of Cost or Market
A
A motorsports
motorsports retailer
retailer has
has the
the following
following items
items in
in
inventory:
inventory:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Lower of Cost or Market
Here is how to compute lower of cost or market
for individual inventory items.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Lower of Cost or Market
Here
Here is
is how
how to
to compute
compute lower
lower of
of cost
cost or
or market
market
for
for the
the two
two groups
groups of inventory items.
items.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Exh.

Financial Statement Effects of Inventory 5.10

Errors
Income Statement Effects

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Financial Statement Effects of Inventory
Errors

Balance Sheet Effects

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Illustration 1
 A company that uses the perpetual
inventory system purchased $8,500 on
September 25. Terms of the purchase
were 2/10, n/30. The invoice was paid in
full on October 4. Prepare the journal
entries to record these merchandise
transactions.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 Illustration 2
 Ceres Computer Sales uses the
perpetual inventory system and had the
following transactions during
December.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010
  Required:
Prepare the general journal entries to
record these transactions.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010

 End of Chapter of Inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2010