ACCOUNTING FOR

Inventories
AFU 07202
Some of the action has been automated,
so click the mouse when you see this
lightning bolt in the lower right-hand
corner of the screen. You can point and
click anywhere on the screen.
 Objectives
1. Summarize and provide examples of internal
After studying
control procedures thisto inventories.
that apply
2. Describe the chapter,
effect ofyou should errors on the
inventory
be able to:
financial statement.
3. Describe the three inventory cost flow
assumptions and how they impact the income
statement and balance sheet.
4. Compute the cost of inventory under the
perpetual inventory system, using the
following cost methods: first-in, first-out; last-
in, first-out; average cost.
 Objectives
5. Compute the cost of inventory under the
periodic inventory system, using the
following costing methods: first-in, first-out;
last-in, first-out; average cost.
6. Compare and contrast the use of the three
inventory costing methods.
7. Compute the proper valuation of inventory at
other than cost, using the lower-of-cost-or-
market and net realization value concepts.
8. Prepare a balance sheet presentation of
merchandise inventory.
 Objectives
9. Estimate the cost of inventory, using the
retail method and the gross profit method.
10. Compute the interpret the inventory
turnover ratio and number of days’ sales in
inventory.
Why is Inventory Control Important?
 Inventory is a significant asset and for many
companies the largest asset.
 Inventory is central to the main activity of
merchandising and manufacturing
companies.
 Mistakes in determining inventory cost can
cause critical errors in financial statements.
 Inventory must be protected from external
risks ( such as fire and theft) and internal
fraud by employees.
Receiving Purchase
report AGREE order

AG

EE
R EE

R
Invoice

AG
JOURNAL
Post.
Date
Description
Ref.
Nov. 9 Inventory 1 222 00
Accounts Payable--XYZ Co. 1 222 00
Purchased merchandise on
account.
 Effect of Inventory Errors on
Financial Statements
LIABILITIES

Merchandise ASSETS OWNER’S

Inventory EQUITY

Net Income

Cost of COSTS & REVENUES

Merchandise Sold EXPENSES

If merchandise inventory is . . . . . . . overstated

Cost of merchandise sold is . . . . . . understated
Gross profit and net income are . . . overstated
Ending owner’s equity is . . . . . . . . . overstated
 Effect of Inventory Errors on
Financial Statements

If merchandise inventory is . . . . . . . understated

Cost of merchandise sold is . . . . . . overstated
Gross profit and net income are . . . understated
Ending owner’s equity is . . . . . . . . . understated
Inventory Cost Flow Assumptions
Purchased
goods

Sold
goods
Inventory Cost Flow Assumptions

Sold
Purchased
goods
goods
Inventory Cost Flow Assumptions

Purchased Sold
goods goods
 Inventory Costing Methods
43%
40%
34%
30%

20% 19%

10%
4%
0%
Fifo Lifo Average Other
 Perpetual Inventory Costs
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B Units Cost Price
Jan. 1 Inventory 10 Ts.20
4CostSale
of 7 Ts.30
10 Purchase
Mdse. Sold 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22
 FIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200

The firm begins the year with 10

units of Item 127B on hand at a
total cost of Ts.200.
FIFO Perpetual Inventory Account

Inventory cost data to demonstrate

FIFO and LIFO Perpetual Systems
Item 127B Units Cost Price
Jan. 1 Inventory 10 Ts.20
4CostSale
of 7 Ts.30
10 Purchase
Mdse. Sold 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22

On January 4, 7 units of Item

127B are sold at Ts.30 each.
 FIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 7 20 140 3 20 60

The sale of 7 units leaves a

balance of 3 units.

On January 4, 7 units of Item

127B are sold at Ts.30 each.
FIFO Perpetual Inventory Account

Inventory cost data to demonstrate

FIFO and LIFO Perpetual Systems
Item 127B Units Cost Price
Jan. 1 Inventory 10 Ts.20
4CostSale
of 7 Ts.30
10 Purchase
Mdse. Sold 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22

On January 10, the firm purchased

eight units at Ts.21 each.
 FIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 7 20 140 3 20 60
10 8 21 168 3 20 60
8 21 168

Because the purchase price of Ts.21 is

different than the cost of the previous 3
units On
on hand, the inventory
January balance of
10, the firm
11 units is accounted for separately.
purchased eight units at Ts.21
FIFO Perpetual Inventory Account

Inventory cost data to demonstrate

FIFO and LIFO Perpetual Systems
Item 127B Units Cost Price
Jan. 1 Inventory 10 Ts.20
4CostSale
of 7 Ts.30
10 Purchase
Mdse. Sold 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22

On January 22, the firm sold

four units for Ts.31 each.
 FIFO Perpetual Inventory Account
Item 127B

Purchases
On January 22, the Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

firm sold
Date Qty. Cost
four units
Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1
for Ts.31 each. 10 20 200
4 7 20 140 3 20 60
10 8 21 168 3 20 60
8 21 168
22 3 20 60
1 21 21 7 21 147

Of the four units sold, three are

from the first units in (fifo) at a
cost of Ts.20.
FIFO Perpetual Inventory Account

Inventory cost data to demonstrate

FIFO and LIFO Perpetual Systems
Item 127B Units Cost Price
Jan. 1 Inventory 10 Ts.20
4CostSale
of 7 Ts.30
10 Purchase
Mdse. Sold 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22

On January 28, the firm

sold two units at Ts.32.
 FIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 7 20 140 3 20 60
10 8 21 168 3 20 60
8 21 168
22 3 20 60
1 21 21 7 21 147
28 2 21 42 5 21 105

On January 28, the firm

sold two units at Ts.32.
 FIFO Perpetual Inventory Account

Inventory cost data to demonstrate

FIFO and LIFO Perpetual Systems
Item 127B Units Cost Price
Jan. 1 Inventory 10 Ts.20
4CostSale
of 7 Ts.30
10 Purchase
Mdse. Sold 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22

On January 30, purchased ten additional

units of Item 127B at Ts.22 each.
 FIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 On January 30, purchased
7 20 140 3 20 60
10 8ten additional
21 168 units of Item 3 20 60
8 21 168
22
127B at Ts.223 each. 20 60
1 21 21 7 21 147
28 2 21 42 5 21 105
30 10 22 220 5 21 105
10 22 220
Totals 18 Ts.388 13 Ts.263 15
Ts.325
 LIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200

The firm begins the year with

10 units of Item 127B on
hand at a total cost of Ts.200.
 LIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 7 20 140 3 20 60

On January 4, the firm sold

7 units at Ts.30 each.
 LIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 7 20 140 3 20 60
10 8 21 168 3 20 60
8 21 168

On January 10, the

firm purchased eight Note that a new
units at Ts.21 each. layer is formed.
 LIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 7 20 140 3 20 60
10 8 21 168 3 20 60
8 21 168
22 4 21 84 3 20 60
4 21 84
On
Of January
the 4 units22,sold,
the all come
firm
from thesells
mostfour
recent purchase
unitsatata Ts.31
cost ofeach.
Ts.21 each.
 LIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 7 20 140 3 20 60
10 8 21 168 3 20 60
8 21 168
22 4 21 84 3 20 60
4 21 84
28 2 21 42 3 20 60
2 21 42

On January 28, sold

two units at Ts.32 each.
 LIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 7 20 140 3 20 60
10 8 21 168 3 20 60
8 21 168
22 4 21 84 3 20 60
4 21 84
28 2 21 42 3 20 60
2 21 42
30 10 22 220 3 20 60
2 21 42
On January 30, purchase 10 22 220
10 units at Ts.22 each.
 LIFO Perpetual Inventory Account
Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200
4 7 20 140 3 20 60
10 8 21 168 3 20 60
8 21 168
22 4 21 84 3 20 60
4 21 84
28 2 21 42 3 20 60
2 21 42
30 10 22 220 3 20 60
2 21 42
10 22 220
Totals 18 Ts.388 13 Ts.266 15 Ts.322
 Fifo
Periodic
 Fifo Periodic
200 units @ Ts.9 Jan. 1 Beginning
Inventory
300 units @ Ts.10 Mar. 10 Purchase

400 units @ Ts.11 Sept. 21 Purchase

100 units @ Ts.12 Nov. 18 Purchase

1,000 units available
for sale during
year
 Fifo Periodic
200 units @ Ts.9 = Ts.1,800 Jan. 1

300 units @ Ts.10 = 3,000 Mar. 10

400 units @ Ts.11 = 4,400 Sept. 21

100 units @ Ts.12 = 1,200 Nov. 18

1,000 units available Ts.10,400
for sale during
year Cost of merchandise
available for sale
 Fifo Periodic
A physical count on
December 31 reveals that
700 of the 1,000 units
have been sold.

Using fifo, the first units

purchased are theoretically the
first units sold. We begin the
count with January 1.
 Fifo Periodic
Sold
200 these
units @200
Ts.9 = Ts.1,800
Ts. 0 Jan. 1

Sold
300 these
units @ 300
Ts.10 = 3,0000 Mar. 10

400
Soldunits
200 200 @of these
Ts.11 = 4,400
2,200 Sept. 21

100 units @ Ts.12 = 1,200 Nov. 18

1,000 units available Ts.10,400
Ts. 3,400
for sale during
year Ending inventory
 Fifo Periodic

Cost of merchandise available for sale Ts.10,400

Less ending inventory 3,400
Cost of merchandise sold Ts. 7,000
 Summary of Fifo Periodic
Cost of
Merchandise Merchandise
Available Sold
Purchases for Sale
Ts.1,800 200 units at Ts.9
Jan. 1
200 units at Ts.9 Ts.1,800
Ts.3,000 300 units at Ts.10
Mar. 10
300 units at Ts.10 Ts.3,000 200 units at Ts.11
Ts.2,200
Sep. 21
Ts.7,000 700 units
400 units at Ts.11 Ts.4,400
Merchandise
Nov. 18
100 units at Ts.12 Ts.1,200 Inventory
Ts.2,200 200 units at Ts.11
1,000 units Ts.10,40
0 Ts.1,200 100 units at Ts.12

Ts.3,400 300 units

 Lifo
Periodic
 Lifo Periodic
200 units @ Ts.9 Jan. 1 Beginning
Inventory
300 units @ Ts.10 Mar. 10 Purchase

400 units @ Ts.11 Sept. 21 Purchase

100 units @ Ts.12 Nov. 18 Purchase

1,000 units lifo,
Using available
the most recent batch
for sale during
purchased is considered the first
year
batch of merchandise sold.
 Lifo Periodic
Jan. 1 Beginning
200 units @ Ts.9 Assume again that
Inventory
700 units were sold
300 units @ Ts.10 Mar.during
10 Purchase
the year.
400 units @ Ts.11 Sept. 21 Purchase

100 units @ Ts.12 Nov. 18 Purchase

1,000 units available
for sale during
year
 Lifo Periodic
200 units @ Ts.9 = Ts.1,800 Jan. 1

Soldunits
100
300 200 @of these
Ts.10 = 3,000
1,000 Mar. 10

400
Sold
units
these
@ 400
Ts.11 = 4,4000 Sept. 21

100
Sold
units
these
@ 100
Ts.12 = 1,2000 Nov. 18
1,000 units available Ts.10,400
Ts.2,800
for sale during
year Ending Inventory
 Lifo Periodic

Cost of merchandise available for sale Ts.10,400

Less ending inventory 2,800
Cost of merchandise sold Ts. 7,600
 Summary of Lifo Periodic
Cost of
Merchandise Merchandise Sold
Available
Purchases for Sale Ts.1,800 200 units at Ts.9
Ts.1,800
Jan. 1 Ts.1,000 100 units at Ts.10
200 units at Ts.9 Ts.1,800
Ts.2,800 300 units
Mar. 10
300 units at Ts.10 Ts.3,000 Cost of
Merchandise
Sep. 21 Sold
400 units at Ts.11 Ts.4,400
Ts.2,000 200 units at Ts.10
Nov. 18
100 units at Ts.12 Ts.1,200
Ts.4,400 400 units at Ts.11

1,000 units Ts.10,40

0 Ts.1,200 100 units at Ts.12

Ts.7,600 700 units

 Average Cost Periodic

200 units @ Ts.9 Jan. 1 Beginning

The average cost
Inventory
periodic method is based
300 units @ Ts.10 Mar. 10ofPurchase
on the average cost
400 units @ identical
Ts.11 units.21 Purchase
Sept.

100 units @ Ts.12 Nov. 18 Purchase

1,000 units available
for sale during
year
 Average Cost Periodic
200 units @ Ts.9 = Ts. 1,800

300 units @ Ts.10 = Ts. 3,000

400 units @ Ts.11 = Ts. 4,400

100 units @ Ts.11 = Ts. 1,200

1,000 units available Ts.10,400 Cost of

for sale during merchandise
year available for
sale
 Average Cost Periodic
Cost of Merchandise
Available for Sale
= Average Unit Cost
Units Available for Sale
During Year

Ts.10,400
= Ts.10.40 per Unit
1,000 Units
 Average Cost Periodic

Cost of merchandise available for sale Ts.10,400

Less ending inventory (Ts.10.40 x 300) 3,120
Cost of merchandise sold Ts. 7,280
To verify this
amount, multiply
700 units sold
times Ts.10.40 to
get the same
Ts.7,280.
 Valuation of Inventory at
Lower-of-Cost-or-Market
Unit Unit
Inventory Cost Market Total Total Lower
Item Quantity Price Price Cost Market C or M

A Ts. 3,800Ts.10.25 Ts. 9.50 Ts. 4,100 Ts. 3,800

400
B 2,700 22.50
120 24.10 2,700 2,892
C 4,650
600 8.00 7.75 4,800 4,650
D 3,920 14.00
280 14.75 3,920 4,130
Total Ts.15,520 Ts.15,472 Ts.15,070

The market decline based on individual items

(Ts.15,520 – Ts.15,070) = Ts.450
Estimating Inventory Cost
Retail Method of Estimating Inventory Cost
 Retail method is based on relationship between
cost of merchandise available for sale and the
retail price.
 Retail prices of all merchandise must be
accumulated and totaled.
 Inventory at retail is calculated at retail price of
merchandise available for sale less net sales at
retail.
 Ratio is calculated as cost divided by retail
price.
 Inventory at retail price times cost ratio equals
estimated cost of inventory.
 Retail Inventory Method
Cost Retail
Merchandise inventory, Jan. 1 Ts.19,400 Ts. 36,000
Purchases in January (net) 42,600 64,000
Merchandise available for sale Ts.62,000 Ts.100,000
Ts.62,000
Ratio of cost to retail price = = 62%
Ts.100,000

Step 1: Determine the ratio of

cost to the retail price.
 Retail Inventory Method
Cost Retail
Merchandise inventory, Jan. 1 Ts.19,400 Ts. 36,000
Purchases in January (net) 42,600 64,000
Merchandise available for sale Ts.62,000 Ts.100,000
Sales for January (net) 70,000
Merchandise inventory, January 31, at retailTs. 30,000

Step 2: Determine the ending

inventory at retail.
 Retail Inventory Method
Cost Retail
Merchandise inventory, Jan. 1 Ts.19,400 Ts. 36,000
Purchases in January (net) 42,600 64,000
Merchandise available for sale Ts.62,000 Ts.100,000
Sales for January (net) 70,000
Merchandise inventory, January 31, at retailTs. 30,000
Merchandise inventory, January 31, at cost
(Ts.30,000 x 62%) Ts.18,600

Step 3: Calculate the estimated

inventory at cost.
 Gross Profit Method of Estimating
Inventory Cost
1. A gross profit percentage rate is estimated based on
previous experience adjusted for known changes.
2. Estimated gross profit is calculated by multiplying
the estimated gross profit rate times the actual net
sales.
3. Estimated cost of merchandise sold is calculated by
subtracting the gross profit from actual sales.
4. The cost of merchandise sold estimate is deducted
from actual merchandise available for sale to
determine the estimated cost of merchandise
inventory.
 Gross Profit Method
Merchandise inventory, January 1 Ts.
57,000
Purchases in January (net) 180,000
Ts.237,000
Merchandise available for sale
Sales in January (net) Ts.250,000
Less: Estimatedx gross
(Ts.250,000 30%)profit 75,000
175,000
Estimated cost of merchandise sold Ts.
62,000
Estimated merchandise inventory, January 31
The gross profit method is useful for estimating
inventories for monthly or quarterly financial
statements in a periodic inventory system.
 Inventory Turnover
SUPERVALU Zale
Cost of merchandise sold Ts.15,620,127,000 Ts. 737,188,000
Inventories:
Beginning of year Ts.1,115,529,000 Ts.478,467,000
End of year 1,067,837,000 571,669,000
Total Ts.2,183,366,000 Ts.1,050,136,000
Average Ts.1,091,683,000 Ts.525,068,000
Inventory turnover 14.3 times 1.4 times

Use: Inventory turnover measures the relationship

between the volume of goods sold and the
amount of inventory carried during the period.
Number of Days’ Sales in Inventory
SUPERVALU Zale
Average daily cost of
merchandise sold:
Ts.15,620,127,000/365 Ts.42,794,868
Ts.737,188,000/365 Ts.2,019,693
Ending inventory Ts.1,067,837,000 Ts.571,669,000

Average selling period 25 days 283 days

Use: To assess the efficiency in the

management of inventory