Chapter 7

Inventory and Cost of Goods Sold

PowerPoint Author:
Brandy Mackintosh, CPA, CA

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 Learning Objective 7-1

Describe the issues in

managing different types of
inventory.

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 Inventory Management Decisions

The primary goals of inventory managers are to:

1. Maintain a sufficient quantity of inventory to
meet customers’ needs
2. Ensure quality meets customers’
expectations and company standards
3. Minimize the cost of acquiring and carrying
the inventory

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 Types of Inventory
Merchandisers . . . Manufacturers . . .
 Buy finished goods.  Buy raw materials.
 Sell finished goods.  Produce and sell
finished goods.

Raw Materials
Merchandise inventory Work in Process
Finished goods

Materials waiting to Completed products

be processed awaiting sale

Partially
complete products
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 Learning Objective 7-2

Explain how to report

inventory and cost of goods
sold.

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 Balance Sheet and Income
Statement Reporting

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 Cost of Goods Sold Equation
End of the accounting
Periodic Updating: period –previously
used by counting
Beginning Inventory + Purchases – Ending Inventory =
manually
Cost of Goods Sold

Recently used with the

Perpetual Updating: introduction of barcoding-

Beginning Inventory + Purchases – Cost of Goods Sold =

Ending Inventory

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 Cost of Goods Sold Equation Example
A company has beginning inventory of 5 units that each cost
$10, then purchases 20 units with a cost of $10 each, sells 15
units, and is left with 10 units in ending inventory.

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 Learning Objective 7-3

Compute costs using four

inventory costing methods.

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 Inventory Costing Methods

Specific Merchandising store-different items have

different prices
identification

First-in, first-out
(FIFO)

Last-in, first-out
(LIFO)

Weighted
average

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 Inventory Costing Methods Example
Consider the following information
May 6
May 3 Purchased 1 unit for $70 $95 cost
May 5 Purchased 1 more unit for $75
May 6 Purchased 1 more unit for $95 May 5
$75 cost
May 8 Sold 2 units for $125 each
May 3
$70 cost
Specific Identification
This method individually identifies and records the cost of
each item sold as part of cost of goods sold. If the items
sold were identified as the ones that cost $70 and $95, the
total cost of those items ($70 + 95 = $165) would be
reported as Cost of Goods Sold. The cost of the remaining
item ($75) would be reported as Inventory on the balance
sheet at the end of the period.
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 Inventory Costing Methods Example,
continued
FIFO LIFO Weighted average

May 6 May 6 May 6

$95 cost $95 cost $95 cost $240 $80
= per unit
May 5
3
May 5 May 5
$75 cost $75 cost $75 cost
Still there

May 3 May 3 May 3

$70 cost $70 cost $70 cost
Sold

Sold

Still there
Income Statement Income Statement Income Statement
Net Sales $250 Net Sales
Cost of Goods Sold 145
Net Sales $250
Cost of Goods Sold
$250
160
Sold
Cost of Goods Sold 170
Gross Profit $105 Gross Profit $ 80 Gross Profit $ 90
Still
Balance Sheet Balance Sheet Balance Sheet
Inventory
there
$95 Inventory $70 Inventory $80

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 Inventory Costing Methods Summary
Summary

Weighted
FIFO LIFO Average
Cost of Goods Sold (Income Statement) Oldest cost Newest cost Average cost
Inventory (Balance Sheet) Newest cost Oldest cost Average cost

Let’s consider a more complex example.

Date Description # of Units Cost per Unit Total Cost
Oct 1 Beginning Inventory 10 $ 7 $ 70
Oct 3 Purchase 30 $ 8 240
Oct 5 Purchase 10 $10 100
Oct 6 Sales (35) To calculate To calculate
Ending Inventory 15 To calculate To calculate

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 Inventory Cost Flow Computations
- FIFO
FIFO
beginning Inventory 10 units x $ 7 = $ 70
+ purchases 30 units x $ 8 = 240
10 units x $ 10 =
cost of goods available for sale 100
- ending Inventory $ 410
= Cost of Goods Sold 140
$ 270

(10 units @ $10) + (5 units @ $8)

(10 units @ $7) + (25 units @ $8)

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 Inventory Cost Flow Computations
- LIFO
LIFO
beginning Inventory 10 units x $ 7 = $ 70
+ purchases 30 units x $ 8 = 240
10 units x $ 10 =
cost of goods available for sale 100
- ending Inventory $ 410
= Cost of Goods Sold 110
$ 300

(10 units @ $7) + (5 units @ $8)

(10 units @ $10) + (25 units @ $8)

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 Inventory Cost Flow Computations
– Weighted Average
Weighted Average
# of Cost Total
Description Units per Unit Cost
beginning Inventory 10 $ 7 $ 70
purchase 30 $ 8 240
purchase 10 $10 100
cost of goods available for sale 50 $ 410

Weighted Cost of goods Available for Sale

=
Average Cost Number of Units Available for Sale
Weighted $410
= = $8.20 per unit
Average Cost 50 units
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 Inventory Cost Flow Computations
– Weighted Average, continued
Weighted Average
Beginning Inventory 10 units x $ 7 = $ 70
+ Purchases 30 units x $ 8 = 240
10 units x $ 10 =
Cost of Goods Available for Sale 100
- Ending Inventory $ 410
= Cost of Goods Sold 123
$ 287

15 units @ $8.20

35 units @ $8.20

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 Financial Statement Effects
Weighted
Effects on the Income Statement FIFO LIFO Average
Sales $ 525 $ 525 $ 525
Cost of Goods Sold 270 300 287
Gross Profit 255 225 238
Operating Expenses 125 125 125
Income from Operations 130 100 113
Other Revenue (Expenses) 20 20 20
Income before Income Tax Expense 150 120 133
Income Tax Expense (30%) 45 36 40
Net Income $ 105 $ 84 $ 93

Effects on the Balance Sheet

Inventory $ 140 $ 110 $ 123

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 Financial Statement Effects,
continued

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 Tax Implications and Cash Flow
Effects
Weighted
Effects on the Income Statement FIFO LIFO Average
Sales $ 525 $ 525 $ 525
Cost of Goods Sold 270 300 287
Gross Profit 255 225 238
Operating Expenses 125 125 125
Income from Operations 130 100 113
Other Revenue (Expenses) 20 20 20
Income before Income Tax Expense 150 120 133
Income Tax Expense (30%) 45 36 40
Net Income $ 105 $ 84 $ 93

Effects on the Balance Sheet

Inventory $ 140 $ 110 $ 123

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 Learning Objective 7-4

Report inventory at the

lower of cost or market/net
realizable value.

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 Lower of Cost or Market/Net Realizable
Value
The value of inventory can fall below its
recorded cost for two reasons:
1. it’s easily replaced by identical goods at a
lower cost, or
2. it’s become outdated or damaged.
When the value of inventory falls below its recorded cost,
the amount recorded for inventory is written down to its
lower market/net realizable value. This is known as the
lower of cost or market/net realizable value (LCM/NRV)
rule.

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 Lower of Cost or Market/Net
Realizable Value Example
Cost Value Write-Down Total
per per Item per Item Write-down
Item Item Quantity
Vintage jeans $20 $25 -
Leather coats 165 150 $15 1,000 $15,000

1 Analyze
Assets = Liabilities + Stockholders’ Equity
Inventory -$15,000 Cost of Goods
Sold (+E) -$15,000

2 Record
Cost of Goods Sold 15,000
Inventory 15,000

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 Lower of Cost or Market/Net
Realizable Value - Samsung
Stop using your smartphone! It might catch
fire and explode. That’s the message
Samsung Electronics hinted at one
weekend in September 2016.
Samsung was recalling all the Galaxy Note 7 devices it had sold
and was scrapping all its inventory too. When stock markets
opened Monday morning, Samsung’s stock price plunged 7%.
And, as if that wasn’t bad enough, a few weeks later the
company recalled millions of washing machines that also were
blowing up. The total inventory write-down for “obsolescence
and scrapping of inventory” was massive . . . 2.9 TRILLION
Korean won. Converted, that’s $2.5 billion U.S. dollars, or
roughly 11% of Samsung’s net income for the year.

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 Learning Objective 7-5

Evaluate inventory
management by computing
and interpreting the inventory
turnover ratio.

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 Inventory Turnover Analysis

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 Comparison to Benchmarks

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 Supplement 7A

FIFO, LIFO, and Weighted Average in a

Perpetual Inventory System

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 Learning Objective 7-S1

Compute inventory costs in

perpetual systems.

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 Perpetual Inventory System
This is the same information that we used earlier in the
chapter to illustrate a periodic inventory system. The only
difference is that we have assumed the sales occurred on
October 4, prior to the final inventory purchase.
Date Description # of Units Cost per Unit Total Cost
Oct 1 Beginning Inventory 10 $ 7 $ 70
Oct 3 Purchase 30 $ 8 $ 240
Oct 4 Sales (35) To calculate To calculate
Oct 5 Purchase 10 $ 10 $ 100
Ending Inventory 15 To calculate To calculate

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 FIFO (First-in, First-Out)

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 LIFO (Last-in, First-Out)

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 Weighted Average Cost

$310 ÷ 40 units
= $7.75 per unit

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 Financial Statement Effects Using
a Perpetual Inventory System
Summary of Perpetual Inventory System Cost
Flow Assumptions on Financial Statements

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 Supplement 7B

The Effects of Errors in Ending Inventory

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 Learning Objective 7-S2

Determine the effects of

inventory errors.

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 The Effects of Errors in Ending
Inventory
Cost of Goods Sold Equation Errors in Ending
Inventory will affect
BI + P – EI = CGS the Balance Sheet and
the Income Statement.

Assume that Ending Inventory was overstated in Year 1 by

$10,000 due to an error that was not discovered until Year 2.

Year 1
Beginning Inventory Accurate
+ Purchases Accurate
- Ending Inventory Overstated $10,000
= Cost of Goods Sold Understated $10,000

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 The Effects of Errors in Ending
Inventory Example
Now let’s examine the effects of the
Year 1 Ending Inventory Error on Year 2.

Assume that Ending Inventory was overstated in Year 1 by

$10,000 due to an error that was not discovered until Year 2.

Year 2
Beginning Inventory Overstated $10,000
+ Purchases Accurate
- Ending Inventory Accurate
= Cost of Goods Sold Overstated $10,000

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 Chapter 7
Solved Exercises

M7-7, M7-8, M7-9, M7-10, E7-5, E7-11, E7-

13

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 M7-7 Calculating Cost of Goods Available for Sale, Ending Inventory,
Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO

Given the following information, calculate cost of goods available for sale and
ending inventory, then sales, cost of goods sold, and gross profit, under FIFO.
Assume a periodic inventory system is used.

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 M7-7 Calculating Cost of Goods Available for Sale, Ending Inventory,
Sales, Cost of Goods Sold, and Gross Profit under Periodic FIFO,
continued

Beginning Inventory 50 units x $10 = $ 500

+ Purchase 250 units x $13 = $3,250
Cost of Goods Available for Sale $3,750
- Ending Inventory (200 x $13) = $2,600
= Cost of Goods Sold (50 x $10) + (50 x $13) $1,150

Sales (100 units at $15) $1,500

Cost of Goods Sold 1,150

Gross Profit $ 350

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 M7-8 Calculating Cost of Goods Available for Sale, Ending Inventory,
Sales, Cost of Goods Sold, and Gross Profit under Periodic LIFO

Given the following information, calculate cost of goods available for sale and
ending inventory, then sales, cost of goods sold, and gross profit, under LIFO.
Assume a periodic inventory system is used.

Beginning Inventory 50 units x $10 = $ 500

+ Purchase 250 units x $13 = $3,250
Cost of Goods Available for Sale $3,750
- Ending Inventory (50 x $10) + (150 x $13) = $2,450
= Cost of Goods Sold (100 x $13) $1,300

Sales (100 units at $15) $1,500

Cost of Goods Sold 1,300
Gross Profit $ 200
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 M7-9 Calculating Cost of Goods Available for Sale, Ending Inventory,
Sales, Cost of Goods Sold, and Gross Profit under Periodic Weighted
Average Cost
Given the following information, calculate cost of goods available for sale and
ending inventory, then sales, cost of goods sold, and gross profit, under
Weighted Average Cost. Assume a periodic inventory system is used.

Beginning Inventory 50 units x $10 = $ 500

+ Purchase 250 units x $13 = $3,250
Cost of Goods Available for Sale $3,750
- Ending Inventory (200 x $12.50) = $2,500
= Cost of Goods Sold (100 x $12.50) $1,250
Weighted $3,750
Average Cost = 300 units = $12.50 per unit
Sales (100 units at $15) $1,500
Cost of Goods Sold 1,250
Gross Profit $ 250
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 M7-10 Calculating Cost of Goods Available for Sale, Cost of Goods
Sold, and Ending Inventory under FIFO, LIFO, and Weighted Average
Cost (Periodic Inventory)
Aircard Corporation tracks the number of units purchased and sold
throughout each accounting period, but applies its inventory costing method
at the end of each period as if it uses a periodic inventory system. Given the
following information, calculate the cost of goods available for sale, ending
inventory, and cost of goods sold, if Aircard uses (a) FIFO, (b) LIFO, or (c)
weighted average cost.

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 M7-10 Calculating Cost of Goods Available for Sale, Cost of Goods Sold,
and Ending Inventory under FIFO, LIFO, and Weighted Average Cost
(Periodic Inventory), continued

Goods Available for Sale – same for all methods

Units Unit Total
Cost Cost
Beginning Inventory 2,000 $40 $ 80,000
+ Purchase (July 13) 6,000 $44 264,000
+ Purchase (July 25) 8,000 $50 400,000
Goods Available for Sale 16,000 $744,000

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 M7-10 Calculating Cost of Goods Available for Sale, Cost of Goods Sold,
and Ending Inventory under FIFO, LIFO, and Weighted Average Cost
(Periodic Inventory) – Parts a and b

a. FIFO
Ending Inventory (7,000 units x $50) = $350,000

Cost of Goods Sold (2,000 units x $40)

(6,000 units x $44)
(1,000 units x $50) = $394,000

b. LIFO
Ending Inventory (2,000 units x $40)
(5,000 units x $44) = $300,000

Cost of Goods Sold (8,000 units x $50)

(1,000 units x $44) = $444,000

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 M7-10 Calculating Cost of Goods Available for Sale, Cost of Goods Sold,
and Ending Inventory under FIFO, LIFO, and Weighted Average Cost
(Periodic Inventory) – Part c

c. Weighted Average
Average Unit Cost $744,000 / 16,000 = $46.50

Ending Inventory (7,000 units x $46.50) = $325,500

Cost of Goods Sold (9,000 units x $46.50) = $418,500

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 E7-5 Calculating Cost of Ending Inventory and Cost of Goods Sold
under Periodic FIFO, LIFO, and Weighted Average Cost
Oahu Kiki tracks the number of units purchased and sold throughout each
accounting period but applies its inventory costing method at the end of each
month, as if it uses a periodic inventory system. Assume Oahu Kiki’s records
show the following for the month of January. Sales totaled 240 units.

Required:
1. Calculate the number and cost of goods available for sale.
Goods Available for Sale – same for all methods
Units UnitTotal
Cost Cost
Beginning Inventory 120 $80 $ 9,600
+ Purchase (Jan 15) 380 $90 34,200
+ Purchase (Jan 24) 200 $110 22,000
Goods Available for Sale 700 $65,800

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 E7-5 Calculating Cost of Ending Inventory and Cost of Goods Sold
under Periodic FIFO, LIFO, and Weighted Average Cost, continued
Assume Oahu Kiki’s uses a periodic inventory system, which shows the
following for the month of January. Sales totaled 240 units.

Required:
2. Calculate the number of units in ending inventory.

Units in Ending Inventory = Units Available – Units Sold

Units in Ending Inventory = 700 – 240 = 460 units

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 E7-5 Calculating Cost of Ending Inventory and Cost of Goods Sold
under Periodic FIFO, LIFO, and Weighted Average Cost – part 3a
Assume Oahu Kiki’s uses a periodic inventory system, which shows the
following for the month of January. Sales totaled 240 units.

Required:
3. Calculate the cost of ending inventory and cost of goods sold using the
(a) FIFO, (b) LIFO, and (c) weighted average cost methods.

a. FIFO
ending Inventory (200 units x $110)
(260 units x $ 90) = $45,400

Cost of Goods Sold (120 units x $80)

(120 units x $90) = $20,400
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 E7-5 Calculating Cost of Ending Inventory and Cost of Goods Sold
under Periodic FIFO, LIFO, and Weighted Average Cost – part 3b
Assume Oahu Kiki’s uses a periodic inventory system, which shows the
following for the month of January. Sales totaled 240 units.

Required:
3. Calculate the cost of ending inventory and cost of goods sold using the
(a) FIFO, (b) LIFO, and (c) weighted average cost methods.

b. LIFO
Ending Inventory (120 units x $80)
(340 units x $90) = $40,200

Cost of Goods Sold (200 units x $110)

( 40 units x $ 90) = $25,600

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 E7-5 Calculating Cost of Ending Inventory and Cost of Goods Sold
under Periodic FIFO, LIFO, and Weighted Average Cost – part 3c
Assume Oahu Kiki’s uses a periodic inventory system, which shows the
following for the month of January. Sales totaled 240 units.

Required:
3. Calculate the cost of ending inventory and cost of goods sold using the
(a) FIFO, (b) LIFO, and (c) weighted average cost methods.

c. Weighted Average
Average Unit Cost $65,800 / 700 units = $94

Ending Inventory (460 units x $94) = $43,240

Cost of Goods Sold (240 units x $94) = $22,560

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 E7-11 Reporting Inventory at Lower of Cost or Market/Net Realizable Value
Peterson Furniture Designs is preparing the annual financial statements dated
December 31. Ending inventory information about the five major items stocked
for regular sale follows:

Required:
1. Complete the table column “Write-Down per Item” and then sum the final
column to compute the amount of the total write-down when the LCM/NRV rule
is applied to each item.

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 E7-11 Reporting Inventory at Lower of Cost or Market/Net Realizable Value
– Part 1
Peterson Furniture Designs is preparing the annual financial statements dated
December 31. Ending inventory information about the five major items stocked
for regular sale follows:

Item Unit Cost NRV per Write-Down Quantity Total Write-

(FIFO) Item per Item Down
Alligator Armoires $30 $24 $6 50 $300
Bear Bureaus 40 40 0 75 0
Cougar Beds 50 52 0 10 0
Dingo Cribs 30 30 0 30 0
Elephant Dressers 15 12 3 400 1,200

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 E7-11 Reporting Inventory at Lower of Cost or Market – Part 2
Peterson Furniture Designs is preparing the annual financial statements dated
December 31. Ending inventory information about the five major items stocked for
regular sale follows:

Required:
2. Prepare the journal entry that Peterson Furniture Designs would record
on December 31 to write-down its inventory to LCM/NRV.

Cost of Goods Sold 1,500

Inventory 1,500

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 E7-13 Analyzing and Interpreting the Inventory Turnover Ratio – Part 1
Polaris Industries Inc. is the biggest snowmobile manufacturer in the world. It
reported the following amounts in its financial statements (in millions):

Required:
1. Calculate to one decimal place the inventory turnover ratio and average
days to sell inventory for 2015, 2014, and 2013.

2015 2014 2013

Inventory
Turnover Cost of Goods Sold = 5.3* 6.4** 7.0***
=
Ratio Average Inventory
Times per year
Days to 365 Days
Sell = = 68.957.052.1
Inventory Turnover
days

*5.3 = $3,380 ÷ $640 **6.4 = $3,160 ÷ $490 ***7.0 = $2,660 ÷ $380

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 E7-13 Analyzing and Interpreting the Inventory Turnover Ratio – Part 2
Polaris Industries Inc. is the biggest snowmobile manufacturer in the world. It
reported the following amounts in its financial statements (in millions):

Required:
2. Comment on any trends, and compare the effectiveness of inventory
managers at Polaris to inventory managers at its main competitor, Arctic
Cat, where inventory turned over 3.7 times per year in 2015
(98.6 days to sell).
Both companies use the same inventory costing method (FIFO).

The inventory turnover ratio reflects how many times average inventory was
acquired and sold during the year. The inventory turnover ratio for Polaris
Industries has been consistently decreasing from 2013 through to 2015.
However Polaris is still performing better than Arctic Cat as Polaris’ inventory
turnover is 5.3 times per year or every 68.9 days versus Arctic Cat’s turnover
of only 3.7 times or 98.6 days.
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 End of Chapter 7

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