Lesson 7
Merchandise Inventories
and Cost of Sales
Task Team of
FUNDAMENTAL ACCOUNTING
School of Business,Sun Yat-sen University
2
Outline
?Flow of inventory cost
?Items and costs of merchandising inventory
?Assigning costs to inventory
?Lower of cost or market
?Errors in measuring inventory
?Inventory estimating method
3
Introduction
?While sales and purchases are the focus of
operations,inventory is no less important,
Inventory costing and evaluation methods can
substantially influence the bottom line,Since
China’s listed companies were permitted to write
down inventories in 1998,inventory has long been
criticized as the,income adjustor”,Besides,
inventory costing policies and the scope of
inventory can also significant change the current
and future years income numbers.
4
Nature of Inventory and Cost of
Goods Sold
Beginning
Inventory
Purchases
for the Period
Ending Inventory
(Balance Sheet)
Goods Available
for Sale
Cost of Goods Sold
(Income Statement)
Beginning inventory + Purchases – Ending inventory = Cost of goods sold
+
+
5
Flow of Inventory Costs
Merchandise
Purchases
Cost of
Goods Sold
Merchandise
Inventory
Direct
Labour
Factory
Overhead
Raw Materials
Inventory
Work in Process
Inventory
Finished Goods
Inventory
Cost of
Goods Sold
Merchandiser
Manufacturer
Raw
Materials
6
Accounting for Inventory
?Accounting for inventory requires
several decisions which include:
?Items to include in cost,
?Inventory System.
→ Perpetual or Periodic
?Costing Method.
→ FIFO,LIFO,Weighted Average,Specific ID
?Use of estimates.
→ Gross profit method,Retail inventory method
7
Items in Merchandise Inventory
?Inventory includes all goods owned by
a company and held for sale.
?Items requiring special attention:
→ Goods in Transit
→ Goods on consignment
→ Obsolete or damaged goods
8
Costs of Merchandise Inventory
?All expenditures necessary to bring an
item to a saleable condition and
location.
?This includes:
→ Invoice price less discounts
→ Import duties
→ Transportation-in
→ Storage
→ Insurance
9
? Management must decide on method
of determining unit cost.
? This will affect both the income
statement and the balance sheet.
?Methods:
→ Specific Identification
→ FIFO
→ LIFO
→ Average Cost
Assigning Costs to Inventory
10
Specific Identification
?This method is used when items:
?Are unique.
?Can be directly identified with a specific
purchase and its invoice.
Examples,Automobiles,
custom furniture,art.
11
Specific Identification-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 8 90$ 720$ 2 90$ 180$
12 100$ 1,2 0 0$ 3 100$ 300$
5 480$
2 90$ 180$
3 100$ 300$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 8 0$
8 / 2 8 2 90$ 180$ 3 100$ 300$
12 110$ 1,3 2 0$ 8 110$ 880$
To t a l s 45 4,6 0 0$ 34 3,4 2 0$ 11 1,1 8 0$
S pe c i f i c I de nt i f i c a t on C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
The opening inventory consists of 10 units @ $90/unit.
12
Specific Identification-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 8 90$ 720$ 2 90$ 180$
12 100$ 1,2 0 0$ 3 100$ 300$
5 480$
2 90$ 180$
3 100$ 300$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 8 0$
8 / 2 8 2 90$ 180$ 3 100$ 300$
12 110$ 1,3 2 0$ 8 110$ 880$
To t a l s 45 4,6 0 0$ 34 3,4 2 0$ 11 1,1 8 0$
S pe c i f i c I de nt i f i c a t on C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
This results in two layers of
inventory.Additional units re purchased @ $100/unit.
13
Specific Identification-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 8 90$ 720$ 2 90$ 180$
12 100$ 1,2 0 0$ 3 100$ 300$
5 480$
2 90$ 180$
3 100$ 300$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 8 0$
8 / 2 8 2 90$ 180$ 3 100$ 300$
12 110$ 1,3 2 0$ 8 110$ 880$
To t a l s 45 4,6 0 0$ 34 3,4 2 0$ 11 1,1 8 0$
S pe c i f i c I de nt i f i c a t on C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
On August 14,20 units are sold,Eight of these units came from
the opening inventory and the remaining 12 units came from
the August 3 purchase.
14
Specific Identification-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 8 90$ 720$ 2 90$ 180$
12 100$ 1,2 0 0$ 3 100$ 300$
5 480$
2 90$ 180$
3 100$ 300$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 8 0$
8 / 2 8 2 90$ 180$ 3 100$ 300$
12 110$ 1,3 2 0$ 8 110$ 880$
To t a l s 45 4,6 0 0$ 34 3,4 2 0$ 11 1,1 8 0$
S pe c i f i c I de nt i f i c a t on C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
This leaves 2 units remaining from the
original inventory and 3 units remaining
from the August 3 purchase.
15
?Based on the assumption that the items are
sold in the order acquired.
?When a sale occurs:
?The earliest units purchased are charged to
Cost of Goods Sold.
?The cost of the most recent purchases remain in
inventory
First-In,First-Out (FIFO)
16
FIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 10 90$ 900$
10 100$ 1,0 0 0$ 5 100$ 500$
5 100$ 500$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,7 0 0$
8 / 2 8 5 100$ 500$
9 110$ 990$ 11 110$ 1,2 1 0$
To t a l s 45 4,6 0 0$ 34 3,3 9 0$ 11 1,2 1 0$
FI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
Under FIFO,units are assumed to be sold in the order acquired,Therefore,
of the 20 units sold on August 14,the first 10 units come from beginning
inventory,Therefore,those 10 units are removed from the inventory record
based on the cost of those units of $90.
17
FIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 10 90$ 900$
10 100$ 1,0 0 0$ 5 100$ 500$
5 100$ 500$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,7 0 0$
8 / 2 8 5 100$ 500$
9 110$ 990$ 11 110$ 1,2 1 0$
To t a l s 45 4,6 0 0$ 34 3,3 9 0$ 11 1,2 1 0$
FI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
The remaining 10 units sold on August 14th come from the next
purchase,made on August 3rd,Therefore,these units are
removed from the inventory record based on their cost of $100.
18
FIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 10 90$ 900$
10 100$ 1,0 0 0$ 5 100$ 500$
5 100$ 500$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,7 0 0$
8 / 2 8 5 100$ 500$
9 110$ 990$ 11 110$ 1,2 1 0$
To t a l s 45 4,6 0 0$ 34 3,3 9 0$ 11 1,2 1 0$
FI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
The ending inventory consists of
the 5 remaining units from the
August 3 purchase.
Ending inventory
approximates current
replacement cost.
19
Last-In,First-Out (LIFO)
?Based on the assumption that the most
recently purchased items are sold first.
?When a sale occurs:
?The latest units purchased are charged to Cost of
Goods Sold.
?The cost of the earliest purchases remain in
inventory.
20
LIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 15 100$ 1,5 0 0$
5 90$ 450$ 5 90$ 450$
5 90$ 450$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 5 0$
8 / 2 8 14 110$ 1,5 4 0$ 5 90$ 450$
6 110$ 660$
To t a l s 45 4,6 0 0$ 34 3,4 9 0$ 11 1,1 1 0$
LI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
Of the 20 units sold,these
units are assumed to be sold
first.
21
LIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 15 100$ 1,5 0 0$
5 90$ 450$ 5 90$ 450$
5 90$ 450$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 5 0$
8 / 2 8 14 110$ 1,5 4 0$ 5 90$ 450$
6 110$ 660$
To t a l s 45 4,6 0 0$ 34 3,4 9 0$ 11 1,1 1 0$
LI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
Once the latest units purchased are
sold,units are sold from the
previous purchase.
22
LIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 15 100$ 1,5 0 0$
5 90$ 450$ 5 90$ 450$
5 90$ 450$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 5 0$
8 / 2 8 14 110$ 1,5 4 0$ 5 90$ 450$
6 110$ 660$
To t a l s 45 4,6 0 0$ 34 3,4 9 0$ 11 1,1 1 0$
LI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
This leaves 5 units remaining
from the first purchase.
Better matches
current costs in cost
of goods sold with
revenues.
23
?Under this method,the cost of all units are
averaged together.
Average cost per unit
Cost of goods available for sale
Number of units available for sale=
Moving Weighted Average Method
24
Moving Weighted Average-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 25 96$ 2,4 0 0$
8 / 1 4 20 96$ 1,9 2 0$ 5 96$ 480$
8 / 1 7 20 110$ 2,2 0 0$ 25 107$ 2,6 8 0$
8 / 2 8 14 107$ 1,5 0 1$ 11 107$ 1,1 7 9$
Tot a l s 45 4,6 0 0$ 34 3,4 2 1$ 11 1,1 7 9$
M ov i ng W e i ght e d A v e r a ge C om put a t i ons - P e r pe t ua l I nv e nt or y S y s t e m
Additional units are
purchased @ $100/unit,This results in an average cost
of $100/unit.
(10 x $90) + (15 x $100)
25 units
25
Moving Weighted Average-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 25 96$ 2,4 0 0$
8 / 1 4 20 96$ 1,9 2 0$ 5 96$ 480$
8 / 1 7 20 110$ 2,2 0 0$ 25 107$ 2,6 8 0$
8 / 2 8 14 107$ 1,5 0 1$ 11 107$ 1,1 7 9$
Tot a l s 45 4,6 0 0$ 34 3,4 2 1$ 11 1,1 7 9$
M ov i ng W e i ght e d A v e r a ge C om put a t i ons - P e r pe t ua l I nv e nt or y S y s t e m
These 20 units are sold at the
average cost of $96/unit.
26
Moving Weighted Average-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 25 96$ 2,4 0 0$
8 / 1 4 20 96$ 1,9 2 0$ 5 96$ 480$
8 / 1 7 20 110$ 2,2 0 0$ 25 107$ 2,6 8 0$
8 / 2 8 14 107$ 1,5 0 1$ 11 107$ 1,1 7 9$
Tot a l s 45 4,6 0 0$ 34 3,4 2 1$ 11 1,1 7 9$
M ov i ng W e i ght e d A v e r a ge C om put a t i ons - P e r pe t ua l I nv e nt or y S y s t e m
This leaves 5 units remaining
at an average cost of $96/unit.
Smoothes out
purchase price
changes.
27
?Because prices change,the choice of an inventory
method influences both income statement and the
balance sheet.
S I N P E C C o m p a n y
M o n t h e n d i n g A u g u s t 3 1,2 0 0 5
S p e c i f i c
I d e n t i f i c a t i o n F I F O L I F O
M o v i n g
W e i g h t e d
A v e r a g e
S a l e s 5,6 4 0$ 5,6 4 0$ 5,6 4 0$ 5,6 4 0$
C o s t o f G o o d s S o l d 3,4 2 0$ 3,3 9 0$ 3,4 9 0$ 3,4 2 1$
G r o s s P r o f i t 2,2 2 0 2,2 5 0 2,1 5 0 2,2 1 9
O p e r a t i n g e x p e n s e s 374 374 374 374
I n c o m e f r o m o p e r a t i o n s 1,8 4 6$ 1,8 7 6$ 1,7 7 6$ 1,8 4 5$
M e r c h a n d i s e I n v e n t o r y 1,1 8 0$ 1,2 1 0$ 1,1 1 0$ 1,1 7 9$
A u g u s t 3 1,2 0 0 1
B a l a n c e S h e e t
Financial Reporting
28
? Inventory must be reported at market value when
market is lower than cost (conservatism principle).
? Market may be defined as:
?Net realizable value
?Current replacement cost
? May be applied in one of three ways:
?Separately to each item.
?To major categories of items.
?To the inventory as a whole.
Lower of Cost or Market
29
A motor retailer has the following items in inventory:
P e r U ni t
I nv e nt or y I t e m s
U ni t s on
H a nd C os t M a r k e t Tot a l C os t
Tot a l
M a r k e t
C y c l e s,
R o a d s t e r 20 6,0 0 0$ 5,0 0 0$ $ 1 2 0,0 0 0 $ 1 0 0,0 0 0
S p r i n t 10 4,0 0 0 5,0 0 0 4 0,0 0 0 5 0,0 0 0
C a t e g o r y s u b t o t a l 1 6 0,0 0 0 1 5 0,0 0 0
O f f - R oa d
T r a x - 4 10 5,0 0 0 6,0 0 0 5 0,0 0 0 6 0,0 0 0
B l a z e r 5 8,0 0 0 7,0 0 0 4 0,0 0 0 3 5,0 0 0
C a t e g o r y s u b t o t a l 9 0,0 0 0 9 5,0 0 0
T o t a l $ 2 5 0,0 0 0 $ 2 4 5,0 0 0
Lower of Cost or Market
30
I nv e nt or y I t e m s
U ni t s on
H a nd Tot a l C os t
Tot a l
M a r k e t I t e m s C a t e g o r i e s W h o l e
C y c l e s,
R o a d s t e r 20 $ 1 2 0,0 0 0 $ 1 0 0,0 0 0 1 0 0,0 0 0$
S p r i n t 10 4 0,0 0 0 5 0,0 0 0 4 0,0 0 0
C a t e g o r y s u b t o t a l $ 1 6 0,0 0 0 $ 1 5 0,0 0 0
O f f - R oa d
T r a x - 4 10 $ 5 0,0 0 0 $ 6 0,0 0 0 5 0,0 0 0
B l a z e r 5 4 0,0 0 0 3 5,0 0 0 3 5,0 0 0
C a t e g o r y s u b t o t a l $ 9 0,0 0 0 $ 9 5,0 0 0
T o t a l $ 2 5 0,0 0 0 $ 2 4 5,0 0 0 2 2 5,0 0 0$
L C M A p p l i e d t o
Compute lower of cost or market for individual inventory items.
Lower of Cost or Market
31
I nv e nt or y I t e m s
U ni t s on
H a nd Tot a l C os t
Tot a l
M a r k e t I t e m s C a t e g o r i e s W h o l e
C y c l e s,
R o a d s t e r 20 $ 1 2 0,0 0 0 $ 1 0 0,0 0 0 1 0 0,0 0 0$
S p r i n t 10 4 0,0 0 0 5 0,0 0 0 4 0,0 0 0
C a t e g o r y s u b t o t a l $ 1 6 0,0 0 0 $ 1 5 0,0 0 0 1 5 0,0 0 0$
O f f - R oa d
T r a x - 4 10 $ 5 0,0 0 0 $ 6 0,0 0 0 5 0,0 0 0
B l a z e r 5 4 0,0 0 0 3 5,0 0 0 3 5,0 0 0
C a t e g o r y s u b t o t a l $ 9 0,0 0 0 $ 9 5,0 0 0 9 0,0 0 0
T o t a l $ 2 5 0,0 0 0 $ 2 4 5,0 0 0 2 2 5,0 0 0$ 2 4 0,0 0 0$
L C M A p p l i e d t o
Lower of Cost or Market
Compute lower of cost or market for the two groups of inventory items.
32
I nv e nt or y I t e m s
U ni t s on
H a nd Tot a l C os t
Tot a l
M a r k e t I t e m s C a t e g o r i e s W h o l e
C y c l e s,
R o a d s t e r 20 $ 1 2 0,0 0 0 $ 1 0 0,0 0 0 1 0 0,0 0 0$
S p r i n t 10 4 0,0 0 0 5 0,0 0 0 4 0,0 0 0
C a t e g o r y s u b t o t a l $ 1 6 0,0 0 0 $ 1 5 0,0 0 0 1 5 0,0 0 0$
O f f - R oa d
T r a x - 4 10 $ 5 0,0 0 0 $ 6 0,0 0 0 5 0,0 0 0
B l a z e r 5 4 0,0 0 0 3 5,0 0 0 3 5,0 0 0
C a t e g o r y s u b t o t a l $ 9 0,0 0 0 $ 9 5,0 0 0 9 0,0 0 0
T o t a l $ 2 5 0,0 0 0 $ 2 4 5,0 0 0 2 2 5,0 0 0$ 2 4 0,0 0 0$ 2 4 5,0 0 0$
L C M A p p l i e d t o
Lower of Cost or Market
Compute lower of cost or market for the entire inventory.
33
Errors in Measuring Inventory
E r r o r s i n M e a s u r i n g I n v e n t o r y
B e gi nni ng I nv e nt or y E ndi ng I nv e nt or y
O v e r s t a t e d U nde r s t a t e d O v e r s t a t e d U nde r s t a t e d
E f f e c t on I nc om e S t a t e m e nt
G ood s A v a i l a bl e f or S a l e + - N / A N / A
C os t of G ood s S ol d + - - +
G r os s P r of i t - + + -
N e t I nc om e - + + -
E f f e c t on B a l a nc e S he e t
I nv e nt or y ( 1 2 / 3 1 ) N / A N / A + -
R e t a i ne d E a r ni ngs - + + -
B e g in n in g in v e n to r y + P u r c h a s e s – E n d in g in v e n to r y = C o s t o f g o o d s s o ld
34
?Occasionally used for interim period
reporting.
?Needed information includes:
?Beginning inventory at cost and retail.
?Net purchases at cost and retail.
?Net sales.
Retail Inventory Method
35
Retail Inventory Method
Step 3 Cost to retail ratioEnding inventory at retail
Estimated
ending
inventory at
cost
=×
Step 2 Goods available for sale at retailGoods available for sale at cost =÷ Cost to retail ratio
Step 1 Net sales at retailGoods available for sale at retail – = Ending inventory at retail
36
C o m p u t i n g E n d i n g I n v e n t o r y U s i n g t h e R e t a i l M e t h o d
A t C o s t A t R e t a i l
G o o d s A v a i l a b l e f o r S a l e
B e g i n n i n g I n v e n t o r y 2 0,0 0 0$ 3 5,0 0 0$
C o s t o f g o o d s p u r c h a s e d 4 0,0 0 0 7 2,0 0 0
G o o d s a v a i l a b l e f o r s a l e 6 0,0 0 0$ 1 0 7,0 0 0$
S t e p 1 D e d u c t n e t s a l e s a t r e t a i l 7 0,0 0 0
E n d i n g i n v e n t o r y a t r e t a i l 3 7,0 0 0$
Retail Inventory Method
37
C o m p u t i n g E n d i n g I n v e n t o r y U s i n g t h e R e t a i l M e t h o d
A t C o s t A t R e t a i l
G o o d s A v a i l a b l e f o r S a l e
B e g i n n i n g I n v e n t o r y 2 0,0 0 0$ 3 5,0 0 0$
C o s t o f g o o d s p u r c h a s e d 4 0,0 0 0 7 2,0 0 0
G o o d s a v a i l a b l e f o r s a l e 6 0,0 0 0$ 1 0 7,0 0 0$
S t e p 1 D e d u c t n e t s a l e s a t r e t a i l 7 0,0 0 0
E n d i n g i n v e n t o r y a t r e t a i l 3 7,0 0 0$
S t e p 2 C o s t - t o - r e t a i l r a t i o 56%
Retail Inventory Method
38
C o m p u t i n g E n d i n g I n v e n t o r y U s i n g t h e R e t a i l M e t h o d
A t C o s t A t R e t a i l
G o o d s A v a i l a b l e f o r S a l e
B e g i n n i n g I n v e n t o r y 2 0,0 0 0$ 3 5,0 0 0$
C o s t o f g o o d s p u r c h a s e d 4 0,0 0 0 7 2,0 0 0
G o o d s a v a i l a b l e f o r s a l e 6 0,0 0 0$ 1 0 7,0 0 0$
S t e p 1 D e d u c t n e t s a l e s a t r e t a i l 7 0,0 0 0
E n d i n g i n v e n t o r y a t r e t a i l 3 7,0 0 0$
S t e p 2 C o s t - t o - r e t a i l r a t i o 56%
S t e p 3 E s t i m a t e d e n d i n g i n v e n t o r y a t c o s t, 2 0,7 4 6$
$ 3 7,0 0 0 * 5 6 %
Retail Inventory Method
39
Gross Profit Method
?Estimate ending inventory by applying the
gross profit ratio to net sales at retail.
?Useful when inventories have been
destroyed,lost or stolen.
40
Gross Profit Method
Step 1 1.0 minus the gross profit ratioNet sales at retail × = Estimated cost of goods sold
Step 2 Estimated cost of goods soldGoods available for sale at cost – =
Estimated
ending
inventory at
cost
41
Gross Profit Method
? In March of 2002,CheTec Company’s inventory was
destroyed by fire,CheTec’s normal gross profit ratio is
40% of net sales,At the time of the fire,CheTec showed
the following balances:
S a l e s 4 0,0 0 0$
S a l e s r e t u r n s 2,0 0 0
I n v e n t o r y,1 / 1 / 0 2 1 2,0 0 0
N e t c o s t o f g o o d s p u r c h a s e d 3 0,0 0 0
42
Gross Profit Method
S a l e s 4 0,0 0 0$
L e s s, s a l e s r e t u r n s ( 2,0 0 0 )
N e t s a l e s 3 8,0 0 0
( 1 0 0 % - 4 0 % ) 60%
E s t i m a t e d c o s t o f g o o d s s o l d 2 2,8 0 0$
Step 1
43
Gross Profit Method
G oo ds A v a i l a bl e f or S a l e,
I nv e nt or y,1 / 1 / 0 2 1 2,0 0 0$
N e t c os t of go od s pu r c ha s e d 3 0,0 0 0
G oo ds a v a i l a bl e f or s a l e 4 2,0 0 0
Le s s e s t i m a t e d c os t of go od s s ol d:
E s t i m a t e d c os t of go od s s ol d ( 2 2,8 0 0 )
E s t i m a t e d M a r c h i nv e nt or y l os s 1 9,2 0 0$
Step 2
44
Discussion Case
Northeast Pharmaceutical
?When preparing financial statement of 1996,
Northeast Pharmaceutical recorded RMB
21,280,000 expenses as inventory cost,which
carries to next year’s beginning inventory,
As a result,the bottom line is RMB
19,950,000 profits,instead of a big loss,This
was discovered and was fined by CSRC as
securities fraud.
45
Discussion Case
?Required:
?What’s the difference between
expenses and inventory costs?
?What are the impacts of inventory
errors on financial statements?
?Why Northeast Pharmaceutical
chose to report false income
numbers?
?How to prevent the occurrence of
such kind of cases.
46
Summary
? Inventory includes all goods owned by a company and held for
sale.
? Costs of merchandise inventory include all expenditures
necessary to bring an item to a saleable condition and location.
? There are four method to assigning costs to inventory,specific
identification,FIFO,LIFO and average cost,The average cost
method smoothes out purchase price changes,Ending
inventory under FIFO approximates current replacement cost,
LIFO better matches current cost in cost of goods sold with
revenue.
? Inventory must be reported at market value when market is
lower than cost.
? Retail inventory method and gross profit method can be used
to estimate ending inventory.
The End of Lesson 7
Merchandise Inventories
and Cost of Sales
Task Team of
FUNDAMENTAL ACCOUNTING
School of Business,Sun Yat-sen University
2
Outline
?Flow of inventory cost
?Items and costs of merchandising inventory
?Assigning costs to inventory
?Lower of cost or market
?Errors in measuring inventory
?Inventory estimating method
3
Introduction
?While sales and purchases are the focus of
operations,inventory is no less important,
Inventory costing and evaluation methods can
substantially influence the bottom line,Since
China’s listed companies were permitted to write
down inventories in 1998,inventory has long been
criticized as the,income adjustor”,Besides,
inventory costing policies and the scope of
inventory can also significant change the current
and future years income numbers.
4
Nature of Inventory and Cost of
Goods Sold
Beginning
Inventory
Purchases
for the Period
Ending Inventory
(Balance Sheet)
Goods Available
for Sale
Cost of Goods Sold
(Income Statement)
Beginning inventory + Purchases – Ending inventory = Cost of goods sold
+
+
5
Flow of Inventory Costs
Merchandise
Purchases
Cost of
Goods Sold
Merchandise
Inventory
Direct
Labour
Factory
Overhead
Raw Materials
Inventory
Work in Process
Inventory
Finished Goods
Inventory
Cost of
Goods Sold
Merchandiser
Manufacturer
Raw
Materials
6
Accounting for Inventory
?Accounting for inventory requires
several decisions which include:
?Items to include in cost,
?Inventory System.
→ Perpetual or Periodic
?Costing Method.
→ FIFO,LIFO,Weighted Average,Specific ID
?Use of estimates.
→ Gross profit method,Retail inventory method
7
Items in Merchandise Inventory
?Inventory includes all goods owned by
a company and held for sale.
?Items requiring special attention:
→ Goods in Transit
→ Goods on consignment
→ Obsolete or damaged goods
8
Costs of Merchandise Inventory
?All expenditures necessary to bring an
item to a saleable condition and
location.
?This includes:
→ Invoice price less discounts
→ Import duties
→ Transportation-in
→ Storage
→ Insurance
9
? Management must decide on method
of determining unit cost.
? This will affect both the income
statement and the balance sheet.
?Methods:
→ Specific Identification
→ FIFO
→ LIFO
→ Average Cost
Assigning Costs to Inventory
10
Specific Identification
?This method is used when items:
?Are unique.
?Can be directly identified with a specific
purchase and its invoice.
Examples,Automobiles,
custom furniture,art.
11
Specific Identification-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 8 90$ 720$ 2 90$ 180$
12 100$ 1,2 0 0$ 3 100$ 300$
5 480$
2 90$ 180$
3 100$ 300$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 8 0$
8 / 2 8 2 90$ 180$ 3 100$ 300$
12 110$ 1,3 2 0$ 8 110$ 880$
To t a l s 45 4,6 0 0$ 34 3,4 2 0$ 11 1,1 8 0$
S pe c i f i c I de nt i f i c a t on C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
The opening inventory consists of 10 units @ $90/unit.
12
Specific Identification-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 8 90$ 720$ 2 90$ 180$
12 100$ 1,2 0 0$ 3 100$ 300$
5 480$
2 90$ 180$
3 100$ 300$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 8 0$
8 / 2 8 2 90$ 180$ 3 100$ 300$
12 110$ 1,3 2 0$ 8 110$ 880$
To t a l s 45 4,6 0 0$ 34 3,4 2 0$ 11 1,1 8 0$
S pe c i f i c I de nt i f i c a t on C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
This results in two layers of
inventory.Additional units re purchased @ $100/unit.
13
Specific Identification-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 8 90$ 720$ 2 90$ 180$
12 100$ 1,2 0 0$ 3 100$ 300$
5 480$
2 90$ 180$
3 100$ 300$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 8 0$
8 / 2 8 2 90$ 180$ 3 100$ 300$
12 110$ 1,3 2 0$ 8 110$ 880$
To t a l s 45 4,6 0 0$ 34 3,4 2 0$ 11 1,1 8 0$
S pe c i f i c I de nt i f i c a t on C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
On August 14,20 units are sold,Eight of these units came from
the opening inventory and the remaining 12 units came from
the August 3 purchase.
14
Specific Identification-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 8 90$ 720$ 2 90$ 180$
12 100$ 1,2 0 0$ 3 100$ 300$
5 480$
2 90$ 180$
3 100$ 300$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 8 0$
8 / 2 8 2 90$ 180$ 3 100$ 300$
12 110$ 1,3 2 0$ 8 110$ 880$
To t a l s 45 4,6 0 0$ 34 3,4 2 0$ 11 1,1 8 0$
S pe c i f i c I de nt i f i c a t on C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
This leaves 2 units remaining from the
original inventory and 3 units remaining
from the August 3 purchase.
15
?Based on the assumption that the items are
sold in the order acquired.
?When a sale occurs:
?The earliest units purchased are charged to
Cost of Goods Sold.
?The cost of the most recent purchases remain in
inventory
First-In,First-Out (FIFO)
16
FIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 10 90$ 900$
10 100$ 1,0 0 0$ 5 100$ 500$
5 100$ 500$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,7 0 0$
8 / 2 8 5 100$ 500$
9 110$ 990$ 11 110$ 1,2 1 0$
To t a l s 45 4,6 0 0$ 34 3,3 9 0$ 11 1,2 1 0$
FI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
Under FIFO,units are assumed to be sold in the order acquired,Therefore,
of the 20 units sold on August 14,the first 10 units come from beginning
inventory,Therefore,those 10 units are removed from the inventory record
based on the cost of those units of $90.
17
FIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 10 90$ 900$
10 100$ 1,0 0 0$ 5 100$ 500$
5 100$ 500$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,7 0 0$
8 / 2 8 5 100$ 500$
9 110$ 990$ 11 110$ 1,2 1 0$
To t a l s 45 4,6 0 0$ 34 3,3 9 0$ 11 1,2 1 0$
FI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
The remaining 10 units sold on August 14th come from the next
purchase,made on August 3rd,Therefore,these units are
removed from the inventory record based on their cost of $100.
18
FIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 10 90$ 900$
10 100$ 1,0 0 0$ 5 100$ 500$
5 100$ 500$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,7 0 0$
8 / 2 8 5 100$ 500$
9 110$ 990$ 11 110$ 1,2 1 0$
To t a l s 45 4,6 0 0$ 34 3,3 9 0$ 11 1,2 1 0$
FI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
The ending inventory consists of
the 5 remaining units from the
August 3 purchase.
Ending inventory
approximates current
replacement cost.
19
Last-In,First-Out (LIFO)
?Based on the assumption that the most
recently purchased items are sold first.
?When a sale occurs:
?The latest units purchased are charged to Cost of
Goods Sold.
?The cost of the earliest purchases remain in
inventory.
20
LIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 15 100$ 1,5 0 0$
5 90$ 450$ 5 90$ 450$
5 90$ 450$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 5 0$
8 / 2 8 14 110$ 1,5 4 0$ 5 90$ 450$
6 110$ 660$
To t a l s 45 4,6 0 0$ 34 3,4 9 0$ 11 1,1 1 0$
LI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
Of the 20 units sold,these
units are assumed to be sold
first.
21
LIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 15 100$ 1,5 0 0$
5 90$ 450$ 5 90$ 450$
5 90$ 450$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 5 0$
8 / 2 8 14 110$ 1,5 4 0$ 5 90$ 450$
6 110$ 660$
To t a l s 45 4,6 0 0$ 34 3,4 9 0$ 11 1,1 1 0$
LI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
Once the latest units purchased are
sold,units are sold from the
previous purchase.
22
LIFO-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 15 100$ 1,5 0 0$
25 2,4 0 0$
8 / 1 4 15 100$ 1,5 0 0$
5 90$ 450$ 5 90$ 450$
5 90$ 450$
8 / 1 7 20 110$ 2,2 0 0$ 20 110$ 2,2 0 0$
25 2,6 5 0$
8 / 2 8 14 110$ 1,5 4 0$ 5 90$ 450$
6 110$ 660$
To t a l s 45 4,6 0 0$ 34 3,4 9 0$ 11 1,1 1 0$
LI FO C om pu t a t i on s - P e r pe t ua l I nv e nt ory S y s t e m
This leaves 5 units remaining
from the first purchase.
Better matches
current costs in cost
of goods sold with
revenues.
23
?Under this method,the cost of all units are
averaged together.
Average cost per unit
Cost of goods available for sale
Number of units available for sale=
Moving Weighted Average Method
24
Moving Weighted Average-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 25 96$ 2,4 0 0$
8 / 1 4 20 96$ 1,9 2 0$ 5 96$ 480$
8 / 1 7 20 110$ 2,2 0 0$ 25 107$ 2,6 8 0$
8 / 2 8 14 107$ 1,5 0 1$ 11 107$ 1,1 7 9$
Tot a l s 45 4,6 0 0$ 34 3,4 2 1$ 11 1,1 7 9$
M ov i ng W e i ght e d A v e r a ge C om put a t i ons - P e r pe t ua l I nv e nt or y S y s t e m
Additional units are
purchased @ $100/unit,This results in an average cost
of $100/unit.
(10 x $90) + (15 x $100)
25 units
25
Moving Weighted Average-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 25 96$ 2,4 0 0$
8 / 1 4 20 96$ 1,9 2 0$ 5 96$ 480$
8 / 1 7 20 110$ 2,2 0 0$ 25 107$ 2,6 8 0$
8 / 2 8 14 107$ 1,5 0 1$ 11 107$ 1,1 7 9$
Tot a l s 45 4,6 0 0$ 34 3,4 2 1$ 11 1,1 7 9$
M ov i ng W e i ght e d A v e r a ge C om put a t i ons - P e r pe t ua l I nv e nt or y S y s t e m
These 20 units are sold at the
average cost of $96/unit.
26
Moving Weighted Average-Example
P u r c h a s e s S a l e s B a l a n c e
D a t e U n i t s C o s t T o t a l U n i t s C o s t T o t a l U n i t s C o s t T o t a l
8 / 1 10 90$ 900$ 10 90$ 900$
8 / 3 15 100$ 1,5 0 0$ 25 96$ 2,4 0 0$
8 / 1 4 20 96$ 1,9 2 0$ 5 96$ 480$
8 / 1 7 20 110$ 2,2 0 0$ 25 107$ 2,6 8 0$
8 / 2 8 14 107$ 1,5 0 1$ 11 107$ 1,1 7 9$
Tot a l s 45 4,6 0 0$ 34 3,4 2 1$ 11 1,1 7 9$
M ov i ng W e i ght e d A v e r a ge C om put a t i ons - P e r pe t ua l I nv e nt or y S y s t e m
This leaves 5 units remaining
at an average cost of $96/unit.
Smoothes out
purchase price
changes.
27
?Because prices change,the choice of an inventory
method influences both income statement and the
balance sheet.
S I N P E C C o m p a n y
M o n t h e n d i n g A u g u s t 3 1,2 0 0 5
S p e c i f i c
I d e n t i f i c a t i o n F I F O L I F O
M o v i n g
W e i g h t e d
A v e r a g e
S a l e s 5,6 4 0$ 5,6 4 0$ 5,6 4 0$ 5,6 4 0$
C o s t o f G o o d s S o l d 3,4 2 0$ 3,3 9 0$ 3,4 9 0$ 3,4 2 1$
G r o s s P r o f i t 2,2 2 0 2,2 5 0 2,1 5 0 2,2 1 9
O p e r a t i n g e x p e n s e s 374 374 374 374
I n c o m e f r o m o p e r a t i o n s 1,8 4 6$ 1,8 7 6$ 1,7 7 6$ 1,8 4 5$
M e r c h a n d i s e I n v e n t o r y 1,1 8 0$ 1,2 1 0$ 1,1 1 0$ 1,1 7 9$
A u g u s t 3 1,2 0 0 1
B a l a n c e S h e e t
Financial Reporting
28
? Inventory must be reported at market value when
market is lower than cost (conservatism principle).
? Market may be defined as:
?Net realizable value
?Current replacement cost
? May be applied in one of three ways:
?Separately to each item.
?To major categories of items.
?To the inventory as a whole.
Lower of Cost or Market
29
A motor retailer has the following items in inventory:
P e r U ni t
I nv e nt or y I t e m s
U ni t s on
H a nd C os t M a r k e t Tot a l C os t
Tot a l
M a r k e t
C y c l e s,
R o a d s t e r 20 6,0 0 0$ 5,0 0 0$ $ 1 2 0,0 0 0 $ 1 0 0,0 0 0
S p r i n t 10 4,0 0 0 5,0 0 0 4 0,0 0 0 5 0,0 0 0
C a t e g o r y s u b t o t a l 1 6 0,0 0 0 1 5 0,0 0 0
O f f - R oa d
T r a x - 4 10 5,0 0 0 6,0 0 0 5 0,0 0 0 6 0,0 0 0
B l a z e r 5 8,0 0 0 7,0 0 0 4 0,0 0 0 3 5,0 0 0
C a t e g o r y s u b t o t a l 9 0,0 0 0 9 5,0 0 0
T o t a l $ 2 5 0,0 0 0 $ 2 4 5,0 0 0
Lower of Cost or Market
30
I nv e nt or y I t e m s
U ni t s on
H a nd Tot a l C os t
Tot a l
M a r k e t I t e m s C a t e g o r i e s W h o l e
C y c l e s,
R o a d s t e r 20 $ 1 2 0,0 0 0 $ 1 0 0,0 0 0 1 0 0,0 0 0$
S p r i n t 10 4 0,0 0 0 5 0,0 0 0 4 0,0 0 0
C a t e g o r y s u b t o t a l $ 1 6 0,0 0 0 $ 1 5 0,0 0 0
O f f - R oa d
T r a x - 4 10 $ 5 0,0 0 0 $ 6 0,0 0 0 5 0,0 0 0
B l a z e r 5 4 0,0 0 0 3 5,0 0 0 3 5,0 0 0
C a t e g o r y s u b t o t a l $ 9 0,0 0 0 $ 9 5,0 0 0
T o t a l $ 2 5 0,0 0 0 $ 2 4 5,0 0 0 2 2 5,0 0 0$
L C M A p p l i e d t o
Compute lower of cost or market for individual inventory items.
Lower of Cost or Market
31
I nv e nt or y I t e m s
U ni t s on
H a nd Tot a l C os t
Tot a l
M a r k e t I t e m s C a t e g o r i e s W h o l e
C y c l e s,
R o a d s t e r 20 $ 1 2 0,0 0 0 $ 1 0 0,0 0 0 1 0 0,0 0 0$
S p r i n t 10 4 0,0 0 0 5 0,0 0 0 4 0,0 0 0
C a t e g o r y s u b t o t a l $ 1 6 0,0 0 0 $ 1 5 0,0 0 0 1 5 0,0 0 0$
O f f - R oa d
T r a x - 4 10 $ 5 0,0 0 0 $ 6 0,0 0 0 5 0,0 0 0
B l a z e r 5 4 0,0 0 0 3 5,0 0 0 3 5,0 0 0
C a t e g o r y s u b t o t a l $ 9 0,0 0 0 $ 9 5,0 0 0 9 0,0 0 0
T o t a l $ 2 5 0,0 0 0 $ 2 4 5,0 0 0 2 2 5,0 0 0$ 2 4 0,0 0 0$
L C M A p p l i e d t o
Lower of Cost or Market
Compute lower of cost or market for the two groups of inventory items.
32
I nv e nt or y I t e m s
U ni t s on
H a nd Tot a l C os t
Tot a l
M a r k e t I t e m s C a t e g o r i e s W h o l e
C y c l e s,
R o a d s t e r 20 $ 1 2 0,0 0 0 $ 1 0 0,0 0 0 1 0 0,0 0 0$
S p r i n t 10 4 0,0 0 0 5 0,0 0 0 4 0,0 0 0
C a t e g o r y s u b t o t a l $ 1 6 0,0 0 0 $ 1 5 0,0 0 0 1 5 0,0 0 0$
O f f - R oa d
T r a x - 4 10 $ 5 0,0 0 0 $ 6 0,0 0 0 5 0,0 0 0
B l a z e r 5 4 0,0 0 0 3 5,0 0 0 3 5,0 0 0
C a t e g o r y s u b t o t a l $ 9 0,0 0 0 $ 9 5,0 0 0 9 0,0 0 0
T o t a l $ 2 5 0,0 0 0 $ 2 4 5,0 0 0 2 2 5,0 0 0$ 2 4 0,0 0 0$ 2 4 5,0 0 0$
L C M A p p l i e d t o
Lower of Cost or Market
Compute lower of cost or market for the entire inventory.
33
Errors in Measuring Inventory
E r r o r s i n M e a s u r i n g I n v e n t o r y
B e gi nni ng I nv e nt or y E ndi ng I nv e nt or y
O v e r s t a t e d U nde r s t a t e d O v e r s t a t e d U nde r s t a t e d
E f f e c t on I nc om e S t a t e m e nt
G ood s A v a i l a bl e f or S a l e + - N / A N / A
C os t of G ood s S ol d + - - +
G r os s P r of i t - + + -
N e t I nc om e - + + -
E f f e c t on B a l a nc e S he e t
I nv e nt or y ( 1 2 / 3 1 ) N / A N / A + -
R e t a i ne d E a r ni ngs - + + -
B e g in n in g in v e n to r y + P u r c h a s e s – E n d in g in v e n to r y = C o s t o f g o o d s s o ld
34
?Occasionally used for interim period
reporting.
?Needed information includes:
?Beginning inventory at cost and retail.
?Net purchases at cost and retail.
?Net sales.
Retail Inventory Method
35
Retail Inventory Method
Step 3 Cost to retail ratioEnding inventory at retail
Estimated
ending
inventory at
cost
=×
Step 2 Goods available for sale at retailGoods available for sale at cost =÷ Cost to retail ratio
Step 1 Net sales at retailGoods available for sale at retail – = Ending inventory at retail
36
C o m p u t i n g E n d i n g I n v e n t o r y U s i n g t h e R e t a i l M e t h o d
A t C o s t A t R e t a i l
G o o d s A v a i l a b l e f o r S a l e
B e g i n n i n g I n v e n t o r y 2 0,0 0 0$ 3 5,0 0 0$
C o s t o f g o o d s p u r c h a s e d 4 0,0 0 0 7 2,0 0 0
G o o d s a v a i l a b l e f o r s a l e 6 0,0 0 0$ 1 0 7,0 0 0$
S t e p 1 D e d u c t n e t s a l e s a t r e t a i l 7 0,0 0 0
E n d i n g i n v e n t o r y a t r e t a i l 3 7,0 0 0$
Retail Inventory Method
37
C o m p u t i n g E n d i n g I n v e n t o r y U s i n g t h e R e t a i l M e t h o d
A t C o s t A t R e t a i l
G o o d s A v a i l a b l e f o r S a l e
B e g i n n i n g I n v e n t o r y 2 0,0 0 0$ 3 5,0 0 0$
C o s t o f g o o d s p u r c h a s e d 4 0,0 0 0 7 2,0 0 0
G o o d s a v a i l a b l e f o r s a l e 6 0,0 0 0$ 1 0 7,0 0 0$
S t e p 1 D e d u c t n e t s a l e s a t r e t a i l 7 0,0 0 0
E n d i n g i n v e n t o r y a t r e t a i l 3 7,0 0 0$
S t e p 2 C o s t - t o - r e t a i l r a t i o 56%
Retail Inventory Method
38
C o m p u t i n g E n d i n g I n v e n t o r y U s i n g t h e R e t a i l M e t h o d
A t C o s t A t R e t a i l
G o o d s A v a i l a b l e f o r S a l e
B e g i n n i n g I n v e n t o r y 2 0,0 0 0$ 3 5,0 0 0$
C o s t o f g o o d s p u r c h a s e d 4 0,0 0 0 7 2,0 0 0
G o o d s a v a i l a b l e f o r s a l e 6 0,0 0 0$ 1 0 7,0 0 0$
S t e p 1 D e d u c t n e t s a l e s a t r e t a i l 7 0,0 0 0
E n d i n g i n v e n t o r y a t r e t a i l 3 7,0 0 0$
S t e p 2 C o s t - t o - r e t a i l r a t i o 56%
S t e p 3 E s t i m a t e d e n d i n g i n v e n t o r y a t c o s t, 2 0,7 4 6$
$ 3 7,0 0 0 * 5 6 %
Retail Inventory Method
39
Gross Profit Method
?Estimate ending inventory by applying the
gross profit ratio to net sales at retail.
?Useful when inventories have been
destroyed,lost or stolen.
40
Gross Profit Method
Step 1 1.0 minus the gross profit ratioNet sales at retail × = Estimated cost of goods sold
Step 2 Estimated cost of goods soldGoods available for sale at cost – =
Estimated
ending
inventory at
cost
41
Gross Profit Method
? In March of 2002,CheTec Company’s inventory was
destroyed by fire,CheTec’s normal gross profit ratio is
40% of net sales,At the time of the fire,CheTec showed
the following balances:
S a l e s 4 0,0 0 0$
S a l e s r e t u r n s 2,0 0 0
I n v e n t o r y,1 / 1 / 0 2 1 2,0 0 0
N e t c o s t o f g o o d s p u r c h a s e d 3 0,0 0 0
42
Gross Profit Method
S a l e s 4 0,0 0 0$
L e s s, s a l e s r e t u r n s ( 2,0 0 0 )
N e t s a l e s 3 8,0 0 0
( 1 0 0 % - 4 0 % ) 60%
E s t i m a t e d c o s t o f g o o d s s o l d 2 2,8 0 0$
Step 1
43
Gross Profit Method
G oo ds A v a i l a bl e f or S a l e,
I nv e nt or y,1 / 1 / 0 2 1 2,0 0 0$
N e t c os t of go od s pu r c ha s e d 3 0,0 0 0
G oo ds a v a i l a bl e f or s a l e 4 2,0 0 0
Le s s e s t i m a t e d c os t of go od s s ol d:
E s t i m a t e d c os t of go od s s ol d ( 2 2,8 0 0 )
E s t i m a t e d M a r c h i nv e nt or y l os s 1 9,2 0 0$
Step 2
44
Discussion Case
Northeast Pharmaceutical
?When preparing financial statement of 1996,
Northeast Pharmaceutical recorded RMB
21,280,000 expenses as inventory cost,which
carries to next year’s beginning inventory,
As a result,the bottom line is RMB
19,950,000 profits,instead of a big loss,This
was discovered and was fined by CSRC as
securities fraud.
45
Discussion Case
?Required:
?What’s the difference between
expenses and inventory costs?
?What are the impacts of inventory
errors on financial statements?
?Why Northeast Pharmaceutical
chose to report false income
numbers?
?How to prevent the occurrence of
such kind of cases.
46
Summary
? Inventory includes all goods owned by a company and held for
sale.
? Costs of merchandise inventory include all expenditures
necessary to bring an item to a saleable condition and location.
? There are four method to assigning costs to inventory,specific
identification,FIFO,LIFO and average cost,The average cost
method smoothes out purchase price changes,Ending
inventory under FIFO approximates current replacement cost,
LIFO better matches current cost in cost of goods sold with
revenue.
? Inventory must be reported at market value when market is
lower than cost.
? Retail inventory method and gross profit method can be used
to estimate ending inventory.
The End of Lesson 7
