?The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Chapter 8
Inventories and the Cost of
Goods Sold
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Inventory Defined
Goods owned and
held for sale to
customers
Current
asset
Inventory
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Flow of Inventory Costs
B A L A N C E S H E E T
C u r r e n t a s s e t s,
I n v e n t o r y
I N C O M E S TA TE M E N T
R e v e nu e
C os t of go od s s ol d
G r os s pr of i t
E x pe ns e s
N e t i nc om e
Purchase cost
(or manufacturing
costs) as
incurred
as goods
are sold
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Flow of Inventory Costs
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
E n t r y o n P u r c h a s e D a t e
I n v e n t o r y $$$$
A c c o u n t s P a y a b l e $$$$
E n t r y o n S a l e D a t e
C o s t o f G o o d s S o l d $$$$
I n v e n t o r y $$$$
In a perpetual inventory system,inventory entries
parallel the flow of costs.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Which Unit Did We Sell?
Does It Really Matter?
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
E n t r y o n S a l e D a t e
C o s t o f G o o d s S o l d $$$$
I n v e n t o r y $$$$
When identical units of inventory have
different unit costs,a question naturally
arises as to which of these costs should be
used in recording a sale of inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Inventory Subsidiary Ledger
A separate subsidiary account is
maintained for each item in inventory.
How can we determine the unit cost for the
Sept,10 sale?
I t e m LL0 0 2 P r i m a r y s uppl i e r E l e c t r oni c C i t y
D e s c r i pt i on La s e r Li ght S e c onda r y s uppl i e r E l e c t r i c C om pa ny
Loc a t i on S t or e r oom 2 I nv e nt or y l e v e l, M i n,2 5 M a x, 2 0 0
P ur c ha s e d S ol d B a l a nc e
D a t e U ni t s
U ni t
C os t Tot a l U ni t s
U ni t
C os t
C os t of
G oods
S ol d U ni t s
U ni t
C os t Tot a l
S e pt, 5 100 30$ 3,0 0 0$ 100 30$ 3,0 0 0$
S e pt, 9 75 50 3,7 5 0 100 30 3,0 0 0
75 50 3,7 5 0
S e pt, 1 0 10
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific
identification
LIFO
Average
cost
FIFO
To determine the cost of inventory sold,
accountants use one of the following
inventory valuation methods.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Information for the Following
Inventory Examples
C os t of G oo ds A v a i l a bl e f or S a l e
A ug, 1 B e g,I nv e nt or y 10 un i t s @ 91$ = 910$
A ug, 3 P ur c ha s e d 15 un i t s @ 106$ = 1,5 9 0$
A ug, 17 P ur c ha s e d 20 un i t s @ 115$ = 2,3 0 0$
A ug, 28 P ur c ha s e d 10 un i t s @ 119$ = 1,1 9 0$
R e t a i l S a l e s of G oo ds
A ug, 14 S a l e s 20 un i t s @ 130$ = 2,6 0 0$
A ug, 31 S a l e s 23 un i t s @ 150$ = 3,4 5 0$
The Bike Company (TBC)
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
When units
are sold,the
specific cost
of the unit
sold is added
to cost of
goods sold.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
Example
On August 14,TBC sold 20 bikes for $130 each,
Nine bikes originally cost $91 and 11 bikes
originally cost $106.
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
Example
The Cost of Goods Sold for the August 14 sale is
$1,985,leaving $515 and 5 units in inventory,
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 9 @ 91$ = 819$
11 @ 106$ = 1,1 6 6$ 515$
Let抯 look at the entries
for the Aug,14 sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
Example
Continue
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
A u g, 14 C a s h 2,6 0 0
S a l e s 2,6 0 0
14 C o s t o f G o o d s S o l d 1,9 8 5
I n v e n t o r y 1,9 8 5
Retail
Cost
A similar entry is made after
each sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
Example
Additional purchases were made on August 17 and 28,
Costs associated with sales on August 31 were as
follows,1 @ $91,3 @ $106,15 @ $115,& 4 @ $119.
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 9 @ 91$ = 819$
11 @ 106$ = 1,1 6 6$ 515$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 1 5$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 4,0 0 5$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug,1 10 @ 91$ = 910$ 910$
A ug,3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A ug,1 4 9 @ 91$ = 819$
11 @ 106$ = 1,1 6 6$ 515$
A ug,1 7 20 @ 115$ = 2,3 0 0$ 2,8 1 5$
A ug,2 8 10 @ 119$ = 1,1 9 0$ 4,0 0 5$
A ug,3 1 1 @ 91$ = 91$
3 @ 106$ = 318$
15 @ 115$ = 1,7 2 5$
4 @ 119$ = 476$ 1,3 9 5$
Specific Identification
Example
Cost of Goods
Sold for
August 31 =
$2,610
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Balance Sheet
Inventory = $1,395
Income Statement
COGS = $4,595
Specific Identification
Example
1 @ 106$ = 106$
5 @ 115$ = 575
6 @ 119$ = 714
E n d, I n v, 1,3 9 5$
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 9 @ 91$ = 819$
11 @ 106$ = 1,1 6 6$ 515$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 1 5$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 4,0 0 5$
A u g, 3 1 1 @ 91$ = 91$
3 @ 106$ = 318$
15 @ 115$ = 1,7 2 5$
4 @ 119$ = 476$ 1,3 9 5$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Since specific
identification is so
easy,can’nt we use
it all the time?
Not really,Specific
identification is hard to use
when we sell a lot of
inventory that has lots of
different costs.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
When a unit is sold,the
average cost of each
unit in inventory is
assigned to cost of
goods sold,
Cost of Goods
Available for
Sale
Units on hand
on the date of
sale
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
Example
On August 14,TBC sold 20 bikes for
$130 each,
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
$100 = $2,500 ? 25
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
Average-Cost Method
Example
Continue
The average cost per
unit must be
computed prior to
each sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
$100 = $2,500 ? 25
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A ug, 1 4 20 @ 100$ = 2,0 0 0$ 500$
Average-Cost Method
Example
Continue
The average cost per
unit is $100.
Let’s look at the entries
for the Aug,14 sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
Example
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
A u g, 14 C a s h 2,6 0 0
S a l e s 2,6 0 0
14 C o s t o f G o o d s S o l d 2,0 0 0
I n v e n t o r y 2,0 0 0
Retail
Cost
Continue
A similar entry is made after
each sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Additional purchases were made on August 17 and
August 28.
On August 31,an additional 23 units were sold.
Average-Cost Method
Example
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A ug, 1 4 20 @ 100$ = 2,0 0 0$ 500$
A ug, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 0 0$
A ug, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 9 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
$114 = $3,990 ? 35
Average-Cost Method
Example
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A ug, 1 4 20 @ 100$ = 2,0 0 0$ 500$
A ug, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 0 0$
A ug, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 9 0$
T o ta l P u r ch a se s 55
L e ss,S a l e s to Da te - 2 0
Un i ts o n Ha n d 35
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
Example
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A ug, 1 4 20 @ 100$ = 2,0 0 0$ 500$
A ug, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 0 0$
A ug, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 9 0$
A ug, 3 1 23 @ 114$ = 2,6 2 2$ 1,3 6 8$
$114 = $3,990 ? 35The average cost per
unit is $114.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Income Statement
COGS = $4,622
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 20 @ 100$ = 2,0 0 0$ 500$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 0 0$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 9 0$
A u g, 3 1 23 @ 114$ = 2,6 2 2$ 1,3 6 8$
Average-Cost Method
Example
Balance Sheet
Inventory = $1,368
$114?12 = $1,368
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
First-In,First-Out Method
(FIFO)
Costs of
Goods Sold
Oldest
Costs
Ending
Inventory
Recent
Costs
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
FIFO
Example
On August 14,TBC sold 20 bikes for
$130 each,
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 10 @ 91$ = 910$
10 @ 106$ = 1,0 6 0$ 530$
FIFO
Example
The Cost of Goods Sold for the August 14 sale is
$1,970,leaving $530 and 5 units in inventory,
Continue
Let’s look at the entries
for the Aug,14 sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
FIFO
Example
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
A u g, 14 C a s h 2,6 0 0
S a l e s 2,6 0 0
14 C o s t o f G o o d s S o l d 1,9 7 0
I n v e n t o r y 1,9 7 0
Retail
Cost
Continue
A similar entry is made after
each sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Additional purchases were made on August 17 and
August 28.
On August 31,an additional 23 units were sold.
FIFO
Example
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 10 @ 91$ = 910$
10 @ 106$ = 1,0 6 0$ 530$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 3 0$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 4,0 2 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
FIFO
Example
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 10 @ 91$ = 910$
10 @ 106$ = 1,0 6 0$ 530$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 3 0$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 4,0 2 0$
A u g, 3 1 5 @ 106$ = 530$
18 @ 115$ = 2,0 7 0$ 1,4 2 0$
Cost of Goods Sold for August 31 = $2,600
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 10 @ 91$ = 910$
10 @ 106$ = 1,0 6 0$ 530$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 3 0$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 4,0 2 0$
A u g, 3 1 5 @ 106$ = 530$
18 @ 115$ = 2,0 7 0$ 1,4 2 0$
FIFO
Example
Balance Sheet
Inventory = $1,420
Income Statement
COGS = $4,570
2 @ 115$ = 230$
10 @ 119$ = 1,1 9 0
E n d, I n v, 1,4 2 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Last-In,First-Out Method
(LIFO)
Costs of
Goods Sold
Recent
Costs
Ending
Inventory
Oldest
Costs
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
On August 14,TBC sold 20 bikes for
$130 each,
LIFO
Example
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 15 @ 106$ = 1,5 9 0$
5 @ 91$ = 455$ 455$
LIFO
Example
The Cost of Goods Sold for the August 14 sale is
$2,045,leaving $455 and 5 units in inventory,
Continue
Let’s look at the entries
for the Aug,14 sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
LIFO
Example
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
A u g, 14 C a s h 2,6 0 0
S a l e s 2,6 0 0
14 C o s t o f G o o d s S o l d 2,0 4 5
I n v e n t o r y 2,0 4 5
Retail
Cost
Continue
A similar entry is made after
each sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
LIFO
Example
Additional purchases were made on August 17 and
August 28.
On August 31,an additional 23 units were sold.
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 15 @ 106$ = 1,5 9 0$
5 @ 91$ = 455$ 455$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,7 5 5$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 4 5$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
LIFO
Example
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 15 @ 106$ = 1,5 9 0$
5 @ 91$ = 455$ 455$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,7 5 5$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 4 5$
A u g, 3 1 10 @ 119$ = 1,1 9 0$
13 @ 115$ = 1,4 9 5$ 1,2 6 0$
Cost of Goods Sold for August 31 = $2,685
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 15 @ 106$ = 1,5 9 0$
5 @ 91$ = 455$ 455$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,7 5 5$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 4 5$
A u g, 3 1 10 @ 119$ = 1,1 9 0$
13 @ 115$ = 1,4 9 5$ 1,2 6 0$
LIFO
Example
Balance Sheet
Inventory = $1,260
Income Statement
COGS = $4,730
5 @ 91$ = 455$
7 @ 115$ = 805
E n d, I n v, 1,2 6 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
I nv e nt or y V a l ua t i on M e t hod s, A S um m a r y
C os t s A l l oc a t e d t o:
V a l ua t i on
M e t hod
C os t of G ood s
S ol d I nv e nt or y C om m e nt s
S pe c i f i c A c t ua l c os t of A c t ua l c os t of uni t s P a r a l l e l s phy s i c a l f l ow
i de nt i f i c a t i on t he uni t s s ol d r e m a i ni ng Log i c a l m e t hod w he n uni t s
a r e uni que
M a y be m i s l e a di ng f or
i de nt i c a l uni t s
A v e r a ge c os t N um be r of uni t s
s ol d t i m e s t he
N um be r of uni t s on
ha nd t i m e s t he
A s s i gns a l l uni t s t he s a m e
a v e r a ge uni t c os t
a v e r a ge uni t c os t a v e r a ge uni t c os t C ur r e nt c os t s a r e a v e r a ge d
i n w i t h ol de r c os t s
Fi r s t - i n,Fi r s t - out
( FI FO )
C os t of e a r l i e s t
pur c ha s e s on
C os t of m os t
r e c e nt l y
C os t of goo ds s ol d i s ba s e d
on ol de r c os t s
ha nd pr i or t o t he
s a l e
pur c ha s e d uni t s I nv e nt or y v a l ue d a t c ur r e nt
c os t s
M a y ov e r s t a t e i nc om e dur i ng
pe r i ods of r i s i ng pr i c e s ; m a y
i nc r e a s e i nc om e t a x e s due
La s t - i n,Fi r s t - out
( LI FO )
C os t of m os t
r e c e nt l y
C os t of e a r l i e s t
pur c ha s e s
C os t of goo ds s ol d s how n a t
r e c e nt pr i c e s
pur c ha s e d uni t s a s s um e d s t i l l i n
i nv e nt or y )
I nv e nt or y s how n a t ol d ( a nd
pe r ha ps out of da t e ) c os t s
M os t c ons e r v a t i v e m e t hod
dur i ng pe r i ods of r i s i ng
pr i c e s ; of t e n r e s ul t s i n l ow e r
i nc om e t a x e s
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Principle of Consistency
Once a company has
adopted a particular
accounting method,it
should follow that
method consistently,
rather than switch
methods from one
year to the next.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Just-In-Time (JIT) Inventory
Systems
This inventory arrived
just in time for us to use
in the manufacturing
process.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Taking a Physical Inventory
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
D e c, 31 C o s t o f G o o d s S o l d $$$$
I n v e n t o ry $$$$
The primary reason for taking a physical inventory
is to adjust the perpetual inventory records for
unrecorded shrinkage losses,such as theft,
spoilage,or breakage.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
LCM and Other Write-Downs of
Inventory
Reduces the value
of the inventory.Obsolescence
Adjust inventory
value to the lower
of historical cost or
current
replacement cost
(market).
Lower of Cost
or Market
(LCM)
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Goods In Transit
Year
End
A sale should be recorded when
title to the merchandise passes
to the buyer.
F.O.B,
shipping
point ? title
passes to
buyer at the
point of
shipment.
F.O.B,
destination
point ? title
passes to
buyer at the
point of
destin tion.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Periodic Inventory Systems
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
E n t r y o n P u r c h a s e D a t e
P u r c h a s e s $$$$
A c c o u n t s P a y a b l e $$$$
In a periodic inventory system,inventory entries
are as follows.
Note that an entry is not
made to inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Periodic Inventory Systems
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
E n t r y o n S a l e D a t e
N o e n t r y t o i n v e n t o r y,
A c c o u n t s R e c e i v a b l e $$$$
S a l e s $$$$
In a periodic inventory system,inventory entries
are as follows.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Periodic Inventory Systems
The inventory on
hand and the
cost of goods
sold for the year
are not
determined until
year-end.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific
identification
LIFO
Average
cost
FIFO
Accountants use one of the following
inventory valuation methods in a periodic
inventory system.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0?
C o s t o f
G o o d s So l d 600?
Information for the Following
Inventory Examples
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
Example
By reviewing actual
purchase invoices,
Computers,Inc,
determines that the 1,200
mouse pads on hand at
year-end have an actual
total cost of $6,400.
Determine the cost of
goods sold for the year.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0 6,4 0 0, 0 0$
C o s t o f
G o o d s So l d 600 3,3 2 5, 0 0$
Specific Identification
Example
Cost of Goods Sold
$9,725 - $6,400 = $3,325
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Now let’s move
on to the
average-cost
valuation method.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
The average cost is
calculated at year-end
as follows:
Total Cost of
Goods
Available for
Sale
Total Number
of Units
Available for
Sale
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
Example
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0?
C o s t o f
G o o d s So l d 600?
Avg,Cost $5.40278 = $9,725 ? 1,800
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
Example
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0 6,4 8 3, 0 0$
C o s t o f
G o o d s So l d 600 3,2 4 2, 0 0$
Ending Inventory
Avg,Cost $5.40278 ??1,200 = $6,483
Cost of Goods Sold
Avg,Cost $5.40278 ??600 = $3,242
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
First-In,First-Out Method
(FIFO)
Costs of
Goods Sold
Oldest
Costs
Ending
Inventory
Recent
Costs
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0?
C o s t o f
G o o d s So l d 600?
FIFO
Example
Remember,Start with the 11/29 purchase and then
add other purchases until you reach the number of
units in ending inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
N o v, 2 9 1 5 0 @ $ 5, 9 0 1 5 0 @ $ 5, 9 0
U n i ts 150
FIFO
Example
Now,let’s complete the
table.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
1,0 0 0 @ $ 5, 2 5 6 0 0 @ $ 5, 2 5
4 0 0 @ $ 5, 2 5
J a n, 3 3 0 0 @ $ 5, 3 0 3 0 0 @ $ 5, 3 0
J u n e 2 0 1 5 0 @ $ 5, 6 0 1 5 0 @ $ 5, 6 0
Se p t,1 5 2 0 0 @ $ 5, 8 0 2 0 0 @ $ 5, 8 0
N o v, 2 9 1 5 0 @ $ 5, 9 0 1 5 0 @ $ 5, 9 0
U n i ts 1,2 0 0 600
FIFO
Example
Now,we have allocated
the cost to all 1,200 units
in ending inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
1,0 0 0 @ $ 5, 2 5 6 0 0 @ $ 5, 2 5
4 0 0 @ $ 5, 2 5
J a n, 3 3 0 0 @ $ 5, 3 0 3 0 0 @ $ 5, 3 0
J u n e 2 0 1 5 0 @ $ 5, 6 0 1 5 0 @ $ 5, 6 0
Se p t,1 5 2 0 0 @ $ 5, 8 0 2 0 0 @ $ 5, 8 0
N o v, 2 9 1 5 0 @ $ 5, 9 0 1 5 0 @ $ 5, 9 0
U n i ts 1,2 0 0 600
C o s ts $ 6,5 7 5 $ 3,1 5 0
C o s t o f G o o d s A v a i l a b l e fo r Sa l e $ 9,7 2 5
FIFO
Example
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
ANY QUESTIONS
BEFORE WE
DISCUSS LIFO?
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Last-In,First-Out Method
(LIFO)
Costs of
Goods Sold
Recent
Costs
Ending
Inventory
Oldest
Costs
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0?
C o s t o f
G o o d s So l d 600?
LIFO
Example
Remember,Start with beginning inventory and then
add other purchases until you reach the number of
units in ending inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
1,0 0 0 @ $ 5, 2 5 1,0 0 0 @ $ 5, 2 5
U n i ts 1,0 0 0
LIFO
Example
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
1,0 0 0 @ $ 5, 2 5 1,0 0 0 @ $ 5, 2 5
J a n, 3 3 0 0 @ $ 5, 3 0 2 0 0 @ $ 5, 3 0
1 0 0 @ $ 5, 3 0
U n i ts 1,2 0 0 100
LIFO
Example
Now,we have allocated
the cost to all 1,200 units
in ending inventory.
Next,let’s
complete the
table.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
1,0 0 0 @ $ 5, 2 5 1,0 0 0 @ $ 5, 2 5
J a n, 3 3 0 0 @ $ 5, 3 0 2 0 0 @ $ 5, 3 0
1 0 0 @ $ 5, 3 0
J u n e 2 0 1 5 0 @ $ 5, 6 0 1 5 0 @ $ 5, 6 0
Se p t,1 5 2 0 0 @ $ 5, 8 0 2 0 0 @ $ 5, 8 0
N o v, 2 9 1 5 0 @ $ 5, 9 0 1 5 0 @ $ 5, 9 0
U n i ts 1,2 0 0 600
C o s ts $ 6,3 1 0 $ 3,4 1 5
C o s t o f G o o d s A v a i l a b l e fo r Sa l e $ 9,7 2 5
LIFO
Example
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Importance of an Accurate
Valuation of Inventory
E r r o r s i n M ea su r i n g I n ve n t o r y
B e gi nn i ng I nv e nt or y E nd i ng I nv e nt or y
E f f e c t on I nc om e S t a t e m e nt O v e r s t a t e d U nd e r s t a t e d O v e r s t a t e d U nd e r s t a t e d
G oo ds A v a i l a bl e f or S a l e + - N / A N / A
C os t of G oo ds 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
E nd i ng I nv e nt or y N / A N / A + -
R e t a i ne d E a r ni ng s - + + -
An error in ending inventory in a year will result in the same
error in the beginning inventory of the next year.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Gross Profit Method
?Determine cost of goods
available for sale.
?Estimate cost of goods
sold by multiplying the
net sales by the cost ratio.
?Deduct cost of goods sold
from cost of goods
available for sale to
determine ending
inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Gross Profit Method
Example
In March of 1999,Chemico’s inventory was
destroyed by fire,Chemico’s normal gross
profit ratio is 30% of net sales,At the time of
the fire,Chemico showed the following
balances:
Sa l e s 3 1,5 0 0$
Sa l e s r e t u r n s 1,5 0 0
I n v e n t o r y,1 / 1 / 9 9 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 2 0,5 0 0
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u t i n g I n v e n t o ry u s i n g t h e G ros s P rof i t M e t h o d
G o o d s A v a i l a b l e f o r S a l e,
I n v e n t o r y,1 / 1 / 9 9 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 2 0,5 0 0
G o o d s a v a i l a b l e f o r s a l e 3 2,5 0 0$
L e s s e s t i m a t e d c o s t o f g o o d s s o l d,
The Gross Profit Method
Example
? Estimate Cost
of Goods Sold.
?
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u t i n g I n v e n t o ry u s i n g t h e G ros s P rof i t M e t h o d
G o o d s A v a i l a b l e f o r S a l e,
I n v e n t o r y,1 / 1 / 9 9 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 2 0,5 0 0
G o o d s a v a i l a b l e f o r s a l e 3 2,5 0 0$
L e s s e s t i m a t e d c o s t o f g o o d s s o l d,
S a l e s 3 1,5 0 0$
L e s s s a l e s r e t u r n s ( 1,5 0 0 )
N e t s a l e s 3 0,0 0 0$
The Gross Profit Method
Example
Since gross margin = 30%,then the
COGS ratio must be 70%.
?
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u t i n g I n v e n t o ry u s i n g t h e G ros s P rof i t M e t h o d
G o o d s A v a i l a b l e f o r S a l e,
I n v e n t o r y,1 / 1 / 9 9 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 2 0,5 0 0
G o o d s a v a i l a b l e f o r s a l e 3 2,5 0 0$
L e s s e s t i m a t e d c o s t o f g o o d s s o l d,
S a l e s 3 1,5 0 0$
L e s s s a l e s r e t u r n s ( 1,5 0 0 )
N e t s a l e s 3 0,0 0 0$
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 1,0 0 0 )
E s t i m a t e d M a r c h i n v e n t o r y l o s s 1 1,5 0 0$
The Gross Profit Method
Example
70%
?
?
?
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Inventory Turnover Rate
Measures how quickly a company sells its
merchandise inventory.
A ratio that is low compared to competitors
suggests inefficient use of assets.
M e r c h a n d is e
T u r n o v e r =
C o s t o f g o o d s s o ld
Av g, in v e n t o r y
Avg,Inventory = (Beg,Inv,+ End,Inv.)?2
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Accounting Methods Can Affect
Analytical Ratios
Remember that identical
companies that use
different inventory methods
(e.g.,FIFO and LIFO) will
have different inventory
turnover ratios.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
End of Chapter 8
Chapter 8
Inventories and the Cost of
Goods Sold
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Inventory Defined
Goods owned and
held for sale to
customers
Current
asset
Inventory
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Flow of Inventory Costs
B A L A N C E S H E E T
C u r r e n t a s s e t s,
I n v e n t o r y
I N C O M E S TA TE M E N T
R e v e nu e
C os t of go od s s ol d
G r os s pr of i t
E x pe ns e s
N e t i nc om e
Purchase cost
(or manufacturing
costs) as
incurred
as goods
are sold
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Flow of Inventory Costs
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
E n t r y o n P u r c h a s e D a t e
I n v e n t o r y $$$$
A c c o u n t s P a y a b l e $$$$
E n t r y o n S a l e D a t e
C o s t o f G o o d s S o l d $$$$
I n v e n t o r y $$$$
In a perpetual inventory system,inventory entries
parallel the flow of costs.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Which Unit Did We Sell?
Does It Really Matter?
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
E n t r y o n S a l e D a t e
C o s t o f G o o d s S o l d $$$$
I n v e n t o r y $$$$
When identical units of inventory have
different unit costs,a question naturally
arises as to which of these costs should be
used in recording a sale of inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Inventory Subsidiary Ledger
A separate subsidiary account is
maintained for each item in inventory.
How can we determine the unit cost for the
Sept,10 sale?
I t e m LL0 0 2 P r i m a r y s uppl i e r E l e c t r oni c C i t y
D e s c r i pt i on La s e r Li ght S e c onda r y s uppl i e r E l e c t r i c C om pa ny
Loc a t i on S t or e r oom 2 I nv e nt or y l e v e l, M i n,2 5 M a x, 2 0 0
P ur c ha s e d S ol d B a l a nc e
D a t e U ni t s
U ni t
C os t Tot a l U ni t s
U ni t
C os t
C os t of
G oods
S ol d U ni t s
U ni t
C os t Tot a l
S e pt, 5 100 30$ 3,0 0 0$ 100 30$ 3,0 0 0$
S e pt, 9 75 50 3,7 5 0 100 30 3,0 0 0
75 50 3,7 5 0
S e pt, 1 0 10
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific
identification
LIFO
Average
cost
FIFO
To determine the cost of inventory sold,
accountants use one of the following
inventory valuation methods.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Information for the Following
Inventory Examples
C os t of G oo ds A v a i l a bl e f or S a l e
A ug, 1 B e g,I nv e nt or y 10 un i t s @ 91$ = 910$
A ug, 3 P ur c ha s e d 15 un i t s @ 106$ = 1,5 9 0$
A ug, 17 P ur c ha s e d 20 un i t s @ 115$ = 2,3 0 0$
A ug, 28 P ur c ha s e d 10 un i t s @ 119$ = 1,1 9 0$
R e t a i l S a l e s of G oo ds
A ug, 14 S a l e s 20 un i t s @ 130$ = 2,6 0 0$
A ug, 31 S a l e s 23 un i t s @ 150$ = 3,4 5 0$
The Bike Company (TBC)
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
When units
are sold,the
specific cost
of the unit
sold is added
to cost of
goods sold.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
Example
On August 14,TBC sold 20 bikes for $130 each,
Nine bikes originally cost $91 and 11 bikes
originally cost $106.
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
Example
The Cost of Goods Sold for the August 14 sale is
$1,985,leaving $515 and 5 units in inventory,
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 9 @ 91$ = 819$
11 @ 106$ = 1,1 6 6$ 515$
Let抯 look at the entries
for the Aug,14 sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
Example
Continue
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
A u g, 14 C a s h 2,6 0 0
S a l e s 2,6 0 0
14 C o s t o f G o o d s S o l d 1,9 8 5
I n v e n t o r y 1,9 8 5
Retail
Cost
A similar entry is made after
each sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
Example
Additional purchases were made on August 17 and 28,
Costs associated with sales on August 31 were as
follows,1 @ $91,3 @ $106,15 @ $115,& 4 @ $119.
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 9 @ 91$ = 819$
11 @ 106$ = 1,1 6 6$ 515$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 1 5$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 4,0 0 5$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug,1 10 @ 91$ = 910$ 910$
A ug,3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A ug,1 4 9 @ 91$ = 819$
11 @ 106$ = 1,1 6 6$ 515$
A ug,1 7 20 @ 115$ = 2,3 0 0$ 2,8 1 5$
A ug,2 8 10 @ 119$ = 1,1 9 0$ 4,0 0 5$
A ug,3 1 1 @ 91$ = 91$
3 @ 106$ = 318$
15 @ 115$ = 1,7 2 5$
4 @ 119$ = 476$ 1,3 9 5$
Specific Identification
Example
Cost of Goods
Sold for
August 31 =
$2,610
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Balance Sheet
Inventory = $1,395
Income Statement
COGS = $4,595
Specific Identification
Example
1 @ 106$ = 106$
5 @ 115$ = 575
6 @ 119$ = 714
E n d, I n v, 1,3 9 5$
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 9 @ 91$ = 819$
11 @ 106$ = 1,1 6 6$ 515$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 1 5$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 4,0 0 5$
A u g, 3 1 1 @ 91$ = 91$
3 @ 106$ = 318$
15 @ 115$ = 1,7 2 5$
4 @ 119$ = 476$ 1,3 9 5$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Since specific
identification is so
easy,can’nt we use
it all the time?
Not really,Specific
identification is hard to use
when we sell a lot of
inventory that has lots of
different costs.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
When a unit is sold,the
average cost of each
unit in inventory is
assigned to cost of
goods sold,
Cost of Goods
Available for
Sale
Units on hand
on the date of
sale
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
Example
On August 14,TBC sold 20 bikes for
$130 each,
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
$100 = $2,500 ? 25
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
Average-Cost Method
Example
Continue
The average cost per
unit must be
computed prior to
each sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
$100 = $2,500 ? 25
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A ug, 1 4 20 @ 100$ = 2,0 0 0$ 500$
Average-Cost Method
Example
Continue
The average cost per
unit is $100.
Let’s look at the entries
for the Aug,14 sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
Example
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
A u g, 14 C a s h 2,6 0 0
S a l e s 2,6 0 0
14 C o s t o f G o o d s S o l d 2,0 0 0
I n v e n t o r y 2,0 0 0
Retail
Cost
Continue
A similar entry is made after
each sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Additional purchases were made on August 17 and
August 28.
On August 31,an additional 23 units were sold.
Average-Cost Method
Example
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A ug, 1 4 20 @ 100$ = 2,0 0 0$ 500$
A ug, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 0 0$
A ug, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 9 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
$114 = $3,990 ? 35
Average-Cost Method
Example
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A ug, 1 4 20 @ 100$ = 2,0 0 0$ 500$
A ug, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 0 0$
A ug, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 9 0$
T o ta l P u r ch a se s 55
L e ss,S a l e s to Da te - 2 0
Un i ts o n Ha n d 35
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
Example
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A ug, 1 10 @ 91$ = 910$ 910$
A ug, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A ug, 1 4 20 @ 100$ = 2,0 0 0$ 500$
A ug, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 0 0$
A ug, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 9 0$
A ug, 3 1 23 @ 114$ = 2,6 2 2$ 1,3 6 8$
$114 = $3,990 ? 35The average cost per
unit is $114.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Income Statement
COGS = $4,622
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 20 @ 100$ = 2,0 0 0$ 500$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 0 0$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 9 0$
A u g, 3 1 23 @ 114$ = 2,6 2 2$ 1,3 6 8$
Average-Cost Method
Example
Balance Sheet
Inventory = $1,368
$114?12 = $1,368
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
First-In,First-Out Method
(FIFO)
Costs of
Goods Sold
Oldest
Costs
Ending
Inventory
Recent
Costs
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
FIFO
Example
On August 14,TBC sold 20 bikes for
$130 each,
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 10 @ 91$ = 910$
10 @ 106$ = 1,0 6 0$ 530$
FIFO
Example
The Cost of Goods Sold for the August 14 sale is
$1,970,leaving $530 and 5 units in inventory,
Continue
Let’s look at the entries
for the Aug,14 sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
FIFO
Example
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
A u g, 14 C a s h 2,6 0 0
S a l e s 2,6 0 0
14 C o s t o f G o o d s S o l d 1,9 7 0
I n v e n t o r y 1,9 7 0
Retail
Cost
Continue
A similar entry is made after
each sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Additional purchases were made on August 17 and
August 28.
On August 31,an additional 23 units were sold.
FIFO
Example
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 10 @ 91$ = 910$
10 @ 106$ = 1,0 6 0$ 530$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 3 0$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 4,0 2 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
FIFO
Example
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 10 @ 91$ = 910$
10 @ 106$ = 1,0 6 0$ 530$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 3 0$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 4,0 2 0$
A u g, 3 1 5 @ 106$ = 530$
18 @ 115$ = 2,0 7 0$ 1,4 2 0$
Cost of Goods Sold for August 31 = $2,600
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 10 @ 91$ = 910$
10 @ 106$ = 1,0 6 0$ 530$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,8 3 0$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 4,0 2 0$
A u g, 3 1 5 @ 106$ = 530$
18 @ 115$ = 2,0 7 0$ 1,4 2 0$
FIFO
Example
Balance Sheet
Inventory = $1,420
Income Statement
COGS = $4,570
2 @ 115$ = 230$
10 @ 119$ = 1,1 9 0
E n d, I n v, 1,4 2 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Last-In,First-Out Method
(LIFO)
Costs of
Goods Sold
Recent
Costs
Ending
Inventory
Oldest
Costs
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
On August 14,TBC sold 20 bikes for
$130 each,
LIFO
Example
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 15 @ 106$ = 1,5 9 0$
5 @ 91$ = 455$ 455$
LIFO
Example
The Cost of Goods Sold for the August 14 sale is
$2,045,leaving $455 and 5 units in inventory,
Continue
Let’s look at the entries
for the Aug,14 sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
LIFO
Example
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
A u g, 14 C a s h 2,6 0 0
S a l e s 2,6 0 0
14 C o s t o f G o o d s S o l d 2,0 4 5
I n v e n t o r y 2,0 4 5
Retail
Cost
Continue
A similar entry is made after
each sale.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
LIFO
Example
Additional purchases were made on August 17 and
August 28.
On August 31,an additional 23 units were sold.
Continue
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 15 @ 106$ = 1,5 9 0$
5 @ 91$ = 455$ 455$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,7 5 5$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 4 5$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
LIFO
Example
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 15 @ 106$ = 1,5 9 0$
5 @ 91$ = 455$ 455$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,7 5 5$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 4 5$
A u g, 3 1 10 @ 119$ = 1,1 9 0$
13 @ 115$ = 1,4 9 5$ 1,2 6 0$
Cost of Goods Sold for August 31 = $2,685
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a t e P u r c h a s e s C o s t o f G o o d s S o l d
I n v e n t o r y
B a l a n c e
A u g, 1 10 @ 91$ = 910$ 910$
A u g, 3 15 @ 106$ = 1,5 9 0$ 2,5 0 0$
A u g, 1 4 15 @ 106$ = 1,5 9 0$
5 @ 91$ = 455$ 455$
A u g, 1 7 20 @ 115$ = 2,3 0 0$ 2,7 5 5$
A u g, 2 8 10 @ 119$ = 1,1 9 0$ 3,9 4 5$
A u g, 3 1 10 @ 119$ = 1,1 9 0$
13 @ 115$ = 1,4 9 5$ 1,2 6 0$
LIFO
Example
Balance Sheet
Inventory = $1,260
Income Statement
COGS = $4,730
5 @ 91$ = 455$
7 @ 115$ = 805
E n d, I n v, 1,2 6 0$
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
I nv e nt or y V a l ua t i on M e t hod s, A S um m a r y
C os t s A l l oc a t e d t o:
V a l ua t i on
M e t hod
C os t of G ood s
S ol d I nv e nt or y C om m e nt s
S pe c i f i c A c t ua l c os t of A c t ua l c os t of uni t s P a r a l l e l s phy s i c a l f l ow
i de nt i f i c a t i on t he uni t s s ol d r e m a i ni ng Log i c a l m e t hod w he n uni t s
a r e uni que
M a y be m i s l e a di ng f or
i de nt i c a l uni t s
A v e r a ge c os t N um be r of uni t s
s ol d t i m e s t he
N um be r of uni t s on
ha nd t i m e s t he
A s s i gns a l l uni t s t he s a m e
a v e r a ge uni t c os t
a v e r a ge uni t c os t a v e r a ge uni t c os t C ur r e nt c os t s a r e a v e r a ge d
i n w i t h ol de r c os t s
Fi r s t - i n,Fi r s t - out
( FI FO )
C os t of e a r l i e s t
pur c ha s e s on
C os t of m os t
r e c e nt l y
C os t of goo ds s ol d i s ba s e d
on ol de r c os t s
ha nd pr i or t o t he
s a l e
pur c ha s e d uni t s I nv e nt or y v a l ue d a t c ur r e nt
c os t s
M a y ov e r s t a t e i nc om e dur i ng
pe r i ods of r i s i ng pr i c e s ; m a y
i nc r e a s e i nc om e t a x e s due
La s t - i n,Fi r s t - out
( LI FO )
C os t of m os t
r e c e nt l y
C os t of e a r l i e s t
pur c ha s e s
C os t of goo ds s ol d s how n a t
r e c e nt pr i c e s
pur c ha s e d uni t s a s s um e d s t i l l i n
i nv e nt or y )
I nv e nt or y s how n a t ol d ( a nd
pe r ha ps out of da t e ) c os t s
M os t c ons e r v a t i v e m e t hod
dur i ng pe r i ods of r i s i ng
pr i c e s ; of t e n r e s ul t s i n l ow e r
i nc om e t a x e s
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Principle of Consistency
Once a company has
adopted a particular
accounting method,it
should follow that
method consistently,
rather than switch
methods from one
year to the next.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Just-In-Time (JIT) Inventory
Systems
This inventory arrived
just in time for us to use
in the manufacturing
process.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Taking a Physical Inventory
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C re d i t
D e c, 31 C o s t o f G o o d s S o l d $$$$
I n v e n t o ry $$$$
The primary reason for taking a physical inventory
is to adjust the perpetual inventory records for
unrecorded shrinkage losses,such as theft,
spoilage,or breakage.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
LCM and Other Write-Downs of
Inventory
Reduces the value
of the inventory.Obsolescence
Adjust inventory
value to the lower
of historical cost or
current
replacement cost
(market).
Lower of Cost
or Market
(LCM)
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Goods In Transit
Year
End
A sale should be recorded when
title to the merchandise passes
to the buyer.
F.O.B,
shipping
point ? title
passes to
buyer at the
point of
shipment.
F.O.B,
destination
point ? title
passes to
buyer at the
point of
destin tion.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Periodic Inventory Systems
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
E n t r y o n P u r c h a s e D a t e
P u r c h a s e s $$$$
A c c o u n t s P a y a b l e $$$$
In a periodic inventory system,inventory entries
are as follows.
Note that an entry is not
made to inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Periodic Inventory Systems
G E N E R A L J O U R N A L
D a t e A c c o u n t T i t l e s a n d E x p l a n a t i o n D e b i t C r e d i t
E n t r y o n S a l e D a t e
N o e n t r y t o i n v e n t o r y,
A c c o u n t s R e c e i v a b l e $$$$
S a l e s $$$$
In a periodic inventory system,inventory entries
are as follows.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Periodic Inventory Systems
The inventory on
hand and the
cost of goods
sold for the year
are not
determined until
year-end.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific
identification
LIFO
Average
cost
FIFO
Accountants use one of the following
inventory valuation methods in a periodic
inventory system.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0?
C o s t o f
G o o d s So l d 600?
Information for the Following
Inventory Examples
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Specific Identification
Example
By reviewing actual
purchase invoices,
Computers,Inc,
determines that the 1,200
mouse pads on hand at
year-end have an actual
total cost of $6,400.
Determine the cost of
goods sold for the year.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0 6,4 0 0, 0 0$
C o s t o f
G o o d s So l d 600 3,3 2 5, 0 0$
Specific Identification
Example
Cost of Goods Sold
$9,725 - $6,400 = $3,325
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Now let’s move
on to the
average-cost
valuation method.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
The average cost is
calculated at year-end
as follows:
Total Cost of
Goods
Available for
Sale
Total Number
of Units
Available for
Sale
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
Example
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0?
C o s t o f
G o o d s So l d 600?
Avg,Cost $5.40278 = $9,725 ? 1,800
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Average-Cost Method
Example
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0 6,4 8 3, 0 0$
C o s t o f
G o o d s So l d 600 3,2 4 2, 0 0$
Ending Inventory
Avg,Cost $5.40278 ??1,200 = $6,483
Cost of Goods Sold
Avg,Cost $5.40278 ??600 = $3,242
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
First-In,First-Out Method
(FIFO)
Costs of
Goods Sold
Oldest
Costs
Ending
Inventory
Recent
Costs
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0?
C o s t o f
G o o d s So l d 600?
FIFO
Example
Remember,Start with the 11/29 purchase and then
add other purchases until you reach the number of
units in ending inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
N o v, 2 9 1 5 0 @ $ 5, 9 0 1 5 0 @ $ 5, 9 0
U n i ts 150
FIFO
Example
Now,let’s complete the
table.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
1,0 0 0 @ $ 5, 2 5 6 0 0 @ $ 5, 2 5
4 0 0 @ $ 5, 2 5
J a n, 3 3 0 0 @ $ 5, 3 0 3 0 0 @ $ 5, 3 0
J u n e 2 0 1 5 0 @ $ 5, 6 0 1 5 0 @ $ 5, 6 0
Se p t,1 5 2 0 0 @ $ 5, 8 0 2 0 0 @ $ 5, 8 0
N o v, 2 9 1 5 0 @ $ 5, 9 0 1 5 0 @ $ 5, 9 0
U n i ts 1,2 0 0 600
FIFO
Example
Now,we have allocated
the cost to all 1,200 units
in ending inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
1,0 0 0 @ $ 5, 2 5 6 0 0 @ $ 5, 2 5
4 0 0 @ $ 5, 2 5
J a n, 3 3 0 0 @ $ 5, 3 0 3 0 0 @ $ 5, 3 0
J u n e 2 0 1 5 0 @ $ 5, 6 0 1 5 0 @ $ 5, 6 0
Se p t,1 5 2 0 0 @ $ 5, 8 0 2 0 0 @ $ 5, 8 0
N o v, 2 9 1 5 0 @ $ 5, 9 0 1 5 0 @ $ 5, 9 0
U n i ts 1,2 0 0 600
C o s ts $ 6,5 7 5 $ 3,1 5 0
C o s t o f G o o d s A v a i l a b l e fo r Sa l e $ 9,7 2 5
FIFO
Example
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
ANY QUESTIONS
BEFORE WE
DISCUSS LIFO?
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Last-In,First-Out Method
(LIFO)
Costs of
Goods Sold
Recent
Costs
Ending
Inventory
Oldest
Costs
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u te r s,I n c,
M o u s e Pa d I n v e n to r y
D a te U n i ts $ / U n i t T o ta l
B e g i n n i n g
I n v e n to r y 1,0 0 0 5, 2 5$ 5,2 5 0, 0 0$
Pu r c h a s e s,
J a n, 3 300 5, 3 0 1,5 9 0, 0 0
J u n e 2 0 150 5, 6 0 8 4 0, 0 0
Se p t,1 5 200 5, 8 0 1,1 6 0, 0 0
N o v, 2 9 150 5, 9 0 8 8 5, 0 0
G o o d s
A v a i l a b l e
fo r Sa l e 1,8 0 0 9,7 2 5, 0 0$
En d i n g
I n v e n to r y 1,2 0 0?
C o s t o f
G o o d s So l d 600?
LIFO
Example
Remember,Start with beginning inventory and then
add other purchases until you reach the number of
units in ending inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
1,0 0 0 @ $ 5, 2 5 1,0 0 0 @ $ 5, 2 5
U n i ts 1,0 0 0
LIFO
Example
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
1,0 0 0 @ $ 5, 2 5 1,0 0 0 @ $ 5, 2 5
J a n, 3 3 0 0 @ $ 5, 3 0 2 0 0 @ $ 5, 3 0
1 0 0 @ $ 5, 3 0
U n i ts 1,2 0 0 100
LIFO
Example
Now,we have allocated
the cost to all 1,200 units
in ending inventory.
Next,let’s
complete the
table.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
D a te B e g, I n v, Pu r c h a s e s En d, I n v,
C o s t o f
G o o d s So l d
1,0 0 0 @ $ 5, 2 5 1,0 0 0 @ $ 5, 2 5
J a n, 3 3 0 0 @ $ 5, 3 0 2 0 0 @ $ 5, 3 0
1 0 0 @ $ 5, 3 0
J u n e 2 0 1 5 0 @ $ 5, 6 0 1 5 0 @ $ 5, 6 0
Se p t,1 5 2 0 0 @ $ 5, 8 0 2 0 0 @ $ 5, 8 0
N o v, 2 9 1 5 0 @ $ 5, 9 0 1 5 0 @ $ 5, 9 0
U n i ts 1,2 0 0 600
C o s ts $ 6,3 1 0 $ 3,4 1 5
C o s t o f G o o d s A v a i l a b l e fo r Sa l e $ 9,7 2 5
LIFO
Example
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Importance of an Accurate
Valuation of Inventory
E r r o r s i n M ea su r i n g I n ve n t o r y
B e gi nn i ng I nv e nt or y E nd i ng I nv e nt or y
E f f e c t on I nc om e S t a t e m e nt O v e r s t a t e d U nd e r s t a t e d O v e r s t a t e d U nd e r s t a t e d
G oo ds A v a i l a bl e f or S a l e + - N / A N / A
C os t of G oo ds 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
E nd i ng I nv e nt or y N / A N / A + -
R e t a i ne d E a r ni ng s - + + -
An error in ending inventory in a year will result in the same
error in the beginning inventory of the next year.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Gross Profit Method
?Determine cost of goods
available for sale.
?Estimate cost of goods
sold by multiplying the
net sales by the cost ratio.
?Deduct cost of goods sold
from cost of goods
available for sale to
determine ending
inventory.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
The Gross Profit Method
Example
In March of 1999,Chemico’s inventory was
destroyed by fire,Chemico’s normal gross
profit ratio is 30% of net sales,At the time of
the fire,Chemico showed the following
balances:
Sa l e s 3 1,5 0 0$
Sa l e s r e t u r n s 1,5 0 0
I n v e n t o r y,1 / 1 / 9 9 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 2 0,5 0 0
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u t i n g I n v e n t o ry u s i n g t h e G ros s P rof i t M e t h o d
G o o d s A v a i l a b l e f o r S a l e,
I n v e n t o r y,1 / 1 / 9 9 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 2 0,5 0 0
G o o d s a v a i l a b l e f o r s a l e 3 2,5 0 0$
L e s s e s t i m a t e d c o s t o f g o o d s s o l d,
The Gross Profit Method
Example
? Estimate Cost
of Goods Sold.
?
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u t i n g I n v e n t o ry u s i n g t h e G ros s P rof i t M e t h o d
G o o d s A v a i l a b l e f o r S a l e,
I n v e n t o r y,1 / 1 / 9 9 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 2 0,5 0 0
G o o d s a v a i l a b l e f o r s a l e 3 2,5 0 0$
L e s s e s t i m a t e d c o s t o f g o o d s s o l d,
S a l e s 3 1,5 0 0$
L e s s s a l e s r e t u r n s ( 1,5 0 0 )
N e t s a l e s 3 0,0 0 0$
The Gross Profit Method
Example
Since gross margin = 30%,then the
COGS ratio must be 70%.
?
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
C o m p u t i n g I n v e n t o ry u s i n g t h e G ros s P rof i t M e t h o d
G o o d s A v a i l a b l e f o r S a l e,
I n v e n t o r y,1 / 1 / 9 9 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 2 0,5 0 0
G o o d s a v a i l a b l e f o r s a l e 3 2,5 0 0$
L e s s e s t i m a t e d c o s t o f g o o d s s o l d,
S a l e s 3 1,5 0 0$
L e s s s a l e s r e t u r n s ( 1,5 0 0 )
N e t s a l e s 3 0,0 0 0$
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 1,0 0 0 )
E s t i m a t e d M a r c h i n v e n t o r y l o s s 1 1,5 0 0$
The Gross Profit Method
Example
70%
?
?
?
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Inventory Turnover Rate
Measures how quickly a company sells its
merchandise inventory.
A ratio that is low compared to competitors
suggests inefficient use of assets.
M e r c h a n d is e
T u r n o v e r =
C o s t o f g o o d s s o ld
Av g, in v e n t o r y
Avg,Inventory = (Beg,Inv,+ End,Inv.)?2
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
Accounting Methods Can Affect
Analytical Ratios
Remember that identical
companies that use
different inventory methods
(e.g.,FIFO and LIFO) will
have different inventory
turnover ratios.
The McGraw-Hill Companies,Inc.,1999Irwin/McGraw-Hill
End of Chapter 8
