Professional Documents
Culture Documents
Financial Accounting
Concepts
Fourth Edition
by
Edmonds, McNair, Milam, Olds
PowerPoint® presentation by
J. Lawrence Bergin
8- 2
Chapter 8
Asset Valuation
Inventory Cost
Recall that
inventory is
recorded at the
price paid or the
consideration
given up.
Inventory Cost
◆ The amount recorded for inventory should
include:
• Invoice price, freight charges, inspection costs,
and preparation costs.
Beginning inventory $
Add: Purchases, net
Goods available for sale $
Less: Ending inventory
Cost of Goods Sold $
FIFO LIFO
Spe
Weighted Ide c
ntif ific
Average icat
ion
Inventory Account
Inventory
Beginning Balance
100 units @ $3
Units Sold
Purchases during the period
150 units $3.10 200 units sold
100 units $3.05
Ending Balance
Inventory Account
Inventory
Beginning Balance
100 units @ $3
Sold 200 units
Purchases during the period
150 units $3.10
First-In, First-Out
◆ The cost of the oldest inventory items are
charged to cost of goods sold when goods
are sold.
◆ The cost of the newest inventory items
remain in ending inventory.
◆ The actual physical flow of inventory items
may differ from the FIFO cost flow
assumptions.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
8- 11
Last-In, First-Out
◆ The cost of the newest inventory items are
charged to cost of goods sold when goods
are sold.
◆ The cost of the oldest inventory items
remain in ending inventory.
◆ The actual physical flow of inventory items
may differ from the LIFO cost flow
assumptions.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
8- 12
Weighted-Average
◆ Compute cost of goods available for sale:
Cost of Beginning Inventory + Net Cost of Purchases
Weighted-Average
◆ Compute weighted-average cost per unit:
Cost of Goods Available for Sale
Total Units Available for Sale
Specific Identification
◆ Specific cost of each inventory item is
known.
◆ Used with small volume,
high dollar inventory.
Inventory of Yachts
Customer Cost to build
Smith $120,000
Jones 80,000
Baker 150,000
Total inventory $350,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
8- 15
Example:
Date Event Units Price Total
1/1 Beg. Inv. 10 $ 4 $ 40
3/10 Purchase 12 7 84
6/17 Sale 15 14 210
9/15 Purchase 11 8 88
12/27 Sale 3 20 60
Inventory Account
Inventory
Beginning Balance
10 units @ $4
Sold 18 units
Purchases during the period
12 units @ $7 What is CGS??
11 units @ $8
Ending Balance
= 15 units
What is EI??
Example:
Date Event Units Price Total
1/1 Beg. Inv. 10 $ 4 $ 40
3/10 Purchase 12 7 84
6/17 Sale 15 14 210
9/15 Purchase 11 8 88
12/27 Sale 3 20 60
Example:
Date Event Units Price Total
1/1 Beg. Inv. 10 $ 4 $ 40
3/10 Purchase 12 7 84
6/17 Sale 15 14 210
9/15 Purchase 11 8 88
12/27 Sale 3 20 60
Ending Inventory:
Ending Inventory:
Ending Inventory:
15 units remaining @ $6.42 cost = $ 96 (rounded)
Comparison of Methods
◆ Each of the four methods is acceptable, and
an argument can be made for using each.
◆ The choice of an inventory method will
depend on management’s incentives, the tax
laws, and the reporting company’s
particular economic circumstances.
Consistency Principle
Because the choice of an
inventory method can
significantly affect the
financial statements, a
company might be inclined to
select a new method each year
that would result in the most
favorable financial statements.
However . . .
Consistency Principle
Example:
Date Event Units Price Total
1/1 Beg. Inv. 10 $ 4 $ 40
3/10 Purchase 12 7 84
6/17 Sale 15 14 210
9/15 Purchase 11 8 88
12/27 Sale 3 20 60
FIFO--Perpetual
IN OUT BALANCE
# unit # unit # unit
date units cost date units cost CofGS date units cost $ inv.
FIFO--Perpetual
IN OUT BALANCE
# unit # unit # unit
date units cost date units cost CofGS date units cost $ inv.
1/1 10 @ $4
3/10 12 @ $7 1/1 10 @ $4
3/10 12 @ $7
6/17 1/1 10 @ $4 = $ 40
3/10 5 @ $7 = $ 35 3/10 7 @ $7
$ 75
9/15 11 @ $8 3/10 7 @ $7
9/15 11 @ $8
12/27 3/10 3 @ $7 = $ 21 3/10 4 @ $7 = $ 28
9/15 11 @ $8 = 88
Cost of Goods Sold $ 96 End. Inv. $116
LIFO--Perpetual
IN OUT BALANCE
# unit # unit # unit
date units cost date units cost CofGS date units cost $ inv.
Example:
Date Event Units Price Total
1/1 Beg. Inv. 10 $ 4 $ 40
3/10 Purchase 12 7 84
6/17 Sale 15 14 210
9/15 Purchase 11 8 88
12/27 Sale 3 20 60
LIFO--Perpetual
IN OUT BALANCE
# unit # unit # unit
date units cost date units cost CofGS date units cost $ inv.
1/1 10 @ $4
3/10 12 @ $7 1/1 10 @ $4
3/10 12 @ $7
6/17 3/10 12 @ $7 = $ 84
1/1 3 @ $4 = $ 12 1/1 7 @ $4
$ 96
9/15 11 @ $8 1/1 7 @ $4
9/15 11 @ $8
12/27 9/15 3 @ $8 = $ 24 1/1 7 @ $4 = $ 28
9/15 8 @ $8 = 64
Cost of Goods Sold $120 End. Inv. $ 92
Procedures:
1. A new unit average cost must be calculated after
every purchase.
2. Units SOLD are “costed out” (that is, charged to
Cost of Goods Sold) using the unit average cost of
units in inventory at the time of the sale.
Example:
Date Event Units Price Total
1/1 Beg. Inv. 10 $ 4 $ 40
3/10 Purchase 12 7 84
6/17 Sale 15 14 210
9/15 Purchase 11 8 88
12/27 Sale 3 20 60
Now what?!
1. Until another purchase is made, units SOLD are “costed
out” at $5.64 each.
2. A new average cost must be calculated when the next
purchase is made.
FIFO-Periodic $ 96 $116
FIFO-Perpetual $ 96 $116
LIFO-Periodic $137 $ 75
LIFO-Perpetual $120 $ 92
Ave.-Periodic $116 $ 96
Ave.-Perpetual $106 (rounded) $106 (rounded)
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
8- 61
Example:
Given the following:
$40
Market
Market $40 Value
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2003
8- 74
Ex: In Yr. 3 we find that Yr. 1 ending inv. was understated by $1.
As Reported As Corrected
Year 1 Year 2 Year 1 Year 2
Sales 10 11
C of GS:
Begin. Inv. 1 2
+Purchases 7 8
Gds. Avail. 8 10
- Ending Inv. 2 4
=C of G. Sold 6 6
Gross Margin 4 5
What was the effect of the error on the Yr. 1 and Yr. 2 Statements?
Ex: In Yr. 3 we find that Yr. 1 ending inv. was understated by $1.
As Reported As Corrected
Year 1 Year 2 Year 1 Year 2
Sales 10 11
C of GS: 10
Begin. Inv. 1 2
+Purchases 7 8 1
Gds. Avail. 8 10 7
- Ending Inv. 2 48
=C of G. Sold 6 6 3
Gross Margin 4 5 5
5
What was the effect of the error on the Yr. 1 and Yr. 2 Statements?
Ex: In Yr. 3 we find that Yr. 1 ending inv. was understated by $1.
As Reported As Corrected
Year 1 Year 2 Year 1 Year 2
Sales 10 11 11
C of GS: 10
Begin. Inv. 1 2 3
+Purchases 7 8 1 8
Gds. Avail. 8 10 7 11
- Ending Inv. 2 48 4
=C of G. Sold 6 6 3 7
Gross Margin 4 5 5 4
5
What was the effect of the error on the Yr. 1 and Yr. 2 Statements?
Ex: In Yr. 3 we find that Yr. 1 ending inv. was understated by $1.
As Reported As Corrected
Year 1 Year 2 Year 1 Year 2
Sales 10 11 11
C of GS: 10
Same = No effect
Begin. Inv. 1 2 3
+Purchases 7 8 1 8
Gds. Avail. 8 10 7 11
- Ending Inv. 2 48 4
=C of G. Sold 6 6 3 7
Gross Margin 4 5 5 4
5
What was the effect of the error on the Yr. 1 and Yr. 2 Statements?
Inventory Ratios
Inventory Turnover: (A measure of how fast
inventory sells. Higher is better.)
Cost of Goods Sold $30,000
Inventory
=
$ 5,000
= 6.0 times
Chapter 8
Chapter 8
APPENDIX
Accounting For Investments
and
Reporting Comprehensive
Income
Trading securities
◆ Debt and equity securities
◆ Readily determinable fair
values
◆ Bought and held to sell in the
near term
◆ Actively and frequently
traded (goal: profit!)
◆ Measured at fair value and
classified as a current asset
◆ Unrealized gains and losses,
included in determination of
net income
Comprehensive Income
Reporting Options
Bottom of Income Statement: Separate Statements
Income Statement Income Statement
Revenue $100 Revenue $100
- Expenses 40 - Expenses 40
Net Income 60
Net Income $ 60
Other Comp. Inc.(Loss) $(10)
Comprehensive Income $ 50
Chapter 8
The End