8-1

Chapter

8 INVENTORIES AND
THE COST OF GOODS
SOLD

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-2

Inventory
Inventory Defined
Defined

Inventory
Inventory

Goods
Goods owned
owned Current
Current
and
and held
held for
for sale
sale asset
asset
to
to customers
customers

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-3

The
The Flow
Flow of
of Inventory
Inventory Costs
Costs
BALANCE SHEET

As purchase cost
Current assets:
(or manufacturing Inventory
costs) are incurred $ $
as goods
INCOME STATEMENT are sold
Revenue $
Cost of goods sold
Gross profit
Expenses
Net income
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-4

The
The Flow
Flow of
of Inventory
Inventory Costs
Costs
In a perpetual inventory system, inventory entries
parallel the flow of costs.

GE N ER AL JOU R N AL
P
Da te Account Title s a nd Ex pla na tion R De bit Cre dit
Entry on P urcha se Da te
Inve ntory $$$$
Accounts P a ya ble $$$$

Entry on Sa le Da te
Cost of Goods S old $$$$
Inve ntory $$$$
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-5

Which
Which Unit
Unit Did
Did We
We Sell?
Sell?
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.
G E N E R AL JO U R N AL
P
D a te A c c o u n t T i tl e s a n d E x p l a n a ti o n R D e b it C re d it
E n tr y o n S a l e D a te
C o st o f G o o d s S o ld $$$$
I n v e n to r y $$$$

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-6

Inventory
Inventory Cost
Cost Flows
Flows
We use one of these inventory valuation
methods to determine cost of inventory sold.

Specific Average
identification cost

FIFO LIFO
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 Information
Information for
for the
the Following
Following Inventory
Inventory
8-7

Examples
Examples

The Bike Company (TBC)

Cost of Goods Available for Sale

Aug. 1 Beg. Inventory 10 units @ $ 91 = $ 910
Aug. 3 Purchased 15 units @ $ 106 = $ 1,590
Aug. 17 Purchased 20 units @ $ 115 = $ 2,300
Aug. 28 Purchased 10 units @ $ 119 = $ 1,190

Retail Sales of Goods

Aug. 14 Sales 20 units @ $ 130 = $ 2,600
Aug. 31 Sales 23 units @ $ 150 = $ 3,450

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-8

Specific
Specific Identification
Identification

When
When aa unit
unit
is
is sold,
sold, the
the
specific
specific cost
cost of
of
the
the unit
unit sold
sold is
is
added
added to to cost
cost of
of
goods
goods sold.
sold.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-9

Specific
Specific Identification
Identification
In v e n t o r y
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 ld B a la n c e
A u g . 1 1 0 @ $ 9 1 = $ 9 1 0 $ 9 1 0
A u g . 3 1 5 @ $ 1 0 6 = $ 1 ,5 9 0 $ 2 , 5 0 0

On
OnAugust
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.
Nine
Nine bikes
bikes originally
originally cost
cost $91
$91 and
and 1111 bikes
bikes
originally
originally cost
cost $106.
$106.

Continue
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-10

Specific
Specific Identification
Identification
In v e n t o r y
D a te P u rc h a s e s C os t of G o o ds S o ld B a la n c e
A u g . 1 1 0 @ $ 9 1 = $ 9 1 0 $ 91 0
A u g . 3 1 5 @ $ 1 0 6 = $ 1 ,5 9 0 $ 2 ,5 0 0
A u g . 1 4 9 @ $ 9 1 = $ 8 1 9
1 1 @ $ 1 0 6 = $ 1 ,1 6 6 $ 51 5

The
The Cost
Cost ofof Goods
Goods Sold
Sold for
for the
theAugust
August 14 14 sale
sale is
is
$1,985,
$1,985, leaving
leaving $515
$515 and
and 55 units
units in
in inventory.
inventory.

Let’s look at the entries for

Continue the Aug. 14 sale.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-11

Specific
Specific Identification
Identification

GE N E R AL JOU R N AL
P
D a te A c c o u n t T i tle s a n d Ex p l a n a ti o n R De b it C re d i t
A u g . 14 C a sh 2, 6 0 0
S a le s Retail
Retail 2, 6 00

14 C o st o f G o o d s S o ld 1, 9 8 5
In ve n to ry Cost
Cost 1, 9 85

AAsimilar
similar entry
entry is
is
made Continue
made after
after each
each sale.
sale.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-12

Specific
Specific Identification
Identification
In ve n t o r y
D a te P u rc h a s e s C o s t o f G o o d s S o ld Inventory
B a la n c e
Aug. 1 $ 910
Date 10 @ $ 91 =
Purchases $ 910
Cost of Goods Sold Balance
Aug. 3 15 @ $ 106 = $ 1 ,5 9 0 $ 2 ,5 0 0
Aug.
Aug. 1 14 Cost
10 @ of
Cost of
$ 91Goods
Goods
= $ 910 9
11
@
@
$ 91
$ 106
=
=
$ 819
$ 1 ,1 6 6
$
$
910
515
Aug.
Aug. 3 1 7 15 @ $ 106 = $ 1,590 $ 2,500
Aug.
A u g . 14
28
20
10
Sold
Sold for
@
@ for
$ 115
$ 119
=
=
$ 2 ,3 0 0
$ 1 ,1 9 0 9 @ $ 91 = $ 819
$
$
2 ,8 1 5
4 ,0 0 5

August
August 31 31 == 11 @ $ 106 = $ 1,166 $ 515
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,815
$2,610
Aug. 28 10 @$2,610$ 119 = $ 1,190 $ 4,005
Aug. 31
Additional purchases were 1 @on$August
made 91 = 17 $ and91 28.
Additional purchases were made on August 17 and 28.
3 @ $ 106 = $ 318
Costs
Costsassociated
associatedwith
withsales
saleson
onAugust
August 31 were
15 @ 31$ were
as follows:
115 =as follows:
$ 1,725
11@@$91,
$91,
33@@$106,
$106,15
15@@$115,
$115,& 4 @ $119.
4 @& 4$ @
119$119.
= $ 476 $ 1,395

McGraw-Hill/Irwin
Continue © The McGraw-Hill Companies, Inc., 2005
 8-13

Specific
Specific Identification
Identification
Inventory
Date Purchases CostofGoodsSold Balance
Aug.1 10 @ $ 91 = $ 910 $ 910
Aug.3 15 @ $106 = $1,590 $ 2,500
Income Statement Aug.14 9 @ $ 91 = $ 819
COGS = $4,595 11 @ $106 = $1,166 $ 515
Aug.17 20 @ $115 = $2,300 $ 2,815
Aug.28 10 @ $119 = $1,190 $ 4,005
Aug.31 1 @ $ 91 = $ 91
3 @ $106 = $ 318
15 @ $115 = $1,725
4 @ $119 = $ 476 $ 1,395
Balance Sheet
Inventory = $1,395 1 @ $ 106 = $ 106
5 @ $ 115 = 575
6 @ $ 119 = 714
End. Inv. © The$McGraw-Hill
1,395 Companies, Inc., 2005
McGraw-Hill/Irwin
 8-14

Average-Cost
Average-Cost Method
Method

When a unit is sold,

the average cost of each unit
in inventory is assigned to
cost
of goods sold.

Cost of Goods Units on hand

Available for ÷ on the date of
Sale sale

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-15

Average-Cost
Average-Cost Method
Method
In v e n t o r y
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 ld B a la n c e
A u g . 1 1 0 @ $ 9 1 = $ 9 1 0 $ 9 1 0
A u g . 3 1 5 @ $ 1 0 6 = $ 1 , 5 9 0 $ 2 , 5 0 0

The
Theaverage
averagecost
cost per
per unit
unit
must
must be
becomputed
computedprior
prior
to
toeach
eachsale.
sale. $100 $2,500  25
$100 == $2,500 25
On
OnAugust
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.
Continue
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-16

Average-Cost
Average-Cost Method
Method
In v e n t o r y
D a t e P u rc h a s e s C o s t o f G o o d s S o ld B a la n c e
A u g . 1 1 0 @ $ 9 1 = $ 9 1 0 $ 9 1 0
A u g . 3 1 5 @ $ 1 0 6 = $ 1 ,5 9 0 $ 2 ,5 0 0
A u g . 1 4 2 0 @ $ 1 0 0 = $ 2 ,0 0 0 $ 5 0 0

The
The average
average costcost per
per
unit
unit is
is $100.
$100. $100 $2,500  25
$100 == $2,500 25

Let’s look at the entries

Continue for the Aug. 14 sale.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-17

Average-Cost
Average-Cost Method
Method
GE N E R AL JOU R N AL
P
D a te A cco u n t T itle s a n d Ex p la n a tio n R D e b it C re d it
A u g . 14 C a sh 2,600
S a le s Retail
Retail 2,600

14 C o st o f G o o d s S o ld 2,000
In ve n to ry Cost
Cost 2,000

AAsimilar
similar entry
entry is
is
made Continue
made after
after each
each sale.
sale.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-18

Average-Cost
Average-Cost Method
Method
In ve n t o r y
D a te P u rc h a s e s C o s t o f G o o d s S o ld B a la 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. 14 20 @ $ 100 = $ 2 ,0 0 0 $ 500
A ug. 17 20 @ $ 115 = $ 2 ,3 0 0 $ 2 ,8 0 0
A ug. 28 10 @ $ 119 = $ 1 ,1 9 0 $ 3 ,9 9 0

Additional
Additional purchases
purchaseswere
weremade
madeononAugust
August 17
17and
and
August
August 28.
28.
On
OnAugust
August 31,
31, an
anadditional
additional 23
23units
unitswere
were sold.
sold.

Continue
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-19

Average-Cost
Average-Cost Method
Method
In v e n t o r y
D a te P u rc h a s e s C o s t o f G o o d s S o ld B a la 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 . 14 20 @ $ 100 = $ 2 ,0 0 0 $ 500
A ug . 17 20 @ $ 115 = $ 2 ,3 0 0 $ 2 ,8 0 0
A ug . 28 10 @ $ 119 = $ 1 ,1 9 0 $ 3 ,9 9 0

Total Purchases 55 $114 $3,990  35

$114 == $3,990 35
Less: Sales to Date -20
Units on Hand 35

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-20

Average-Cost
Average-Cost Method
Method
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 20 @ $ 100 = $ 2,000 $ 500
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,800
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,990
Aug. 31 23 @ $ 114 = $ 2,622 $ 1,368

The
The average
average costcost per
per $114 $3,990  35
$114 == $3,990 35
unit
unit is
is $114.
$114.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-21

Average-Cost
Average-Cost Method
Method
Inventory
Date Purchases Cost of GoodsSold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $106 = $1,590 $ 2,500
Income Statement Aug. 14 20 @ $100 = $2,000 $ 500
COGS = $4,622 Aug. 17 20 @ $115 = $2,300 $ 2,800
Aug. 28 10 @ $119 = $1,190 $ 3,990
Aug. 31 23 @ $114 = $2,622 $ 1,368

Balance Sheet
Inventory = $1,368
$114
$114 ×× 12
12 == $1,368
$1,368
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-22

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)

Oldest
Oldest Costs
Costs of
of
Costs
Costs Goods
Goods Sold
Sold

Recent
Recent Ending
Ending
Costs
Costs Inventory
Inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-23

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)
In v e n t o r y
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 ld IBn va el an nt oc rey
A uD ga .t e1 1 0 @ P $u r c 9h1 a s e= s $ 9 1 0 C o s t o f G o o d s S o ld $B a l a n9 c1 e0
A u g . 3 1 5 @ $ 1 0 6 = $ 1 ,5 9 0 $ 2 , 5 0 0
A u g . 1 1 0 @ $ 9 1 = $ 9 1 0 $ 9 1 0
A u g . 3 1 5 @ $ 1 0 6 = $ 1 ,5 9 0 $ 2 ,5 0 0
A u g . 1 4 1 0 @ $ 9 1 = $ 9 1 0
1 0 @ $ 1 0 6 = $ 1 ,0 6 0 $ 5 3 0

The
TheCost
Cost of
of Goods
Goods Sold
Sold for
for the
theAugust
August 14 14sale
saleisis $1,970,
$1,970,
leaving
leaving $530
$530and
and55 units
units in
ininventory.
inventory.
On
OnAugust
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.
Continue
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-24

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)
GE N E R AL JOU R N AL
P
D a te A cco u n t T itle s a n d Ex p la n a tio n R D e b it C re d it
A u g . 14 C a sh 2,600
S a le s Retail
Retail 2,600

14 C o st o f G o o d s S o ld 1,970
In ve n to ry Cost
Cost 1,970

AAsimilar
similar entry
entry is
is
made Continue
made after
after each
each sale.
sale.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-25

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)
In ve n t o r y
D a te P u rc h a s e s C o s t o f G o o d s S o ld Inventory
B a la n c e
Aug. 1 $Balance910
Date 10 @
Purchases
$ 91 = $ 910
Cost of Goods Sold
Aug. 3 15 @ $ 106 = $ 1 ,5 9 0 $ 2 ,5 0 0
Aug.
Aug. 1 14 10 @ $ 91 = $ 910 10 @ $ 91 = $ 910 $ 910
$ 530
Aug. 3 15 @ $ 106 = $ 1,590 10 @ $ 106 = $ 1 ,0 6 0
$ 2,500
Aug. 17 20 @ $ 115 = $ 2 ,3 0 0 $ 2 ,8 3 0
Aug. 14
Aug. 2 8 10 @ $ 119 = $ 1 ,1 9 0 10 @ $ 91 = $ 910 $ 4 ,0 2 0
10 @ $ 106 = $ 1,060 $ 530
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,830
Aug. 28 10 @ $ 119 = $ 1,190 $ 4,020
Aug. 31 5 @ $ 106 = $ 530
18 @ $ 115 = $ 2,070 $ 1,420

Additional
Additionalpurchases
purchaseswere
weremade
madeon onAug.
Aug.17
17and
andAug.
Aug.28.
28.
Cost
CostOn of
of Goods
Goods
August 31,
Sold
Sold
an
for
for August
August
additional 23 units
31
31
were
=sold.
= $2,600
$2,600
On August 31, an additional 23 units were sold.

McGraw-Hill/Irwin
Continue © The McGraw-Hill Companies, Inc., 2005
 8-26

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)
Inventory
Date Purchases Cost ofGoodsSold Balance
Aug.1 10 @ $ 91 = $ 910 $ 910
Aug.3 15 @ $106 = $1,590 $ 2,500
Income Statement
Aug.14 10 @ $ 91 = $ 910
COGS = $4,570 10 @ $106 = $1,060 $ 530
Aug.17 20 @ $115 = $2,300 $ 2,830
Aug.28 10 @ $119 = $1,190 $ 4,020
Aug.31 5 @ $106 = $ 530
18 @ $115 = $2,070 $ 1,420

Balance Sheet
2 @ $ 115 = $ 230
10 @ $ 119 = 1,190
Inventory = $1,420
End. Inv. $ 1,420

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-27

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)

Recent
Recent Costs
Costs of
of
Costs
Costs Goods
Goods Sold
Sold

Oldest
Oldest Ending
Ending
Costs
Costs Inventory
Inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-28

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)
In v e n t o r y
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 ld IBn va el an nt oc rey
A uD ga .t e1 1 0 @ P $u r c 9h1 a s e= s $ 9 1 0 C o s t o f G o o d s S o ld $B a l a n9 c1 e0
A u g . 3 1 5 @ $ 1 0 6 = $ 1 ,5 9 0 $ 2 , 5 0 0
A u g . 1 1 0 @ $ 9 1 = $ 9 1 0 $ 9 1 0
A u g . 3 1 5 @ $ 1 0 6 = $ 1 ,5 9 0 $ 2 ,5 0 0
A u g . 1 4 1 5 @ $ 1 0 6 = $ 1 ,5 9 0
5 @ $ 9 1 = $ 4 5 5 $ 4 5 5

The
The Cost
Cost ofof Goods
Goods Sold
Sold for
for the
the August
August 14 14 sale
sale is
is
$2,045,
$2,045, leaving
leaving $455
$455 and
and 55 units
units in
in inventory.
inventory.
On
OnAugust
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.
Continue
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-29

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)
GE N E R AL JOU R N AL
P
D a te A cco u n t T itle s a n d Ex p la n a tio n R D e b it C re d it
A u g . 14 C a sh 2,600
S a le s Retail
Retail 2,600

14 C o st o f G o o d s S o ld 2,045
In ve n to ry Cost
Cost 2,045

AAsimilar
similar entry
entry is
is
made Continue
made after
after each
each sale.
sale.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-30

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)
In ve n t o r y
D a te P u rc h a s e s C o s t o f G o o d s S o ld B a la n c e
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1 ,5 9 0 $ 2 ,5 0 0
Aug. 14 15 @ $ 106 = $ 1 ,5 9 0
5 @ $ 91 = $ 455 $ 455
Aug. 17 20 @ $ 115 = $ 2 ,3 0 0 $ 2 ,7 5 5
Aug. 28 10 @ $ 119 = $ 1 ,1 9 0 $ 3 ,9 4 5

Additional
Additionalpurchases
purchaseswere
weremade
madeononAug.
Aug.17
17and
andAug.
Aug.28.
28.
On
OnAug.
Aug.31,
31,an
anadditional
additional23
23units
unitswere
weresold.
sold.

Continue © The McGraw-Hill Companies, Inc., 2005

McGraw-Hill/Irwin
 8-31

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)
In ve n t o r y
D a te P u rc h a s e s C o s t o f G o o d s S o ld Inventory
B a la n c e
Date
Au g. 1 10 @ Purchases
$ 91 = $ 910 Cost of Goods Sold $Balance910
Aug. 3 15 @ $ 106 = $ 1 ,5 9 0 $ 2 ,5 0 0
Aug.
Aug. 1 14 10 @ $ 91 = $ 910 15 @ $ 106 = $ 1 ,5 9 0 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 5 @ $ 91 = $ 455 $ 2,500
$ 455
Aug. 17 20 @ $ 115 = $ 2 ,3 0 0 $ 2 ,7 5 5
Aug. 14
Aug. 28 10 @ $ 119 = $ 1 ,1 9 0 15 @ $ 106 = $ 1,590 $ 3 ,9 4 5
5 @ $ 91 = $ 455 $ 455
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,755
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,945
Aug. 31 10 @ $ 119 = $ 1,190
13 @ $ 115 = $ 1,495 $ 1,260

Cost
Cost of
of Goods
Goods Sold
Sold for
forAugust
August 31
31 == $2,685
$2,685

Continue © The McGraw-Hill Companies, Inc., 2005

McGraw-Hill/Irwin
 8-32

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)
Inventory
Date Purchases Cost ofGoodsSold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $106 = $1,590 $ 2,500
Income Statement Aug. 14 15 @ $106 = $1,590
COGS = $4,730 5 @ $ 91 = $ 455 $ 455
Aug. 17 20 @ $115 = $2,300 $ 2,755
Aug. 28 10 @ $119 = $1,190 $ 3,945
Aug. 31 10 @ $119 = $1,190
13 @ $115 = $1,495 $ 1,260

Balance Sheet 5 @ $ 91 = $ 455

Inventory = $1,260 7 @ $ 115 = 805
En d . In v. $ 1 ,2 6 0

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Inventory Valuation Methods: A Summary
Costs Allocated to: 8-33

Valuation Cost of Goods

Method Sold Inventory Comments
Specific Actual cost of Actual cost of units Parallels physical flow
identification the units sold remaining Logical method when units
are unique
May be misleading for
identical units
Average cost Number of units Number of units on Assigns all units the same
sold times the hand times the average unit cost
average unit cost average unit cost Current costs are averaged
in with older costs
First-in, First-out Cost of earliest Cost of most Cost of goods sold is based
(FIFO) purchases on recently on older costs
hand prior to the purchased units Inventory valued at current
sale costs
May overstate income during
periods of rising prices; may
increase income taxes due
Last-in, First-out Cost of most Cost of earliest Cost of goods sold shown at
(LIFO) recently purchases recent prices
purchased units (assumed still in Inventory shown at old (and
inventory) perhaps out of date) costs
Most conservative method
during periods of rising
prices; often results in lower
McGraw-Hill/Irwin © The McGraw-Hill
income taxes Companies, Inc., 2005
 8-34

The
The Principle
Principle of
of Consistency
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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-35

Just-In-Time
Just-In-Time (JIT)
(JIT) Inventory
Inventory Systems
Systems

This inventory arrived just

in time for us to use it in
the manufacturing
process.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-36

Taking
Taking aa Physical
Physical Inventory
Inventory

The
The primary
primary reason
reason for
for taking
taking aa physical
physical inventory
inventory
is
is to
to adjust
adjust the
the perpetual
perpetual inventory
inventory records
records for
for
unrecorded
unrecorded shrinkage
shrinkage losses,
losses, such
such as
as theft,
theft,
spoilage,
spoilage, oror breakage.
breakage.

GE N E R AL JOU R N AL
P
D a te A cco u n t T itle s a n d Ex p la n a tio n R D e b it C re d it
D e c. 31 C o st o f G o o d s S o ld $$$$
In ve n to ry $$$$

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 LCM
LCM and
and Other
Other Write-Downs
Write-Downs
8-37

of
of Inventory
Inventory

Reduces
Reduces the the value
value
Obsolescence
Obsolescence of
of the
the inventory.
inventory.

Lower
Lower of
of Cost
Cost Adjust
Adjust inventory
inventory
or
or Market
Market value
value toto the
the lower
lower
(LCM)
(LCM) of
of historical
historical cost
cost or
or
current
current
replacement
replacement cost cost
(market).
(market).
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-38

Periodic
Periodic Inventory
Inventory Systems
Systems
In a periodic inventory system, inventory entries
are as follows.
GEN ER AL JOU R N AL
P
D a te A c c o u n t T i tl e s a n d E x p l a n a ti o n R D e b it C re d it
E n tr y o n P u r c h a se D a te
P u r c h a se s $$$$
A c c o u n ts P a y a b l e $$$$

Note
Note that
that an
an entry
entry is
is not
not
made
made toto inventory.
inventory.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-39

For interim fi
nancial
statements, w
e may need
to estimate e
nding
inventory an
d cost of
goods sold.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-40

The
The Gross
Gross Profit
Profit Method
Method

Determine
Determine costcost of
of goods
goods
available
available for
for sale.
sale.

Estimate
Estimate cost
cost of
of goods
goods
sold
sold by
by multiplying
multiplying the the net
net
sales
sales by
by the
the cost
cost ratio.
ratio.

Deduct
Deduct cost
cost of of goods
goods sold
sold
from
from cost
cost ofof goods
goods
available
available for
for sale
sale to
to
determine
determine ending
ending
inventory.
inventory.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-41

The
The Gross
Gross Profit
Profit Method
Method
In
In March
March of of 2005,
2005, ChemCo’s
ChemCo’s inventory
inventory was
was destroyed
destroyed
by
by fire.
fire. ChemCo’s
ChemCo’s normalnormal gross
gross profit
profit ratio
ratio isis 30%
30% of
of
net
net sales.
sales. At
At the
the time
time of
of the
the fire,
fire, ChemCo
ChemCo showed showed
the
the following
following balances:
balances:

Sales $ 31,500
Sales returns 1,500
Beginning Inventory 12,000
Net cost of goods purchased 20,500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-42

The
The Gross
Gross Profit
Profit Method
Method
Estimating Inventory
The Gross Profit Method
Goods Available for Sale:
Beginning Inventory $ 12,000
Net cost of goods purchased 20,500
Goods available for sale $ 32,500
Less estimated cost of goods sold:
Sales $ 31,500
Less sales returns (1,500) × 70%
Net sales $ 30,000
Estimated cost of goods sold (21,000)
 Estimated March inventory loss $ 11,500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 8-43

Financial
Financial Analysis
Analysis

Measures
Measures how how quickly
quickly aa company
company
sells
sells its
its merchandise
merchandise inventory.
inventory.

Inventory Cost of Goods Sold

Turnover Rate = Average Inventory

Average
AverageInventory
Inventory== (Beg.
(Beg.Inv.
Inv. ++End.
End. Inv.)
Inv.)÷÷ 22

A
A ratio
ratio that
that is
is low
low compared
compared to to competitors
competitors
suggests
suggests inefficient
inefficient use
use of
of assets.
assets.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005
 8-44

Financial
Financial Analysis
Analysis
Avg. Number
Days in the Year
of Days to = Inventory Turnover
Sell Inventory

Measures
Measures how
how manymany days
days onon
average
average itit takes
takes to
to sell
sell its
its
inventory.
inventory.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005

 Accounting
Accounting Methods
Methods Can
Can Affect
Affect
8-45

Financial
Financial Ratios
Ratios
Remember that identical
companies that use different
inventory methods (e.g.,
FIFO and LIFO) will have
different inventory turnover
ratios.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005