Chapter 5, Slide #1

Accounting for Inventories

and Cost of Goods Sold


by
Ms. Shaher bano

Chapter 5, Slide #2
1.1 Inventory of Wholesalers and
Retailers
Purchased in finished form
Resold without transformation
Classified as Merchandise Inventory
on balance sheet
LO1
Chapter 5, Slide #3
1.2 Condensed Income Statement for
a Merchandiser
Net sales $100,000
Cost of goods sold 60,000
Gross profit $ 40,000
Selling and administrative expenses 29,300
Net income before tax $ 10,700
Income tax expense 4,280
Net income $ 6,420


Chapter 5, Slide #4
1.3 how companies keep track of
their inventory
Perpetual inventory system
Periodic inventory system
Chapter 5, Slide #5
Perpetual Inventory Systems
Point-of-sale terminals have improved the ability
of mass merchandisers to maintain perpetual
systems
Company knows the cost of sales and ending
inventory figure from their books
Inventory records are
updated after each
purchase or sale
Chapter 5, Slide #6
Periodic Inventory Systems
Reduces record keeping but also decreases the
ability to track theft, breakage, etc., and prepare
interim financial statements
Inventory records are
updated periodically
based on physical
inventory counts
Chapter 5, Slide #7
Inventory Costs Included
Any freight costs incurred by buyer
Cost of insurance for inventory in transit
Cost of storing inventory before selling
Excise and sales taxes
Chapter 5, Slide #8
Inventory Valuation and Income
Measurement

Value
assigned to
inventory
on balance
sheet


Value
expensed
as cost of
goods sold
on income
statement
When Sold =
LO5
Beginning inventory, Jan. 1: 500 units (unit cost $10)
Inventory purchases:
Date Units Unit Cost
1/20 300 $ 11
4/8 400 12
9/5 200 13
12/12 100 14
Total purchases 1,000 units
Ending inventory, Dec. 31: 600 units
Detailed Costing Method Example
Whatre the cost of goods sold and ending inventory?
Chapter 5, Slide #10
Inventory Costing Methods
(in a period of inflation)
Four costing methods available:
Specific
Identification
Weighted
Average
First-in, First-out
(FIFO)
Last-in, First-out
(LIFO)
LO6
Chapter 5, Slide #11
Specific Identification Method
Step 1: Identify the specific units in
inventory at the end of the year
and their costs.
Chapter 5, Slide #12
Specific Identification Method
Units in ending inventory:
Date purchased Units Cost Total Cost
1/20 100 $11 $1,100
4/8 300 12 3,600
9/5 200 13 2,600
Ending inventory 600 $7,300
Units Cost = Total cost
Chapter 5, Slide #13
Specific Identification Method
Step 2:
cost of goods sold = cost of goods available
for sale ending inventory
= 17,100 7,300 = 9,800

* Few companies use this method
Chapter 5, Slide #14
Weighted Average Method
Step 1: Calculate the cost of goods
available for sale.
Chapter 5, Slide #15
Weighted Average Method
Date purchased Units Cost Total cost
Beg. inventory 500 $10 $ 5,000
1/20 300 11 3,300
4/8 400 12 4,800
9/5 200 13 2,600
12/12 100 14 1,400
Cost of goods
available for sale 1,500 $17,100
Chapter 5, Slide #16
Weighted Average Method
Step 2: Divide the cost of goods available
for sale by the total units to
determine the weighted average
cost per unit.
:
Chapter 5, Slide #17
Weighted Average Method
Cost of Goods Available for Sale
Units Available for Sale
$17,100
1,500
= $11.40/unit
Chapter 5, Slide #18
Weighted Average Method
Step 3: Calculate ending inventory and
cost of goods sold by multiplying
the weighted average cost per unit
by the number of units in ending
inventory and the number of units
sold.

Avg.
Cost
# of
Units
Chapter 5, Slide #19
Weighted Average Method
ALLOCATE TO
Ending Cost of
Inventory Goods Sold
Units on hand 600
Units sold 900
Weighted average cost $11.40 $ 11.40
Total cost of goods
available of $17,100 allocated: $6,840 $10,260
Chapter 5, Slide #20
First-in, First-out (FIFO) Method
Step 1: Assign the cost of the beginning
inventory to cost of goods sold.
1st
in
Chapter 5, Slide #21
First-in, First-out (FIFO) Method
ALLOCATE TO
Ending Cost of
Units Cost Inventory Goods Sold
1/1 500 $10 $5,000
1/20 300 $11
4/8 400 $12
9/5 200 $13
12/12 100 $14

Chapter 5, Slide #22
First-in, First-out (FIFO) Method
Step 2: Continue to work forward until you
assign the total number of units sold
during the period to cost of goods sold.
Allocate the remaining costs to ending
inventory.
2nd
3rd
etc.
Chapter 5, Slide #23
First-in, First-out (FIFO) Method

ALLOCATE TO
Ending Cost of
Units Cost Inventory Goods Sold
1/1 500 $10 $5,000
1/20 300 $11 3,300
4/8 300 / 100 $12 $3,600 1,200
9/5 200 $13 2,600
12/12 100 $14 1,400
TOTALS $7,600 $9,500
Chapter 5, Slide #24
Last-in, First-out (LIFO) Method
Step 1: Assign the cost of the last units
purchased to cost of goods sold.
1st
in
Chapter 5, Slide #25
Last-in, First-out (LIFO) Method

ALLOCATE TO
Ending Cost of
Units Cost Inventory Goods Sold
1/1 500 $10
1/20 300 $11
4/8 400 $12
9/5 200 $13
12/12 100 $14 $1,400

Chapter 5, Slide #26
1st
in
Step 2: Work backwards until you assign the
total number of units sold during the
period to cost of goods sold (allocate
the remaining costs to ending
inventory).
Last-in, First-out (LIFO) Method
Chapter 5, Slide #27
Last-in, First-out (LIFO) Method

ALLOCATE TO
Ending Cost of
Units Cost Inventory Goods Sold
1/1 500 $10 $5,000
1/20 100 / 200 $11 1,100 $ 2,200
4/8 400 $12 4,800
9/5 200 $13 2,600
12/12 100 $14 1,400
TOTALS $6,100 $11,000
Chapter 5, Slide #28
Comparison of Costing Methods
Cost of
Goods
Sold
Ending
Inventory
11,000
6,840
7,600
10,260
9,500
17,100
17,000
17,100
Weighted
Average
FIFO
LIFO
Goods
Available
for Sale
6,100
Specific
Identification
$7,300
$ 9,800 $17,100
Chapter 5, Slide #29
Chapter 5, Slide #30
Comparison of Costing Methods
X
X
X
X
X
Weighted
Average FIFO LIFO


In periods of rising prices:

Highest cost of goods sold?
Lowest cost of goods sold?
Highest gross profit?
Lowest net income?
Lowest income taxes?
LO7
Chapter 5, Slide #31
LIFO Conformity Rule
LIFO conformity rule
If used for tax, LIFO must also be
used for books

In general, companies can use one
accounting method for financial reporting
purpose and use a different method for tax
purpose. Accounting choice should be
made based on which method produces
most useful information.
Chapter 5, Slide #32
Lower of Cost or Market
(for your information only)
If inventorys market value has fallen below
the cost, the inventory must be reported at
the lower market value, and a loss must be
recorded.