Chap 008

Inventories:
Measurement
8
Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
8-2
Inventory
Those assets that a company:

1. Intends to sell in the normal
course of business.
2. Has in production (work in

process) for future sale.
3. Uses currently in the production
of goods to be sold (raw materials).
8-3
Types of Inventories
Types of Inventory
Merchandise
Inventory
Manufacturing
Inventory
Goods acquired for

resale
Raw Materials
Work-in-Process
Finished Goods
8-4
Inventory Cost Flows

Raw
Materials
(1) $XX
Work in
Process
$XX (4)
$XX
$XX (7)
Finished
Goods
$XX $XX (8)
Direct
Labor
(2) $XX
Cost of Good
Sold
$XX (5)
Manufacturing
Overhead
(3) $XX
$XX
$XX (6)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
Raw materials purchased

Direct labor incurred
Manufacturing overhead incurred
Raw materials used
Direct labor applied
Manufacturing overhead applied
Work in process transferred to finished goods
Finished goods sold
8-5
Learning Objective
Explain the difference between a
perpetual inventory system and a
periodic inventory system.
8-6
Inventory Methods
Two accounting systems are used to record
transactions involving inventory:
Perpetual
Inventory System
Periodic Inventory
System
The inventory
account is
continuously
updated as
purchases and
sales are made.
The inventory
account is
adjusted at the end
of a reporting
cycle.
8-7
Perpetual Inventory System

Matrix, Inc. purchases on account $600,000
of merchandise for resale to customers.
GENERAL JOURNAL
Date
Description
2006
Inventory
Accounts Payable
Debit
Credit
600,000
600,000
Returns of inventory are credited to the inventory account.

Discounts on inventory purchases can be recorded using the
gross or net method.
8-8

Matrix, Inc. sold, on account, inventory with a
retail price of $820,000 and a cost basis
of $540,000, to a customer.
GENERAL JOURNAL
Date
Description
2006
Accounts Receivable
Debit
820,000
820,000
Sales
Cost of Goods Sold
Inventory
Credit
540,000
540,000
8-9
Periodic Cost of Goods Sold Equation

Beginning Inventory
+ Net Purchases
Cost of Goods
Available for Sale
- Ending Inventory
= Cost of Goods Sold
8-10
Periodic Inventory System

Matrix, Inc. purchases on account $600,000
of merchandise for resale to customers.
GENERAL JOURNAL
Date
Description
2006
Purchases
Accounts Payable
Debit
Credit
600,000
600,000
Returns of inventory are credited to the Purchase Returns and

Allowances account.
Discounts on inventory purchases can be recorded using the

gross or net method.
8-11

Matrix, Inc. sold on account, inventory with a
retail price of $820,000 and a cost basis
of $540,000, to a customer.
GENERAL JOURNAL
Date
Description
2006
Accounts Receivable
Sales
Debit
Credit
820,000
820,000
No entry is made to record Cost of Good Sold. Assuming Beginning

Inventory of $120,000. A physical count of Ending Inventory shows
a balance of $180,000. Lets calculate Cost of Goods Sold at
the end of the accounting period.
8-12

Calculation of Cost of Goods Sold
Beginning inventory
Plus: Purchases
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
120,000
600,000
720,000
(180,000)
540,000
Adjusting entry to determine Cost of Goods Sold

Date
Description
12/31/06 Cost of goods sold

Inventory (ending)
Inventory (beginning)
Purchases
Debit
Credit
540,000
180,000
120,000
600,000
8-13
Comparison of Inventory Systems

Transaction or
Event
Periodic
Inventory
Perpetual
Inventory
Routine purchases of
various inventory items
Costs debited to
purchases account
Costs debited to
inventory account
Sale of inventory
No accounting
entries made
Debit Cost of goods

sold and credit
inventory
End-of-period
accounting entries and
related activities
Physical count of
inventory to
determine cost of
good sold
No separate
determination of cost
of goods sold
necessary
8-14
Learning Objective
Explain which physical quantities of goods
should be included in inventory.
8-15
What is Included in Inventory?

General Rule
All goods owned by the company on the inventory
date, regardless of their location.
Goods in Transit
Depends on FOB
shipping terms.
Goods on
Consignment
8-16
Learning Objective
Determine the expenditures that should
be included in the cost of inventory.
8-17
Expenditures Included in Inventory
Invoice
Price
Purchase
Returns
+
Freight-in
on
Purchases
Purchase
Discounts
8-18
Purchase Discounts
Gross Method
Date
10/5/06
10/14/06
11/4/06
10/5/06
10/14/06
11/4/06
Description
Purchases
Accounts payable
Debit
Credit
20,000
20,000
Accounts payable
Purchase discounts
Cash
14,000
Accounts payable
Cash
Net Method
Purchases
Accounts payable
6,000
280
13,720
6,000
19,600
19,600
Accounts payable
Cash
13,720
Accounts payable
Interest expense
Cash
5,880
120
13,720
6,000
Discount terms
are 2/10, n/30.
$14,000
x 0.02
$ 280
Partial payment not

made within the
discount period
8-19
Net Method Using Perpetual and Periodic

Matrix, Inc. purchased on account $6,000 of
merchandise for resale to customers. The merchandise
was purchased subject to a cash discount of 2/10, n/30.
The company incurred $160 in freight-in on the
merchandise. Upon inspection, the company found that
$200 of merchandise was damaged and the seller
agreed to accept the merchandise return and credit the
account of the company. The inventory was sold for
$8,300 on account. Lets look at the journal entries
under both the perpetual and periodic accounting
system assuming Matrix uses the net method to record
merchandise purchases.
8-20
Net Method Using Perpetual and Periodic

Perpetual Inventory Method
Description
Debit
Credit
Inventory
Accounts payable
Inventory
Cash
Accounts payable
Inventory
Accounts receivable
Sales revenue
5,880
5,880
160
160
200
200
8,300
8,300
Cost of goods sold

5,840
Inventory
Periodic Inventory Method
Purchases
5,880
Accounts payable
Freight-in
Cash
160
Accounts payable
Purchase returns
200
Accounts receivable
Sales revenue
8,300
5,840
5,880
160
200
8,300
Beginning inventory
Purchases
$ 5,880
Less: Returns
(200)
Plus: Freight-in
160
Net purchases
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
5,840
5,840
$ 5,840
8-21
Learning Objective
Differentiate between the specific identification,
FIFO, LIFO, and average cost methods used
to determine the cost of ending inventory and
cost of goods sold.
8-22
Inventory Cost Flow Methods
Specific cost identification
Average cost
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
8-23
Specific Cost Identification
Items are added to

inventory at cost when
they are purchased.
The specific cost of

each inventory item
must be known.
COGS for each sale is

based on the specific
cost of the item sold.
By selecting specific
items from inventory
at the time of sale,
income can be
manipulated.
8-24
Average Cost Method

Periodic average cost uses a
weighted-average unit cost:
Weightedaverage
unit cost
Cost of
goods
=
available for
sale
Quantity
available for
sale
Perpetual average cost uses a moving

average unit cost that is recomputed
each time a new purchase is made.
8-25
Weighted-Average Periodic System

The following schedule shows the frame
inventory for Yore Frame, Inc. for September.
The physical inventory count at September 30
shows 600 frames in ending inventory.
Use the periodic weighted-average method to
determine:
(1) Ending inventory cost.
(2) Cost of goods sold.
8-26

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
$ 47,650.00
?
?
8-27

Now, we have to assign costs to ending
inventory and cost of goods sold.
Ending Inventory
(600 units)
Beginning Inventory
(800 units)
Purchases
(1,150 units)
Available
for Sale
(1,950 units)
Goods Sold
(1,350)
$47,650 1,950 = $24.4359 weightedaverage per unit cost
8-28

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
24.4359
24.4359
$ 47,650.00
14,661.54
$ 32,988.46
8-29
Moving-Average Perpetual System

The following schedule shows the Frame
Use the perpetual weighted-average method to
determine:
8-30

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
Date
9/1
9/10
9/30
Sales Units
600
300
450
8-31

Date
Purchased
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
Sold
600 x
22.000 =
Balance
$ 17,600.00
13,200.00
4,400.00
8-32

Date
Purchased
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep 300 x 24.00 =
7,200
10-Sep
Sold
600 x
22.000 =
300 x
23.200 =
Balance
$ 17,600.00
13,200.00
4,400.00
11,600.00
6,960.00
4,640.00
$11,600.00 (800-600+300) = $23.200
8-33

Date
Beg. Inv.
1-Sep
3-Sep
10-Sep
15-Sep
21-Sep
29-Sep
30-Sep
Purchased
800 x 22.00 = 17,600
300 x
250 x
200 x
400 x
24.00 =
25.00 =
27.00 =
28.00 =
Sold
600 x
22.000 =
300 x
23.200 =
450 x
26.181 =
7,200
6,250
5,400
11,200
Balance
$ 17,600.00
13,200.00
4,400.00
11,600.00
6,960.00
4,640.00
10,890.00
16,290.00
27,490.00
11,781.45
15,708.55
$27,490.00 (800-600+300-300+250+200+400) = $26.181
8-34

Date
Beg. Inv.
1-Sep
3-Sep
10-Sep
15-Sep
21-Sep
29-Sep
30-Sep
Purchased
800 x 22.00 = 17,600
300 x
250 x
200 x
400 x
24.00 =
25.00 =
27.00 =
28.00 =
Sold
600 x
22.000 =
300 x
23.200 =
450 x
26.181 =
7,200
6,250
5,400
11,200
Sum
Cost of Goods Sold in September

Sale Date
Units
Cost/Unit
Total
9/1
600
22.000 $ 13,200.00
9/10
300
23.200
6,960.00
9/30
450
26.181
11,781.45
Total
1,350
31,941.45
Balance
$ 17,600.00
13,200.00
4,400.00
11,600.00
6,960.00
4,640.00
10,890.00
16,290.00
27,490.00
11,781.45
15,708.55
8-35
First-In, First-Out
The FIFO
method
assumes that
items are sold
in the
chronological
order of their
acquisition.
The
cost of the oldest

inventory items are
charged to COGS
when goods are sold.
The cost of the
newest inventory
items remain in
ending inventory.
8-36
First-In, First-Out
Even though the periodic
and the perpetual
approaches differ in the
timing of adjustments to
inventory . . .
. . . COGS and Ending
Inventory Cost are the
same under both
approaches.
8-37
FIFO - Periodic System


Use the periodic FIFO method to determine:
8-38

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
These are
the 600
$ 47,650.00
most recently
acquired units.
8-39

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
$ 47,650.00
16,600.00
8-40

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
These are the first

$ 47,650.00
1,350 units
16,600.00
acquired.
8-41

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
$ 47,650.00
16,600.00
$ 31,050.00
8-42
FIFO - Perpetual System


Use the perpetual FIFO method to determine:
8-43

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
Date
9/1
9/10
9/30
Sales Units
600
300
450
8-44

Date
Purchased
200
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
Sold
600 x
22.00 =
13,200.00
The ending inventory on 9/1 consists of:

200 units from beginning inventory @ $22.00
Balance
$ 17,600.00
4,400.00
8-45

Date
Purchased
200
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep
300 x 24.00 =
7,200
Sold
600 x
22.00 =
13,200.00

300 units from the 9/3 purchase @ $24.00
Balance
$ 17,600.00
4,400.00
11,600.00
8-46

Date
Purchased
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
200
3-Sep
300 x 24.00 =
7,200
10-Sep (remaining from Beg. Inv)
(from the 9/3 layer)
Sold
600 x
22.00 =
13,200.00
200 x
100 x
22.00 =
24.00 =
4,400.00
2,400.00

Balance
$ 17,600.00
4,400.00
11,600.00
7,200.00
4,800.00
8-47

Date
Purchased
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
200
3-Sep
300 x 24.00 =
7,200
15-Sep
250 x 25.00 =
6,250
Sold
600 x
22.00 =
13,200.00
200 x
100 x
22.00 =
24.00 =
4,400.00
2,400.00

Balance
$ 17,600.00
4,400.00
11,600.00
7,200.00
4,800.00
11,050.00
8-48

Date
Purchased
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
200
3-Sep
300 x 24.00 =
7,200
15-Sep
250 x 25.00 =
6,250
21-Sep
200 x 27.00 =
5,400
Sold
600 x
22.00 =
13,200.00
200 x
100 x
22.00 =
24.00 =
4,400.00
2,400.00

Balance
$ 17,600.00
4,400.00
11,600.00
7,200.00
4,800.00
11,050.00
16,450.00
8-49

Date
Purchased
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
200
3-Sep
300 x 24.00 =
7,200
15-Sep
250 x 25.00 =
6,250
21-Sep
200 x 27.00 =
5,400
29-Sep
400 x 28.00 = 11,200
Sold
600 x
22.00 =
13,200.00
200 x
100 x
22.00 =
24.00 =
4,400.00
2,400.00

Balance
$ 17,600.00
4,400.00
11,600.00
7,200.00
4,800.00
11,050.00
16,450.00
27,650.00
8-50

Date
Purchased
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep
300 x 24.00 =
7,200
15-Sep
250 x 25.00 =
6,250
21-Sep
200 x 27.00 =
5,400
29-Sep
400 x 28.00 = 11,200
30-Sep (remaining from 9/3 layer)
Sold
600 x
22.00 =
13,200.00
200 x
100 x
22.00 =
24.00 =
4,400.00
2,400.00
200 x
250 x
24.00 =
25.00 =
4,800.00
6,250.00
Cost of Goods
Sold
=
31,050.00
The ending inventory
on 9/30
consists
of:

400 units from the 9/29 purchase @ $28.00.
Balance
$ 17,600.00
4,400.00
11,600.00
7,200.00
4,800.00
11,050.00
16,450.00
27,650.00
22,850.00
16,600.00
8-51

Date
Purchased
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep
300 x 24.00 =
7,200
15-Sep
250 x 25.00 =
6,250
21-Sep
200 x 27.00 =
5,400
29-Sep
400 x 28.00 = 11,200
30-Sep (remaining from 9/3 layer)
Sold
600 x
22.00 =
13,200.00
200 x
100 x
22.00 =
24.00 =
4,400.00
2,400.00
200 x
250 x
24.00 =
25.00 =
4,800.00
6,250.00
Cost of Goods Sold =
31,050.00
Note that this is the same COGS

computed using the Periodic
approach.
Balance
$ 17,600.00
4,400.00
11,600.00
7,200.00
4,800.00
11,050.00
16,450.00
27,650.00
22,850.00
16,600.00
8-52
Last-In, First-Out
Any questions
before we run into
LIFO?
8-53
Last-In, First-Out
The LIFO
method
assumes that
the newest
items are sold
first, leaving the
older units in
inventory.
The
cost of the
newest inventory
items are charged to
COGS when goods
are sold.
The cost of the oldest
inventory items
remain in inventory.
8-54
Last-In, First-Out
Unlike FIFO, using
the LIFO method
may result in COGS
and Ending
Inventory Cost that
differ under the
periodic and
perpetual
approaches.
8-55
LIFO - Periodic System


Use the periodic LIFO method to determine:
8-56

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
These are
the 600
$ 47,650.00
oldest units in
inventory.
8-57

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
200 $ 22.00
24.00
25.00
27.00
28.00
600 x $22.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
$ 47,650.00
13,200.00
8-58

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
200 $ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
These are the

$ 47,650.00
most recently
600 x $22.00
acquired 13,200.00
1,350
units.
8-59

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
$/Unit
200 $ 22.00
24.00
25.00
27.00
28.00
1,950
600
1,350 $4,400 + $30,050
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
$ 47,650.00
13,200.00
$ 34,450.00
8-60
LIFO - Perpetual System


Use the perpetual LIFO method to determine:
8-61

Yore Frame, Inc.
Frame Inventory
Date
Beg. Inventory
9/3
9/15
9/21
9/29
Goods Available for
Sale
Ending Inventory
Cost of Goods Sold
Units
800
300
250
200
400
1,950
600
1,350
$/Unit
$ 22.00
24.00
25.00
27.00
28.00
Total
$ 17,600.00
7,200.00
6,250.00
5,400.00
11,200.00
Date
9/1
9/10
9/30
Sales Units
600
300
450
8-62

Date
Purchased
200
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
Sold
600 x
22.00 =
13,200.00
In LIFO, we assume that we sell the

newest units in inventory first.
In this case, the 600 newest units
come from beginning inventory,
leaving 200 units in the beginning
inventory layer.
Balance
$ 17,600.00
4,400.00
8-63

Date
Purchased
200
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep
300 x 24.00 =
7,200
Sold
600 x
22.00 =
13,200.00

Balance
$ 17,600.00
4,400.00
11,600.00
8-64

Date
Purchased
200
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep
300 x 24.00 =
7,200
10-Sep (from the 9/3 purchase)
Sold
600 x
22.00 =
13,200.00
300 x
24.00 =
7,200.00
Balance
$ 17,600.00
4,400.00
11,600.00
4,400.00
For the 9/10 sale, we must identify the 300 newest

units. They all come from the September 3
purchase.
Note that all of the 9/3 units have been sold and
only 200 of the beginning inventory units remain.
8-65

Date
Purchased
200
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep
300 x 24.00 =
7,200
15-Sep
250 x 25.00 =
6,250
Sold
600 x
22.00 =
13,200.00
300 x
24.00 =
7,200.00

on 9/15
consists
of:
Cost of Goods
Sold
=
20,400.00
Balance
$ 17,600.00
4,400.00
11,600.00
4,400.00
10,650.00
8-66

Date
Purchased
200
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep
300 x 24.00 =
7,200
15-Sep
250 x 25.00 =
6,250
21-Sep
200 x 27.00 =
5,400
Sold
600 x
22.00 =
13,200.00
300 x
24.00 =
7,200.00

on 9/21
consists
of:
Cost of Goods
Sold
=
20,400.00
Balance
$ 17,600.00
4,400.00
11,600.00
4,400.00
10,650.00
16,050.00
8-67

Date
Purchased
200
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep
300 x 24.00 =
7,200
15-Sep
250 x 25.00 =
6,250
21-Sep
200 x 27.00 =
5,400
29-Sep
400 x 28.00 = 11,200
Sold
600 x
22.00 =
13,200.00
300 x
24.00 =
7,200.00

on 9/29
consists
of:
Cost of Goods
Sold
=
20,400.00
Balance
$ 17,600.00
4,400.00
11,600.00
4,400.00
10,650.00
16,050.00
27,250.00
8-68

Date
Purchased
200
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep
300 x 24.00 =
7,200
15-Sep
250 x 25.00 =
6,250
150
21-Sep
200 x 27.00 =
5,400
29-Sep
400 x 28.00 = 11,200
(from the 9/21 purchase)
Sold
600 x
22.00 =
13,200.00
300 x
24.00 =
7,200.00
400 x
50 x
28.00 =
27.00 =
11,200.00
1,350.00
32,950.00
Balance
$ 17,600.00
4,400.00
11,600.00
4,400.00
10,650.00
16,050.00
27,250.00
16,050.00
14,700.00
For the 9/30 sale, we must identify the 450 newest

units. 400 of them come from the 9/29 purchase.
The other 50 come from the 9/21 purchase.
8-69

Date
Purchased
200
Beg. Inv.
800 x 22.00 = 17,600
1-Sep
3-Sep
300 x 24.00 =
7,200
15-Sep
250 x 25.00 =
6,250
150
21-Sep
200 x 27.00 =
5,400
29-Sep
400 x 28.00 = 11,200
(from the 9/21 purchase)
Sold
600 x
22.00 =
13,200.00
300 x
24.00 =
7,200.00
400 x
50 x
28.00 =
27.00 =
11,200.00
1,350.00
32,950.00

Balance
$ 17,600.00
4,400.00
11,600.00
4,400.00
10,650.00
16,050.00
27,250.00
16,050.00
14,700.00
8-70
When Prices Are Rising . . .
FIFO
Matches low (older) costs
with current (higher)
sales.
Inventory is valued at
approximate replacement
cost.
Results in higher taxable
income.
LIFO
Matches high (newer)
costs with current (higher)
sales.
Inventory is valued based
on low (older) cost basis.
Results in lower taxable
income.
Is not officially endorsed
by the IASC.
8-71
Comparison of Cost Flow Methods
Cost of goods sold

Ending inventory
Total

Average
Cost
FIFO
LIFO
$
31,941
$
31,050
$
32,950
15,709
16,600
14,700
$
47,650
$
47,650
$
47,650
8-72
Comparison of Cost Flow Methods

Inventory Method Used by Major Companies
2003
FIFO
LIFO
Average
Other
Total
1973
# of
Companies
% of
Companies
# of
Companies
% of
Companies
384
251
167
31
833
46%
30%
20%
4%
100%
394
150
235
148
927
43%
16%
25%
16%
100%
8-73
Learning Objective
Discuss the factors affecting a companys
choice of inventory method.
8-74
Decision Makers Perspective

What factors motivate companies to
select one inventory method over another?
How closely do
reported
costs reflect actual
flow of inventory?
How well are costs

matched against
related revenues?
How accurate is the

timing of reported
income
and income taxes?
8-75
Learning Objective
Understand supplemental LIFO disclosures
and the effect of LIFO liquidations on net
income.
8-76
LIFO Liquidation
When prices rise . . .

LIFO inventory costs on the balance
sheet are out of date because they reflect
old purchase transactions.
If inventory declines,
these out of date costs
may be charged to
current earnings.
This LIFO
liquidation
results in
paper profits.
8-77
LIFO Reserves
Many companies use LIFO for external reporting and
income tax purposes but maintain internal records using
FIFO or average cost.
The conversion from FIFO or average cost

to LIFO takes place at the end of the
period. The conversion may look like this:
Total inventories at FIFO

Less: LIFO allowance
Inventories, at LIFO cost
2003
2002
$ 12,541
1,581
$ 10,960
$ 11,544
1,807
$ 9,737
8-78
Learning Objective
Calculate the key ratios used by analysts to
monitor a companys investment in inventories.
8-79
Gross Profit Ratio
Gross profit
ratio
Gross profit
Net sales
This measure indicates how much

of each sales dollar is left after
deducting the cost of goods sold to
cover expenses and provide a profit.
8-80
Inventory Turnover Ratio

Inventory
=
turnover ratio
Cost of goods sold

Average inventory
This ratio measures how many times a

companys inventory has been sold
and replaced during the year.
If a companys inventory
turnover Is less than its
industry average, it either
has excessive inventory or
the wrong sorts of inventory.
8-81
Earnings Quality
Many believe that manipulating income reduces
earnings quality because it can mask permanent
earnings. Inventory write-downs and changes in
inventory method are two additional inventoryrelated techniques a company could use to
manipulate earnings.
8-82
Learning Objective
Determine ending inventory using the
dollar-value LIFO inventory method.
8-83
LIFO Inventory Pools

Inventory Pools consist of
inventory units grouped
according to similarities.
Using Inventory Pools

with LIFO simplifies
record keeping.
For example, all

similar units
purchased at the same
time can be pooled
and assigned an
average unit cost.
8-84
Dollar-Value LIFO (DVL)

DVL inventory pools are viewed as layers
of value, rather than layers of similar units.
DVL simplifies LIFO

record-keeping.
DVL minimizes the

probability of layer
liquidation.
At the
end of the
Example
period, we determine if
The inventory
replacement
a new
layer
inventory
differs
was added
byfrom
the
old inventory
on
comparing
ending
hand.
We to
just
create a
inventory
beginning
new
layer.
inventory.
8-85

We need to determine if the increase in
ending inventory over beginning inventory
was due to a price increase or an increase
in inventory.
1a. Compute a
Cost Index for the
year.
Cost index
in layer
year
Cost in
layer
year
Cost in
base
year
8-86

1b. Deflate the
ending
inventory
value using
the cost index.
1c. Compare
ending
inventory (at
base year
cost) to
beginning
inventory.
Ending
Inventory
at base
year cost
Ending
= Inventory
Cost
Cost
Index
Ending
Change in
Inv. at
Beg.
=
Inventory
Base Year
Inventory
Cost
8-87

Next, identify the layers in ending
inventory and the years they were created.
Convert each layers
base year cost to layer
year cost by
multiplying times the
cost index.
Sum all the layers to

arrive at Ending
Inventory at DVL
cost.
8-88
End of Chapter 8

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Inventories:

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Those assets that a company:

2. Has in production (work in

Goods acquired for

Inventory Cost Flows

$XX $XX (8)

Raw materials purchased

Perpetual Inventory System

Returns of inventory are credited to the inventory account.

Perpetual Inventory System

Periodic Cost of Goods Sold Equation

Periodic Inventory System

Returns of inventory are credited to the Purchase Returns and

Discounts on inventory purchases can be recorded using the

Periodic Inventory System

No entry is made to record Cost of Good Sold. Assuming Beginning

Periodic Inventory System

Adjusting entry to determine Cost of Goods Sold

12/31/06 Cost of goods sold

Comparison of Inventory Systems

Debit Cost of goods

What is Included in Inventory?

Expenditures Included in Inventory

Partial payment not

Net Method Using Perpetual and Periodic

Net Method Using Perpetual and Periodic

Cost of goods sold

Inventory Cost Flow Methods

Specific cost identification

First-in, first-out (FIFO)

Last-in, first-out (LIFO)

Specific Cost Identification

Items are added to

The specific cost of

COGS for each sale is

Average Cost Method

Perpetual average cost uses a moving

Weighted-Average Periodic System

Weighted-Average Periodic System

Weighted-Average Periodic System

$47,650 1,950 = $24.4359 weightedaverage per unit cost

Weighted-Average Periodic System

Moving-Average Perpetual System

Moving-Average Perpetual System

Moving-Average Perpetual System

Moving-Average Perpetual System

$11,600.00 (800-600+300) = $23.200

Moving-Average Perpetual System

$27,490.00 (800-600+300-300+250+200+400) = $26.181

Moving-Average Perpetual System

Cost of Goods Sold in September

cost of the oldest

FIFO - Periodic System

The physical inventory count at September 30

FIFO - Periodic System

FIFO - Periodic System

FIFO - Periodic System

These are the first

FIFO - Periodic System

FIFO - Perpetual System

The physical inventory count at September 30