Chapter 6

INVENTORIES AND COST OF SALES

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
 6-2

C1

DETERMINING INVENTORY ITEMS

Merchandise inventory includes all goods that a
company owns and holds for sale, regardless of where
the goods are located when inventory is counted.

Items requiring special attention include:

Goods
Goods in
Damaged or
Transit
Goods on Obsolete
Consignment
 6-3

C1

GOODS IN TRANSIT
FOB Shipping Point
Public
Carrier

Seller Buyer

Ownership passes
to the buyer here.

Public
Carrier

Seller FOB Destination Point Buyer

 6-4

C1

GOODS ON CONSIGNMENT
Merchandise is included in the inventory of the
consignor, the owner of the inventory.
Thanks for selling my
inventory in your
store.
Consignee

Consignor
 6-5

C1

GOODS DAMAGED OR OBSOLETE

Damaged or obsolete goods are not counted in

inventory if they cannot be sold.

Cost should be reduced to net realizable

value if they can be sold.
 6-6

C2

DETERMINING INVENTORY COSTS

Include all expenditures necessary to bring an item to
a salable condition and location.

Minus
Discounts Invoice Plus
and Insurance
Allowances
Cost

Plus Import Plus

Duties Plus Storage
Freight
 6-7

C2 INTERNAL CONTROLS AND TAKING A

PHYSICAL COUNT
 Most companies take a  When the physical count
physical count of does not match the
inventory at least once Merchandise Inventory
each year. account, an adjustment
must be made.

Good internal controls over count include:

1. Pre-numbered inventory tickets.
2. Counters have no inventory responsibility.
3. Counts confirm existence, amount, and
quality of inventory item.
4. Second count is taken.
5. Manager confirms all items counted.
 6-8

P1

INVENTORY COST FLOW ASSUMPTIONS

First-In, First-Out Assumes costs flow in the order
(FIFO) incurred.

Last-In, First-Out Assumes costs flow in the

(LIFO) reverse order incurred.

Weighted Assumes costs flow at an

Average average of the costs available.
 6-9

P1

FIRST-IN, FIRST-OUT (FIFO)

Oldest Cost of
Costs Goods Sold

Recent Ending
Costs Inventory
 6 - 10

P1

LAST-IN, FIRST-OUT (LIFO)

Recent Cost of
Costs Goods Sold

Oldest Ending
Costs Inventory
 6 - 11

P1

WEIGHTED AVERAGE
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
 6 - 12

A1 FINANCIAL STATEMENT EFFECTS

OF COSTING METHODS
Because prices change, inventory methods nearly always
assign different cost amounts.
 6 - 13

A1 FINANCIAL STATEMENT EFFECTS

OF COSTING METHODS

Advantages of Methods

Weighted First-In, Last-In,

Average First-Out First-Out

Ending inventory Better matches

Smoothes out approximates current costs in cost
price changes. current of goods sold with
replacement cost. revenues.
 6 - 14

A1

TAX EFFECTS OF COSTING METHODS

The Internal Revenue Service (IRS) identifies several

acceptable inventory costing methods for reporting
taxable income.

If LIFO is used for tax

purposes, the IRS requires
it be used in financial
statements.
 6 - 15

P2

LOWER OF COST OR MARKET

Inventory must be reported at market value
when market is lower than cost.

Defined as current Can be applied three ways:

(1) separately to each
replacement cost
individual item.
(not sales price).
(2) to major categories of
Consistent with assets.
the conservatism (3) to the whole inventory.
principle.
 6 - 16

A2 FINANCIAL STATEMENT EFFECTS OF

INVENTORY ERRORS
Income Statement Effects
Inventory Error Cost of Goods Sold Net Income
Understate ending inventory Overstated Understated
Understate beginning inventory Understated Overstated
Overstate ending inventory Understated Overstated
Overstate beginning inventory Overstated Understated
 6 - 17

A2 FINANCIAL STATEMENT EFFECTS OF

INVENTORY ERRORS
Balance Sheet Effects
Inventory Error Assets Equity
Understate ending inventory Understated Understated
Overstate ending inventory Overstated Overstated
 6 - 18

END OF CHAPTER 6