CHAPTER 1

ACCOUNTING FOR
INVENTORY
After studying this chapter, you should be
able to:
1. Describe the importance of control over
inventory.
2. Determine the cost of inventory under the
perpetual system, using the FIFO and average
cost methods.
After studying this chapter, you should be
able to:
3. Determine the cost of inventory under the
periodic system, using the FIFO and average cost
methods.
4. Compare and contrast the use of the two
inventory costing methods.
5. Describe and illustrate the reporting of
merchandise inventory in the financial
statement.
 Objective 1
Describe the importance
of control over inventory.
Two primary objectives of control over inventory are:
1) Safeguarding the inventory, and
Controls over inventory include developing and using security
measures to prevent inventory damage or customer or
employee theft.
2) Properly reporting it in the financial statements.
To ensure the accuracy of the amount of inventory reported
in the financial statements, a merchandising business should
take a physical inventory.
 Objective 2
Determine the cost of
inventory under the
perpetual inventory system,
using FIFO and average cost
methods.
FIFO Perpetual

On January 1, the firm had 100 units of Item 127B that cost $20
per unit.

Item 127B
Units Cost
Jan. 1 Inventory 100 $20
FIFO Perpetual

On January 4, the firm sold 70 units of 127B at $30 each.

Item 127B
Units Cost
Jan. 1 Inventory 100 $20
4 Sale 70
FIFO Perpetual

On January 4, the firm sold 70 units of 127B at $30 each.

4 Accounts Receivable 2 100 00

Sales 2 100 00

On January 22, the firm sold twenty units at $30.

4 Cost of Merchandise Sold 1 400 00
Merchandise Inventory 1 400 00
FIFO Perpetual

Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
FIFO Perpetual

On January 10, the firm purchased 80 units at $21 each.

Item 127B
Units Cost
Jan. 1 Inventory 100 $20
4 Sale 70
10 Purchase 80 21
FIFO Perpetual

On January 10, the firm purchased 80 units at $21 each.

10 Merchandise Inventory 1 680 00

Accounts Payable 1 680 00
FIFO Perpetual

Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680

24
FIFO Perpetual
On January 22, the firm sold 40 units for $30 each.

Item 127B
Units Cost
Jan. 1 Inventory 100 $20
4 Sale 70
10 Purchase 80 21
22 Sale 40
FIFO Perpetual
On January 22, the firm sold 40 units for $30 each.

22 Accounts Receivable 1 200 00

Sales 1 200 00

On January 22, the firm sold twenty units at $30.

22 Cost of Merchandise Sold 810 00
Merchandise Inventory 810 00
FIFO Perpetual

Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 30 20 600
10 21 210 70 21 1,470

Of the forty sold, thirty are considered to be from

those acquired at $20 each. The other ten are
considered to be from the January 10 purchase.
FIFO Perpetual

On January 28, the firm sold 20 units at $30 each.

Item 127B
Units Cost
Jan. 1 Inventory 100 $20
4 Sale 70
10 Purchase 80 21
22 Sale 40
28 Sale 20
FIFO Perpetual

On January 28, the firm sold 20 units at $30 each.

28 Accounts Receivable 600 00

Sales 600 00

28 Cost of Merchandise Sold 420 00

Merchandise Inventory 420 00
FIFO Perpetual

Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 30 20 600
10 21 210 70 21 1,470
28 20 21 420 50 21 1,050
FIFO Perpetual

On January 30, purchased ten additional

units of Item 127B at $22 each.

Item 127B
Units Cost
Jan. 1 Inventory 100 $20
4 Sale 70
10 Purchase 80 21
22 Sale 40
28 Sale 20
30 Purchase 100 22
FIFO Perpetual

On January 30, purchased ten additional

units of Item 127B at $22 each.

30 Merchandise Inventory 2 200 00

Accounts Payable 2 200 00
FIFO Perpetual

Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 30 20 600
10 21 210 70 21 1,470
28 20 21 420 50 21 1,050
30 100 22 2,200 50 21 1,050
100 22
2,200
FIFO Perpetual

Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 30 20 600
10 21 210 70 21 1,470
28 20 21 420 50 21 1,050
30 100 22 2,200 50 21 1,050
100 22
2,200

Cost of merchandise sold for

January is $2,630.
FIFO Perpetual

Item 127B

Purchases Cost of Mdse. Sold Inventory Balance

Unit Total Unit Total Unit Total

Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 100 20 2,000
4 70 20 1,400 30 20 600
10 80 21 1,680 30 20 600
80 21 1,680
22 30 20 600
10 21 210 70 21 1,470
28 20 21 420 50 21 1,050
30 100 22 2,200 50 21 1,050
100 22
2,200

January 31, inventory is $3,250

($1,050 + $2,200)
 Objective 3
Determine the cost of
inventory under the periodic
inventory system, using FIFO
and average cost methods.
FIFO Periodic

Using FIFO, the earliest batch purchased

is considered the first batch of
merchandise sold. The physical flow does
not have to match the accounting method
chosen.
 FIFO Periodic

Jan. 1 100 units @ $20 = $2,000

Jan. 10 80 units @ $21 = 1,680

Jan. 30 100 units @ $22 = 2,200

280 units available $5,880

for sale during
year Cost of merchandise
available for sale
 FIFO Periodic

The physical count on January 31 shows that 150

units are on hand (conclusion: 130 units were sold).
What is the cost of the ending inventory?

Jan. 1 100 units

Sold these @ $20 = $ 0
Sold 30 of these
Jan. 10 80 units @ $21 = 1,050
50 units @ $21
Jan. 30 100 units @ $22 = 2,200

Ending inventory $3,250

FIFO Periodic

Now we can calculate the cost of goods

sold as follows:
Beginning inventory, January 1 (Slide 60) $2,000
Purchases ($1,680 + $2,200) 3,880
Cost of merchandise available for sale $5,880
Ending inventory, January 31(Slide 61) 3,250
Cost of merchandise sold $2,630
Average Cost

The weighted average unit cost method is

based on the average cost of identical units.
The total cost of merchandise available for
sale is divided by the related number of units
of that item.
 Average Cost

Jan. 1 100 units @ $20 = $2,000

Jan. 10 80 units @ $21 = 1,680

Jan. 30 100 units @ $22 = 2,200

280 $5,880
Average unit cost: $5,880 ÷ 280 = $21
Cost of merchandise sold: 130 units at $21 = $2,730
Ending merchandise inventory: 150 units at $21= $3,150
Average Cost

Now we can calculate the cost of goods

sold as follows:
Beginning inventory, January 1 (Slide 68) $2,000
Purchases ($1,680 + $2,200) 3,880
Cost of merchandise available for sale $5,880
Ending inventory, January 31(Slide 68) 3,150
Cost of merchandise sold $2,730
 Objective 4
Compare and contrast the
use of the two inventory
costing methods.
Partial Income Statements

First-In, First-Out
Net sales $3,900
Cost of merchandise sold:
Beginning inventory $2,000
Purchases 3,880
Merchandise available for sale $5,880
Less ending inventory 3,250
Cost of merchandise sold 2,630
Gross profit $1,270

73
Partial Income Statements

Average Cost
Net sales $3,900
Cost of merchandise sold:
Beginning inventory $2,000
Purchases 3,880
Merchandise available for sale $5,880
Less ending inventory 3,150
Cost of merchandise sold 2,730
Gross profit $1,170

74
 Recap

Weighted
FIFO Average

Ending inventory $3,250 $3,050

Cost of merchandise sold $2,630 $2,830
Gross profit $1,270 $1,070
 Objective 5
Describe and illustrate the
reporting of merchandise
inventory in the financial
statements.
Lower-of-Cost-or-Market Method

If the cost of replacing an item in inventory is lower than

the original purchase cost, the lower-of-cost-or-market
(LCM) method is used to value the inventory.

Market, as used in lower of cost or market, is the cost

to replace the merchandise on the inventory date.
Cost and replacement cost can be determined for -

1) each item in the inventory,

2) major classes or categories of inventory, or
3) the inventory as a whole.
Determining Inventory at
Lower-of-Cost-or-Market
Method
 Merchandise that is out of
date, spoiled, or damaged
should be written down to its
net realizable value. This is
the estimated selling price less
any direct cost of disposal,
such as sales commissions.
Merchandise Inventory on the Balance Sheet
Merchandise inventory is usually presented in the
Current Assets section of the balance sheet, following
receivables.
The method of determining the cost of inventory
(FIFO, LIFO, or weighted average) should be shown.
The End of Chapter 1