Chapter 5

Reporting and Analyzing

Inventories

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-2

Conceptual Chapter Objectives

C1: Identify the items making up

merchandise inventory
C2: Identify the costs of merchandise
inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-3

Analytical Chapter Objectives

A1: Analyze the effects of inventory methods

for both financial and tax reporting
A2: Analyze the effects of inventory errors on
current and future financial statements
A3: Assess inventory management using both
inventory turnover and days’ sales in
inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-4

Procedural Chapter Objectives

P1: Compute inventory in a perpetual system using the

methods of specific identification, FIFO, LIFO, and
weighted average
P2: Compute the lower of cost or market amount of
inventory
P3: Appendix 6A: Compute inventory in a periodic
system using the methods of specific identification,
FIFO, LIFO, and weighted average
P4: Appendix 6B: Apply both the retail inventory and
gross profit methods to estimate inventory.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-5
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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-6
C1
Goods in Transit
FOB Shipping Point
Public
Carrier

Seller Buyer

Ownership passes
to the buyer here.

Public
Carrier

Seller FOB Destination Point Buyer

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-7
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
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-8
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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-9
C2
Determining Inventory Costs

Include all expenditures necessary to bring an

item to a salable condition and location.

Minus
Discounts Invoice Plus
and
Allowances
Cost Insurance

Plus Import Plus

Duties Plus Storage
Freight
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-10
C2 Internal Controls and Taking a Physical
Count

 Most companies take

a physical count of
inventory at least once
each year.

 When the physical

count does not match
the Merchandise
Inventory account, an
adjustment must be
made.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-11
P1 Inventory Costing Under a Perpetual
System

Inventory
affects . . .
Balance Income
Sheet Statement

The matching
principle requires
matching cost of
sales with sales.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-12
P1 Inventory Costing Under a Perpetual
System

Accounting for
inventory
 Costing Method
requires several
 Specific Identification, FIFO, LIFO,
decisions . . . or Weighted Average

 Inventory System
 Perpetual or Periodic

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-13
P1
Frequency in Use of Inventory
Methods

FIFO
46%
LIFO
30%

Other
Weighted 4%
Average
20%
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-14
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.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-15
P1
Inventory Costing Illustration

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., 2008

 5-16
P1
Specific Identification

When units are sold, the

specific cost of the unit
sold is added to cost of
goods sold.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-17
P1
Specific Identification

Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 8 @ $ 91 = $ 728

The above 12 @purchases

$ 106 = 1,272 $
$ were 500
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,800
Aug. 28 10 @ $ 119 =
made
$ 1,190
in August. On August 14,
$ 3,990
Aug. 31 a company 2 @ sold
$ eight
91 = $bikes
182
originally3 costing
@ $ 106 $91= $and 31812
14 @ $ 115 = $ 1,610
bikes originally costing $106.
4 @ $ 119 = $ 476 $ 1,404

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-18
P1
Specific Identification
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 8 @ $ 91 = $ 728
The Cost of Goods Sold12for@the$August
106 = 14$sale
1,272 $ 500
Aug. 17 20 is@
$2,000.
$ 115 = $ 2,300 $ 2,800
Aug. 28 10 @ $ 119 = $@1,190
8 bikes 91 = $ 728 $ 3,990
Aug. 31 12 bikes @ 106 =2 @ $1,272
$ 91 = $ 182
3 @ $ 106 = $ 318
After this sale, there are five units in inventory
14 @ $ 115 = $ 1,610
at $500:
2 bikes @ $91 = $ 182
3 bikes @ $106 = $ 318

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-19
P1
Specific Identification
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 8 @ $ 91 = $ 728
12 @ $ 106 = $ 1,272 $ 500
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,800
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,990
Aug. 31 2 @ $ 91 = $ 182
Additional purchases were made3 on@August
$ 106 17
= and
$ 28.
318
14 @ 31
The cost of the 23 items sold on August $ were
115 =as follows:
$ 1,610
2 @ $91 4 @ $ 119 = $ 476 $ 1,404
3 @ $106
15 @ $115
3 @ $119
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-20
P1
Specific Identification
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 8 @ $ 91 = $ 728
12 @ $ 106 = $ 1,272 $ 500
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,800
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,990
Aug. 31 2 @ $ 91 = $ 182
3 @ $ 106 = $ 318
15 @ $ 115 = $ 1,725
3 @ $ 119 = $ 357 $ 1,408

Cost of Goods Sold for

August 31 = $2,582
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-21
P1
Specific Identification
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 8 @ $ 91 = $ 728
12 @ $ 106 = $ 1,272 $ 500
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,800
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,990
Aug. 31 2 @ $ 91 = $ 182
3 @ $ 106 = $ 318
15 @ $ 115 = $ 1,725
3 @ $ 119 = $ 357 $ 1,408
After the August 31 sale, there are
12 units in inventory at $1,408:
5 @ $115
McGraw-Hill/Irwin
7 @ $119 © The McGraw-Hill Companies, Inc., 2008
 5-22
P1
Specific Identification
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 8 @ $ 91 = $ 728
12 @ $ 106 = $ 1,272 $ 500
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,800
Aug. 28Income
10 @ $ 119 = $ 1,190 $ 3,990
Statement
Aug. 31 COGS 2 @ $ 91 = $ 182
= $4,582 3 @ $ 106 = $ 318
15 @ $ 115 = $ 1,725
3 @ $ 119 = $ 357 $ 1,408

Balance Sheet
McGraw-Hill/Irwin
Inventory = $1,408
© The McGraw-Hill Companies, Inc., 2008
 5-23
P1
Specific Identification
Here are the entries to record the purchases and sales. The
numbers in red are determined by the cost flow assumption
used.

All purchases Aug. 3 Merchandise inventory 1,590

and sales are Accounts payable 1,590
Aug. 14 Accounts receivable 2,600
made on
Sales 2,600
credit. Aug. 14 Cost of goods sold 2,000
The selling Merchandise inventory 2,000
price of Aug. 17 Merchandise inventory 2,300
inventory was Accounts payable 2,300
Aug. 28 Merchandise inventory 1,190
as follows:
Accounts payable 1,190
8/14 $130 Aug. 31 Accounts receivable 3,450
Sales 3,450
8/31 150
Aug. 31 Cost of goods sold 2,582
McGraw-Hill/Irwin Merchandise inventory 2,582
© The McGraw-Hill Companies, Inc., 2008
 5-24
P1
First-In, First-Out (FIFO)

Oldest Cost of
Costs Goods Sold

Recent Ending
Costs Inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-25
P1
First-In, First-Out (FIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500

Aug. 17 20 @ $ 115 = $ 2,300 $ 2,300

The28above
Aug. 10 @ purchases
$ 119 = $ 1,190were $ 3,490
made
Aug. 31 in August. 5 @ $ 106 = $ 530
18 @ $ 115 = $ 2,070 $ 890
On August 14, the company
sold 20 bikes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-26
P1
First-In, First-Out (FIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 10 @ $ 91 = $ 910
10 @ $ 106 = $ 1,060 $ 530
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,830
Aug. 28 The
10 @Cost
$ 119 of
= Goods
$ 1,190 Sold for the $ 4,020
Aug. 31 August 14 sale is $1,970.
5 @ $ 106 = $ 530
18 @ $ 115 = $ 2,070 $ 1,420
After this sale, there are five units in
inventory at $530:
5 @ $106
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-27
P1
First-In, First-Out (FIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 10 @ $ 91 = $ 910
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 purchases were made on August 17 and 28.
Twenty-three bikes were sold on August 31.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-28
P1
First-In, First-Out (FIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 10 @ $ 91 = $ 910
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

Cost of Goods Sold for

August 31 = $2,600
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-29
P1
First-In, First-Out (FIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 10 @ $ 91 = $ 910
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

After the August 31 sale, there are

12 units in inventory at $1,420:
2 @ $115
10 @ $119
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-30
P1
First-In, First-Out (FIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 10 @ $ 91 = $ 910
10 @ $ 106 = $ 1,060 $ 530
Income Statement
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,830
COGS
Aug. = $4,570
28 10 @ $ 119 = $ 1,190 $ 4,020
Aug. 31 5 @ $ 106 = $ 530
18 @ $ 115 = $ 2,070 $ 1,420

Balance Sheet
Inventory = $1,420
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-31
P1
First-In, First-Out (FIFO)
Here are the entries to record the purchases and sales
entries. The numbers in red are determined by the cost flow
assumption used.

All purchases Aug. 3 Merchandise inventory 1,590

and sales are Accounts payable 1,590
Aug. 14 Accounts receivable 2,600
made on
Sales 2,600
credit. Aug. 14 Cost of goods sold 1,970
The selling Merchandise inventory 1,970
price of Aug. 17 Merchandise inventory 2,300
inventory was Accounts payable 2,300
Aug. 28 Merchandise inventory 1,190
as follows:
Accounts payable 1,190
8/14 $130 Aug. 31 Accounts receivable 3,450
Sales 3,450
8/31 150
Aug. 31 Cost of goods sold 2,600
McGraw-Hill/Irwin Merchandise inventory 2,600
© The McGraw-Hill Companies, Inc., 2008
 5-32
P1
Last-In, First-Out (LIFO)

Recent Cost of
Costs Goods Sold

Oldest Ending
Costs Inventory

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-33
P1
Last-In, First-Out (LIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 15 @ $ 106 = $ 1,590
5 @ $ 91 = $ 455 $ 455
Aug.
The17above
20 @ $ 115 = $ 2,300
purchases were $ 2,755
Aug. 28 10 @ $ 119 = $ 1,190 $ 3,945
made
Aug. 31 in August. 10 @ $ 119 = $ 1,190
13 @ $ 115 = $ 1,495 $ 1,260
On August 14, the company
sold 20 bikes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-34
P1
Last-In, First-Out (LIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 15 @ $ 106 = $ 1,590
5 @ $ 91 = $ 455 $ 455
Aug. 17 20 @ $ 115 = $ 2,300 $ 2,755
Aug. 28 10
The Cost of Goods Sold for the
@ $ 119 = $ 1,190 $ 3,945
Aug. 31 August 14 sale is $$2,045.
10 @ 119 = $ 1,190
13 @ $ 115 = $ 1,495 $ 1,260
After this sale, there are five units in
inventory at $455:
5 @ $91
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-35
P1
Last-In, First-Out (LIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 15 @ $ 106 = $ 1,590
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
Additional purchases were made
13 @on$ August
115 = 171,495
$ and $28.1,260
Twenty-three bikes were sold on August 31.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-36
P1
Last-In, First-Out (LIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 15 @ $ 106 = $ 1,590
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 of Goods Sold for

August 31 = $2,685
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-37
P1
Last-In, First-Out (LIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 15 @ $ 106 = $ 1,590
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

After the August 31 sale, there are

12 units in inventory at $1,260:
5 @ $91
7 @ $115
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-38
P1
Last-In, First-Out (LIFO)
Inventory
Date Purchases Cost of Goods Sold Balance
Aug. 1 10 @ $ 91 = $ 910 $ 910
Aug. 3 15 @ $ 106 = $ 1,590 $ 2,500
Aug. 14 15 @ $ 106 = $ 1,590
5 @ $ 91 = $ 455 $ 455
Aug. 17Income
20 @ $ 115 = $ 2,300 $ 2,755
Statement
Aug. 28 10 @COGS
$ 119 = $ 1,190 $ 3,945
= $4,730
Aug. 31 10 @ $ 119 = $ 1,190
13 @ $ 115 = $ 1,495 $ 1,260

Balance Sheet
Inventory = $1,260
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-39
P1
Last-In, First-Out (LIFO)
Here are the entries to record the purchases and sales
entries. The numbers in red are determined by the cost flow
assumption used.

All purchases Aug. 3 Merchandise inventory 1,590

and sales are Accounts payable 1,590
Aug. 14 Accounts receivable 2,600
made on
Sales 2,600
credit. Aug. 14 Cost of goods sold 2,045
The selling Merchandise inventory 2,045
price of Aug. 17 Merchandise inventory 2,300
inventory was Accounts payable 2,300
Aug. 28 Merchandise inventory 1,190
as follows:
Accounts payable 1,190
8/14 $130 Aug. 31 Accounts receivable 3,450
Sales 3,450
8/31 150
Aug. 31 Cost of goods sold 2,685
McGraw-Hill/Irwin Merchandise inventory 2,685
© The McGraw-Hill Companies, Inc., 2008
 5-40
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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-41
P1
Weighted Average
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
The
Aug. 28 above
10 @ $purchases
119 = $ 1,190were $ 3,990
Aug. 31 in August.
made 23 @ $ 114 = $ 2,622 $ 1,368

On August 14, 20 bikes were

sold.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-42
P1
Weighted Average
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 @ First,
$ 115 we
= $need
2,300to compute the weighted $ 2,800
Aug. 28 10 @ average
$ 119 = cost per unit of items in inventory. $ 3,990
$ 1,190
Aug. 31 23 @ $ 114 = $ 2,622 $ 1,368

Cost of goods available for sale $ 2,500

Total units in inventory ÷ 25
Weighted average cost per unit $ 100

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-43
P1
Weighted Average
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 The@Cost
10 of =Goods
$ 119 $ 1,190Sold for the August 14 $ 3,990
Aug. 31 sale is $2,000. 23 @ $ 114 = $ 2,622 $ 1,368

After this sale, there are five units in

inventory at $500:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-44
P1
Weighted Average
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
Additional purchases were made on August 17 and 28.
Twenty-three bikes were sold on August 31.

What is the weighted average cost per unit

of items in inventory?
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-45
P1
Weighted Average
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
Units
Inventory 8/14 5 Cost of goods available for sale $ 3,990
Purchase 8/17 20 Total units in inventory ÷ 35
Purchase 8/28 10
Units available for sale 35
Weighted average cost per unit $ 114

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-46
P1
Weighted Average
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

Cost of Goods Sold for

August 31 = $2,622

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-47
P1
Weighted Average
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

After the August 31 sale, there are

12 units in inventory at $1,368:
12 @ $114

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-48
P1
Weighted Average
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 Income
20 @ $ 115 = $ 2,300 $ 2,800
Aug.Statement
28 10 @ $COGS
119 = $ 1,190 $ 3,990
Aug. 31 = $4,622 23 @ $ 114 = $ 2,622 $ 1,368

Balance Sheet
Inventory = $1,368

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-49
P1
Weighted Average
Here are the entries to record the purchases and sales
entries for Trekking. The numbers in red are determined by
the cost flow assumption used.

All purchases Aug. 3 Merchandise inventory 1,590

and sales are Accounts payable 1,590
Aug. 14 Accounts receivable 2,600
made on
Sales 2,600
credit. Aug. 14 Cost of goods sold 2,000
The selling Merchandise inventory 2,000
price of Aug. 17 Merchandise inventory 2,300
inventory was Accounts payable 2,300
Aug. 28 Merchandise inventory 1,190
as follows:
Accounts payable 1,190
8/14 $130 Aug. 31 Accounts receivable 3,450
Sales 3,450
8/31 150
Aug. 31 Cost of goods sold 2,622
McGraw-Hill/Irwin Merchandise inventory 2,622
© The McGraw-Hill Companies, Inc., 2008
 5-50
A1 Financial Statement Effects of Costing
Methods

Because prices change, inventory methods nearly

always assign different cost amounts.

Trekking Company
For Month Ended August 31
Specific Weighted
Identification FIFO LIFO Average
Sales $ 6,050 $ 6,050 $ 6,050 $ 6,050
Cost of goods sold 4,582 4,570 4,730 4,622
Gross profit $ 1,468 $ 1,480 $ 1,320 $ 1,428
Operating expenses 450 450 450 450
Income before taxes $ 1,018 $ 1,030 $ 870 $ 978
Income tax expense (30%) 305 309 261 293
Net income $ 713 $ 721 $ 609 $ 685

Balance sheet inventory

McGraw-Hill/Irwin
$ 1,408 $ 1,420 $ McGraw-Hill
© The 1,260Companies,
$ Inc.,
1,368
2008
 5-51
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.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-52
A1
Tax Effects of Costing
Methods
The Internal Revenue Service (IRS)
identifies several acceptable
methods for inventory costing for
reporting taxable income.

If LIFO is used for tax

purposes, the IRS requires
it be used in financial
statements.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-53
A1
Consistency in Using Costing
Methods

The consistency principle requires a

company to use the same accounting
methods period after period so that
financial statements are comparable
across periods.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-54
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:

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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-55
P2
Lower of Cost or Market

A motorsports retailer has the following items in

inventory:
Per Unit
Units on Total Total
Inventory Items Hand Cost Market Cost Market
Cycles:
Roadster 20 $ 8,000 $ 7,000 $160,000 $ 140,000
Sprint 10 5,000 6,000 50,000 60,000
Category subtotal 210,000 200,000
Off-Road
Trax-4 8 5,000 6,500 40,000 52,000
Blazer 5 9,000 7,000 45,000 35,000
Category subtotal 85,000 87,000
Total $295,000 $ 287,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-56
P2
Lower of Cost or Market

Here is how to compute lower of cost or

market for individual inventory items.
LCM Applied to
Units on Total
Inventory Items Hand Total Cost Market Items Categories Whole
Cycles:
Roadster 20 $ 160,000 $ 140,000 $ 140,000
Sprint 10 50,000 60,000 50,000
Category subtotal $ 210,000 $ 200,000
Off-Road
Trax-4 8 $ 40,000 $ 52,000 40,000
Blazer 5 45,000 35,000 35,000
Category subtotal $ 85,000 $ 87,000
Total $ 295,000 $ 287,000 $ 265,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-57
P2
Lower of Cost or Market

Here is how to compute lower of cost or market

for the two groups of inventory items.
LCM Applied to
Units on Total
Inventory Items Hand Total Cost Market Items Categories Whole
Cycles:
Roadster 20 $ 160,000 $ 140,000 $ 140,000
Sprint 10 50,000 60,000 50,000
Category subtotal $ 210,000 $ 200,000 $ 200,000
Off-Road
Trax-4 8 $ 40,000 $ 52,000 40,000
Blazer 5 45,000 35,000 35,000
Category subtotal $ 85,000 $ 87,000 85,000
Total $ 295,000 $ 287,000 $ 265,000 $ 285,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-58
P2
Lower of Cost or Market

Here is how to compute lower of cost or market

for the entire inventory.
LCM Applied to
Units on Total
Inventory Items Hand Total Cost Market Items Categories Whole
Cycles:
Roadster 20 $ 160,000 $ 140,000 $ 140,000
Sprint 10 50,000 60,000 50,000
Category subtotal $ 210,000 $ 200,000 $ 200,000
Off-Road
Trax-4 8 $ 40,000 $ 52,000 40,000
Blazer 5 45,000 35,000 35,000
Category subtotal $ 85,000 $ 87,000 85,000
Total $ 295,000 $ 287,000 $ 265,000 $ 285,000 $ 287,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-59
Exh.
5.10
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

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-60
A2 Financial Statement Effects of Inventory
Errors

Balance Sheet Effects

Inventory Error Assets Equity
Understate ending inventory Understated Understated
Overstate ending inventory Overstated Overstated

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-61
A3
Inventory Turnover

Shows how many times a company turns over its

inventory during a period. Indicator of how well
management is controlling the amount of
inventory available.

Inventory Cost of goods sold

Turnover = Avg. inventory

Average
Inventory = (Beg. Inv. + End Inv.) ÷ 2
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 5-62
A3
Days’ Sales in Inventory

Reveals how much inventory is available in

terms of the number of days’ sales.

Days' Sales in Ending Inventory

Inventory = Cost of goods sold
× 365

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 5-63

End of Chapter 5

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008