Inventories and the Cost Inventories and the Cost of Goods Sold of Goods Sold

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8-1

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

Inventories and the Cost Inventories and the Cost

of Goods Sold of Goods Sold

Chapter 8

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INCOME STATEMENT Revenue

Cost of goods sold Gross profit

Expenses Net income

as goods are sold

BALANCE SHEET Asset

Inventory

Purchase costs (or manufacturing

costs)

The Flow of Inventory The Flow of Inventory

Costs

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When identical units of inventory have different unit costs, a question naturally arises as to which of these costs should be used in recording a sale of inventory.

Which Unit Did We Sell?

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The Bike Company (TBC)

Data for an Illustration

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On August 14, TBC sold 20 bikes for $130 each.

Of the bikes sold 9 originally cost $91 and 11 cost $106.

On August 14, TBC sold 20 bikes for $130 each.

Of the bikes sold 9 originally cost $91 and 11 cost $106.

Specific Identification Specific Identification

The Cost of Goods Sold for the August 14 sale is $1,985.

This leaves 5 units, with a total cost of $515, in inventory:

1 unit that costs $91 and 4 units that cost $106 each.

The Cost of Goods Sold for the August 14 sale is $1,985.

This leaves 5 units, with a total cost of $515, in inventory:

1 unit that costs $91 and 4 units that cost $106 each.

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Average-Cost Method Average-Cost Method

$114 = $3,990 ³⁵

$114 = $3,990  35

Additional purchases were made on August 17 and August 28. On August 31, an additional 23 units

were sold.

Additional purchases were made on August 17 and August 28. On August 31, an additional 23 units

were sold.

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On August 14, TBC sold 20 bikes for $130 each.

The Cost of Goods Sold for the August 14 sale is $1,970, leaving 5 units, with a total cost of $530, in inventory.

First-In, First-Out Method First-In, First-Out Method

(FIFO)

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On August 14, TBC sold 20 bikes for

$130 each.

On August 14, TBC sold 20 bikes for

$130 each.

Last-In, First-Out Method Last-In, First-Out Method

(LIFO) (LIFO)

The Cost of Goods Sold for the August 14 sale is $2,045, leaving 5 units, with a total cost of $455, in inventory.

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Inventory Valuation Methods: A Summary Costs Allocated to:

Valuation Method

Cost of Goods

Sold Inventory Comments

Specific Actual cost of Actual cost of units Parallels physical flow

identification the units sold remaining Logical method when units are unique

May be misleading for identical units

Average cost Number of units sold times the

Number of units on hand times the

Assigns all units the same average unit cost

average unit cost average unit cost Current costs are averaged in with older costs

First-in, First-out (FIFO)

Cost of earliest purchases on

Cost of most recently

Cost of goods sold is based on older costs

hand prior to the sale

purchased units Inventory valued at current costs

May overstate income during periods of rising prices; may increase income taxes due Last-in, First-out

(LIFO)

Cost of most recently

Cost of earliest purchases

Cost of goods sold shown at recent prices

purchased units (assumed still in inventory)

Inventory shown at old (and perhaps out of date) costs Most conservative method during periods of rising

prices; often results in lower income taxes

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The primary reason for taking a physical inventory is to adjust the perpetual inventory

records for unrecorded shrinkage losses, such as theft, spoilage, or breakage.

The primary reason for taking a physical inventory is to adjust the perpetual inventory

records for unrecorded shrinkage losses, such as theft, spoilage, or breakage.

Taking a Physical Taking a Physical

Inventory

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Reduces the value of the inventory.

Obsolescence Obsolescence

Adjust inventory value to the lower of historical cost or

current

replacement cost (market).

Adjust inventory value to the lower of historical cost or

current

replacement cost (market).

Lower of Cost or Market

(LCM)

Lower of Cost or Market

(LCM)

LCM and Other Write-Downs LCM and Other Write-Downs

of Inventory

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LCM and Other Write-Downs LCM and Other Write-Downs

of Inventory

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In a periodic inventory system, inventory entries are as follows.

Note that an entry is not made to inventory.

Periodic Inventory Periodic Inventory

Systems

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Computers, Inc.

Mouse Pad Inventory

Date Units $/Unit Total Beginning

Inventory 1,000 $ 5.25 $ 5,250.00 Purchases:

Jan. 3 300 5.30 1,590.00 June 20 150 5.60 840.00 Sept. 15 200 5.80 1,160.00 Nov. 29 150 5.90 885.00 Goods

Available

for Sale 1,800 $ 9,725.00

Ending

Inventory 1,200 ?

Cost of

Information for the Following Information for the Following

Inventory Examples

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Computers, Inc.

Date Units $/Unit Total Beginning

Available

for Sale 1,800 $ 9,725.00

Ending

Inventory 1,200 $ 6,400.00 Cost of

Goods Sold 600 $ 3,325.00

Cost of Goods Sold

$9,725

-

$6,400 = $3,325 Cost of Goods Sold

$9,725

-

$6,400 = $3,325

Specific Identification

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Computers, Inc.

Date Units $/Unit Total

Beginning

Available

for Sale 1,800 $ 9,725.00

Ending

Inventory 1,200 ?

Cost of

Goods Sold 600 ?

Avg. Cost $9,725  1,800 =

$5.40278

Avg. Cost $9,725  1,800 =

$5.40278

Average-Cost Method Average-Cost Method

Computers, Inc.

Date Units $/Unit Total

Beginning

Available

for Sale 1,800 $ 9,725.00

Ending

Inventory 1,200 $ 6,483.00

Cost of

Goods Sold 600 $ 3,242.00

Ending Inventory

Avg. Cost $5.40278 1,200 =

$6,483

Ending Inventory

Avg. Cost $5.40278 1,200 =

$6,483

Avg. Cost $5.40278 600 =

$3,242

Avg. Cost $5.40278 600 =

$3,242

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Date Beg. Inv. Purchases End. Inv.

Cost of Goods Sold

Nov. 29 150@$5.90 150@$5.90

Units 150

First-In, First-Out Method First-In, First-Out Method

(FIFO) (FIFO)

1,000@$5.25 600@$5.25

400@$5.25

Jan. 3 300@$5.30 300@$5.30

June 20 150@$5.60 150@$5.60 Sept. 15 200@$5.80 200@$5.80 Nov. 29 150@$5.90 150@$5.90

Units 1,200 600

1,000@$5.25 600@$5.25

400@$5.25

Jan. 3 300@$5.30 300@$5.30

June 20 150@$5.60 150@$5.60 Sept. 15 200@$5.80 200@$5.80 Nov. 29 150@$5.90 150@$5.90

Units 1,200 600

Costs $6,575 $3,150

Cost of Goods Available for Sale $9,725

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Cost of Goods Sold 1,000@$5.25 1,000@$5.25

Units 1,000

Last-In, First-Out Method Last-In, First-Out Method

(LIFO) (LIFO)

Jan. 3 300@$5.30 200@$5.30

100@$5.30

Units 1,200 100

Jan. 3 300@$5.30 200@$5.30

100@$5.30

June 20 150@$5.60 150@$5.60

Sept. 15 200@$5.80 200@$5.80

Nov. 29 150@$5.90 150@$5.90

Units 1,200 600

Costs $6,310 $3,415

Cost of Goods Available for Sale $9,725

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Importance of an Accurate Importance of an Accurate

Valuation of Inventory

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8-20

The Gross Profit Method The Gross Profit Method

1. Determine cost of goods available for sale.

2. Estimate cost of goods sold by

multiplying the net sales by the cost

ratio.

3. Deduct cost of goods sold from cost of

goods available for sale to determine 1. Determine cost of

goods available for sale.

2. Estimate cost of goods sold by

multiplying the net sales by the cost

ratio.

3. Deduct cost of goods sold from cost of

goods available for sale to determine

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The Gross Profit Method The Gross Profit Method

× 70%

Step 1

Step 2 Step 3

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The Retail Method The Retail Method

a Goods available for sale at cost $ 32,500 b Goods available for sale at retail 50,000

c Cost ratio [a b] 65%

d Physical count of ending inventory priced at retail 22,000 e Estimated ending inventory at cost [ c d] $ 14,300

Estimating Inventory The Retail Method

Matrix would follow the steps below to estimate their ending inventory using the retail method.

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(Beginning Inventory + Ending Inventory) ÷ 2 (Beginning Inventory + Ending Inventory) ÷ 2

Inventories and the Cost Inventories and the Cost of Goods Sold of Goods Sold

Inventories and the Cost Inventories and the Cost

of Goods Sold of Goods Sold

The Flow of Inventory The Flow of Inventory

Costs

Costs

Which Unit Did We Sell?

Which Unit Did We Sell?

Data for an Illustration

Data for an Illustration

Specific Identification Specific Identification

Average-Cost Method Average-Cost Method

First-In, First-Out Method First-In, First-Out Method

(FIFO)

(FIFO)

Last-In, First-Out Method Last-In, First-Out Method

(LIFO) (LIFO)

Taking a Physical Taking a Physical

Inventory

Inventory

LCM and Other Write-Downs LCM and Other Write-Downs

of Inventory

of Inventory

LCM and Other Write-Downs LCM and Other Write-Downs

of Inventory

of Inventory

Periodic Inventory Periodic Inventory

Systems

Systems

Information for the Following Information for the Following

Inventory Examples

Inventory Examples

-

-

Specific Identification

Specific Identification

Average-Cost Method Average-Cost Method

First-In, First-Out Method First-In, First-Out Method

(FIFO) (FIFO)

Last-In, First-Out Method Last-In, First-Out Method

(LIFO) (LIFO)

Importance of an Accurate Importance of an Accurate

Valuation of Inventory

Valuation of Inventory

The Gross Profit Method The Gross Profit Method

The Gross Profit Method The Gross Profit Method

The Retail Method The Retail Method

Financial Analysis

Financial Analysis

End of Chapter 8

End of Chapter 8