1. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Chapter 5 Inventories and Cost of Sales

2. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Conceptual Chapter Objectives C1: Identify the items making up merchandise inventory C2: Identify the costs of merchandise inventory

3. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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

4. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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.

5. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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 in Transit Goods Damaged or Obsolete Goods on Consignment C 1

6. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin FOB Destination Point Public Carrier SellerBuyer Goods in Transit Public Carrier SellerBuyer FOB Shipping Point Ownership passes to the buyer here. C 1

7. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Goods on Consignment Merchandise is included in the inventory of the consignor, the owner of the inventory. Consignor Consignee Thanks for selling my inventory in your store. C 1

8. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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. C 1

9. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Determining Inventory Costs Invoice Cost Include all expenditures necessary to bring an item to a salable condition and location. Minus Discounts and Allowances Plus Import Duties Plus Freight Plus Storage Plus Insurance C 2

10. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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.  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. Inventory Count Tag Counted by _______ Quantity Counted ___ C 2

11. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Inventory Costing Under a Perpetual System Inventory affects... The matching principle requires matching cost of sales with sales. Balance Sheet Income Statement P1

12. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Inventory Costing Under a Perpetual System Accounting for inventory requires several decisions...  Costing Method Specific Identification, FIFO, LIFO, or Weighted Average  Inventory System Perpetual or Periodic  Costing Method Specific Identification, FIFO, LIFO, or Weighted Average  Inventory System Perpetual or Periodic P1

13. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Frequency in Use of Inventory Methods P1

14. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Inventory Cost Flow Assumptions First-In, First-Out (FIFO) Assumes costs flow in the order incurred. Last-In, First-Out (LIFO) Assumes costs flow in the reverse order incurred. Weighted Average Assumes costs flow at an average of the costs available. P1

15. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Inventory Costing Illustration P1

16. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Specific Identification When units are sold, the specific cost of the unit sold is added to cost of goods sold. P1

17. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Specific Identification The above purchases were made in August. On August 14, a company sold eight bikes originally costing $91 and 12 bikes originally costing $106. P1

18. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin The Cost of Goods Sold for the August 14 sale is $2,000. 8 bikes @ 91 = $ 728 12 bikes @ 106 = $1,272 After this sale, there are five units in inventory at $500: 2 bikes @ $91 = $ 182 3 bikes @ $106 = $ 318 The Cost of Goods Sold for the August 14 sale is $2,000. 8 bikes @ 91 = $ 728 12 bikes @ 106 = $1,272 After this sale, there are five units in inventory at $500: 2 bikes @ $91 = $ 182 3 bikes @ $106 = $ 318 Specific Identification P1

19. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Additional purchases were made on August 17 and 28. The cost of the 23 items sold on August 31 were as follows: 2 @ $91 3 @ $106 15 @ $115 3 @ $119 Additional purchases were made on August 17 and 28. The cost of the 23 items sold on August 31 were as follows: 2 @ $91 3 @ $106 15 @ $115 3 @ $119 Specific Identification P1

20. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Specific Identification Cost of Goods Sold for August 31 = $2,582 P1

21. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Specific Identification After the August 31 sale, there are 12 units in inventory at $1,408: 5 @ $115 7 @ $119 P1

22. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Specific Identification Balance Sheet Inventory = $1,408 Income Statement COGS = $4,582 P1

23. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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 and sales are made on credit. The selling price of inventory was as follows: 8/14 $130 8/31 150 P1

24. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin First-In, First-Out (FIFO) Cost of Goods Sold Ending Inventory Oldest Costs Recent Costs P1

25. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin First-In, First-Out (FIFO) The above purchases were made in August. On August 14, the company sold 20 bikes. The above purchases were made in August. On August 14, the company sold 20 bikes. P1

26. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin First-In, First-Out (FIFO) The Cost of Goods Sold for the August 14 sale is $1,970. After this sale, there are five units in inventory at $530: 5 @ $106 The Cost of Goods Sold for the August 14 sale is $1,970. After this sale, there are five units in inventory at $530: 5 @ $106 P1

27. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin First-In, First-Out (FIFO) Additional purchases were made on August 17 and 28. Twenty-three bikes were sold on August 31. Additional purchases were made on August 17 and 28. Twenty-three bikes were sold on August 31. P1

28. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin First-In, First-Out (FIFO) Cost of Goods Sold for August 31 = $2,600 P1

29. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin First-In, First-Out (FIFO) After the August 31 sale, there are 12 units in inventory at $1,420: 2 @ $115 10 @ $119 P1

30. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin First-In, First-Out (FIFO) Balance Sheet Inventory = $1,420 Income Statement COGS = $4,570 P1

31. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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 and sales are made on credit. The selling price of inventory was as follows: 8/14 $130 8/31 150 P1

32. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Last-In, First-Out (LIFO) Cost of Goods Sold Ending Inventory Recent Costs Oldest Costs P1

33. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Last-In, First-Out (LIFO) The above purchases were made in August. On August 14, the company sold 20 bikes. The above purchases were made in August. On August 14, the company sold 20 bikes. P1

34. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Last-In, First-Out (LIFO) The Cost of Goods Sold for the August 14 sale is $2,045. After this sale, there are five units in inventory at $455: 5 @ $91 The Cost of Goods Sold for the August 14 sale is $2,045. After this sale, there are five units in inventory at $455: 5 @ $91 P1

35. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Last-In, First-Out (LIFO) Additional purchases were made on August 17 and 28. Twenty-three bikes were sold on August 31. Additional purchases were made on August 17 and 28. Twenty-three bikes were sold on August 31. P1

36. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Last-In, First-Out (LIFO) Cost of Goods Sold for August 31 = $2,685 P1

37. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Last-In, First-Out (LIFO) After the August 31 sale, there are 12 units in inventory at $1,260: 5 @ $91 7 @ $115 P1

38. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Last-In, First-Out (LIFO) Balance Sheet Inventory = $1,260 Income Statement COGS = $4,730 P1

39. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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 and sales are made on credit. The selling price of inventory was as follows: 8/14 $130 8/31 150 P1

40. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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 Available for Sale Units on hand on the date of sale ÷ P1

41. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Weighted Average The above purchases were made in August. On August 14, 20 bikes were sold. The above purchases were made in August. On August 14, 20 bikes were sold. P1

42. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin ÷ Weighted Average First, we need to compute the weighted average cost per unit of items in inventory. P1

43. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Weighted Average The Cost of Goods Sold for the August 14 sale is $2,000. After this sale, there are five units in inventory at $500: The Cost of Goods Sold for the August 14 sale is $2,000. After this sale, there are five units in inventory at $500: P1

44. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Weighted Average Additional purchases were made on August 17 and 28. Twenty-three bikes were sold on August 31. 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? P1

45. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Weighted Average ÷ P1

46. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Weighted Average Cost of Goods Sold for August 31 = $2,622 P1

47. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Weighted Average After the August 31 sale, there are 12 units in inventory at $1,368: 12 @ $114 P1

48. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Weighted Average Balance Sheet Inventory = $1,368 Income Statement COGS = $4,622 P1

49. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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 and sales are made on credit. The selling price of inventory was as follows: 8/14 $130 8/31 150 P1

50. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Financial Statement Effects of Costing Methods Because prices change, inventory methods nearly always assign different cost amounts. A1

51. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Financial Statement Effects of Costing Methods Advantages of Methods Smoothes out price changes. Better matches current costs in cost of goods sold with revenues. Ending inventory approximates current replacement cost. First-In, First-Out Weighted Average Last-In, First-Out A1

52. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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. A1

53. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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. A1

54. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Lower of Cost or Market Inventory must be reported at market value when market is lower than cost. Can be applied three ways: (1)separately to each individual item. (2)to major categories of assets. (3)to the whole inventory. Can be applied three ways: (1)separately to each individual item. (2)to major categories of assets. (3)to the whole inventory. Defined as current replacement cost (not sales price). Consistent with the conservatism principle. Defined as current replacement cost (not sales price). Consistent with the conservatism principle. P2

55. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Lower of Cost or Market A motorsports retailer has the following items in inventory: P2

56. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Lower of Cost or Market Here is how to compute lower of cost or market for individual inventory items. P2

57. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Lower of Cost or Market Here is how to compute lower of cost or market for the two groups of inventory items. P2

58. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Lower of Cost or Market Here is how to compute lower of cost or market for the entire inventory. P2

59. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Financial Statement Effects of Inventory Errors Income Statement Effects Exh. 5.10 A2

60. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Financial Statement Effects of Inventory Errors Balance Sheet Effects A2

61. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin 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 Turnover = Cost of goods sold Avg. inventory A3

62. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin Days’ Sales in Inventory Reveals how much inventory is available in terms of the number of days’ sales. Days' Sales in Inventory = Ending Inventory Cost of goods sold × 365 A3

63. © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill/Irwin End of Chapter 5