1. Cash, Short-term Investments and Accounts Receivable
Chapter 4
Cash, Short-term Investments and Accounts Receivable
Chapter 4

2. Chapter 5
Inventory
Chapter 5

3. Chapter 5 Learning Objectives
Account for common inventory transactions.
Use the four major inventory cost flow methods to calculate ending inventory and cost of goods sold.
Use the retail inventory method to calculate ending inventory and cost of goods sold.
Apply the lower-of-cost-or-market rule to inventory.
Determine the effects of inventory errors on financial statements.
Use ratios and other analysis techniques to make decisions about inventory.
Chapter 5
Chapter 5 3

4. Comparison of Perpetual and Periodic Inventory Systems
Chapter 5

5. Inventory Accounting Terms
Sales
Sales Returns and Allowances
Sales Discounts
Purchase Returns and Allowances
Purchase Discounts
Freight-In
Delivery Expense(Freight-out)
Cost of Goods Sold
Chapter 5

6. Shipping Terms
FOB Shipping Point: Buyer pays to get the goods to the destination.
FOB Destination: Seller pays to get the goods to the destination.
Chapter 5

7. Accounting for Common Inventory Transactions
Six common transactions are related to
accounting for inventory:
Purchasing inventory from a supplier
Paying for freight on purchases
Returning inventory to a supplier
Selling inventory to a customer
Accepting returns of inventory from a customer
Paying on account for purchases of inventory
The next few slides will show examples of journal entries for
the above transactions.
Chapter 5

8. Purchasing Inventory From a Supplier
On August 1, Marcia’s Boutique purchased 12 dresses at $50 each from a supplier, Kwon, Inc. The credit terms are 2/10, n/30 and the shipping terms are FOB shipping point.
Chapter 5

9. Paying for Freight-In on Purchases
On August 3, Marcia receives and pays the $22 freight bill on the dresses purchased on August 1.
Chapter 5

10. Returning Inventory to a Supplier
On August 5, Marcia’s Boutique returned a dress to Kwon because the dress had a fabric flaw.
Chapter 5

11. Selling Inventory to a Customer
Marcia’s Boutique sells three dresses for cash ($110 per dress) on August 7. Because the company uses a perpetual inventory system, two journal entries are required.
Chapter 5

12. Accepting Returns of Inventory from a Customer
On August 8, one customer who bought a dress on August 7 decided to return it. Marcia’s Boutique will prepare two journal entries to record the return.
Chapter 5

13. Paying on Account for Purchases of Inventory
On August 11, Marcia’s paid for the dresses purchased from Kwon. The credit terms allow Marcia’s Boutique to deduct 2% from the total amount owed if payment is made by August 11.
Chapter 5

14. Summary of Perpetual Inventory Transactions
Chapter 5

15. Review purchases. accounts payable. inventory. accounts receivable.
The entry to purchase merchandise under a perpetual inventory system includes a debit to:
purchases.
accounts payable.
inventory.
accounts receivable.
Chapter 5
Chapter 5 15

16. Review purchases. accounts payable. inventory. accounts receivable.
The entry to purchase merchandise under a perpetual inventory system includes a debit to:
purchases.
accounts payable.
inventory.
accounts receivable.
Chapter 5
Chapter 5 16

17. Review purchases. accounts payable. inventory. cost of goods sold.
The entry under a perpetual inventory system for the seller to record the cost of merchandise returned includes a credit to:
purchases.
accounts payable.
inventory.
cost of goods sold.
Chapter 5
Chapter 5 17

18. Review purchases. accounts payable. inventory. cost of goods sold.
The entry under a perpetual inventory system for the seller to record the cost of merchandise returned includes a credit to:
purchases.
accounts payable.
inventory.
cost of goods sold.
Chapter 5
Chapter 5 18

19. Review accounts receivable. inventory. cost of goods sold. sales.
The entry under a perpetual inventory system to record the cost of merchandise sold includes a debit to:
accounts receivable.
inventory.
cost of goods sold.
sales.
Chapter 5
Chapter 5 19

20. Review accounts receivable. inventory. cost of goods sold. sales.
The entry under a perpetual inventory system to record the cost of merchandise sold includes a debit to:
accounts receivable.
inventory.
cost of goods sold.
sales.
Chapter 5
Chapter 5 20

21. Inventory Cost Flow Methods
Specific Identification
First In First Out
Last In First Out
Weighted Average
Chapter 5

22. Cost Flow Example
The operations of University Bookstore are used to explore the topic of inventory costing. Following are inventory data for January for a Principles of Marketing textbook. The text is a paperback version and, thus, there are no used copies of the text available for sale. To simplify the example, it is assumed that University Bookstore is only open two days in January; all sales, therefore, occur on those two days.
1/ 1 Beginning inventory 100 $30 each $ 3,000
1/ 8 Purchased $35 each ,000
1/14 Sold copies
1/18 Purchased $39 each ,730
1/22 Sold copies
Chapter 5

23. Purchases Sold Balance
Item: Principles of Marketing, Perpetual Inventory Record, FIFO Method
Purchases
Sold
Balance
Date #
Unit
Cost
Total
Unit Cost
Jan. 1
100
$30
$3,000
Jan. 8
400
$35
14,000
500 35
$ 3,000
$17,000
Jan. 17
260
$9,100
140
$4,900
Jan. 18 70
$39
$2,730
210 39
2,730
$7,630
Jan. 22 40
$4,900 $1,560 30
$1,170
Chapter 5

24. Purchases Sold Balance
Item: Principles of Marketing, Perpetual Inventory Record, Perpetual LIFO
Purchases
Sold
Balance
Date #
Unit
Cost
Total
Unit Cost
Jan. 1
100
$30
$3,000
Jan. 8
400
$35
$14,000
 100
500 35
 $ 3,000
14,000
$17,000
Jan. 17
360
$12,600 40
$ 3,000
1,400
$4,400
Jan. 18 70
$39
$2,730
210
 $30 39
2,730
$7,130
Jan. 22 30
1, ,100
 30 $
Chapter 5

25. Purchases Sold Balance Date
Item: Principles of Marketing, Perpetual Inventory Record, Moving Average Method
Purchases
Sold
Balance
Date #
Unit
Cost
Total
Unit Cost
Jan. 1
100
$30
$ 3,000
Jan. 8
400
$35
$14,000
500
$17,000
Jan. 17
360
$34
$12,240
140
$ 4,760
Jan. 18 70
$39
$2,730
210
$ 7,490
Jan. 22
180
$35.67
$6,421 30
$ 1,069
Chapter 5

26. Cost of Goods Sold, Gross Profit and Inventory Amounts
Chapter 5

27. Cost Flow
Chapter 5

28. Problem Review
Compute the ending inventory for Rayborn Company using the LIFO perpetual method based on the following information. On January 1 Rayborn Company had 25 units at a cost of $50 each.
Date
Purchases
Sales
Feb. 10
20 $56
April 5
32 units
June 19
26 $60
Aug. 29
15 units
Nov. 10
10 $63
Chapter 5
Chapter 5 28

29. Problem Review Solution
Date
Purchases
Sales
Balance
Jan. 1
$50 = $1,250
Feb. 10
$56 = $1,120
April 5
$50 = $600
$50 = $650
June 19
$60 = $1,560
Aug. 29
$60 = $900
$60 =$660
Nov. 10
$63 = $630
$60 = $660
Total ending inventory = $1,940
Chapter 5

30. Retail Inventory Method
Often used in small businesses to estimate the amount of inventory on hand.
Should be a consistent relationship between the costs and selling prices of a company’s products.
Can be used with FIFO, LIFO, or average cost flow assumptions.
Chapter 5

31. Retail Inventory Method Illustrated
Chapter 5

32. Problem Review
Compute estimated ending inventory using the retail inventory method for the King Company on December 31, 2011.
Cost
Retail
Jan. 1 inventory
$50,000
$ 90,000
Purchases during 2011
70,000
150,000
Sales during 2011
200,000
Chapter 5
Chapter 5 32

33. Problem Review Solution
Compute estimated ending inventory using the retail inventory method for the King Company on Dec. 31, 2011.
Cost
Retail
Jan. 1 inventory
$ 50,000
$ 90,000
Purchases during 2011
70,000
150,000
Goods available for sale
120,000
240,000
Sales during 2011
(200,000)
Ending inventory at retail
$ 40,000
Cost to retail % (120,000/240,000 = 50%
Ending inventory at cost ($40,000 X 50%)
$ 20,000
Chapter 5
Chapter 5 33

34. Lower of Cost or Market Total Market 540 340 1000 560 2440 Total Cost
420
480
750
720
2,370*
LCM
420
340
750
560
2,070**
Replacement
Cost 18 17 20 14
ITEM
727 Jeans
757 Jeans
Tank tops
Pullovers
Quantity 30 20 50 40
Unit Cost 14 24 15 18
*Applying LCM on a total inventory basis
**Applying LCM on an Item by Item basis
Chapter 5

35. Review
John Company has 200 units of inventory on hand at December 31. John’s cost under FIFO is $52 per unit. The Dec. 31 current cost is $55 per unit. Using lower-of-cost-or-market, John should show an ending inventory balance of
$10,400.
$11,000.
$10,700.
$10,500.
Chapter 5
Chapter 5 35

36. Review
John Company has 200 units of inventory on hand at December 31. John’s cost under FIFO is $52 per unit. The Dec. 31 current cost is $55 per unit. Using lower-of-cost-or-market, John should show an ending inventory balance of
$10,400.
$11,000.
$10,700.
$10,500.
Chapter 5
Chapter 5 36

37. Chapter 5

38. Review overstate and understate overstate and overstate
John Company overstated 2010 ending inventory by $25,000. What effect will this error have on 2010 and 2011 net income, respectively?
overstate and understate
overstate and overstate
understate and understate
understate and overstate
Chapter 5
Chapter 5 38

39. Review overstate and understate overstate and overstate
John Company overstated 2010 ending inventory by $25,000. What effect will this error have on 2010 and 2011 net income, respectively?
overstate and understate
overstate and overstate
understate and understate
understate and overstate
Chapter 5
Chapter 5 39

40. Relevant Ratios Age of Inventory = 360 days ÷ Inventory Turnover Ratio
Cost of Goods Sold ÷ Average Inventory
The inventory turnover ratio indicates the number of times that a company sells or "turns over" its inventory each year.
Age of Inventory =
360 days ÷ Inventory Turnover Ratio
Inventory age indicates the average period required to sell an item of inventory.
Chapter 5

41. THE END!
Chapter 5
Chapter 5 41