1. Chapter 9 Inventories Accounting, 21st Edition Warren Reeve Fess
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PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

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3. After studying this chapter, you should be able to:
Objectives
1. Summarize and provide examples of internal control procedures that apply to inventories.
2. Describe the effect of inventory errors on the financial statement.
3. Describe the three inventory cost flow assumptions and how they impact the income statement and balance sheet.
4. Compute the cost of inventory under the perpetual inventory system, using the following cost methods: first-in, first-out; last-in, first-out; average cost.
After studying this chapter, you should be able to:

4. Objectives
5. Compute the cost of inventory under the periodic inventory system, using the following costing methods: first-in, first-out; last-in, first-out; average cost.
6. Compare and contrast the use of the three inventory costing methods.
7. Compute the proper valuation of inventory at other than cost, using the lower-of-cost-or-market and net realization value concepts.
8. Prepare a balance sheet presentation of merchandise inventory.

5. Objectives
9. Estimate the cost of inventory, using the retail method and the gross profit method.
10. Compute the interpret the inventory turnover ratio and number of days’ sales in inventory.

6. Why is Inventory Control Important?
Inventory is a significant asset and for many companies the largest asset.
Inventory is central to the main activity of merchandising and manufacturing companies.
Mistakes in determining inventory cost can cause critical errors in financial statements.
Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.

7. AGREE AGREE AGREE Receiving report Purchase order Invoice JOURNAL
Date
Description
Post Ref.
Nov. 9
Inventory
Accounts Payable--XYZ Co
Purchased merchandise on
account.

8. Effect of Inventory Errors on Financial Statements
LIABILITIES
Merchandise
Inventory
ASSETS
OWNER’S
EQUITY
Net Income
Cost of
Merchandise Sold
COSTS & EXPENSES
REVENUES
If merchandise inventory is
Cost of merchandise sold is
Gross profit and net income are . . .
Ending owner’s equity is
overstated
understated

9. Effect of Inventory Errors on Financial Statements
If merchandise inventory is
Cost of merchandise sold is
Gross profit and net income are . . .
Ending owner’s equity is
understated
overstated

10. Inventory Cost Flow Assumptions
Purchased goods
FIFO
Sold goods

11. Inventory Cost Flow Assumptions
Sold goods
Purchased goods
LIFO

12. Inventory Cost Flow Assumptions
Purchased goods
Sold goods
Average
Cost

13. Inventory Costing Methods
43%
40%
30%
20%
10% 0%
34%
19% 4%
Fifo
Lifo
Average
Other

14. Perpetual Inventory Costs
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B Units Cost Price
Jan. 1 Inventory 10 $20
4 Sale 7 $30
10 Purchase 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22
Cost of
Mdse. Sold

15. Fifo
Perpetual

16. FIFO Perpetual Inventory Account
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
The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

17. FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B Units Cost Price
Jan. 1 Inventory 10 $20
4 Sale 7 $30
10 Purchase 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22
Cost of
Mdse. Sold
On January 4, 7 units of Item 127B are sold at $30 each.

18. FIFO Perpetual Inventory Account
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
Jan
The sale of 7 units leaves a balance of 3 units.
On January 4, 7 units of Item 127B are sold at $30 each.

19. FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Item 127B Units Cost Price
Jan. 1 Inventory 10 $20
4 Sale 7 $30
10 Purchase 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22
Cost of
Mdse. Sold
On January 10, the firm purchased eight units at $21 each.

20. FIFO Perpetual Inventory Account
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
Because the purchase price of $21 is different than the cost of the previous 3 units on hand, the inventory balance of 11 units is accounted for separately.
On January 10, the firm purchased eight units at $21 each.

21. FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Cost of
Mdse. Sold
Item 127B Units Cost Price
Jan. 1 Inventory 10 $20
4 Sale 7 $30
10 Purchase 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22
On January 22, the firm sold four units for $31 each.

22. FIFO Perpetual Inventory Account
Item 127B
Purchases Cost of Mdse. Sold Inventory Balance
On January 22, the firm sold four units for $31 each.
Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan
Of the four units sold, three are from the first units in (fifo) at a cost of $20.

23. FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Cost of
Mdse. Sold
Item 127B Units Cost Price
Jan. 1 Inventory 10 $20
4 Sale 7 $30
10 Purchase 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22
On January 28, the firm sold two units at $32.

24. FIFO Perpetual Inventory Account
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
On January 28, the firm sold two units at $32.

25. FIFO Perpetual Inventory Account
Inventory cost data to demonstrate
FIFO and LIFO Perpetual Systems
Cost of
Mdse. Sold
Item 127B Units Cost Price
Jan. 1 Inventory 10 $20
4 Sale 7 $30
10 Purchase 8 21
22 Sale 4 31
28 Sale 2 32
30 Purchase 10 22
On January 30, purchased ten additional units of Item 127B at $22 each.

26. FIFO Perpetual Inventory Account
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
On January 30, purchased ten additional units of Item 127B at $22 each.
Totals 18 $ $ $325

27. Lifo
Perpetual

28. LIFO Perpetual Inventory Account
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
The firm begins the year with 10 units of Item 127B on hand at a total cost of $200.

29. LIFO Perpetual Inventory Account
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
On January 4, the firm sold 7 units at $30 each.

30. LIFO Perpetual Inventory Account
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
Note that a new layer is formed.
On January 10, the firm purchased eight units at $21 each.

31. LIFO Perpetual Inventory Account
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
Of the 4 units sold, all come from the most recent purchase at a cost of $21 each.
On January 22, the firm sells four units at $31 each.

32. LIFO Perpetual Inventory Account
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
On January 28, sold two units at $32 each.

33. LIFO Perpetual Inventory Account
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
On January 30, purchase 10 units at $22 each.

34. LIFO Perpetual Inventory Account
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
Totals 18 $ $ $322

35. Fifo Periodic

36. Fifo Periodic Jan. 1 Beginning Inventory 200 units @ $9
Mar. 10 Purchase
400 $11
Sept. 21 Purchase
100 $12
Nov. 18 Purchase
1,000 units available for sale during year

37. Cost of merchandise available for sale
Fifo Periodic
200 $9
= $1,800 Jan. 1
= 3,000 Mar. 10
= 4,400 Sept. 21
= 1,200 Nov. 18
300 $10
400 $11
100 $12
1,000 units available for sale during year
$10,400
Cost of merchandise available for sale

38. Fifo Periodic
A physical count on December 31 reveals that 700 of the 1,000 units have been sold.
Using fifo, the first units purchased are theoretically the first units sold. We begin the count with January 1.

39. Fifo Periodic 200 units @ $9 Sold these 200 = $1,800 Jan. 1
= 0 Mar. 10
= 3,000 Mar. 10
Sold 200 of these
200 $11
400 $11
= 2,200 Sept. 21
= 4,400 Sept. 21
100 $12
= 1,200 Nov. 18
1,000 units available for sale during year
$10,400
$ 3,400
Ending inventory

40. Fifo Periodic Cost of merchandise available for sale $10,400
Less ending inventory 3,400
Cost of merchandise sold $ 7,000

41. Summary of Fifo Periodic
Cost of
Merchandise
Sold
Merchandise
Available
for Sale
Purchases
$1,800
200 units at $9
Jan. 1
200 units at $9
$1,800
$3,000
300 units at $10
Mar. 10
300 units at $10
$3,000
$2,200
200 units at $11
Sep. 21
400 units at $11
$7,000
700 units
$4,400
Merchandise
Inventory
Nov. 18
100 units at $12
$1,200
$2,200
200 units at $11
1,000 units
$10,400
$1,200
100 units at $12
$3,400
300 units

42. Lifo Periodic

43. Lifo Periodic
200 $9
Jan. 1 Beginning Inventory
300 $10
Mar. 10 Purchase
400 $11
Sept. 21 Purchase
100 $12
Nov. 18 Purchase
1,000 units available for sale during year
Using lifo, the most recent batch purchased is considered the first batch of merchandise sold.

44. Assume again that 700 units were sold during the year.
Lifo Periodic
200 $9
Jan. 1 Beginning Inventory
Assume again that 700 units were sold during the year.
300 $10
Mar. 10 Purchase
400 $11
Sept. 21 Purchase
100 $12
Nov. 18 Purchase
1,000 units available for sale during year

45. Lifo Periodic 200 units @ $9 = $1,800 Jan. 1 = 3,000 Mar. 10
= 4,400 Sept. 21
= 1,200 Nov. 18
Sold 200 of these
300 $10
100 $10
1,000
Sold these 400
400 $11
Sold these 100
100 $12
1,000 units available for sale during year
Ending Inventory
$2,800
$10,400

46. Lifo Periodic Cost of merchandise available for sale $10,400
Less ending inventory 2,800
Cost of merchandise sold $ 7,600

47. Cost of Merchandise Sold
Summary of Lifo Periodic
Cost of Merchandise Sold
Merchandise
Available
for Sale
Purchases
$1,800
200 units at $9
$1,800
Jan. 1
200 units at $9
$1,000
100 units at $10
$1,800
$2,800
300 units
Mar. 10
300 units at $10
$3,000
Cost of
Merchandise
Sold
Sep. 21
400 units at $11
$4,400
$2,000
200 units at $10
Nov. 18
100 units at $12
$1,200
$4,400
400 units at $11
1,000 units
$10,400
$1,200
100 units at $12
$7,600
700 units

48. Average Cost Periodic
200 $9
Jan. 1 Beginning Inventory
The average cost periodic method is based on the average cost of identical units.
300 $10
Mar. 10 Purchase
400 $11
Sept. 21 Purchase
100 $12
Nov. 18 Purchase
1,000 units available for sale during year

49. Average Cost Periodic 200 units @ $9 = $ 1,800
1,000 units available for sale during year
$10,400 Cost of merchandise available for sale

50. Average Cost Periodic Cost of Merchandise Available for Sale
= Average Unit Cost
Units Available for Sale During Year
$10,400
1,000 Units
= $10.40 per Unit

51. Average Cost Periodic Cost of merchandise available for sale $10,400
Less ending inventory ($10.40 x 300) 3,120
Cost of merchandise sold $ 7,280
To verify this amount, multiply 700 units sold times $10.40 to get the same $7,280.

52. Valuation of Inventory at Lower-of-Cost-or-Market
Unit Unit
Inventory Cost Market Total Total Lower
Item Quantity Price Price Cost Market C or M
$ 3,800
2,700
4,650
3,920
Total $15,520 $15,472 $15,070
A 400 $10.25 $ $ 4,100 $ 3,800
B ,700 2,892
C ,800 4,650
D ,920 4,130
The market decline based on individual items
($15,520 – $15,070) = $450

53. Metro-Arts Balance Sheet December 31, 2007
Presentation of Merchandise Inventory on the Balance Sheet
Metro-Arts Balance Sheet December 31, 2007
Assets
Current assets:
Cash $
Accounts receivable $
Less allowance for
doubtful accounts
Merchandise inventory
at lower of cost (first-in,
first-out method) or market

54. Estimating Inventory Cost

55. Retail Method of Estimating Inventory Cost
Retail method is based on relationship between cost of merchandise available for sale and the retail price.
Retail prices of all merchandise must be accumulated and totaled.
Inventory at retail is calculated at retail price of merchandise available for sale less net sales at retail.
Ratio is calculated as cost divided by retail price.
Inventory at retail price times cost ratio equals estimated cost of inventory.

56. Retail Inventory Method
Cost Retail
Merchandise inventory, Jan. 1 $19,400 $ 36,000
Purchases in January (net) , ,000
Merchandise available for sale $62,000 $100,000
$62,000
$100,000
Ratio of cost to retail price =
= 62%
Step 1: Determine the ratio of cost to the retail price.

57. Retail Inventory Method
Cost Retail
Merchandise inventory, Jan. 1 $19,400 $ 36,000
Purchases in January (net) , ,000
Merchandise available for sale $62,000 $100,000
Sales for January (net) ,000
Merchandise inventory, January 31, at retail $ 30,000
Step 2: Determine the ending inventory at retail.

58. Retail Inventory Method
Sales for January (net) ,000
Merchandise inventory, January 31, at retail $ 30,000
Cost Retail
Merchandise inventory, Jan. 1 $19,400 $ 36,000
Purchases in January (net) , ,000
Merchandise available for sale $62,000 $100,000
Merchandise inventory, January 31, at cost
($30,000 x 62%) $18,600
Step 3: Calculate the estimated inventory at cost.

59. Gross Profit Method of Estimating Inventory Cost
1. A gross profit percentage rate is estimated based on previous experience adjusted for known changes.
2. Estimated gross profit is calculated by multiplying the estimated gross profit rate times the actual net sales.
3. Estimated cost of merchandise sold is calculated by subtracting the gross profit from actual sales.
4. The cost of merchandise sold estimate is deducted from actual merchandise available for sale to determine the estimated cost of merchandise inventory.

60. Gross Profit Method
Merchandise inventory, January 1 $ 57,000
Purchases in January (net) 180,000
Merchandise available for sale
Sales in January (net) $250,000
Less: Estimated gross profit
Estimated cost of merchandise sold
Estimated merchandise inventory, January 31
$237,000
($250,000 x 30%) ,000
175,000
$ 62,000
The gross profit method is useful for estimating inventories for monthly or quarterly financial statements in a periodic inventory system.

61. Inventory Turnover
SUPERVALU Zale
Cost of merchandise sold $15,620,127,000 $ 737,188,000
Inventories:
Beginning of year $1,115,529,000 $478,467,000
End of year 1,067,837, ,669,000
Total $2,183,366,000 $1,050,136,000
Average $1,091,683,000 $525,068,000
Inventory turnover 14.3 times 1.4 times
Use: Inventory turnover measures the relationship between the volume of goods sold and the amount of inventory carried during the period.

62. Number of Days’ Sales in Inventory
SUPERVALU Zale
Average daily cost of
merchandise sold:
$15,620,127,000/365 $42,794,868
$737,188,000/365 $2,019,693
Ending inventory $1,067,837,000 $571,669,000
Average selling period 25 days 283 days
Use: To assess the efficiency in the management of inventory

63. Chapter 9
The End