Cengage – Century 21 Accounting -- Edited for Advanced Accounting Chapter 20-1 Determining the Quantity of Merchandise Inventory Learning Objective LO1 Prepare a stock record. Cengage – Century 21 Accounting -- Edited for Advanced Accounting

Why Merchandise Inventory Is Important Lesson 20-1 Why Merchandise Inventory Is Important LO1 Helps managers to maintain a merchandise inventory of sufficient quantity, variety, and price Allows current assets and retained earnings to be correctly reported on the balance sheet Ensures that gross profit and net income are reported correctly on the income statement

The Most Efficient Quantity of Inventory Lesson 20-1 The Most Efficient Quantity of Inventory LO1 If larger than needed Requires a business to spend money for store and warehouse space Uses capital that could be invested in other assets Requires a business to spend money for expenses, such as taxes and insurance premiums, which increase with the cost of the merchandise inventory Merchandise may become obsolete and unsalable Conclusion: A merchandise inventory larger than necessary may reduce net income.

The Most Efficient Quantity of Inventory Lesson 20-1 The Most Efficient Quantity of Inventory LO1 If smaller than needed Sales may be lost Per unit cost of merchandise may be higher for small quantities Consequently, a merchandise inventory that is smaller than needed may decrease net income.

Methods Used to Determine the Quantity of Merchandise Inventory Lesson 20-1 Methods Used to Determine the Quantity of Merchandise Inventory LO1 A merchandise inventory evaluated at the end of a fiscal period is known as a periodic inventory. A merchandise inventory determined by keeping a continuous record of increases, decreases, and the balance on hand of each item of merchandise is known as a perpetual inventory. A perpetual inventory is also referred to as a book inventory because it is maintained as items are purchased and sold. You still need to do a physical inventory every year

Lesson 20-1 Inventory Documents LO1 A form used during a physical inventory to record information about each item of merchandise on hand is called an inventory record. 1 Stock Number and Description 2 Actual Units on Hand 3 Unit Price and Total Cost

Lesson 20-1 Inventory Forms LO1 Some businesses keep inventory records that show continuously the quantity on hand for each kind of merchandise. A form used to show the kind of merchandise, quantity received, quantity sold, and balance on hand is called a stock record. A separate stock record is prepared for each kind of merchandise on hand. A file of stock records for all merchandise on hand is called a stock ledger.

Lesson 20-1 Stock Record Note: Stock records do not reflect the cost of the merchandise LO1 Purchase Information Sales Information New Balance on Hand

Perpetual Inventory Using a Computer Lesson 20-1 Perpetual Inventory Using a Computer LO1 Point-of-sales terminals Universal Product Codes (UPC) Computerized stock ledger—instead of a manual record Note: Companies that use a product’s UPC code and a point-of-sale terminal should still take a physical inventory at least once each fiscal year.

Cost of Merchandise Sold Lesson 20-1 Cost of Merchandise Sold LO1 Beginning Inventory Plus Net Purchases Equals Merchandise Available for Sale Minus Ending Inventory Equals Cost of Merchandise Sold True or False: The cost of merchandise sold can be calculated by subtracting the cost of merchandise available from the cost of ending inventory. (Please research and study why this is false.)

Lesson 20-1 Audit Your Understanding 1. Identify four reasons why a merchandise inventory that is larger than needed may decrease the net income of a business. ANSWER 1. Excess inventory requires that a business spend money for expensive store and warehouse space. 2. Excess inventory uses capital that could be invested in other assets to earn a profit for the business. 3. Excess inventory requires that a business spend money for expenses, such as taxes and insurance premiums, which increase with the cost of the merchandise inventory. 4. Excess inventory may become obsolete and unsalable merchandise.

Lesson 20-1 Audit Your Understanding 2. When are physical inventories normally taken? ANSWER At the end of a fiscal period. (All items are manually counted. Therefore, they are counted at the time of year when the inventory is at a minimum.)

Lesson 20-1 Audit Your Understanding 3. How do inventory levels affect the period a business selects for its fiscal year? Why? ANSWER A business frequently establishes its fiscal period to end when inventory normally is at a minimum because it takes less time to count a smaller inventory.

Lesson 20-1 Audit Your Understanding 4. How is the accuracy of a perpetual inventory checked?  ANSWER A customary practice is to take a physical inventory at least once a fiscal period. The physical inventory results are then compared with the perpetual inventory records.

© 2014 Cengage Learning. All Rights Reserved. 20-2 Determining the Cost of Merchandise Inventory Learning Objectives LO2 Calculate the cost of merchandise inventory using the first-in, first-out (FIFO) inventory costing method. LO3 Calculate the cost of merchandise inventory using the last-in, first-out (LIFO) inventory costing method. LO4 Calculate the cost of merchandise inventory using the weighted-average inventory costing method. © 2014 Cengage Learning. All Rights Reserved.

First-In, First-Out Inventory Costing Method Lesson 20-2 First-In, First-Out Inventory Costing Method LO2 Using the price of merchandise purchased first to calculate the cost of merchandise sold first is called the first-in, first-out inventory costing method. The first-in, first-out method is frequently abbreviated as FIFO. When FIFO is used, the cost of merchandise sold is priced at the earliest price. In periods of rising prices, FIFO gives the lowest cost of merchandise sold Note: LIFO determines the cost of the merchandise sold, not the quantity of each type of merchandise on hand.

First-In, First-Out Inventory Costing Method Lesson 20-2 First-In, First-Out Inventory Costing Method LO2 3 Units Needed to Equal the Total Units on Hand 4 Unit Price Times FIFO Units Purchase Dates Units Purchased Unit Price Total Cost FIFO Units on Hand FIFO Cost January 1, beginning inventory 10 $20.80 $ 208.00 February 16, purchases 6 21.60 129.60 April 17, purchases 14 22.40 313.60 September 5, purchases 12 23.40 280.80 $234.00 November 22, purchases 8 23.50 188.00 50 $ 1,120.00 18 $422.00 2 Units from the Most Recent Purchase 1 Total Units on Hand 5 Total FIFO Cost

Last-In, First-Out Inventory Costing Method Lesson 20-2 Last-In, First-Out Inventory Costing Method LO3 Using the price of merchandise purchased last to calculate the cost of merchandise sold first is called the last-in, first-out inventory costing method. Ending inventory units are priced at the earliest cost. The last-in, first-out method is frequently abbreviated as LIFO. Understand Why: In a period of rising prices, LIFO gives the lowest possible ending inventory cost. (Items purchased first and still on the shelves—they were bought when prices were lower.)

Last-In, First-Out Inventory Costing Method Lesson 20-2 Last-In, First-Out Inventory Costing Method LO3 2 Beginning Inventory Units 5 Unit Price Times LIFO Units Purchase Dates Units Purchased Unit Price Total Cost LIFO Units on Hand LIFO Cost January 1, beginning inventory 10 $20.80 $ 208.00 $208.00 February 16, purchases 6 21.60 129.60 April 17, purchases 14 22.40 313.60 2 44.80 September 5, purchases 12 23.40 280.80 November 22, purchases 8 23.50 188.00 50 $ 1,120.00 18 $382.40 3 Units from the Earliest Purchase Units Needed to Equal the Total Units on Hand 4 1 Total Units on Hand Total LIFO Cost 6

Weighted-Average Inventory Costing Method Lesson 20-2 Weighted-Average Inventory Costing Method LO4 Using the average cost of beginning inventory plus merchandise purchased during a fiscal period to calculate the cost of merchandise sold is called the weighted-average inventory costing method. The average unit price of the total inventory available is calculated. This average unit price is used to calculate both ending inventory and cost of merchandise sold. The average cost of merchandise is then charged against current revenue.

Weighted-Average Inventory Costing Method Lesson 20-2 Weighted-Average Inventory Costing Method LO4 Purchases Total Cost Purchase Dates Units Unit Price January 1, beginning inventory 10 $20.80 $ 208.00 February 16, purchases 6 21.60 129.60 April 17, purchases 14 22.40 313.60 September 5, purchases 12 23.40 280.80 November 22, purchases 8 23.50 188.00 50 $ 1,120.00 Total Cost of Inventory Available 1 2 Weighted-Average Price per Unit Total of Beginning Inventory and Purchases ÷ Total Units = Weighted-Average Price per Unit $1,120.00 50 $22.40 Units in Ending Inventory × Cost of 18 $403.20 3 Cost of Ending Inventory

Calculating the Cost of Merchandise Sold Lesson 20-2 Calculating the Cost of Merchandise Sold LO4 Cost of Merchandise Available for Sale − FIFO Cost of Ending Inventory = Cost of Merchandise Sold $1,120.00 − $422.00 = $698.00

Comparison of Inventory Methods Lesson 20-2 Comparison of Inventory Methods LO4 FIFO LIFO Weighted- Average Cost of merchandise sold: Merchandise inventory, Jan. 1…………........... $208.00 Net purchases .............................................. 912 Merchandise available for sale .................... $1,120.00 Less ending inventory, Dec. 31 .................... 422 382.4 403.2 Cost of merchandise sold............................. $698.00 $737.60 $716.80 In a period of rising prices: Relative cost of ending inventory highest lowest intermediate Relative cost of merchandise sold The actual inventory flow of merchandise in a company does not have to not have to match the inventory costing method a company chooses.

Lower of Cost or Market Inventory Costing Method Lesson 20-2 Lower of Cost or Market Inventory Costing Method LO4 The price that must be paid to replace an asset is called the market value. Using the lower of cost or market price to calculate the cost of ending merchandise inventory is called the lower of cost or market inventory costing method. In this context, cost refers to the actual amount paid for the unit of inventory on hand. Market refers to the amount that must be paid to replace the unit of inventory.

Lower of Cost or Market Inventory Costing Method Lesson 20-2 Lower of Cost or Market Inventory Costing Method LO4 Lower of Cost or Market Inventory Costing Method Costing Method Cost Market Value (18 units × $22.50 current market price) Lower of Cost or Market FIFO $422.00 $405.00 LIFO 382.40 405.00 Weighted-average 403.20 Calculate the cost Calculate the market price Determine the smaller number to use as the lower of cost or market

Adequate Disclosure Concept Lesson 20-2 Adequate Disclosure Concept LO4 Lower of Cost or Market Inventory Costing Method Costing Method Cost Market Value (18 units × $22.50 current market price) Lower of Cost or Market FIFO $422.00 $405.00 LIFO 382.40 405.00 Weighted-average 403.20 Note: Calculating an accurate inventory cost to ensure that gross profit and net income are reported correctly on the income statement is an application of the Adequate Disclosure concept.

Lesson 20-2 Audit Your Understanding 1. On what idea is the FIFO method based? ANSWER The price of merchandise purchased first should be charged against current revenue.

Lesson 20-2 Audit Your Understanding 2. When the LIFO method is used, at what price is each item in ending merchandise inventory recorded? ANSWER The prices of merchandise purchased first are used in recording prices for each item on the inventory record.

Lesson 20-2 Audit Your Understanding 3. In a period of rising prices, which inventory costing method gives the lowest cost of merchandise sold? . ANSWER FIFO First ones bought did not cost as much – so if they are sold first, the cost of merchandise sold will be lower.

Lesson 20-2 Audit Your Understanding 4. Why should a business select one inventory costing method and use that same method continuously for each fiscal period? ANSWER Using the same inventory costing method for all fiscal periods provides financial statements that can be compared with other fiscal period statements. If a business changes inventory cost methods, part of the difference in gross profit and net income may be caused by the change in methods.

© 2014 Cengage Learning. All Rights Reserved. Lesson 20-3 Estimating Inventory Learning Objective LO5 Estimate the cost of merchandise inventory using the gross profit method of estimating inventory. © 2014 Cengage Learning. All Rights Reserved.

Gross Profit Method of Estimating Inventory Lesson 20-3 Gross Profit Method of Estimating Inventory LO5 Estimating inventory by using the previous year’s percentage of gross profit on operations is called the gross profit method of estimating inventory. The gross profit method makes it possible to prepare monthly income statements without taking a physical inventory.

Gross Profit Method of Estimating Inventory Lesson 20-3 Gross Profit Method of Estimating Inventory LO5 STEP 1: Beginning inventory, January 1 $331,235.20 Plus net purchases for January 1 to January 31 +64,516.21 Equals cost of merchandise available for sale $395,751.41 STEP 2: Net sales for January 1 to January 31 $122,367.00 Times previous year’s gross profit percentage × 40.00% Equals estimated gross profit on operations $48,946.80 STEP 3: Net sales for January 1 to January 31 $122,367.00 Less estimated gross profit on operations −48,946.80 Equals estimated cost of merchandise sold $73,420.20 STEP 4: Cost of merchandise available for sale $395,751.41 Less estimated cost of merchandise sold −73,420.20 Equals estimated ending merchandise inventory $322,331.21

Estimating Inventory for Other Months Lesson 20-3 Estimating Inventory for Other Months LO5 When the gross profit method of estimating inventory is used for months other than the first month of the fiscal period, the process is the same as that just illustrated.

Lesson 20-3 Audit Your Understanding 1. When neither a perpetual system is maintained nor a physical inventory is taken, how can an ending merchandise inventory be determined that is accurate enough for a monthly income statement? ANSWER By using the gross profit method of estimating inventory

Lesson 20-3 Audit Your Understanding 2. What amounts are needed to estimate ending merchandise inventory? ANSWER Actual net sales and net purchases amounts The beginning inventory amount The gross profit percentage

Lesson 20-3 Audit Your Understanding 3. What amount is used for beginning inventory for a month that is not the first month of a fiscal year? ANSWER The beginning inventory for the month is the same as the ending inventory from the previous month.

Thank you for working hard at understanding this chapter.  The End Thank you for working hard at understanding this chapter. 