7 Inventories Student Version

Describe the importance of control over inventory. 1 Describe the importance of control over inventory. 7-2

Two primary objectives of control over inventory are: 1 Two primary objectives of control over inventory are: Safeguarding the inventory, and Properly reporting it in the financial statements.

1 A physical inventory or count of inventory should be taken near year-end to make sure that the quantity of inventory reported in the financial statements is accurate.

2 Describe the three inventory cost flow assumptions and how they impact the income statement and balance sheet. 7-5

2 Under the first-in, first out (FIFO) inventory cost flow method, the first units purchased are assumed to be sold and the ending inventory is made up of the most recent purchases.

2 Under the last-in, first out (LIFO) inventory cost flow method, the last units purchased are assumed to be sold first and the ending inventory is made up of the first units purchased.

2 Under the average inventory cost flow method, the cost of the units sold and in ending inventory is an average of the purchase costs.

3 Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and average cost methods. 7-9

First-In, First-Out Method 3 First-In, First-Out Method On January 1, the firm had 100 units of Item 127B that cost $20 per unit. Item 127B Units Cost Jan. 1 Inventory 100 $20

First-In, First-Out Method 3 First-In, First-Out Method On January 4, the firm sold 70 units of 127B at $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70

3 Exhibit 3 Entries and Perpetual Inventory Account (FIFO)

First-In, First-Out Method 3 First-In, First-Out Method On January 10, the firm purchased 80 units at $21 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21

3 Entries and Perpetual Inventory Account (FIFO) (continued) Exhibit 3 10 Merchandise Inventory 1,680 Accounts Payable 1,680 Date Jan. 1

First-In, First-Out Method 3 First-In, First-Out Method On January 22, the firm sold 40 units for $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40

3 Entries and Perpetual Inventory Account (FIFO) (continued) Exhibit 3 Jan. 1 Date

First-In, First-Out Method 3 First-In, First-Out Method On January 28, the firm sold 20 units at $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40 28 Sale 20

3 Entries and Perpetual Inventory Account (FIFO) (continued) Exhibit 3 Date Jan. 1

First-In, First-Out Method 3 First-In, First-Out Method On January 30, purchased one hundred additional units of Item 127B at $22 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40 28 Sale 20 30 Purchase 100 22

3 Entries and Perpetual Inventory Account (FIFO) (continued) Exhibit 3

Cost of merchandise sold 3 Entries and Perpetual Inventory Account (FIFO) (concluded) Exhibit 3 Cost of merchandise sold January 31 inventory

Last-In, First-Out Method 3 Last-In, First-Out Method On January 1, the firm had 100 units of Item 127B that cost $20 per unit. Item 127B Units Cost Jan. 1 Inventory 100 $20

Last-In, First-Out Method 3 Last-In, First-Out Method On January 4, the firm sold 70 units of 127B at $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70

3 Exhibit 4 Entries and Perpetual Inventory Account (LIFO)

Last-In, First-Out Method 3 Last-In, First-Out Method On January 10, the firm purchased 80 units at $21 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21

3 Entries and Perpetual Inventory Account (LIFO) (continued) Exhibit 4 10 Merchandise Inventory 1,680 Accounts Payable 1,680 Date Jan. 1 4

Last-In, First-Out Method 3 Last-In, First-Out Method On January 22, the firm sold 40 units for $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40

3 Entries and Perpetual Inventory Account (LIFO) (continued) Exhibit 4 Date Jan. 1 4

Last-In, First-Out Method 3 Last-In, First-Out Method On January 28, the firm sold 20 units at $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40 28 Sale 20

3 Entries and Perpetual Inventory Account (LIFO) (continued) Exhibit 4 Date Jan. 1 4

Last-In, First-Out Method 3 Last-In, First-Out Method On January 30, the firm purchased one hundred additional units of Item 127B at $22 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40 28 Sale 20 30 Purchase 100 22

3 Entries and Perpetual Inventory Account (LIFO) (continued) Exhibit 4 Date Jan. 1 4 10

Cost of Merchandise Sold 3 Entries and Perpetual Inventory Account (LIFO) (concluded) Exhibit 4 Cost of Merchandise Sold January 31 Inventory

4 Determine the cost of inventory under the periodic inventory system, using the FIFO, LIFO, and average cost methods. 7-34

4 Exhibit 5 First-In, First-Out Flow of Costs

4 Exhibit 5 Last-In, First-Out Flow of Costs

Total Cost of Units Available for Sale Units Available for Sale 4 The weighted average unit cost is determined as follows: Total Cost of Units Available for Sale Units Available for Sale Average Unit Cost =

Compare and contrast the use of the three inventory costing methods. 5 Compare and contrast the use of the three inventory costing methods. 7-38

Partial Income Statements 5 Partial Income Statements First-In, First-Out Net sales $3,900 Cost of merchandise sold: Beginning inventory $2,000 Purchases 3,880 Merchandise available for sale $5,880 Less ending inventory 3,250 Cost of merchandise sold 2,630 Gross profit $1,270

Partial Income Statements 5 Partial Income Statements Average Cost Net sales $3,900 Cost of merchandise sold: Beginning inventory $2,000 Purchases 3,880 Merchandise available for sale $5,880 Less ending inventory 3,150 Cost of merchandise sold 2,730 Gross profit $1,170

Partial Income Statements 5 Partial Income Statements Last-In, First-Out Net sales $3,900 Cost of merchandise sold: Beginning inventory $2,000 Purchases 3,880 Merchandise available for sale $5,880 Less ending inventory 3,050 Cost of merchandise sold 2,830 Gross profit $1,070

6 Describe and illustrate the reporting of merchandise inventory in the financial statements. 7-42

6 Cost Cost is the primary basis for valuing and reporting inventories in the financial statements. However, inventory may be valued at other than cost in the following cases: (continued)

The cost of replacing items in inventory is below the recorded cost. 6 The cost of replacing items in inventory is below the recorded cost. The inventory cannot be sold at normal prices due to imperfections, style changes, or other causes.

6 Market Market, as used in lower of cost or market, is the cost to replace the merchandise on the inventory date.

6 Determining Inventory at Lower of Cost or Market Exhibit 8

6 Net Realizable Value Merchandise that is out of date, spoiled, or damaged should be written down to its net realizable value. This is the estimated selling price less any direct cost of disposal, such as sales commissions.