College Accounting, 22nd Edition

Chapter 13 Accounting for Merchandise Inventory

Learning Objective 1 Explain the impact of merchandise inventory on the financial statements.

Impact of Merchandise Inventory on Financial Statements Errors in inventory will cause errors on the: Income statement Statement of owner’s equity Balance sheet Since this year’s ending inventory becomes next year’s beginning inventory, financial statements for the following year will also contain errors.

Learning Objective 2 Describe the two principal systems of accounting for merchandise inventory—the periodic system and the perpetual system.

Types of Inventory Systems, Part 1 PERIODIC INVENTORY SYSTEM Merchandise inventory account balance = most recent physical inventory Purchases account used for all merchandise purchases Merchandise inventory and cost of goods sold are only computed at the end of the accounting period.

The periodic system uses a Purchases account. General Journal, Part 1 The periodic system uses a Purchases account.

The periodic system separates freight charges into their own account. General Journal, Part 3 The periodic system separates freight charges into their own account.

Periodic EXAMPLE: Sold merchandise on account, $80. The cost of the merchandise was $50.

General Journal, Part 5 The periodic system only records the selling price of merchandise sold. No attempt is made to reduce the inventory account for items sold.

Learning Objective 3 Compute the costs allocated to the ending inventory and cost of goods sold using different inventory methods.

Computing the Cost of Ending Inventory, Part 4 Of the goods available for sale, how do we decide which units were sold and which units remain on the shelf? Four inventory methods have become generally accepted for answering this question: Specific identification First-in, first-out (FIFO) Weighted-average Last-in, first-out (LIFO) This decision affects the income statement and balance sheet.

Computing the Cost of Ending Inventory, Part 5

Periodic Inventory System Specific Identification Method Used when each unit of inventory can be specifically identified Examples: cars, motorcycles, furniture, appliances, fine jewelry Practical only for businesses in which sales volume is relatively low and inventory unit value is relatively high Let’s apply this method to the printer example.

30 of the beginning inventory were sold. Computing Cost of Goods Sold Using the Specific Identification Method, Part 1 The identity of the 200 printers sold is as follows: 30 of the beginning inventory were sold.

50 from the 1st purchase were sold. Computing Cost of Goods Sold Using the Specific Identification Method, Part 2 The identity of the 200 printers sold is as follows: 50 from the 1st purchase were sold.

60 from the 2nd purchase were sold. Computing Cost of Goods Sold Using the Specific Identification Method, Part 3 The identity of the 200 printers sold is as follows: 60 from the 2nd purchase were sold.

60 from the 3rd purchase were sold. Computing Cost of Goods Sold Using the Specific Identification Method, Part 4 The identity of the 200 printers sold is as follows: 60 from the 3rd purchase were sold.

Computing Cost of Goods Sold Using the Specific Identification Method, Part 5 Description Units Unit Price Total Beginning Inventory 30 $62 $1,860 1st Purchase 50 65 3,250 2nd Purchase 60 67 4,020 3rd Purchase 68 4,080 200 Empty cell $13,210

Computing Ending Inventory Using the Specific Identification Method, Part 6 Description Units Unit Price Total Beginning Inventory 10 $62 $620 1st Purchase 65 650 2nd Purchase 20 67 1,340 3rd Purchase 68 680 50 Empty cell $3,920 This ending inventory will be reported on the income statement and the balance sheet.

Periodic Inventory System First-In, First-Out (FIFO) Assumes that the first goods purchased were the first goods sold Therefore, the latest goods purchased remain in inventory. Often follows the actual movement of goods Especially true of grocery stores, fresh fruit stands, and computer software businesses Let’s apply this method to the printer example.

Computing Cost of Goods Sold Using the FIFO Method, Part 1 The identity of the 200 printers sold is as follows:

Computing Cost of Goods Sold Using the FIFO Method, Part 2 The identity of the 200 printers sold is as follows:

Computing Cost of Goods Sold Using the FIFO Method, Part 3 The identity of the 200 printers sold is as follows:

Computing Cost of Goods Sold Using the FIFO Method, Part 4 The identity of the 200 printers sold is as follows:

Computing Cost of Goods Sold Using the FIFO Method, Part 5 The identity of the 200 printers sold is as follows:

Computing Cost of Goods Sold Using the FIFO Method, Part 6 Description Units Unit Price Total Beginning Inventory 40 $62 $2,480 1st Purchase 60 65 3,900 2nd Purchase 80 67 5,360 3rd Purchase 20 68 1,360 The remaining units from the 3rd purchase are the 50 units in ending inventory.

Computing Cost of Goods Sold Using the FIFO Method, Part 7 Cost of goods (the 200 printers) sold

Computing Ending Inventory Using the FIFO Method Description Units Unit Price Total Beginning Inventory $62 $0 1st Purchase 65 2nd Purchase 67 3rd Purchase 50 68 3,400 Empty cell $3,400 This ending inventory will be reported on the income statement and the balance sheet.

Periodic Inventory System Weighted-Average Method Computes an average cost per unit using the following formula: Total cost of units available for sale divided by the total number of units available for sale Let’s apply this method to the printer example.

Computing Cost of Goods Sold Using the Weighted-Average Method, Part 1 The identity of the 200 printers sold is as follows:

Computing Cost of Goods Sold Using the Weighted-Average Method, Part 2 Cost of goods sold 200 units at $66 = $13,200 Ending inventory 50 units at $66 = 3,300 One of the advantages of the weighted-average method is its simplicity.

Periodic Inventory System Last-In, First-Out (LIFO) Method Assumes that the sales in the period were made from the most recently purchased goods Therefore, the earliest goods purchased remain in inventory. The use of this method has been justified because: The physical movement of goods in some businesses is actually last-in, first-out. It matches the most current cost of items purchased against the current sales revenue. It results in lower net income, and therefore lower income tax, when prices are rising.

Computing Cost of Goods Sold Using the LIFO Method, Part 1 The identity of the 200 printers sold is as follows:

Computing Cost of Goods Sold Using the LIFO Method, Part 2 The identity of the 200 printers sold is as follows:

Computing Cost of Goods Sold Using the LIFO Method, Part 3 The identity of the 200 printers sold is as follows:

Computing Cost of Goods Sold Using the LIFO Method, Part 4 The identity of the 200 printers sold is as follows:

Computing Cost of Goods Sold Using the LIFO Method, Part 5 Description Units Unit Price Total Beginning Inventory $62 $0 1st Purchase 50 65 3,250 2nd Purchase 80 67 5,360 3rd Purchase 70 68 4,760 200 Empty cell $13,370

Computing Ending Inventory Using the LIFO Method Description Units Unit Price Total Beginning Inventory 40 $62 $2,480 1st Purchase 10 65 650 2nd Purchase 67 3rd Purchase 00 68 3,400 50 Empty cell $3,130

Comparison of Inventory Methods, Part 1 Goods available for sale is the same for all four methods!

Comparison of Inventory Methods, Part 2

Comparison of Inventory Methods, Part 4

Gross Profit Method of Estimating Inventory, Part 1 A business’s normal gross profit (net sales – cost of goods sold) is used to estimate the cost of goods sold and ending inventory. 3 STEPS

Gross Profit Method of Estimating Inventory, Part 2 Example: Inventory, start of period $80,000 Net purchases, first month $70,000 Net sales, first month $110,000 Normal gross profit as a percentage of sales 40%

Gross Profit Method of Estimating Inventory, Part 3 Step #1: Compute the cost of goods available for sale.

Gross Profit Method of Inventory, Part 1 Step #2: Estimate cost of goods sold by deducting the normal gross profit from net sales. *$110,000 × 40%

Gross Profit Method of Inventory, Part 2 Step #3: Estimate the ending inventory by deducting cost of goods sold from the cost of goods available for sale.