1. Merchandise Inventory
Chapter 6
Merchandise Inventory
02/12/2018
6-Okt-03

2. Inventory
Inventory : All the goods that the company owns and expects to sell in the normal course of operations.
Merchandise Companies
Merchanise inventory
Manufacturing Companies
Raw materials
Work-in process
Finished goods
Companies usually operate in three broad business categories:
* Service
*Retail or wholesale
* Manufacturing
Service companies provide service such as advertising, bookkeeping, and consultihng, and therefore they do not have any goods on hand for resale.
Retail or wholesale companies on the other hand, buy ready-made goods and sell those redy-made goods to costumers who colud also be the end users.
In general, wholesale companies sell merchandise to retail companies and the retail companies sell these goods to consumers.
Manufacturing companies on the other hand also have inventories of raw materials that neeed to be turned into finished goods, complete products for sale
Merchandise companies have one general class of merchandise inventory or simply inventory. However, this account usually consists of several different
types of goods for resale purposes.
MC have at least three inventory categories because they produce their own products. They buy raw materials and work on the raw materials
Toturn them into a product for sale.
02/12/2018 MK
6-Okt-03

3. Inventory and financial statement
Income Statement
Balance Sheet:
Current Assets
Cash
Account receivable
INVENTORIES (*)
Prepaid expenses
Non-Current Assets
Net Sales xxx
COST OF GOODS SOLD (xx)
GROSS PROFIT xx
Ending inventory : Number of Units on Hand x Unit Cost
Cost of goods sold: Number of Units Sold x Unit Cost
02/12/2018 MK
6-Okt-03

4. Inventory Costing Methods
Debit
Inventory Account
Credit
10 units x $10 = $100
Suppose the company sells 8 units of inventories
Cost of goods sold : 8 x 10 = 80
Ending inventory : 2 x 10 = 20
02/12/2018 MK
6-Okt-03

5. Inventory Costing Methods
Debit
Inventory Account
Credit
10 units x $10 = $100
15 units x $10 = $150
Suppose the company sells 18 units of inventories
Cost of goods sold : 18 x 10 = 180
Ending inventory : x 10 = 70
Journal enteries:
02/12/2018 MK
6-Okt-03

6. Inventory Costing Methods
Debit
Inventory Account
Credit
10 units x $10 = $100
15 units x $12 = $180
Suppose the company sells 18 units of inventories
Cost of goods sold : ?
Ending inventory : ?
02/12/2018 MK
6-Okt-03

7. Inventory Costing Methods
Specific unit cost (specific idendification method).
FIFO
LIFO
Average-Cost Method
02/12/2018 MK
6-Okt-03

8. Inventory Accounting Systems
Perpetual system
Perpetual systems maintain a running record to show the inventory on hand at all times.
2. Periodic system
Periodic systems do not keep a
continuous record of inventory on hand.
02/12/2018 MK
6-Okt-03

9. Inventory Costing in a Perpetual System
Now let’s see how to compute inventory amounts under the FIFO, LIFO and average costing methods.
Assume that inventory transactions are as below during december
Dec.1 Begining inventory (balance) 5 units x $60
5 Purchase units x 65
16 Sale units
26 Purchase units
30 Sale units
02/12/2018 MK
6-Okt-03

10. Inventory Costing in a Perpetual System
FIFO
Date
Purchases
Cost of Good Sold
Inventory on Hand
Quantity
Unit Cost ($)
Total Cost($)
Unit Cost($)
Dec. 1 5 60
300
Dec. 5 20 65
1.300
Dec.16 10
650
Dec.26 70
1.400
Dec.30 6
420 14
980
Dec. 31 40
2.700 31
2.020
02/12/2018 MK
6-Okt-03

11. Inventory Costing in a Perpetual System
Journal entries / The sale price of unit is $ FIFO
Date
Description
Debit
Credit
Dec. 5
Inventory
Cash/Accounts Payable
1.300
Dec. 16
Cash/Accounts Receivable (15x$80)
Sales
Cost of Goods Sold
1.200
950
Dec. 26
1.400
Dec. 30
Cash/Accounts Receivable (16x$80)
1.280
1.070
02/12/2018 MK
6-Okt-03

12. Inventory Costing in a Perpetual System
Journal entries / The sale price of unit is $ FIFO
Debit Inventory C redit
Dec. 1 Balance 300
Des
Dec
Dec
Dec
Total
Total
Debit Cost of Goods Sold Credit
Dec
Dec
Total
Debit Sales Revenue Credit
Dec
Dec
Total
Income Statement
Sales
COST OF GOODS SOLD
Gross Profit
2.480
(2.020)
460
02/12/2018 MK
6-Okt-03

13. Inventory Costing in a Perpetual System
LIFO
Date
Purchases
Cost of Good Sold
Inventory on Hand
Quantity
Unit Cost ($)
Total Cost($)
Unit Cost($)
Dec. 1 5 60
300
Dec. 5 20 65
1.300
Dec.16 15
975
325
Dec.26 70
1.400
1400
Dec.30 16
1.120 4
280
Dec. 31 40
2.700 31
2.095 14
905
02/12/2018 MK
6-Okt-03

14. Inventory Costing in a Perpetual System
Journal entries / The sale price of unit is $ LIFO
Date
Description
Debit
Credit
Dec. 5
Inventory
Cash/Accounts Payable
1.300
Dec. 16
Cash/Accounts Receivable (15x$80)
Sales
Cost of Goods Sold
1.200
975
Dec. 26
1.400
Dec. 30
Cash/Accounts Receivable (16x$80)
1.280
1.120
02/12/2018 MK
6-Okt-03

15. Inventory Costing in a Perpetual System
Journal entries / The sale price of unit is $ LIFO
Debit Inventory C redit
Dec. 1 Balance 300
Des
Dec
Dec
Dec
Total
Total
Debit Cost of Goods Sold Credit
Dec
Dec
Total
Debit Sales Revenue Credit
Dec
Dec
Total
Income Statement
Sales
COST OF GOODS SOLD
Gross Profit
2.480
(2.095)
385
02/12/2018 MK
6-Okt-03

16. Inventory Costing in a Perpetual System
Average Cost Method
Date
Purchases
Cost of Good Sold
Inventory on Hand
Quantity
Unit Cost ($)
Total Cost($)
Unit Cost($)
Dec. 1 5 60
300
Dec. 5 20 65
1.300 25 64
1.600
Dec.16 15
960 10
640
Dec.26 70
1.400 30 68
2.040
Dec.30 16
1.088 14
952
Dec. 31 40
2.700 31
2.048
02/12/2018 MK
6-Okt-03

17. Inventory Costing in a Perpetual System
Journal entries / The sale price of unit is $ Average
Date
Description
Debit
Credit
Dec. 5
Inventory
Cash/Accounts Payable
1.300
Dec. 16
Cash/Accounts Receivable (15x$80)
Sales
Cost of Goods Sold
1.200
960
Dec. 26
1.400
Dec. 30
Cash/Accounts Receivable (16x$80)
1.280
1.088
02/12/2018 MK
6-Okt-03

18. Inventory Costing in a Perpetual System
Journal entries / The sale price of unit is $ Average
Debit Inventory C redit
Dec. 1 Balance 300
Des
Dec
Dec
Dec
Total
Total
Debit Cost of Goods Sold Credit
Dec
Dec
Total
Debit Sales Revenue Credit
Dec
Dec
Total
Income Statement
Sales
COST OF GOODS SOLD
Gross Profit
2.480
(2.048)
432
02/12/2018 MK
6-Okt-03

19. Inventory Costing in a Perpetual System
Compare Results for FIFO, LIFO and Average Cost
FIFO
Average
LIFO
Sales
Cost of Goods Sold
Gross Profit
$ 2.480
2.020
460
2.048
432
2.095
385
Ending ınventory
$980
$952
$905
02/12/2018 MK
6-Okt-03

20. Inventory Costing in a Periodic System
COST OF GOODS SOLD IN A PERIODIC INVENTORY SYSTEM
BEGINING INVENTORY
(The inventory on hand at the end of the preceding period)
NET PURCHASES
Xxx
XXXX
Cost of goods available for sale
Less: ENDING INVENTORY
(The inventory on hand at the end of the current period)
Xxxxx
(xxxx)
COST OF GOODS SOLD
XXX
COST OF GOODS SOLD : Begining Inventory + Net Purchases – Ending Inventory
Net purchases is determined as follows (all amount assumed) Purchases Less: Puchase discounts (1.000) Puchase returns and allowances (2.000) Add: Transpotation – In NET PURCHASES
02/12/2018 MK
6-Okt-03

21. Inventory Costing in a Periodic System
Now let’s see how to compute inventory amounts under the FIFO, LIFO and average costing methods.
Assume that inventory transactions are as below during december
Dec.1 Begining inventory (balance) 5 units x $60
5 Purchase units x 65
16 Sale units
26 Purchase units
30 Sale units
02/12/2018 MK
6-Okt-03

22. Inventory Costing in a Periodic System
COST OF GOODS SOLD IN A PERIODIC INVENTORY SYSTEM FIFO
BEGINING INVENTORY
NET PURCHASES
$300
2.700
Cost of goods available for sale (45 units)
Less: ENDING INVENTORY (14 X $70)
3.000
(980)
COST OF GOODS SOLD
2.020
Cost of goods avaliable is always the sum of begining inventory plus net purchases Under FIFO, the ending inventory comes from the latest – the most recent- purchases (in our case, unit cost of the latest purchase is $ 70) Ending inventory is therefore $980, cost of goods sold is $ These amounts are exactly the same as we saw for FIFO in the perpetual system. There is no cost of goods sold entry in the periodic system during the period.
02/12/2018 MK
6-Okt-03

23. Inventory Costing in a Periodic System
Journal entries / The sale price of unit is $80
Date
Description
Debit
Credit
Dec. 5
Purchases
Cash/Accounts Payable
1.300
Dec. 16
Cash/Accounts Receivable (15x$80)
Sales
1.200
Dec. 26
1.400
Dec. 30
Cash/Accounts Receivable (16x$80)
1.280
02/12/2018 MK
6-Okt-03

24. Inventory Costing in a Periodic System
At the end of period before updating inventory and recording COGS, “T” accounts as follows:
Debi Inventory (Begining) Credit
Dec. 1 Balance 300
Total
Debit Purchases Credit
Dec
Dec
Total
End of the period entries to update inventory and record cost of goods sold
Date
Description
Debit
Credit
Dec. 31
Cost of Goods Sold
Inventory (Begining balance)
300
Dec. 31
Purchases
2.700
Inventory (Ending balance)
980
02/12/2018 MK
6-Okt-03

25. Inventory Costing in a Periodic System
After updating inventory and recording COGS, “T” accounts as follows:
Debi Inventory (Begining) Credit
Dec. 1 Balance 300
Dec
Total
Total
Debit Purchases Credit
Dec
Dec
Dec
Total
Total
Debit Cost of Goods Sold Credit
Dec
Dec
Dec
Total
Total
Balance of COGS: $ : $2.220
Debit Inventory (Ending balance) Credit
Dec
Total
02/12/2018 MK
6-Okt-03

26. Inventory Costing in a Periodic System
COST OF GOODS SOLD IN A PERIODIC INVENTORY SYSTEM LIFO
BEGINING INVENTORY
NET PURCHASES
$300
2.700
Cost of goods available for sale(45 units)
Less: ENDING INVENTORY (5 units X $ units x $65)
3.000
(885)
COST OF GOODS SOLD (31 units)
2.115
Under LIFO, the ending inventory comes from the earliest units obtained – the 5 units that cost $60 plus 9 of the units purchased for $65. Ending inventory is therefore $885, cost of goods sold is $ These amounts are not the same as we saw for LIFO in the perpetual system. In some cases, the LIFO amounts can be same both perpetual and the periodic systems.
02/12/2018 MK
6-Okt-03

27. Inventory Costing in a Periodic System
COST OF GOODS SOLD IN A PERIODIC INVENTORY SYSTEM Average
BEGINING INVENTORY
NET PURCHASES
$300
2.700
Cost of goods available for sale(45 units)
Less: ENDING INVENTORY (14x$66,67)
3.000
(933)
COST OF GOODS SOLD (31 units x 66,67)
2.067
Average Cost Per Unit Cost of Goods Number of Units For the entire period = Available For Sale / Avaliable For Sale = $3.000 / 45 units = $66,67 Ending inventory and cost of goods sold under the periodic system differ from the amounts in a perpetual system. Why? Because under teh perpetual system a new average cost is computed after each purchase. But the periodic system uses a single average cost that is determined at the end of the period.
02/12/2018 MK
6-Okt-03

28. Consistency prenciple Disclosure prenciple Materiality Concept
Accounting Principles and Inventories
Several accounting prenciples have special relevance to inventories.
Consistency prenciple
Disclosure prenciple
Materiality Concept
Accounting Conservatism
02/12/2018 MK
6-Okt-03

29. Other Inventory Issues
LOWER-OF-COST-OR-MARKET RULE
The lower-of-cost-or-market rule (abbreviated as LCM) shows accounting conservatism in action. LCM requires that inventory be reported in the financial statements at whichever is lower-the invenory’s historical cost or its market value. For inventories, market value generally means current replacement cost (that is, the cost to replace on hand). If the replacement cost of the inventory falls below its historical cost, the business must write down its goods. The business reports ending inventory at its LCM value on the balance sheet.
02/12/2018 MK
6-Okt-03

30. Other Inventory Issues
LOWER-OF-COST-OR-MARKET RULE
Assume that inventory transactions are as below during May
May.1 Begining inventory (balance) 20 units x $20
25 Purchase 10 units x 22
30 Sale 25 units
Compute ending inventory and cost of goods sold under FIFO in periodic system
Ending inventory : (5 units x $22) = $110
Market value per unit : $18 (5 units x $18 =$90)
Market value is below FIFO cost, and the entry to write down the inventory to LCM follows.
Date
Description
Debit
Credit
Dec. 31
Cost of Goods Sold
Inventory (Ending balance) 20
Balance Sheet
Current assets
Inventory, at market $90
(which is lower than FIFO cost)
NOTE: STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES
Inventories: Inventories are carried at the lower of cost or market. Cost is determined using the first in, first out.
02/12/2018 MK
6-Okt-03

31. Other Inventory Issues
EFFECT OF INVENTORY ERRORs
Business count their invenories at the end od the period. An error in the ending inventory creates errors in cost of goods sold and gross profit.
Recall that one period’s ending inventory becomes the next period’s begining inventory. Thus, the error in ending inventory carries over the next period.
The results of errors made current period on inventory effect financial statements of both current and the following period.
Because ending inventory is subtracted to compute COGS in one period and the same amount is added as beginin inventory the next period cancels out after two periods. The overstatement of COGS in period 2 countebalances the understatement for period 1. Thus, total gross profit for the two periods combined is correct.
02/12/2018 MK
6-Okt-03

32. Exercises E6-1 p. 268 Date Item Quantity Unit cost May1 May 6 May 8
Picker paradise carries a large inventory of guitars and other musical instruments.
Picker uses the FIFO method and a perpetual inventory system. Company records indicate the following for a particular line of Honeydew guitar.
Date
Item
Quantity
Unit cost
May1
May 6
May 8
May 17
May 30
Balance
Sale
Puchase 5 3 10 4
$70 80
Required:
Prepare a perpetual inventory record for the guitars. Then determine the amounts Picker should report for ending inventory and cost of goods sold by the FIFO
02/12/2018 MK
6-Okt-03

33. HONEYDEW GUITARS May 1 5 $70 $350 6 3 $210 2 70 140 8 10 $80 $800 80
(10-15 min.) E 6-1
Perpetual Inventory Record – FIFO
HONEYDEW GUITARS
Purchases
Cost of Goods Sold
Inventory on Hand
Date
Quantity
Unit
Cost
Total
May 1 5
$70
$350 6 3
$210 2 70
140 8 10
$80
$800 80
800 17
160
640 30
400
240 31 12
$910
$240
Ending inventory = $240.
Cost of goods sold = $910.
02/12/2018 MK
6-Okt-03

34. Exercises
E6-2
After preparing the FIFO perpetual inventory records in E-6-1, journalize Picker Paradise’s May 8 purchase of inventory on account and cash sale on May 17 (sale price of each guitar was $140).
E6-3
Refer to the Picker Paradise inventory data in E6-1. Assume that the Picker uses LIFO method. …
E6-4
Refer to the Picker Paradise inventory data in E6-1. Assume that the Picker uses Average cost method. …
02/12/2018 MK
6-Okt-03

35. (15-20 min.) E 6-4 Perpetual Inventory Record – AVerage Cost
HONEYDEW GUITARS
Purchases
Cost of Goods Sold
Inventory on Hand
Date
Quantity
Unit
Cost
Total
May 1 5
$70.00
$350 6 3
$210 2
70.00
140 8 10
$80.00
$800 12
78.33
940 17 4
313
627 30
392
235 31
$915
$235
02/12/2018 MK
6-Okt-03

36. Exercises E6-5 Inventory, December 31, 2004
Accounting records for Durraşş Luggage yield the following data for the year ended December 31, 2005 (amounts in thousands)
Inventory, December 31, 2004
Purchases of inventory (on account)
Sales of inventory-80% on account; %20 for cash (cost $2821)
Inventory, December 31, 2005
$ 370
3,105
4,395 ?
Required:
Journalize Durall’s inventory transactions in the perpetual system.
Report ending inventory on the balance sheet, cost of goods sold and gross profit on the income statement.
Acc. Rec Cash 879
02/12/2018 MK
6-Okt-03

37. Exercises E6-9 Oct. 1 Begining inventory 8 Purchase 15 Purchase
The periodic inventory records of Flexon indicate the following at October 31:
Oct. 1 Begining inventory
8 Purchase
15 Purchase
26 Purchase
9 units x $160
4 units x $160
12 units x $170
3 units x $176
The physical inventory at October 31 counts 8 units on hand.
Required:
Compute ending inventory and cost of goods sold, using each of the following methods.
Specific unit cost, assuming four $170 units and four $160 units are on hand.
Average cost ( round average unit cost to three decimall places)
FİFO
LIFO
02/12/2018 MK
6-Okt-03

38. Exercises (15-20 min.) E 6-9 Cost of goods available for sale Oct. 1
Beginning inventory………. 9 @
$160 =
$1,440 8
Purchase……………………. 4
160
640 15 12
170
2,040 26 3
176
528
Goods available for sale…. 28
$4,648
02/12/2018 MK
6-Okt-03

39. Exercises (15-20 min.) E 6-9 02/12/2018 MK Ending inventory
Cost of goods sold      
(1)
Specific unit cost $170) + $160) =
$1,320
$4,648 – $1,320
$3,328
(2)
Average cost $4,648  28 units = average
unit cost of $166  8
$1,328
$4,648 – $1,328
$3,320
(3)
FIFO $176) + $170)
$1,378
$4,648 – $1,378
$3,270
(4)
LIFO $160
$1,280
$4,648 – $1,280
$3,368
02/12/2018 MK
6-Okt-03