1. © 2009 Cengage Learning. All rights reserved.
CHAPTER 16
Inventory
© 2009 Cengage Learning. All rights reserved.

2. PERFORMANCE OBJECTIVES
Section I Inventory Valuation
16-1: Pricing inventory by using the first-in, first-out (FIFO) method
16-2: Pricing inventory by using the last-in, first-out (LIFO) method
16-3: Pricing inventory by using the average cost method
16-4: Pricing inventory by using the lower-of-cost-or-market (LCM) rule
Section II Inventory Estimation
16-5: Estimating the value of ending inventory by using the retail method
16-6: Estimating the value of ending inventory by using the gross profit method
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3. PERFORMANCE OBJECTIVES (cont’d)
Section III Inventory Turnover and Targets
16-7: Calculating inventory turnover rate at retail
16-8: Calculating inventory turnover rate at cost
16-9: Calculating target inventories based on industry standards
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4. merchandise inventory
Inventory Valuation
inventory
Goods that a company has in its possession at any given time. May be in the form of raw materials, partially finished goods, or goods available for sale.
merchandise inventory
Goods purchased by wholesalers and retailers for resale.
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5. periodic inventory system
Inventory Systems
periodic inventory system
Inventory system in which merchandise is physically counted at least once a year to determine the value of the goods available for sale.
perpetual inventory system
Inventory system in which goods available for sale are updated on a continuous basis by computer.
Purchases by the company are added to inventory, whereas sales to customers are subtracted from inventory.
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6. Inventory Systems (cont’d)
book inventory
Is the balance of a perpetual inventory system at any given time.
Must be confirmed with an actual physical count at least once a year.
specific identification method
Is a valuation method in which each item in inventory is matched or coded with its actual cost.
Is feasible only for low-volume merchandise flow such as automobiles, boats, or other expensive items.
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7. Methods for Pricing Inventory
first-in, first-out (FIFO) method
Assumes the items purchased by a company first are the first items to be sold. Items remaining in ending inventory at the end of an accounting period are therefore the most recently purchased.
last-in, first-out (LIFO) method
Assumes the items purchased by a company last are the first items to be sold. Items remaining in ending inventory at the end of an accounting period are therefore the oldest goods.
average cost, or weighted average, method
Assumes the cost of each unit of inventory is the average cost of all goods available for sale during that accounting period.
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8. Exhibit 16-1 First-In, First-Out—FIFO
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9. First-In, First-Out (FIFO) Method
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10. FIFO Example
Using the FIFO method of inventory pricing for the following data , what is the dollar value of ending inventory if 167 units were on hand on December 31?
Date
Inventory
Units
Cost
Total
Jan 1
Beginning inventory
235
140.00
32,900
March 10
Purchase
152
143.50
21,812
May 16
135
146.80
19,818
Oct 9 78
150.00
11,700
600
86,230
FIFO Inventory Valuation (12/31) 89
13,065.20
167
24,765.20
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11. Inventory Costs and Inventory Valuation
When inventory costs are rising:
FIFO: Higher gross profit
LIFO: Lower gross profit
When inventory costs are decreasing:
FIFO: Lower gross profit
LIFO: Higher gross profit
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12. Last-In, First-Out (LIFO) Method
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13. Exhibit 16-2 Last-In, First-Out—LIFO
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14. Last-In, First-Out (LIFO) Method Example
Using the LIFO method of inventory pricing for the following data, what is the dollar value of ending inventory if 167 units were on hand on December 31?
Date
Inventory
Units
Cost
Total
Jan 1
Beginning inventory
235
140.00
32,900
March 10
Purchase
152
143.50
21,812
May 16
135
146.80
19,818
Oct 9 78
150.00
11,700
600
86,230
LIFO Inventory Valuation (12/31)
167
23,380
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15. The Average Cost Method
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16. Average Cost Method Example
Using the average cost method of inventory pricing for the following data, what is the dollar value of ending inventory if 167 units were on hand on December 31?
Date
Inventory
Units
Cost
Total
Jan 1
Beginning inventory
235
140.00
32,900
March 10
Purchase
152
143.50
21,812
May 16
135
146.80
19,818
Oct 9 78
150.00
11,700
600
86,230
Average Cost Inventory Valuation
Average Cost =
Total Value = 167 × = 24,001.24
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17. Lower-of-Cost-or-Market (LCM) Rule
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18. Lower-of-Cost-or-Market (LCM) Rule Example
Determine the value of the following inventory by using lower-of- cost-or-market rule.
Unit Price
Valuation
Description
Quantity
Cost
Market
Basis
Amount
Lamp 75
9.50
9.20
690.00
Tray
120
26.30
27.15
3,156.00
16’ vase 88
42.40
39.70
3,493.60
12’ vase 64
23.65
21.40
1,369.60
Fruit bowl 42
36.90
42.00
1,549.80
Total Value of Inventory
10,259.00
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19. cost to retail price ratio, or cost ratio
Inventory Estimation
retail method
Is used by most retailers based on a comparison of goods available for sale at cost and at retail.
cost to retail price ratio, or cost ratio
Is the ratio of goods available for sale at cost to the goods available for sale at retail.
Used in the retail method of inventory estimation to represent the cost of each dollar of retail sales.
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20. Inventory Estimation: The Retail Method
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21. Retail Method Example
Using the retail method, estimate the value of the ending inventory at cost on August 31, from the following information:
August 1 – August 31
Cost
Retail
Beginning inventory
600,000
800,000
Net purchases
285,000
380,000
Goods available for sale
885,000
1,180,000
August net sales = $744,000
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22. Retail Method Example (cont’d)
August 1 – August 31
Cost
Retail
Beginning inventory
600,000
800,000
Net purchases
285,000
380,000
Goods available for sale
885,000
1,180,000
Net sales
- 744,000
Ending inventory
436,000
Ending inventory at cost = Ending inventory at retail × Cost Ratio
Ending inventory at cost = 436,000 × .75 = 327,000
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23. Inventory Estimation: Gross Profit Method
gross profit or gross margin method
Uses a company’s gross margin percent to estimate the ending inventory. This method assumes that a company maintains approximately the same gross margin from year to year.
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24. The Gross Profit Method
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25. Gross Profit Method Example
A firm maintains a gross margin of 39% on all its inventory. In November, the company had a beginning inventory of $137,000, net purchases of $220,000, and net sales of $410,000. Use the gross profit method to estimate the cost of ending inventory in November.
Beginning inventory
137,000
Net Purchases
+220,000
Goods available for sale
357,000
Estimated cost of goods sold = Net sales × (100% - Gross margin %)= 410,000 (100% - 39%) = 410,000 (.61) = $250,100
Goods available for sale
357,000
Estimated cost of goods sold
-250,100
Estimated ending inventory
106,900
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26. Inventory Turnover and Targets
inventory or stock turnover
The number of times during an operating period that the average dollars invested in merchandise inventory was theoretically sold out or turned over.
May be calculated in retail dollars or in cost dollars.
average inventory
An estimate of a company’s typical inventory at any given time, calculated by dividing the total of all inventories taken during an operating period by the number of times inventory was taken.
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27. Inventory Turnover Rate at Retail
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28. Inventory Turnover Rate at Retail Example
A firm had net sales of $260,700 for the year. If the beginning inventory at retail was $65,100 and the ending inventory at retail was $52,800, what are (a) the average inventory and (b) the inventory turnover rounded to the nearest tenth?
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29. Inventory Turnover Rate At Cost
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30. Inventory Turnover Rate At Cost Example
A store had a cost of goods sold of $756,400 for the year. If the beginning inventory at cost was $43,500 and the ending inventory at cost was $59,300, what are (a) the average inventory at cost and (b) the inventory turnover rounded to the nearest tenth?
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31. target average inventory
Target Inventories
target average inventory
Inventory standards published by trade associations and the federal government for companies of all sizes and in all industries.
Used by managers as targets for the ideal amount of inventory to carry for maximum efficiency.
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32. Target Inventories Example
A firm. had net sales of $2,650,000 for the year. The beginning inventory at retail was $495,000, and the ending inventory at retail amounted to $380,000. The inventory turnover at retail published as the standard for a business of this size is seven times. (a) Calculate the average inventory and actual inventory turnover for the company. (b) If the turnover is less than seven times, calculate the target average inventory needed to come up to industry standards.
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33. Target Inventories Example (cont’d)
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