1. Inventories: Cost Measurement and Flow Assumptions7
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Inventories: Cost Measurement and Flow Assumptions 1 1 1 1

2. Objectives 1. Describe how inventory accounts are classified.
2. Explain the uses of perpetual and periodic inventory systems.
3. Identify how inventory quantities are determined.
4. Determine the cost of inventory.
5. Compute ending inventory and cost of goods sold under specific identification, FIFO, average cost, and LIFO. 2 2 2 4

3. Objectives
6. Explain the conceptual issues regarding alternative inventory cost flow assumptions.
7. Understand dollar-value LIFO.
8. Explain additional LIFO issues.
9. Understand inventory disclosures.
10. Record foreign currency transactions involving inventory (Appendix).

4. Flow of Inventory Costs
Merchandising Company
Accounts Payable (or Cash)
Merchandise Inventory
Cost of Goods Sold
Goods Purchased
Goods Sold

5. Flow of Inventory Costs
Manufacturing Company
Accounts Payable (or Cash)
Raw Materials Inventory
Materials Used in Production
To Goods in Process Inventory
Materials Purchased
Continued

6. Flow of Inventory Costs
Manufacturing Company
Direct Labor
Actual Direct Labor
Labor Charged to Production
To Goods in Process Inventory
Manufacturing (Factory) Overhead
Actual Mfg. Over-head
Overhead Applied to Production
To Goods in Process Inventory
Continued

7. Flow of Inventory Costs
Manufacturing Company
Goods in Process Inventory
Finished Goods Inventory
Materials Used
Direct Labor
Overhead Applied
Goods Finished (Manufactured)
Goods Sold to Cost of Goods Sold

8. Alternative Inventory Systems
A company using a perpetual system maintains a continuous record of the physical quantities in its inventory.

9. Alternative Inventory Systems
A company using a periodic system does not maintains a continuous record of the physical quantities on hand.

10. Alternative Inventory Systems
Purchases
+ Freight-in
- Purchases Returns and Allowances
- Purchases Discounts Taken
= Net Purchases

11. Alternative Inventory Systems
Perpetual Inventory System
Periodic
Inventory System
Beginning inventory
+ Purchases (net)
- Goods Sold
= Ending Inventory
Beginning inventory
+ Purchases (net)
- Ending Inventory
= Goods Sold

12. Goods being shipped included in inventory of buyer.
FOB Shipping Point
Fruit Express
Goods being shipped included in inventory of buyer.

13. Goods being shipped included in inventory of seller.
FOB Destination
Fruit Express
Goods being shipped included in inventory of seller.

14. Determination of Inventory Costs
Price paid or consideration given
Freight-in
Receiving
Unpacking
Inspecting
Storage
Insurance
Applicable taxes

15. A company purchases $1,000 of goods under terms of 1/10, n/30.
Purchases Discounts
A company purchases $1,000 of goods under terms of 1/10, n/30.
Gross Price Method
To record the purchase
Inventory (or Purchases) 1,000
Accounts Payable 1,000

16. A company purchases $1,000 of goods under terms of 1/10, n/30.
Purchases Discounts
A company purchases $1,000 of goods under terms of 1/10, n/30.
Gross Price Method
To record payment within the discount period:
Accounts Payable 1,000
Purchases Discounts Taken 10 Cash 990

17. A company purchases $1,000 of goods under terms of 1/10, n/30.
Purchases Discounts
A company purchases $1,000 of goods under terms of 1/10, n/30.
Gross Price Method
To record payment after the discount period:
Accounts Payable 1,000
Cash 1,000

18. A company purchases $1,000 of goods under terms of 1/10, n/30.
Purchases Discounts
A company purchases $1,000 of goods under terms of 1/10, n/30.
Net Price Method
To record the purchase:
Inventory (or Purchases) 990
Accounts Payable 990

19. A company purchases $1,000 of goods under terms of 1/10, n/30.
Purchases Discounts
A company purchases $1,000 of goods under terms of 1/10, n/30.
Net Price Method
To record payment within the discount period:
Accounts Payable 990
Cash 990

20. A company purchases $1,000 of goods under terms of 1/10, n/30.
Purchases Discounts
A company purchases $1,000 of goods under terms of 1/10, n/30.
Net Price Method
To record payment after the discount period:
Accounts Payable 990
Purchases Discounts Lost 10
Cash 1,000

21. A company purchases $1,000 of goods under terms of 1/10, n/30.
Purchases Discounts
A company purchases $1,000 of goods under terms of 1/10, n/30.
Net Price Method
Adjusting entry at the end of period if discount has expired and invoice is unpaid:
Purchases Discounts Lost 10
Accounts Payable 10

22. Specific Identification
Apr. 1
Apr. 10
Apr. 20
100 $10 per unit
80 $11 per unit
70 $12 per unit
Sold 80 units from the beginning inventory, 40 units from the April 10 purchase, and 20 units from the April 20 purchase.

23. Specific Identification
Apr. 1
Apr. 10
Apr. 20
20 $10 per unit
= $ 200
= 440 =
$1,240
40 $11 per unit
50 $12 per unit
Ending inventory…………….
Sold 80 units from the beginning inventory, 40 units from the April 10 purchase, and 20 units from the April 20 purchase.
Beg. Inv. + Purchases - End. Inv. = Cost of Goods Sold
$1, $1, $1,240 = $1,480

24. First-In, First-Out (FIFO)
Sold all
Apr. 1
Apr. 10
Apr. 20
100 $10 per unit
0 $10 per unit
Sold 40
40 $11 per unit
80 $11 per unit
70 $12 per unit
Sold 0
Sold 140 units during April.

25. First-In, First-Out (FIFO)
Note that the ending inventory and the cost of goods sold under perpetual and periodic FIFO are identical.
100 $10 per unit
Apr. 1
Apr. 10
Apr. 20
80 $11 per unit
40 $11 per unit
0 $10 per unit
70 $12 per unit
= $
= 440 =
$1,280
Ending inventory…………….……
Beg. Inv. + Purchases - End. Inv. = Cost of Goods Sold
$1, $1, $1,280 = $1,440

26. Average Cost 100 units @ $10 per unit Apr. 1 = $1,000 Apr. 10 = 880
= $1,000
= 880 =
$2,720
250 units
$2,720  250 units = $10.88
$10.88 x 110 units = ending inventory of $1,197
Sold 140 units during April.
Beg. Inv. + Purchases - End. Inv. = Cost of Goods Sold
$1, $1, $1,197 = $1,523

27. Moving Average
Apr. 1 Beginning Inventory 100 $10 $1,000
Apr. 10 Purchases 80 $
Apr. 10 Balance 180 $10.44 $1,880
Apr. 18 Sales -90 $
Apr. 18 Balance 90 $10.44 $ 940
Apr. 20 Purchases 70 $
Apr. 20 Balance 160 $ $1,780
$1,880  180
Apr. 27 Sales -50 $
Apr. 30 Balance 110 $ $1,224
$1,780  160
Cost of Goods Sold (140 units) $940 + $556 $1,496
Ending Inventory (110 $11.125) $1,224

28. Last-In, First-Out (LIFO)
Periodic Inventory System
Sold 0
Apr. 1
Apr. 10
Apr. 20
100 $10 per unit
Sold 70
10 $11 per unit
80 $11 per unit
0 $12 per unit
70 $12 per unit
Sold all
Sold 140 units during April.

29. Last-In, First-Out (LIFO)
100 $10 per unit
Apr. 1
Apr. 10
Apr. 20
80 $11 per unit
10 $11 per unit
70 $12 per unit
Periodic Inventory System
0 $12 per unit
= $1,000
= 110 =
$1,110
Ending inventory………………..
Beg. Inv. + Purchases - End. Inv. = Cost of Goods Sold
$1, $1, $1,110 = $1,610

30. Last-In, First-Out (LIFO)
Perpetual Inventory System
Apr. 1
Apr. 10
Apr. 20
90 $10 per unit
100 $10 per unit
Sold 10
80 $11 per unit
0 $11 per unit
80 $11 per unit
Purchased 80
Sold 80
20 $12 per unit
70 $12 per unit
Sold 50
Purchased 70

31. Last-In, First-Out (LIFO)
100 $10 per unit
90 $10 per unit
Last-In, First-Out (LIFO)
Apr. 1
Apr. 10
Apr. 20
80 $11 per unit
70 $12 per unit
Perpetual Inventory System
20 $12 per unit
0 $11 per unit
= $ 900
= 0 =
$1,140
Ending inventory………………..
Beg. Inv. + Purchases - End. Inv. = Cost of Goods Sold
$1, $1, $1,140 = $1,580

32. Comparison of Inventory Assumptions
Cost of Goods Cost of
Available Goods Ending
for Sale Sold Inventory
Cost Flow Assumption and Method
FIFO, periodic $2,720 $1,440 $1,280
FIFO, perpetual 2,720 1,440 1,280
Weighted average 2,720 1,523 1,197
Moving average 2,720 1,496 1,224
LIFO, periodic 2,720 1,610 1,110
LIFO, perpetual 2,720 1,580 1,140

33. Alternative Cost Flow Assumptions
Per Unit
FIFO LIFO ($12) LIFO ($11)
Revenue $30 $30 $30
Cost of goods sold (10) (12) (11)
Gross profit $20 $18 $19
Holding gains (ex-
cluded from income)
$20 $20

34. Liquidation of LIFO Layers
1997:
1998:
1999:
2000:
10,000 units at $20 per unit
= $200,00
= 132,000
= 192,000
= 120,000
$644,000
6,000 units at $22 per unit
8,000 units at $24 per unit
4,000 units at $30 per unit
Inventory, January 1, 2001………….
In 2001 the company purchases 50,000 units at $35 per unit and sells 60,000 units.

35. Liquidation of LIFO Layers
1997:
1998:
1999:
2000:
2001:
10,000 units at $20 per unit
= $200,00
= 132,000
= 192,000
= 120,000
= 1,750,000
6,000 units at $22 per unit
Sold 6,000
6,000 units at $24 per unit
8,000 units at $24 per unit
Sold 4,000
4,000 units at $30 per unit
4,000 units at $30 per unit
Sold 50,000
50,000 units at $35 per unit
50,000 units at $35 per unit
In 2001 the company purchases 50,000 units at $35 per unit and sells 60,000 units.

36. Liquidation of LIFO Layers
1997:
1998:
1999:
10,000 units at $20 per unit
6,000 units at $22 per unit
2,000 units at $24 per unit
6,000 units at $24 per unit
= $ 144,000
= 120,000
= 1,750,000
$2,014,000
1999:
2000:
2001:
4,000 units at $30 per unit
50,000 units at $35 per unit
50,000 units at $35 per unit
Cost of goods sold…………

37. Difficulties in Applying Simple LIFO
The LIFO method requires a company to keep numerous detailed records.
Fluctuations in the physical quantities of similar inventory items may occur.
As technological changes take place, inventory made up with one material is replaced by inventory made with substitute materials or an outdated design is replaced by a newer design.

38. Dollar-Value LIFO
Step 1: Value the total ending inventory at current-year costs.
01/1/00 $10,000
12/31/00 $12,100
12/31/01 $13,125
12/31/02 $16,800
12/31/03 $12,360

39. Ending Inventory at Current Cost
Dollar-Value LIFO
Step 2: Convert the ending inventory cost to base-year cost:
12/31/00 $12,100
12/31/01 $13,125
12/31/02 $16,800
12/31/03 $12,360
x 100/110 = $11,000
x 100/125 = $10,500
x 100/140 = $12,000
x 100/120 = $10,300
Base Year Cost Index
12/31/00
Ending Inventory at Current Cost x
Current Cost Index

40. Dollar-Value LIFO
Step 3: Compute the change in the inventory level for the year at base-year costs.
$11,000 - $10,000
12/31/00
12/31/01
12/31/02
12/31/03
$11,000
$10,500
$12,000
$10,300
$1,000
Base year, $10,000
12/31/00
1/1/00

41. Dollar-Value LIFO
Step 4a: If there has been an increase, convert this increase to current-year costs.
$1,000
x 110/100 = $ 1,100
x 100/100 = 10,000
Base year, $10,000
$11,100
Ending inventory, 12/31/00
12/31/00

42. Ending Inventory at Current Cost
Dollar-Value LIFO
Step 2: Convert the ending inventory cost to base-year cost:
12/31/00 $12,100
12/31/01 $13,125
12/31/02 $16,800
12/31/03 $12,360
x 100/110 = $11,000
x 100/125 = $10,500
x 100/140 = $12,000
x 100/120 = $10,300
Base Year Cost Index
12/31/01
Ending Inventory at Current Cost x
Current Cost Index

43. Dollar-Value LIFO
Step 3: Compute the change in the inventory level for the year at base-year costs.
12/31/00
12/31/01
12/31/02
12/31/03
$11,000
$10,500
$12,000
$10,300
$11,000 - $10,500
$1,000
$500
$1,000
Base year, $10,000
12/31/01

44. Dollar-Value LIFO
Step 4b: If there is a decrease, this decrease reduces the inventory.
$500
x 110/100 = $ 550
x 100/100 = 10,000
Base year, $10,000
$10,550
Ending inventory, 12/31/01
12/31/01

45. Ending Inventory at Current Cost
Dollar-Value LIFO
Step 2: Convert the ending inventory cost to base-year cost:
12/31/00 $12,100
12/31/01 $13,125
12/31/02 $16,800
12/31/03 $12,360
x 110/100 = $11,000
x 100/125 = $10,500
x 100/140 = $12,000
x 100/120 = $10,300
Base Year Cost Index
12/31/02
Ending Inventory at Current Cost x
Current Cost Index

46. Dollar-Value LIFO
Step 3: Compute the change in the inventory level for the year at base-year costs.
12/31/00
12/31/01
12/31/02
12/31/03
$11,000
$10,500
$12,000
$10,300
$12,000 - $10,500 = $1,500
$1,000
$500
$1,000
Base year, $10,000
12/31/02

47. Dollar-Value LIFO 12/31/00 12/31/01 12/31/02 12/31/03 $11,000 $10,500
$12,000
$10,300
$1,500
$500
Base year, $10,000
12/31/02

48. Dollar-Value LIFO Step 4a: Convert increase to current-year costs.
$1,500
x 140/100 = $ 2,100
x 110/100 = 550
x 100/100 = 10,000
$12,650
$500
Base year, $10,000
12/31/02
Ending inventory, 12/31/02

49. Determination of Cost Index
Sample of Ending Inventory at Current -Year Costs
x 100
Cost Index =
Sample of Ending Inventory at Base-Year Costs
Double-Extension Method

50. Determination of Cost Index
Sample of Ending Inventory at Current -Year Costs
Previous-Year Cost Index x
Cost Index =
Sample of Ending Inventory at Previous-Year Costs
Link-Chain Method

51. Disclosure of Inventory Values and Methods
Methods: Number of Companies
First-in, first-out (FIFO) 415
Last-in, first-out (LIFO) 326
Average cost 188
Other 32
961
1997

52. Disclosure of Inventory Values and Methods
Use of LIFO Number of Companies
All inventories 17
50% or more inventories 170
Less than 50% of inventories 99
Not determinable 40
Not used 274
600
1997

53. Foreign Currency Transactions Involving Inventory
A U.S. company purchases inventory of electronic components from a Japanese company for 50 million yen (¥) when the exchange rate is $0.007.
¥50,000,000 x $0.007 = $350,000
Inventory (or Purchases) 350,000
Cash 350,000
Click button to skip Appendix material.

54. Foreign Currency Transactions Involving Inventory
An exchange gain occurs when the exchange rate declines between the date a payable is recorded as a result of a purchase of inventory and the date of the cash payment.
An exchange gain occurs when the exchange rate increases between the date a receivable is recorded as a result of a sale of inventory and the date of the cash receipt.
When exchange rates are stated in terms of $ per unit of foreign currency, exchange gains and losses occur for purchases or sales on account as follows:
Continued

55. Foreign Currency Transactions Involving Inventory
An exchange loss occurs when the exchange rate increases between the date a payable is recorded as a result of a purchase of inventory and the date of the cash payment.
An exchange loss occurs when the exchange rate declines between the date a receivable is recorded as a result of a sale of inventory and the date of the cash receipt.

56. Foreign Currency Transactions Involving Inventory
Assume that the exchange rate on the date of payment is $ The U.S. company has to pay only $340,000.
¥50,000,000 x $ = $340,000
Accounts Payable 350,000
Cash 340,000
Exchange Gain 10,000

57. Foreign Currency Transactions Involving Inventory
A U.S. company sells computer equipment (cost, $100,000) to Swiss Company on account and the agreed price is 300,000 francs. On the date of the sale, the exchange rate is $0.69.
300,000 x $0.69 = $207,000
Accounts Receivable 207,000
Sales Revenue 207,000
Cost of Goods Sold 100,000
Inventory 100,000

58. Foreign Currency Transactions Involving Inventory
If the exchange rate is $0.67 when Swiss Company pays the amount owed, the U.S. company can convert those francs into only $201,000.
300,000 x $0.67 = $201,000
Cash 201,000
Exchange Loss 6,000
Accounts Receivable 207,000

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