Chapter 9 Inventory and Cost of Goods Sold

Chapter 9 Inventory and Cost of Goods Sold
1. Inventory for merchandising & manufacturing

business
2. Periodic vs. perpetual inventory systems
3. Recognition of inventory on the books
4. Compute total inventory acquisition cost
5. Inventory valuation methods: specific identification,
average cost, FIFO, and LIFO
6. LIFO inventory layers and the LIFO reserve
7. Choose an inventory valuation method
8. The lower-of-cost-or-market (LCM) valuation
9. The gross profit method valuing inventory
9-1
Chapter 9 Inventory and Cost of Goods Sold
(Continued)
10. Financial statement impact of inventory recording
errors
11. Analyze inventory using financial ratios
12. FIFO, LIFO, average cost, and lower-of-cost-or-
market inventory using the retail inventory method
13. Use LIFO pools, dollar-value LIFO, and dollar-
value LIFO retail to compute ending inventory
14. The impact of changing prices on purchase
commitments
15. Record inventory purchase transactions
denominated in foreign currencies
9-2
9-3
9-4
1. Define inventory for a merchandising
business, and identify the different types of
inventory for a manufacturing business
What Is Inventory?
• Inventory designates goods held for sale in
the normal course of business or, for a
manufacturer, also includes goods in
production or to be placed into production.
• For some businesses, inventory represents the
most active element in business operations.
• The terms raw materials, work in process,
and finished goods refer to the inventories of
a manufacturing enterprise. 9-5
9-6
Raw Materials
• Raw Materials are goods acquired to use in

the production process.
• The term direct materials is frequently used
to refer to materials that will be physically
incorporated in the products being
manufactured.
• The term indirect materials is then used to
refer to auxiliary materials, that is, materials
that are necessary in the production process
but not directly incorporated into the product.
9-7
Work in Process
• Work in Process (WIP) consists of

materials partly processed and requiring
further work before they can be sold.
• Work in Process includes three cost
elements.
1. Direct materials
2. Direct labor
3. Manufacturing overhead
(continued)
9-8
Work in Process
1. Direct materials refers to the cost of

materials directly identified with goods in
production.
2. Direct labor refers to the cost of labor
directly identified with goods in production.
3. Manufacturing overhead refers to the
portion of factory overhead assignable to
goods in production.
9-9
Finished Goods
• Finished goods are the manufactured

products awaiting sale.
• As products are completed, the costs
accumulated in the production process are
transferred from Work in Process to the
Finished Goods Inventory account.
9-10
9-11
2. Explain the advantages and disadvantages of
both periodic and perpetual inventory systems
Inventory Systems
Two types of inventory systems that keep track of
how much inventory has been sold and at what
price are:
• Periodic inventory system—requires a physical
count of the inventory periodically, and at the
point of sale only records the sale price.
• Perpetual inventory system—at point of sale
records selling price and type of item sold are
recorded. Example: a bar code scanning system.
9-12
Inventory Systems
The following transactions occurred during the

period for CyBorg, Inc.
Beginning inventory 50 units @ $10 $ 500

Purchases during the period 300 units @ $10 3,000
Sales during the period 275 units @ $15 4,125
Ending inventory (physical) 70 units @ $10 700
(continued)
9-13
Inventory Systems
Periodic Inventory System
Purchases during the period:

Purchases 3,000
Accounts Payable 3,000
Sales during the period:

Accounts Receivable 4,125
Sales 4,125
(continued)
9-14
Inventory Systems
Perpetual Inventory System
Purchases during the period:

Inventory 3,000
Sales during the period:
Accounts Receivable 4,125
Sales 4,125
Cost of Goods Sold 2,750
Inventory 2,750
(continued)
275 units @ $10
9-15
Comparison of Methods
The cost of goods sold in the CyBorg example is

computed as follows:
9-16
3. Determine when ownership of goods in
transit changes hands and what
circumstances require shipped inventory to
be kept on the books
Whose Inventory Is It?

• As a general rule, goods should be included in
the inventory of the business holding legal title.
• The passing of title is a legal term designating
the point at which ownership changes.
• Issues that develop:
• Goods in transit
• Goods on consignment
9-17
Goods in Transit
Whose inventory is it?
When terms of sale are FOB (free on board)

shipping point, title passes to the buyer with
the loading of goods at the point of shipment.
When terms of sale are FOB (free on board)

destination, legal title does not pass until the
goods are received by the buyer.
9-18
9-19
Goods on Consignment
• Shipper retains title and includes the goods in

inventory until their sale or use by the dealer or
customer.
• Consigned goods are properly reported by
the shipper at the sum of their costs, and the
shipping and handling costs incurred transfer
to the dealer or customer.
9-20
Conditional Sales, Installment Sales, and
Repurchase Agreements
• Conditional sales and installment sales
contracts may provide a retention of title by
the seller until the sales price is fully
recovered.
• As a creative way to obtain cash on a short-
term basis, firms sometimes sell inventory to
another company but at the same time agree
to repurchase the inventory at a future date.
9-21
4. Compute total inventory acquisition cost
Items Included in Inventory Cost

Inventory costs consist of all expenditures, both
direct and indirect, relating to acquisition,
preparation, and placement for sale.
• Expenditures that are relatively small and
difficult to allocate are period costs.
These are recognized as expenses in the
current period.
9-22
• Costs that can be identified with the
product being manufactured are called
product or inventoriable costs.
• Costs arising from idle capacity, excessive
spoilage, and reprocessing are usually
considered abnormal and are expensed in
the current period.
9-23
• Traditionally, manufacturing overhead costs

have been allocated to products based on the
amount of direct labor required in production.
• Activity-based cost (ABC) systems strive
to allocate overhead based on clearly
identified cost drivers—characteristics of the
production process that are known to create
overhead costs.
9-24
9-25
Discounts as Reductions in Cost
• Discounts associated with the purchase of

inventory should be treated as a reduction in
the cost assigned to the inventory.
• Trade discounts refer to the difference
between a catalog price and the price actually
charged to a buyer.
• Cost is defined as the list price less the trade
discount.
9-26
• Cash discounts are discounts granted for

payment of invoices within a limited time
period.
• Example: A purchase of $10,000 provides for
payment on a 2/10, n/30 basis. If the buyer
pays by the 10th day, $9,800 settles the
invoice. After that, the full $10,000 is required.
9-27
• The net method records inventory at this

discounted amount (i.e., the gross invoice
prices less the allowable discount).
• The net method reflects that discounts not
taken are in effect a finance charge incurred
for failure to pay within the discount period.
9-28
(continued)
9-29
• Under the gross method, cash discounts are

booked only when they are taken.
• While the net method tracks discounts not
taken, the gross method provides no such
information, and inventory records are
maintained at the gross unit price.
• The net method of accounting for purchases
is strongly preferred.
9-30
Purchases Reported Using
the Net Method
To record the purchase of merchandise priced at
$10,000 with a cash discount of 2%:
Inventory 9,800
To record the payment of the invoice within

discount period:
Cash 9,800
9-31
the Net Method
To record payment of the invoice after the
discount period:
Discounts Lost 200
Cash 10,000
To record adjustment at the end of the period if
invoice has not been paid and the discount
period has lapsed:
Discounts Lost 200
Accounts Payable 200
9-32
the Gross Method
To record the purchase of merchandise priced at
$10,000 with a cash discount of 2%:
Inventory 10,000
To record the payment of the invoice within
discount period:
Inventory 200
Cash 9,800
9-33
the Gross Method
To record payment of the invoice after the
discount period:
Cash 10,000
To record adjustment at the end of the period if
invoice has not been paid and the discount
period has lapsed:
No entry required
9-34
Purchase Returns and Allowances
• Adjustments are Periodic Inventory System

also made when
Accounts Payable 400
goods are Purchase Returns
damaged or are and Allowances 400
lesser in quality
than ordered. Perpetual Inventory System
• Sometimes the Accounts Payable 400

customer Inventory 400
returns the
goods.
9-35
5. Use the four basic inventory valuation
methods: specific identification, average
cost, FIFO, and LIFO
Inventory Valuation Specific

Methods Identification
Cost Average
Allocation Cost
Methods
First-in, first-
out (FIFO)
Last-in, first-
9-36 out (LIFO)
9-37
Inventory Valuation Methods
The four methods will be illustrated using the

following simple example for Dalton Company.
Note: No beginning inventory
9-38
Specific Identification Method
• This specific identification method requires a

way to identify the historical cost of each
individual unit of inventory.
• From a theoretical standpoint, the specific
identification method is very attractive,
especially when each inventory item is unique
and has a high cost.
• This method opens the door to possible profit
manipulation.
9-39
Purchases:
Jan. 1 200 units @ $10 per unit
Mar. 23 300 units @ $12 per unit
July 15 500 units @ $11 per unit
Nov. 6 100 units @ $13 per unit
1,100 units
Sold 200 units from the
January 1 and 500 from
the July 15 purchase.
9-40
Jan. 1 200 units @ $10 per unit = $2,000

not sold
July 15 500 units @ $11 per unit = 5,500
not sold
Total cost of goods sold $7,500
9-41
sold
Mar. 23 300 units @ $12 per unit = $3,600
sold
Nov. 6 100 units @ $13 per unit = 1,300
Ending inventory $4,900
9-42
Average Cost Method
• The average cost method assigns the same

average cost to each unit.
• This method is based on the assumption that
goods sold should be charged at an average
cost.
• For periodic inventory, the unit cost is the
weighted average for the entire period.
9-43
Average Cost Method
Jan. 1 200 units @ $10 per unit = $ 2,000

Mar. 23 300 units @ $12 per unit = 3,600
July 15 500 units @ $11 per unit = 5,500
1,100 units $12,400
$12,400  1,100 units = $11.27 per unit (rounded)

Cost of goods sold = $11.27  700 = $7,890
Ending inventory = $11.27  400 = $4,510
9-44
First-In, First-Out (FIFO) Method
• The First-in, first out (FIFO) method is based

on the assumption that the units sold are the
oldest units on hand.
• FIFO assumes a cost flow closely paralleling the
usual physical flow of goods sold.
• With FIFO, the units remaining in ending
inventory are the most recently purchased units,
so their reported cost would most closely match
end-of-year replacement costs.
9-45
Sold 200
Mar. 23 300 units @ $12 per unit Sold 300
200 units @ $11 per unit
500 = 3,600
July 15 Sold 200
9-46

500 = 2,200
9-47
Last-In, First-Out (LIFO) Method
• The last-in, first-out (LIFO) method is based

on the assumption that the newest units are
sold first.
• There is no required connection between the
actual physical flow of goods and the
inventory valuation method used.
• LIFO is the best method of matching current
inventory costs with current revenues.
9-48

= $1,200
300
July 15 500 units @ $11 per unit = $5,500
Nov. 6 100 units @ $13 per unit = $1,300
9-49

300 = $2,400
Nov. 6 100 units @ $13 per unit
9-50
9-51
Complications with a
• The complications of a perpetual system are
Illustrated in Exhibit 9-11 (Slides 9-53 and 9-
54), in which Dalton Company’s cost of goods
sold and ending inventory for 2013 are
computed assuming that 300 units were sold
on June 30 and 400 units were sold on
December 31.
• For FIFO, cost of goods sold and ending
inventory are the same whether a periodic
system or perpetual system is used.
9-52
Complications with a
• Because the newest units (last in) as of June
30 are not the same as the newest units on
December 31, applying LIFO on a perpetual
basis gives a different cost of goods sold and
ending inventory than if a periodic system is
used.
• Applying average cost on a perpetual and a
periodic basis yields different results.
9-53
Inventory Valuation Methods and
9-54
Inventory Valuation Methods and
9-55
6. Explain how LIFO inventory layers are
created, and describe the significance of
the LIFO reserve
The following data are for Ryanes Company for the first three
years of its existence:
9-56
LIFO Layers
• Each year in which the number of units purchased
exceeds the number of units sold, a new LIFO layer
is created in ending inventory.
• Many companies that use LIFO report the amount of
their LIFO reserve, either as a parenthetical note in
the balance or the notes to the financial statements.
• The difference between the LIFO ending inventory
amount and the amount obtained using another
inventory valuation method (like FIFO or average
cost) is called the LIFO reserve. For example, in this
case, the LIFO reserve is $350 ($1,350 FIFO ending
inventory – $1,000 LIFO ending inventory).
9-57
LIFO Layers
The following data can be used to calculate

FIFO cost of goods sold for Ryanes for 2012.
2011 2012
LIFO ending inventory $ 400 $1,000
LIFO reserve 100 350
LIFO cost of goods sold 1,200 1,800
The FIFO calculations can be done as shown

in the next slide.
9-58
LIFO Layers (2012)
LIFO FIFO
$ 400 Beginning inventory $ 500 ($400 + $100 LIFO reserve)
2,400 + Purchases 2,400 (160 units x $15; same for
LIFO and FIFO)
$2,800 = Cost of goods available $2,900
1,000 – Ending inventory 1,350 ($1,000 + $350 LIFO
reserve)
$1,800 = Cost of goods sold $1,550
9-59
9-60
9-61
LIFO Liquidation
Ryanes Company’s purchases and sales for

2013 are as follows:
Purchases 60 units @ $20
Sales 150 units @ $25
Because the number of units purchased does
not exceed the number sold, no new LIFO layer
is added in 2013.
9-62
LIFO Liquidation
LIFO liquidation causes old LIFO layer costs to flow

through cost of goods sold, sometimes with bizarre
results.
In this example, if Ryanes had not reduced inventory during
2013, LIFO cost of goods sold would have been $3,000
(150 units × $20 per unit). In this example, Thus, the impact
of reducing inventory levels and dragging old LIFO layers
into cost of goods sold is to reduce reported cost of goods
sold by $800, which should be disclosed in notes. 9-63
9-64
LIFO and Income Taxes
• The LIFO inventory method was developed in
the United States during the late 1930s as a
method of reducing income taxes during
periods of rising prices.
• The LIFO conformity rule specifies that only
those taxpayers who use LIFO for financial
reporting purposes may use it for tax purposes.
The rule has been relaxed.
9-65
LIFO and Income Taxes
• As a means of simplifying the valuation process

and extending the applicability to more items,
the IRS developed the technique of establishing
LIFO inventory pools of substantially identical
goods.
• To further simplify the recordkeeping associated
with LIFO and to eliminate the issues
associated with new products replacing old
products, the dollar-value LIFO inventory
method was developed.
9-66
7. Choose an inventory valuation method
based on the trade-offs among income
tax effects, bookkeeping costs, and the
impact on the financial statements
Income Tax Effects

• If a company has large inventory levels, is
experiencing significant inventory cost
increases, and does not anticipate reducing
inventory levels in the future, LIFO gives
substantial cash flow benefits in terms of tax
deferrals.
• This is the primary reason for LIFO adoption by
most firms. 9-67
9-68
Bookkeeping Costs
• The bookkeeping associated with LIFO is a

bit more complicated than with FIFO or
average cost.
• In dollars and cents, a LIFO system costs
more to operate.
• With information technology and with the
simplification of LIFO pools and dollar-value
LIFO, the incremental bookkeeping costs can
be minimized.
9-69
Impact on Financial Statements
• While LIFO gives tax benefits, it also gives
reduced reported income and reduced
reported inventory.
• These negative financial statement effects
can harm a company by scaring off
stockholders, potential investors, and banks.
• Supplement disclosure using FIFO or
average cost might offset this problem.
9-70
International Accounting and
Inventory Valuation
• In 1992, the IASB decided to officially
endorse FIFO and average cost, to kill the
base stock method, and to let LIFO live on as
a second-class “allowed alternative
treatment.”
• In 2003, the IASB adopted a revised version
of IAS 2 and did away with LIFO once and
for all.
9-71
Inventory Accounting Change
When a company changes its method of valuing

inventory, the change is accounted for as a
change in accounting principle.
LIFO Average Cost

change to
or FIFO
Report the effect of changing methods

on the financial statements.
(continued)
9-72
Inventory Accounting Change
If the change is to LIFO from another method, a

company’s records are generally not complete
enough to reconstruct the prior years’ inventory
layer.
Any Method change to LIFO
No adjustment to financial statements for change to

LIFO, but special disclosure required.
(continued)
9-73
9-74
8. Apply the lower-of-cost-or-market
(LCM) rule to reflect declines in the
market value of inventory
Applying the Lower of Cost or Market Method

1. Define pertinent values: historical cost, floor
(NRV ‒ normal profit), replacement cost,
ceiling (NRV).
2. Determine “market” (replacement cost as
constrained by ceiling and floor limits).
3. Compare cost with market (as defined in
step 2 above), and select the lower amount.
9-75
9-76
The term market in lower of cost or market
means replacement cost (entry cost).
Ceiling: Also known as the net
realizable value (NRV)
Replacement
Range Market
Cost
compare to
Historical Cost
Floor: Net realizable value
less a normal profit margin
9-77
Lower of Cost or Market
Fezzig Company sells six products identified with the
letters A through F. For each product, the selling price
per unit is $1.00, selling expenses are $0.20 per unit,
and the normal profit is 25% of sales, or $0.25 per unit.
9-78
Ceiling: $0.80
CASE A
Market
$0.70
Range $0.70
$0.65
Floor: $0.55 Historical Cost
LCM = $0.65
9-79
Ceiling: $0.80
CASE B
Market
$0.60
Range $0.60
$0.65
LCM = $0.60
9-80
Ceiling: $0.80
CASE C
Market
$0.50
Range
$0.50 $0.55
$0.65
LCM = $0.55
9-81
Ceiling: $0.80
CASE D
Market
$0.45
Range
$0.45 $0.55
$0.50
LCM = $0.50
9-82
Ceiling: $0.80
CASE E
Market
$0.85Range $0.80
$0.75
LCM = $0.75
9-83
Ceiling: $0.80
CASE F
Market
$1.00Range
$1.00 $0.80
$0.90
LCM = $0.80
9-84
Lower of Cost or Market Applied Individually
versus as a Whole
(continued)
9-85
Lower of Cost or Market Applied Individually
versus as a Whole
The journal entry to record the write-down of the
inventory on an individual item basis is usually
made as follows:
Loss from Decline in Value
of Inventory 250
Inventory 250
($4,100 ‒ $3,850)
Once an individual item is reduce to a

lower market price, the new market price
is considered to be the item’s cost for
future inventory valuations.
9-86
Allowance Method
Rather than reducing the inventory directly, the
inventory account can be maintained at cost,
and an allowance account can be used to
record the decline in value.
Loss from Decline in Value
of Inventory 100
Allowance for Decline in Value
of Inventory 100
($4,100 ‒ $4,000)
9-87
9. Use the gross profit method to estimate
ending inventory
Gross Profit Method
• The gross profit method is based on the
observation that the relationship between
sales and cost of goods sold is usually fairly
stable.
• The gross profit percentage [(Sales – Cost
of goods sold)/Sales] is applied to sales to
estimate cost of goods sold.
• To be useful, the gross profit percentage must
be a reliable measure of current experience.
9-88
Gross Profit Method—Rugen Company
Beginning inventory, January 1 $25,000

Sales, January 1–January 31 50,000
Purchases, January 1–January 31 40,000
Historical gross profit percentages:
Last year 40%
Two years ago 37%
Three years ago 42%
Last year’s gross profit
percentage 40% is considered a
good estimate.
9-89
Sales (actual) $50,000 100 %

Cost of goods sold (estimate) 30,000 60 %
Gross profit (estimate) $20,000 40 %
Beginning inventory (actual) $25,000
+ Purchases (actual) 40,000
= Cost of goods available for
sale (actual) $65,000
– Ending inventory (estimate) 35,000
= Cost of goods sold (estimate) $30,000
9-90
9-91
• Rugen does a physical inventory count

indicating that January 31 inventory is
$32,000, compared to $35,000 estimate
computed in Slide 9-90.
• One way to determine if the estimated count
is reasonable is to see what range of ending
inventory estimates is possible given the
differences observed in historical gross profit
percentages.
(continued)
9-92
Gross Profit Method
Sales (actual) $50,000 100 %

9-93
Gross Profit Method
Sales (actual) $50,000 100 %

9-94
Retail Inventory Method
• Like the gross profit method, the retail

inventory method can be used to generate a
reliable estimate of inventory position
whenever desired.
• The retail inventory method is more flexible
than the gross profit method in that it allows
estimates to be based on FIFO, LIFO, or
average cost assumptions.
9-95
10. Determine the financial statement
impact of inventory recording errors
Effects of Errors in Recording Inventory

Failure to correctly report inventory results in
misstatements on both the balance sheet and the
income statement. There are three typical inventory
errors:
1. Overstatement of ending inventory through an
improper physical count
2. Understatement of ending inventory through an
improper physical count
3. Understatement of ending inventory through
delay in recording a purchase until the following
year 9-96
9-97
11. Analyze inventory using financial ratios,
and properly compare ratios of different
firms after adjusting for differences in
inventory valuation methods
Consider the financial information relating to inventories

for Deere & Co. provided below.
9-98
Inventory Turnover
Appropriateness of inventory size and

position can be measured by calculating
the inventory turnover ratio.
Cost of Goods Sold $16,255

=
Average Inventory $2,719.5
($2,397 + $3042)/2 = $2,719.5 = 5.98 times
9-99
Inventory Turnover
If Deere & Co. had used FIFO instead of LIFO,

inventory turnover for 2009 would have been
4.03 (instead of 5.98 under LIFO), computed as
follows:
FIFO Cost of Goods Sold $16,212

=
FIFO Average Inventory $4,020
$16,255 +($1,324 – $1,367) =
$16,212
= 4.03 times
(continued)
9-100
Inventory Turnover
If Deere & Co. had used FIFO instead of LIFO,

inventory turnover for 2009 would have been
4.03 (instead of 5.98 under LIFO), computed as
follows:
FIFO Cost of Goods Sold $16,212

=
FIFO Average Inventory $4,020
= 4.03 times
($3,674 + $4,366)/2 = $4,020
9-101
Number of Days’ Sales in Inventory
($3,042 + $2,397)/2
Average Inventory $2,719.5

Average Daily Cost of = $44.534
Goods Sold
$16,255/365
Number of days’ sales in inventory = 61.0

Deere’s number of days’ sales in inventory
results mean that, on average, Deere & Co.
has enough inventory to continue operations
for 61.0 days using just its existing inventory.
9-102
9-103
12. Compute estimates of FIFO,LIFO,
average cost, and lower-of-cost-or-
market inventory using the retail
inventory method

• The retail inventory method is widely employed by
retail firms to arrive at reliable estimates of inventory
position whenever desired.
• This method permits the estimation of an inventory
amount without the time and expense of taking a
physical inventory or maintaining detailed perpetual
inventory records.
9-104
9-105
One Cost Percentage

Cost Retail
Inventory, Jan. 1 $30,000 $50,000
Purchases in January 30,000 40,000
Goods available for sale $60,000 $90,000
Cost percentage ($60,000 ÷
$90,000) = 66.7%
Deduct sales for January 65,000
Inventory, January 31, at retail $25,000
Inventory, January 31, at estimated
cost ($25,000  66.7%) $16,675
9-106
Multiple Cost Percentages

Cost Retail
Inventory, Jan. 1 $30,000 $50,000
Purchases in January 30,000 40,000
Goods available for sale $60,000 $90,000
Cost percentage:
Beg. inventory ($30,000 + $50,000) = 60.0%
Purchases ($30,000 + $40,000) = 75.0%
Deduct sales for January 65,000
Inventory, January 31, at retail $25,000
Inventory, January 31, at estimated cost:
FIFO ($25,000  75.0%) $18,750
LIFO ($25,000  60.0%) $15,000
9-107
Retail Inventory Method: Lower of Cost
or Market
Frequently, retail prices change after they are
originally set. The following terms are used to
describe these changes.
• Original retail—the initial sales price,
including the original increase over cost
referred to as the initial markup.
• Markups—increases that raise sales prices
above original retail.
• Markdowns—decreases that reduce sales
prices below original retail.
9-108
Retail Inventory Method: Lower of Cost or Market
9-109
13. Use LIFO pools, dollar-value LIFO, and dollar-
value LIFO retail to compute ending inventory
To illustrate the formation of LIFO pools, the following

data are provided for Elohar Co., a seller of fine neckties:
LIFO Pools
9-110
LIFO Pools
If two types of neckties are accounted for separately,
computations of LIFO ending inventory are as follows:
LIFO cost of goods sold:
9-111
Dollar-Value LIFO
• Under dollar-value LIFO, LIFO layers are
determined based on total dollar changes
rather than quantity changes.
• With dollar-value LIFO, the unit of
measurement is the dollar.
• All goods in the inventory pool to which dollar-
value LIFO is to be applied are viewed as
though they are identical items.
9-112
Dollar-Value LIFO
First, the replacement cost of ending inventory is

computed using prices prevailing at the end of the
period.
The beginning inventory was $22,000, so there

was an increase in inventory during the period.
9-113
Dollar-Value LIFO
To determine if a new LIFO layer was added, we need
to find out what the value of the beginning inventory
would be at ending prices.
After adjusting for price increases during the year, we

can see that the dollar value of inventory increased.
Finally, dollar-value LIFO ending inventory is computed

as follows:
9-114
9-115
Dollar-Value LIFO Retail Method
The following is the LIFO retail layer data for

Miracle Max Department Store as of December
31.
9-116
Assume that the 2013 year-end price index is

1.08. The incremental cost percentages and 2013
ending inventory at end-of-year retail prices are
computed as follows:
9-117
9-118
14. Account for the impact of changing
prices on purchase commitments
Purchase Commitments
• Extreme fluctuations in the price of inventory
purchases can expose a company to excessive
risk.
• Of the different ways to manage this risk, the
simplest is a purchase commitment that locks
in the inventory purchase price in advance.
• Accounting question: Should the company
committing to the future purchase record an
asset and a liability at the commitment date?
9-119
• A purchase commitment is an exchange of
promises about future action and is known
as an executory contract.
• Rollins Oat Company entered into a
purchase commitment on November 1,
2012, for 100,000 bushes of wheat at $3.40
per bushel to be delivered on March 2013.
At the end of 2012, the market price for
wheat had dropped to $3.20 per bushel.
9-120
2012
Dec. 31 Loss on Purchase Commitments 20,000
Estimated Loss on Purchase
Commitments 20,000
(100,000 bushels  $0.20 per bushel)
2013
Mar. 31 Estimated Loss on Purchase
Commitments 20,000
Purchases 320,000
9-121
15. Record inventory purchase transactions
denominated in foreign currencies
Foreign Currency Inventory Transactions
• Only transactions denominated in currencies

other than the U.S. dollar are foreign
currency transactions for U.S. companies.
• If the transaction contract is written in terms of
U.S. dollars, there is no foreign currency risk
whether the other company is based in
Azerbaijan or Zimbabwe. 9-122
Foreign Currency Inventory
Transactions
On November 1, 2012, Washington Company
purchased inventory from Swiss Company and
the invoice was denominated in Swiss francs with
a purchase price of 50,000 francs. At the time,
the spot rate, the rate at which the two
currencies can be exchanged right now, was 5
francs per U.S. dollar.
(continued)
9-123
Transactions
Washington Company would make the following
journal entry to record the purchase.
2012
Nov.1 Inventory 10,000
Accounts Payable (fc) 10,000
(50,000 francs/5 = $10,000)
Assume the spot rate is 4.7 francs per U.S. dollar
on February 1, 2013.
2013
Feb.1 Accounts Payable (fc) 10,000 $50,000/4.7
Exchange Loss 638
Cash 10,638
(continued)
9-124
Transactions
Assume the spot rate is 5.1 francs per U.S.
dollar on February 1, 2013.
2013
Feb.1 Accounts Payable (fc) 10,000
Exchange Gain 196
Cash 9,804
$50,000/5.1
(continued)
9-125
Transactions
Suppose that Washington Company’s fiscal
year ends on December 31 and the exchange
rate on December 31, 2012 is 4.8 francs per
U.S. dollar, the following adjusting entry is
needed:
2012
Dec. 31 Exchange Loss 417
Accounts Payable (fc) 417
($50,000/4.8)  $10,000
(continued)
9-126
Transactions
When the liability is subsequently paid on
February 1, 2013, the spot rate is 4.7 francs
per dollar, the journal entry would be as
follows:
2013
Feb.1 Accounts Payable (fc) 10,417
Exchange Loss 221
Cash 10,638
$50,000/4.7
9-127

Chapter 9 Inventory and Cost of Goods Sold

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Chapter 9 Inventory and Cost of Goods Sold

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Chapter 9 Inventory and Cost of Goods Sold

1. Inventory for merchandising & manufacturing

• Raw Materials are goods acquired to use in

• Work in Process (WIP) consists of

1. Direct materials refers to the cost of

• Finished goods are the manufactured

The following transactions occurred during the

Beginning inventory 50 units @ $10 $ 500

Periodic Inventory System

Purchases during the period:

Sales during the period:

Perpetual Inventory System

Purchases during the period:

The cost of goods sold in the CyBorg example is

Whose Inventory Is It?

Whose inventory is it?

When terms of sale are FOB (free on board)

When terms of sale are FOB (free on board)

• Shipper retains title and includes the goods in

Items Included in Inventory Cost

• Traditionally, manufacturing overhead costs

• Discounts associated with the purchase of

• Cash discounts are discounts granted for

• The net method records inventory at this

• Under the gross method, cash discounts are

To record the payment of the invoice within

• Adjustments are Periodic Inventory System

• Sometimes the Accounts Payable 400

Inventory Valuation Specific

The four methods will be illustrated using the

Note: No beginning inventory

• This specific identification method requires a

Jan. 1 200 units @ $10 per unit = $2,000

Ending inventory $4,900

• The average cost method assigns the same

Jan. 1 200 units @ $10 per unit = $ 2,000

$12,400  1,100 units = $11.27 per unit (rounded)

• The First-in, first out (FIFO) method is based

Jan. 1 200 units @ $10 per unit

• The last-in, first-out (LIFO) method is based

Jan. 1 200 units @ $10 per unit

Jan. 1 200 units @ $10 per unit = $2,000

The following data can be used to calculate

The FIFO calculations can be done as shown

Ryanes Company’s purchases and sales for

LIFO liquidation causes old LIFO layer costs to flow

• As a means of simplifying the valuation process

Income Tax Effects

• The bookkeeping associated with LIFO is a

When a company changes its method of valuing

LIFO Average Cost

Report the effect of changing methods

If the change is to LIFO from another method, a

Any Method change to LIFO

No adjustment to financial statements for change to

Applying the Lower of Cost or Market Method

Once an individual item is reduce to a

Beginning inventory, January 1 $25,000

Sales (actual) $50,000 100 %

• Rugen does a physical inventory count

Sales (actual) $50,000 100 %

Sales (actual) $50,000 100 %