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6-2
COURSE OUTLINE
Two aims of this course (1) Understanding of a general accounting system (2)
Instructor: Nguyễn Thị Thu, PhD, MBA, MA. Introducing the Uniform accounting system in Vietnamese enterprises

ACC5070 PRINCIPLES OF ACCOUNTING Chapter 1

Source
Accounting in Action

Chapter 2: Chapter 5: Accounting for

The Recording Process Merchandising Operations

Chapter 3: Chapter 6:
Adjusting the Accounts Inventories

Chapter 4: Completing the

Accounting Cycle

Chapter 7
The Vietnamese Accounting System

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6-3 6-4
CHAPTER 6 CHAPTER OUTLINE
INVENTORIES

Chapter Preview

§ In the previous chapter, we discussed the accounting

for merchandise inventory using a perpetual
inventory system. In this chapter, we explain the
methods used to calculate the cost of inventory on
hand at the statement of financial position date and
the cost of goods sold.

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6-5 6-6
LEARNING OBJECTIVE 6.1 CLASSIFYING AND DETERMINING INVENTORY
DISCUSS HOW TO CLASSIFY AND DETERMINE INVENTORY
Merchandising Manufacturing
Cost of goods sold Company Company

The point of tranferring The point of tranferring q One Classification: q Three Classifications:
title of money – goods title of goods – money
• Merchandise • Raw Materials
Goods in Outward goods
Inventory • Work in Process
transit Inward Warehouse
For sales => Merchandise Inventory Out
on consignment
• Finished Goods
For use => Raw materials, Supplies war Used, expired =>
From processing => Finished Goods d Cost of goods used
Helpful Hint
Work in progress Regardless of the classification, companies report all inventories
under Current Assets on the statement of financial position.
Expenses

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DETERMINING INVENTORY QUANTITIES DETERMINING OWNERSHIP OF GOODS

Physical Inventory taken for two reasons: Goods In Transit Consigned Goods
Perpetual System • Purchased goods not yet To hold the goods of other
received parties and try to sell the
1. Check accuracy of inventory records.
goods for them for a fee, but
• Sold goods not yet delivered
2. Determine amount of inventory lost due to wasted raw without taking ownership of
materials, shoplifting, or employee theft. Goods in transit should be included the goods.
in the inventory of the company
Periodic System Many car, boat, and antique
that has legal title to the goods.
dealers sell goods on
1. Determine the inventory on hand. Legal title is determined by the consignment. Why?
terms of sale.
2. Determine the cost of goods sold for the period.
Taking a Physical Inventory: Involves counting, weighing,
or measuring each kind of inventory on hand.
Taken,
• when the business is closed or business is slow
• at the end of the accounting period

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6-9 6-10
LEARNING OBJECTIVE 6.2
APPLY INVENTORY COST FLOW METHODS AND DISCUSS
THEIR FINANCIAL EFFECTS

Inventory is accounted for at cost.

• Cost includes all expenditures necessary to acquire
goods and place them in a condition ready for sale
• Unit costs are applied to quantities to determine the
Solution 1. Goods of ¥15,000 held on consignment should be total cost of inventory and cost of goods sold using
deducted from the inventory count.
the following costing methods:
2. The goods of ¥10,000 purchased FOB shipping
point should be added to the inventory count. § Physical flow assumption: Specific identification
3. Item 3 was treated correctly § Cost flow assumptions: First-in first-out and
Average-cost
Inventory should be ¥195,000 (¥200,000 − ¥15,000 + ¥10,000)

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PHYSICAL FLOW ASSUMPTION - SPECIFIC IDENTIFICATION COST FLOW ASSUMPTIONS
Crivitz purchased 1 red TV on 1/6 @ £720, 1 yellow TV on 3/6 @ £750, and 1 green TV
on 4/6 @ £800. In June, if Crivitz sold the TVs it purchased on 1/6 and 4/6, then its cost q There are two assumed cost flow methods:
of goods sold is £1,520 (£720 + £800), and its ending inventory is £750.
1. First-in, first-out (FIFO)
2. Average-cost
q Cost flow does not need be consistent with the physical
movement of the goods.

Sold on 1/6
Sold on 5/6

Costing method in which items still in inventory are specifically costed to

arrive at the total cost of the ending inventory.

Practice is relatively rare. Most companies make assumptions (cost flow

assumptions) about which units were sold

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6-13 6-14
COST FLOW ASSUMPTIONS - ILLUSTRATION COST FLOW ASSUMPTIONS - FIFO
Costs of earliest goods purchased are first to be recognized in
Data for Lin Electronics’ Astro condensers. determining cost of goods sold. Often parallels actual physical flow
of merchandise

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COST FLOW ASSUMPTIONS – AVERAGE-COST COST FLOW ASSUMPTIONS – AVERAGE-COST
Allocates cost of goods available for sale on basis of weighted-
average unit cost incurred
Applies weighted-average unit cost to units on hand to
determine cost of ending inventory

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FINANCIAL STATEMENT AND TAX EFFECTS INCOME STATEMENT EFFECTS
OF COST FLOW M ETHODS

Either of the two cost flow assumptions is acceptable for

use.
q Lenovo (CHN) uses the average-cost method
q Yingli Solar (CHN) uses average-costing for key raw
materials and FIFO for the remainder of its inventories

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STATEMENT OF FINANCIAL POSITION EFFECTS USING INVENTORY COST FLOW METHODS CONSISTENTLY

A major advantage of the FIFO method is that in a period of

inflation, costs allocated to ending inventory will approximate q Method should be used consistently, enhances comparability
their current cost q Although consistency is preferred, a company may change its
A shortcoming of the average-cost method is that in a period of inventory costing method
inflation, costs allocated to ending inventory may be
understated in terms of current cost Review question
The cost flow method that often parallels the actual
TAX EFFECTS physical flow of merchandise is the:
q Both inventory and net income are higher when companies a. FIFO method
use FIFO in a period of inflation b. LIFO method
q Average-cost results in lower income taxes (because of lower c. average cost method
net income) during times of rising prices
d. gross profit method

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LEARNING OBJECTIVE 6.3 INCOME STATEMENT EFFECTS
INDICATE THE EFFECTS OF INVENTORY ERRORS ON THE
FINANCIAL STATEMENTS
Common Cause:
q Failure to count or price inventory correctly

q Not properly recognizing the transfer of legal title to goods in transit

q Errors affect both the income statement and the statement of
financial position 80
Income statement
Ø Revenues
Net cost of 100
Goods Ø Cost of goods sold
purchases Goods sold Ø Gross: Income/loss Inventory errors affect the computation of cost of goods sold and net income
available in two periods.
for sale • An error in ending inventory of current period will have a reverse effect
Beginning Sta. Financial Position
Ending Ø Assets on net income of next accounting period
Inventory Inventory • Over 2 years, total net income is correct because errors offset each other
Ø Liabilities
20 Ø Equity • Ending inventory depends entirely on accuracy of taking and costing
inventory

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INCOME STATEMENT EFFECTS STATEMENT OF FINANCIAL POSITION EFFECTS

Effect of inventory errors on the statement of financial

position is determined by using the basic accounting
equation:

Assets = Liabilities + Equity

Errors in the ending inventory have the following effects.

Ending
Inventory Error Assets Liabilities Equity
Overstated Overstated No effect Overstated
Understated Understated No effect Understated
Understating ending inventory will overstate:
(a) assets, (b) cost of goods sold, (c) net income, (d) equity

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STATEMENT OF FINANCIAL POSITION EFFECTS LEARNING OBJECTIVE 6.4
EXPLAIN THE STATEMENT PRESENTATION AND
DO IT! 3: INVENTORY ERRORS ANALYSIS OF INVENTORY
Visual Designs overstated its 2019 ending inventory by
NT$22,000. Determine the impact this error has on Presentation
ending inventory, cost of goods sold, and owner’s equity Statement of Financial Position - Inventory
in 2019 and 2020. classified as current asset.
Solution Income Statement - Cost of goods sold subtracted
2019 2020 from sales.
Ending inventory NT$22,000 overstated No effect There also should be disclosure of
Cost of goods sold NT$22,000 understated NT$22,000 overstated
1. major inventory classifications
Owner’s equity NT$22,000 overstated No effect
2. basis of accounting for inventory (cost or LCNRV)
3. costing method (FIFO, or average-cost)

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LOWER-OF-COST-OR-NET REALIZABLE VALUE LOWER-OF-COST-OR-NRV ILLUSTRATION

When the value of inventory is lower than its cost Assume that Gao TVs has the following lines of merchandise
q Companies must “write down” inventory to its net with costs and net realizable values as indicated.
realizable value
q Net realizable value (NRV): Amount that company
expects to realize (receive from the sale of inventory)
q Example of conservatism
requires that when the NRV of inventory falls below historical cost, the
inventory is written down to the lower value and a loss is recorded

NRV Sta. of Financial Position

Cost Inventory (Cost) NT$162,500
LCNRV Provision for Declining on INV 6,700
LCNRV NT$ 155,800

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LEARNING OBJECTIVE 6.5 FIRST-IN, FIRST-OUT (FIFO)
APPLY THE INVENTORY COST FLOW METHODS
TO PERPETUAL INVENTORY RECORDS

Compute Cost of Goods Sold and Ending

Inventory under FIFO and average-cost.

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AVERAGE-COST

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