Slide

8-1

Chapter

McGraw-Hill/Irwin

INVENTORIES AND THE

COST OF GOODS SOLD

The McGraw-Hill Companies, Inc.

Slide
8-2

Inventory
Inventory Defined
Defined

Inventory
Inventory
Goods
Goods owned
owned
and
and held
held for
for sale
sale
to
to customers
customers

McGraw-Hill/Irwin

Current
Current
asset
asset

The McGraw-Hill Companies, Inc.

Slide
8-3

The
The Flow
Flow of
of Inventory
Inventory Costs
Costs
BALANCE SHEET
As purchase costs
(or manufacturing
costs) are incurred

Current assets:
Inventory
INCOME STATEMENT
Revenue
Cost of goods sold
Gross profit
Expenses
Net income

McGraw-Hill/Irwin

$
as goods
are sold
$

The McGraw-Hill Companies, Inc.

Slide
8-4

The
The Flow
Flow of
of Inventory
Inventory Costs
Costs
In a perpetual inventory system, inventory entries
parallel the flow of costs.
GENERAL JOURNAL
Date

Account Titles and Explanation

P
R Debit

Credit

Entry on Purchase Date

Inventory

$$$$

Accounts Payable

$$$$

Entry on Sale Date

Cost of Goods Sold
Inventory
McGraw-Hill/Irwin

$$$$
$$$$

The McGraw-Hill Companies, Inc.

Slide
8-5

Which
Which Unit
Unit Did
Did We
We Sell?
Sell?
When identical units of inventory have
different unit costs, a question naturally
arises as to which of these costs should be
used in recording a sale of inventory.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-6

Inventory
Inventory Subsidiary
Subsidiary Ledger
Ledger
AA separate
separate subsidiary
subsidiary account
account is
is maintained
maintained
for
for each
each item
item in
in inventory.
inventory.
Item LL002
Description Laser Light
Location Storeroom 2
Purchased

Date
Sept. 5
Sept. 9

Units
100
75

Sept. 10

Unit
Cost
$ 30
50

Total
$ 3,000
3,750

Sold

Units

Unit
Cost

10

Primary supplier Electronic City

Secondary supplier Electric Company
Inventory level: Min: 25 Max: 200
Balance
Cost of
Goods
Unit
Sold
Units
Cost
Total
100
$
30 $ 3,000
100
30
3,000
75
50
3,750
?
?
?
?
?
?
?

How can we determine the unit cost for the Sept. 10 sale?
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-7

Inventory
Inventory Cost
Cost Flows
Flows
We use one of these inventory valuation
methods to determine cost of inventory sold.
Specific
identification

Average
cost

FIFO

LIFO

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-8

Information
Information for
for the
the Following
Following
Inventory
Inventory Examples
Examples
The Bike Company (TBC)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-9

Specific
Specific Identification
Identification

When a unit
is sold, the
specific cost of
the unit sold is
added to cost
of goods sold.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-10

Specific
Specific Identification
Identification Example
Example

On
On August
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.
Nine
Nine bikes
bikes originally
originally cost
cost $91
$91 and
and 11
11 bikes
bikes
originally
originally cost
cost $106.
$106.
Continue
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-11

Specific
Specific Identification
Identification Example
Example

The
The Cost
Cost of
of Goods
Goods Sold
Sold for
for the
the August
August 14
14 sale
sale is
is
$1,985,
$1,985, leaving
leaving $515
$515 and
and 55 units
units in
in inventory.
inventory.
Continue
McGraw-Hill/Irwin

Lets look at the entries for

the Aug. 14 sale.

The McGraw-Hill Companies, Inc.

Slide
8-12

Specific
Specific Identification
Identification Example
Example

Retail
Retail
Cost
Cost

A
Asimilar
similar entry
entry is
is
made
made after
after each
each sale.
sale.
McGraw-Hill/Irwin

Continue

The McGraw-Hill Companies, Inc.

Slide
8-13

Specific
Specific Identification
Identification Example
Example

Cost
Cost of
of Goods
Goods
Sold
Sold for
for
August
August 31
31 ==
$2,610
$2,610
Additional
Additionalpurchases
purchaseswere
weremade
madeon
onAugust
August17
17and
and28.
28.
Costs
Costsassociated
associatedwith
withsales
saleson
onAugust
August31
31were
wereas
asfollows:
follows:11@
@$91,
$91,
33@
@$106,
$106,15
15@
@$115,
$115,&&44@
@$119.
$119.

McGraw-Hill/Irwin

Continue

The McGraw-Hill Companies, Inc.

Slide
8-14

Specific
Specific Identification
Identification Example
Example

Income Statement

COGS = $4,595

Balance Sheet

Inventory = $1,395
McGraw-Hill/Irwin

11
55
66

@
@ $$106
106 == $$ 106
106
@
575
@ $$115
115 ==
575
@
714
@ $$119
119 ==
714
End.
$$1,395
End.Inv.
Inv. The
1,395
McGraw-Hill
Companies, Inc.

Slide
8-15

Since specific
identification is so
easy, cant we use it
all the time?

McGraw-Hill/Irwin

Not really. Specific

identification is hard to use
when we sell a lot of
inventory that has lots of
different costs.

The McGraw-Hill Companies, Inc.

Slide
8-16

Average-Cost
Average-Cost Method
Method
When a unit is sold,
the average cost of each unit
in inventory is assigned to
cost
of goods sold.
Cost of Goods Units on hand
Available for on the date of
Sale
sale

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-17

Average-Cost
Average-Cost Method
Method Example
Example

The
Theaverage
averagecost
costper
per unit
unit
must
must be
becomputed
computedprior
prior
to
toeach
eachsale.
sale.

$100
$100 == $2,500
$2,500 25
25

On
On August
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.
Continue
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-18

Average-Cost
Average-Cost Method
Method Example
Example

The
The average
average cost
cost per
per
unit
unit is
is $100.
$100.

Continue
McGraw-Hill/Irwin

$100
$100 == $2,500
$2,500 25
25

Lets look at the entries

for the Aug.
14
sale.
The McGraw-Hill Companies, Inc.

Slide
8-19

Average-Cost
Average-Cost Method
Method Example
Example

Retail
Retail
Cost
Cost

A
Asimilar
similar entry
entry is
is
made
made after
after each
each sale.
sale.
McGraw-Hill/Irwin

Continue

The McGraw-Hill Companies, Inc.

Slide
8-20

Average-Cost
Average-Cost Method
Method Example
Example

Additional
Additional purchases
purchaseswere
weremade
madeon
onAugust
August 17
17and
and
August
August28.
28.
On
OnAugust
August 31,
31,an
anadditional
additional23
23units
unitswere
weresold.
sold.
Continue
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-21

Average-Cost
Average-Cost Method
Method Example
Example

$114
$114 == $3,990
$3,990 35
35

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-22

Average-Cost
Average-Cost Method
Method Example
Example

The
The average
average cost
cost per
per
unit
unit is
is $114.
$114.
McGraw-Hill/Irwin

$114
$114 == $3,990
$3,990 35
35

The McGraw-Hill Companies, Inc.

Slide
8-23

Average-Cost
Average-Cost Method
Method Example
Example

Income Statement

COGS = $4,622

Balance Sheet

Inventory = $1,368

$114
$114 12
12 == $1,368
$1,368
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-24

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)
Oldest
Oldest
Costs
Costs

Costs
Costs of
of
Goods
Goods Sold
Sold

Recent
Recent
Costs
Costs

Ending
Ending
Inventory
Inventory

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-25

FIFO
FIFO Example
Example

The
TheCost
Costof
ofGoods
GoodsSold
Sold for
for the
theAugust
August 14
14 sale
saleis
is$1,970,
$1,970,
leaving
leaving$530
$530and
and55 units
units in
ininventory.
inventory.

On
On August
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.
Continue
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-26

FIFO
FIFO Example
Example

Retail
Retail
Cost
Cost

A
Asimilar
similar entry
entry is
is
made
made after
after each
each sale.
sale.
McGraw-Hill/Irwin

Continue

The McGraw-Hill Companies, Inc.

Slide
8-27

FIFO
FIFO Example
Example

Additional
Additionalpurchases
purchaseswere
weremade
madeon
onAug.
Aug.17
17and
andAug.
Aug.28.
28.
Cost
of
Goods
Sold
for
August
31
=sold.
$2,600
CostOn
of
Goods
Sold
for
August
31
=
$2,600
August
31,
an
additional
23
units
were
On August 31, an additional 23 units were sold.
McGraw-Hill/Irwin

Continue

The McGraw-Hill Companies, Inc.

Slide
8-28

FIFO
FIFO Example
Example

Income Statement

COGS = $4,570

Balance Sheet

Inventory = $1,420
McGraw-Hill/Irwin

22 @
@ $$115
115
10
10 @
@ $$119
119
End.
End. Inv.
Inv.

== $$ 230
230
== 1,190
1,190
$$1,420
1,420

The McGraw-Hill Companies, Inc.

Slide
8-29

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)
Recent
Recent
Costs
Costs

Costs
Costs of
of
Goods
Goods Sold
Sold

Oldest
Oldest
Costs
Costs

Ending
Ending
Inventory
Inventory

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-30

LIFO
LIFO Example
Example

The
The Cost
Cost of
of Goods
Goods Sold
Sold for
for the
the August
August 14
14 sale
sale is
is
$2,045,
$2,045, leaving
leaving $455
$455 and
and 55 units
units in
in inventory.
inventory.
On
On August
August 14,
14, TBC
TBC sold
sold 20
20 bikes
bikes for
for $130
$130 each.
each.
Continue
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-31

LIFO
LIFO Example
Example

Retail
Retail
Cost
Cost

A
Asimilar
similar entry
entry is
is
made
made after
after each
each sale.
sale.
McGraw-Hill/Irwin

Continue

The McGraw-Hill Companies, Inc.

Slide
8-32

LIFO
LIFO Example
Example

Additional
Additionalpurchases
purchaseswere
weremade
madeon
onAug.
Aug.17
17and
andAug.
Aug.28.
28.
Cost
Goods
Sold
for
August
31
== $2,685
Cost of
of
Goods
Sold
for
August
31
$2,685
On
Aug.
31,
an
additional
23
units
were
sold.
On Aug. 31, an additional 23 units were sold.
McGraw-Hill/Irwin

Continue

The McGraw-Hill Companies, Inc.

Slide
8-33

LIFO
LIFO Example
Example

Income Statement

COGS = $4,730

Balance Sheet

Inventory = $1,260
McGraw-Hill/Irwin

55 @
@ $$ 91
91
77 @
@ $$115
115
End.
End. Inv.
Inv.

== $$ 455
455
==
805
805
$$1,260
1,260

The McGraw-Hill Companies, Inc.

Inventory Valuation Methods: A Summary

Costs Allocated to:
Valuation
Cost of Goods
Method
Sold
Inventory
Comments
Specific
Actual cost of
Actual cost of units Parallels physical flow
identification
the units sold
remaining
Logical method when units
are unique
May be misleading for
identical units
Average cost
Number of units Number of units on Assigns all units the same
sold times the
hand times the
average unit cost
average unit cost average unit cost
Current costs are averaged
in with older costs
First-in, First-out Cost of earliest
Cost of most
Cost of goods sold is based
(FIFO)
purchases on
recently
on older costs
hand prior to the purchased units
Inventory valued at current
sale
costs
May overstate income during
periods of rising prices; may
increase income taxes due
Last-in, First-out Cost of most
Cost of earliest
Cost of goods sold shown at
(LIFO)
recently
purchases
recent prices
purchased units (assumed still in
Inventory shown at old (and
inventory)
perhaps out of date) costs
Most conservative method
during periods of rising
prices; often results in lower
The McGraw-Hill
Companies, Inc.
McGraw-Hill/Irwin
income
taxes
Slide
8-34

Slide
8-35

The
The Principle
Principle of
of Consistency
Consistency
Once a company has
adopted a particular
accounting method, it
should follow that
method consistently,
rather than switch
methods from one
year to the next.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-36

Just-In-Time
Just-In-Time (JIT)
(JIT) Inventory
Inventory
Systems
Systems

This inventory arrived just

in time for us to use in the
manufacturing process.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-37

Taking
Taking aa Physical
Physical Inventory
Inventory
The
The primary
primary reason
reason for
for taking
taking aa physical
physical inventory
inventory
is
is to
to adjust
adjust the
the perpetual
perpetual inventory
inventory records
records for
for
unrecorded
unrecorded shrinkage
shrinkage losses,
losses, such
such as
as theft,
theft,
spoilage,
spoilage, or
or breakage.
breakage.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-38

LCM
LCM and
and Other
Other Write-Downs
Write-Downs
of
of Inventory
Inventory

Obsolescence
Obsolescence

Lower
Lower of
of Cost
Cost
or
or Market
Market
(LCM)
(LCM)

McGraw-Hill/Irwin

Reduces
Reduces the
the value
value
of
of the
the inventory.
inventory.
Adjust
Adjust inventory
inventory
value
value to
to the
the lower
lower
of
of historical
historical cost
cost or
or
current
current
replacement
replacement cost
cost
(market).
(market).

The McGraw-Hill Companies, Inc.

Slide
8-39

Goods
Goods In
In Transit
Transit
AAsale
saleshould
should be
be recorded
recorded when
when title
title
to
tothe
themerchandise
merchandisepasses
passesto
tothe
the
buyer.
buyer.

F.O.B.
F.O.B.
shipping
shipping
point
point title
title
passes
passes to
to
buyer
buyer at
at the
the
point
point of
of
shipment.
shipment.
McGraw-Hill/Irwin

Year
End

F.O.B.
F.O.B.
destination
destination
point
point title
title
passes
passes to
to
buyer
buyer at
at the
the
point
point of
of
destination.
destination.

The McGraw-Hill Companies, Inc.

Slide
8-40

Periodic
Periodic Inventory
Inventory Systems
Systems
In a periodic inventory system, inventory entries are
as follows.

Note
Note that
that an
an entry
entry is
is not
not
made
made to
to inventory.
inventory.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-41

Periodic
Periodic Inventory
Inventory Systems
Systems
In a periodic inventory system, inventory entries are
as follows.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-42

Periodic
Periodic Inventory
Inventory Systems
Systems
The inventory on
hand and the
cost of goods
sold for the year
are not
determined until
year-end.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-43

Periodic
Periodic Inventory
Inventory Systems
Systems
We use one of these inventory valuation
methods in a periodic inventory system.
Specific
identification

Average
cost

FIFO

LIFO

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-44

Information
Information for
for the
the Following
Following
Inventory
Inventory Examples
Examples
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit

Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory

Cost of
Goods Sold
McGraw-Hill/Irwin

1,000 $
300
150
200
150

Total

5.25

$ 5,250.00

5.30
5.60
5.80
5.90

1,590.00
840.00
1,160.00
885.00

1,800

$ 9,725.00

1,200

600

The McGraw-Hill Companies, Inc.

Slide
8-45

Specific
Specific Identification
Identification Example
Example
By reviewing actual
purchase invoices,
Computers, Inc. determines
that the 1,200 mouse pads
on hand at year-end have
an actual total cost of
$6,400.
Determine the cost of
goods sold for the year.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-46

Specific
Specific Identification
Identification Example
Example
Computers, Inc.
Mouse Pad Inventory
Units
$/Unit

Date
Beginning
Inventory
1,000 $
Purchases:
Jan. 3
300
June 20
150
Sept.
15
200
Cost
of
Goods
Sold
Cost
Nov.
29of Goods Sold
150
$9,725
Goods
$9,725 $6,400
$6,400==$3,325
$3,325
Available
for Sale
1,800

--

Ending
Inventory
Cost of
Goods Sold
McGraw-Hill/Irwin

Total

5.25

$ 5,250.00

5.30
5.60
5.80
5.90

1,590.00
840.00
1,160.00
885.00

$ 9,725.00

1,200

$ 6,400.00

600

$ 3,325.00

The McGraw-Hill Companies, Inc.

Slide
8-47

Average-Cost
Average-Cost Method
Method
The
The average
average cost
cost is
is
calculated
calculated at
at yearyearend
end as
as follows:
follows:
Total Cost of
Goods
Available for
Sale

McGraw-Hill/Irwin

Total Number
of Units
Available for
Sale

The McGraw-Hill Companies, Inc.

Slide
8-48

Average-Cost
Average-Cost Method
Method Example
Example
Avg.
Avg.Cost
Cost $9,725
$9,7251,800
1,800==
$5.40278
$5.40278
Ending
EndingInventory
Inventory
Avg.
Avg.Cost
Cost $5.40278
$5.402781,200
1,200==
$6,483
$6,483
Cost
Costof
ofGoods
GoodsSold
Sold
Avg.
Avg.Cost
Cost $5.40278
$5.40278600
600==
$3,242
$3,242

Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory
Cost of
Goods Sold

McGraw-Hill/Irwin

Computers, Inc.
Mouse Pad Inventory
Units
$/Unit

Total

1,000 $

5.25

$ 5,250.00

300
150
200
150

5.30
5.60
5.80
5.90

1,590.00
840.00
1,160.00
885.00

1,800

$ 9,725.00

1,200
1,200

$ 6,483.00
?

600

$ 3,242.00
?

The McGraw-Hill Companies, Inc.

Slide
8-49

First-In,
First-In, First-Out
First-Out Method
Method (FIFO)
(FIFO)
Oldest
Oldest
Costs
Costs

Costs
Costs of
of
Goods
Goods Sold
Sold

Recent
Recent
Costs
Costs

Ending
Ending
Inventory
Inventory

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-50

FIFO
FIFO Example
Example
Remember: Start
with the 11/29
purchase and then
add other purchases
until you reach the
number of units in
ending inventory.

Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory
Cost of
Goods Sold

McGraw-Hill/Irwin

Computers, Inc.
Mouse Pad Inventory
Units
$/Unit

Total

1,000 $

5.25

$ 5,250.00

300
150
200
150

5.30
5.60
5.80
5.90

1,590.00
840.00
1,160.00
885.00

1,800

$ 9,725.00

1,200

600

The McGraw-Hill Companies, Inc.

Slide
8-51

FIFO
FIFO Example
Example
Date

Beg. Inv.
Purchases
1,000@$5.25

Jan. 3
June 20
Sept. 15
Nov. 29
Units

300@$5.30
150@$5.60
200@$5.80
150@$5.90

Now, we have allocated

Costs

End. Inv.

Cost of
Goods Sold
600@$5.25

400@$5.25
300@$5.30
150@$5.60
200@$5.80
150@$5.90
1,200
150

600

$6,575

$3,150

Now,
lets complete
complete the
the
the cost to allNow,
1,200 lets
units
table.
endingAvailable
inventory.
table.
Cost in
of Goods
for Sale
$9,725
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc.

Slide
8-52

FIFO
FIFO Example
Example
Completing the table
summarizes the
computations just
made.

Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory
Cost of
Goods Sold

McGraw-Hill/Irwin

Computers, Inc.
Mouse Pad Inventory
Units
$/Unit

Total

1,000 $

5.25

$ 5,250.00

300
150
200
150

5.30
5.60
5.80
5.90

1,590.00
840.00
1,160.00
885.00

1,800

$ 9,725.00

1,200

$ 6,575.00

600

$ 3,150.00

The McGraw-Hill Companies, Inc.

Slide
8-53

Last-In,
Last-In, First-Out
First-Out Method
Method (LIFO)
(LIFO)
Recent
Recent
Costs
Costs

Costs
Costs of
of
Goods
Goods Sold
Sold

Oldest
Oldest
Costs
Costs

Ending
Ending
Inventory
Inventory

McGraw-Hill/Irwin

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Slide
8-54

LIFO
LIFO Example
Example
Remember: Start with
beginning inventory
and then add other
purchases until you
reach the number of
units in ending
inventory.

Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory
Cost of
Goods Sold

McGraw-Hill/Irwin

Computers, Inc.
Mouse Pad Inventory
Units
$/Unit

Total

1,000 $

5.25

$ 5,250.00

300
150
200
150

5.30
5.60
5.80
5.90

1,590.00
840.00
1,160.00
885.00

1,800

$ 9,725.00

1,200

600

The McGraw-Hill Companies, Inc.

Slide
8-55

LIFO
LIFO Example
Example
Date
Jan. 3
June 20
Sept. 15
Nov. 29
Units

Beg. Inv.
Purchases End. Inv.
1,000@$5.25
1,000@$5.25
300@$5.30 200@$5.30
150@$5.60
200@$5.80
150@$5.90

Now, we have allocated

Costs

the cost to all 1,200 units

inventory.
Cost in
of ending
Goods Available
for Sale
McGraw-Hill/Irwin

1,000
1,200

Cost of
Goods Sold

100@$5.30
150@$5.60
200@$5.80
150@$5.90
100
600

$6,310
$3,415
Next,
Next,lets
lets

complete
completethe
the
$9,725
table.
table.

The McGraw-Hill Companies, Inc.

Slide
8-56

LIFO
LIFO Example
Example
Completing the table
summarizes the
computations just
made.

Date
Beginning
Inventory
Purchases:
Jan. 3
June 20
Sept. 15
Nov. 29
Goods
Available
for Sale
Ending
Inventory
Cost of
Goods Sold

McGraw-Hill/Irwin

Computers, Inc.
Mouse Pad Inventory
Units
$/Unit

Total

1,000 $

5.25

$ 5,250.00

300
150
200
150

5.30
5.60
5.80
5.90

1,590.00
840.00
1,160.00
885.00

1,800

$ 9,725.00

1,200

$ 6,310.00

600

$ 3,415.00

The McGraw-Hill Companies, Inc.

Slide
8-57

Importance
Importance of
of an
an Accurate
Accurate
Valuation
Valuation of
of Inventory
Inventory
Errors in Measuring Inventory
Beginning Inventory

Ending Inventory

Effect on Income Statement Overstated Understated Overstated Understated

+
+
-

+
+

Ending Inventory

Retained Earnings

Goods Available for Sale

Cost of Goods Sold
Gross Profit
Net Income

+
+

+
-

+
+

Effect on Balance Sheet

An
Anerror
errorin
inending
endinginventory
inventoryin
inaayear
yearwill
will result
result in
in the
the
same
sameerror
error in
in the
thebeginning
beginninginventory
inventoryof
of the
thenext
next year.
year.
McGraw-Hill/Irwin

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Slide
8-58

For interim fi
nancial
statements, w
e may need
to estimate e
nding
inventory an
d cost of
goods sold.

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Slide
8-59

The
The Gross
Gross Profit
Profit Method
Method

Determine
Determine cost
cost of
of goods
goods

available
available for
for sale.
sale.

Estimate
Estimate cost
cost of
of goods
goods sold
sold
by
by multiplying
multiplying the
the net
net sales
sales
by
by the
the cost
cost ratio.
ratio.

Deduct
Deduct cost
cost of
of goods
goods sold
sold

from
from cost
cost of
of goods
goods available
available
for
for sale
sale to
to determine
determine ending
ending
inventory.
inventory.

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Slide
8-60

Gross
Gross Profit
Profit Method
Method Example
Example
In
In March
March of
of 2003,
2003, Chemicos
Chemicos inventory
inventory was
was
destroyed
destroyed by
by fire.
fire. Chemicos
Chemicos normal
normal gross
gross profit
profit
ratio
ratio is
is 30%
30% of
of net
net sales.
sales. At
At the
the time
time of
of the
the fire,
fire,
Chemico
Chemico showed
showed the
the following
following balances:
balances:

Sales
$$ 31,500
Sales
31,500
Sales
1,500
Salesreturns
returns
1,500
Beginning
12,000
Beginning Inventory
Inventory
12,000
Net
20,500
Net cost
cost of
of goods
goodspurchased
purchased
20,500
McGraw-Hill/Irwin

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Slide
8-61

Gross
Gross Profit
Profit Method
Method Example
Example

70%

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The McGraw-Hill Companies, Inc.

Slide
8-62

Inventory
Inventory Turnover
Turnover Rate
Rate
Measures
Measures how
how quickly
quickly aa company
company
sells
sells its
its merchandise
merchandise inventory.
inventory.

Average
AverageInventory
Inventory==(Beg.
(Beg.Inv.
Inv.++End.
End.Inv.)
Inv.) 22

A
A ratio
ratio that
that is
is low
low compared
compared to
to competitors
competitors
suggests
suggests inefficient
inefficient use
use of
of assets.
assets.
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Slide
8-63

Accounting
Accounting Methods
Methods Can
Can Affect
Affect
Analytical
Analytical Ratios
Ratios
Remember that identical
companies that use different
inventory methods (e.g.,
FIFO and LIFO) will have
different inventory turnover
ratios.

McGraw-Hill/Irwin

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Slide
8-64

End
End of
of Chapter
Chapter 88
Careful! If you
drop the inventory
we will have another
write down.

McGraw-Hill/Irwin

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