3 Inventories

Learning Objectives
1 Classify and determine inventory.

Practice Computing the cost of inventory and record

2 into journal

3 Determine the effects of inventory errors on FS

4 Provide information about inventory on FS

6-1
Key Terms
1. Goods in transit; 11. Weighted average method
2. Raw materials, 12. Specific identification method
3. Materials; 13. Assets in shortage awaiting
resolution (1381)
4. Tools;
14. Surplus of assets awaiting
5. Work in progress
resolution (3381)
6. Merchandised goods;
15. Direct material cost
7. Consignments goods
16. Direct labor cost
8. Perpetual inventory system
17. Manufacturing overhead costs
9. Periodic inventory system
18. Net realizable value (NRV)
10. First in, first out method (FIFO)
19. Allowances for decline in value
of inventories
6-2 *
LEARNING
OBJECTIVE
1 Classify and determine inventory.

Classifying Inventory

Merchandising Manufacturing
Company Company

One Classification: Three Classifications:

◆ Inventory ◆ Raw Materials

◆ Work in Process
Helpful Hint
Regardless of the ◆ Finished Goods
classification, companies
report all inventories
under Current Assets on
the balance sheet.
6-3 LO 1
Determining Inventory Quantities

Physical Inventory taken for two reasons:

Perpetual System
1. Check accuracy of inventory records.

2. Determine amount of inventory lost due to wasted raw

materials, shoplifting, or employee theft.

Periodic System
1. Determine the inventory on hand.

2. Determine the cost of goods sold for the period.

6-4 LO 1
Determining Inventory Quantities

TAKING A PHYSICAL INVENTORY

Involves counting, weighing, or measuring each kind of
inventory on hand.

Companies often “take inventory”

◆ when the business is closed or
business is slow.

◆ at the end of the accounting period.

6-5 LO 1
Determining Ownership of Goods

GOODS IN TRANSIT Illustration 6-2

Terms of sale

Ownership of the goods

passes to the buyer when the
public carrier accepts the
goods from the seller.

Ownership of the goods

remains with the seller until the
goods reach the buyer.

6-6 LO 1
Determining Ownership of Goods

Question
Goods in transit should be included in the inventory of the
buyer when the:

a. public carrier accepts the goods from the seller.

b. goods reach the buyer.

c. terms of sale are FOB destination.

d. terms of sale are FOB shipping point.

6-7 LO 1
LEARNING Computing the cost of inventory and
OBJECTIVE
2
recording into journal

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 compute the total cost
of the inventory and the cost of goods sold using the
following costing methods:
► Specific identification
► First-in, first-out (FIFO)
Cost Flow
► Average-cost
Assumptions

6-8 LO 2
b. Cost of Inventories

Historical cost
Initial Measurement

COST

All costs of purchase, costs of conversion and

other costs incurred in bringing the inventories to
their present location and condition

6-9 *
b. Cost of Inventories

Purchasing Dispatching

• Purchase • Specific identification

+ 1
• Import duties and other taxes
+ • First in - first out
2
• Transport expense; handling
+ expense

• Weighted Average cost

• LESS any trade discounts 3
-
6-10 *
Inventory Costing

Illustration: Crivitz TV Company purchases three identical

50-inch TVs on different dates at costs of $700, $750, and
$800. During the year Crivitz sold two sets at $1,200 each.
These facts are summarized below. Illustration 6-3
Data for inventory
costing example

6-11 LO 2
Specific Identification

If Crivitz sold the TVs it purchased on February 3 and May 22,

then its cost of goods sold is $1,500 ($700 + $800), and its
ending inventory is $750.
Illustration 6-4

6-12 LO 2
Specific Identification

Actual physical flow 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.

6-13 LO 2
Cost Flow Assumptions

Illustration: Data for Houston Electronics’ Astro condensers.

Illustration 6-5

(Beginning Inventory + Purchases) - Ending Inventory = Cost of Goods Sold

6-14 LO 2
Cost Flow Assumptions

FIRST-IN, FIRST-OUT (FIFO)

◆ Costs of the earliest goods purchased are the first to
be recognized in determining cost of goods sold.

◆ Often parallels actual physical flow of merchandise.

◆ Companies determine the cost of the ending inventory

by taking the unit cost of the most recent purchase and
working backward until all units of inventory have been
costed.

6-15 LO 2
FIRST-IN, FIRST-OUT (FIFO)
Illustration 6-6

6-16 LO 2
FIRST-IN, FIRST-OUT (FIFO)
Illustration 6-6

Helpful Hint Another way of

thinking about the calculation
of FIFO ending inventory is the
LISH assumption—last in still here.
6-17 LO 2
Cost Flow Assumptions

AVERAGE-COST
◆ Allocates cost of goods available for sale on the basis of
weighted-average unit cost incurred.

◆ Applies weighted-average unit cost to the units on

hand to determine cost of the ending inventory.

6-18 LO 2
AVERAGE-COST
Illustration 6-11

6-19 LO 2
AVERAGE-COST

Illustration 6-11

6-20 LO 2
Practice 1
ViVu Ltd, has information in May, 2021 as below:
- Beginning balance of raw materials - 152: 1.000kg x 10.000 VND/kg
- 05/05: ViVu purchased 2.000kg at 10.000 VND/kg, VAT 10%. Freight cost with
term of FOB shipping point is 400.000 VND. ViVu paid all for cash.
- 10/5: dispatched 1.600kg A for producing
- 15/05: dispatched 500kg A for producing
- 22/05: ViVu purchased 2.500kg A from XYZ company at 10.500 VND/kg, VAT
10%, paid by cash. Freight cost with term of FOB destination is 500.000 VND
- 26/5: dispatched 800kg A for producing
Requirements: (assume that ViVu Ltd applied perpetual system method)
a. Determine cost of raw materials A at each purchasing
c. Determine cost of raw material A at each dispatching with FiFo method.
b. Determine cost of raw material A at each dispatching with Weighted average
method.
d. Prepare journal entries if ViVu Ltd applies FiFo method

6-21
Guidance

6-22
Practice 2: Minh Vu Ltd, has information in the year of 2021 as below:

Requirements: (assume that ViVu Ltd applied perpetual system method)

a. Prepare tabular to determine cost of goods purchased and cost of
goods sold following to FiFo method
b. Prepare journal entries if FiFo method is applied
c. Prepare tabular to determine cost of goods purchased and cost of
goods sold following to weighted average method
d. Prepare journal entries if weighted average method is applied
e. If FiFo method is applied, assume that maket value at the end of the
year is 48.000 per unit. Compute amount of allowance for inventories.
Record allowance in the journal?
6-23
Guidance

6-24
Inventory Costing

Financial Statement and Tax Effects of Cost

Flow Methods
Each of the three cost flow methods is acceptable for use.
◆ Reebok International Ltd. and Wendy’s International currently
use the FIFO method.

◆ Campbell Soup Company, Krogers, and Walgreen Drugs use

LIFO for part or all of their inventory.

◆ Bristol-Myers Squibb, Starbucks, and Motorola use the

average-cost method.

◆ Stanley Black & Decker Manufacturing Company uses LIFO for

domestic inventories and FIFO for foreign inventories.
6-25 LO 2
Financial Statement and Tax Effects
Illustration 6-13
INCOME STATEMENT EFFECTS Comparative effects of
cost flow methods

6-26 LO 2
Cost Flow Assumptions

Question
The cost flow method that often parallels the actual
physical flow of merchandise is the:
a. FIFO method.
b. LIFO method.
c. average cost method.
d. gross profit method.

6-27 LO 2
LEARNING Indicate the effects of inventory errors
OBJECTIVE
3
on the financial statements.

Common Cause:
◆ Failure to count or price inventory correctly.

◆ Not properly recognizing the transfer of legal title to goods

in transit.

◆ Errors affect both the income statement and balance sheet.

6-28 LO 3
Income Statement Effects

Inventory errors affect the computation of cost of goods sold

and net income in two periods.
Illustration 6-17

Illustration 6-18

6-29 LO 3
Income Statement Effects

Inventory errors affect the computation of cost of goods

sold and net income in two periods.

◆ An error in ending inventory of the current period will

have a reverse effect on net income of the next
accounting period.

◆ Over the two years, the total net income is correct

because the errors offset each other.

◆ Ending inventory depends entirely on the accuracy of

taking and costing the inventory.

6-30 LO 3
Income Statement Effects Illustration 6-17
Effects of inventory errors on
two years’ income statements

2016 2017
Incorrect Correct Incorrect Correct
Sales $ 80,000 $ 80,000 $ 90,000 $ 90,000
Beginning inventory 20,000 20,000 12,000 15,000
Cost of goods purchased 40,000 40,000 68,000 68,000
Cost of goods available 60,000 60,000 80,000 83,000
Ending inventory 12,000 15,000 23,000 23,000
Cost of good sold 48,000 45,000 57,000 60,000
Gross profit 32,000 35,000 33,000 30,000
Operating expenses 10,000 10,000 20,000 20,000
Net income $ 22,000 $ 25,000 $ 13,000 $ 10,000

($3,000) $3,000
Combined income for Net Income Net Income
2-year period is correct. understated overstated

6-31 LO 3
Income Statement Effects

Question
Understating ending inventory will overstate:

a. assets.
b. cost of goods sold.

c. net income.

d. stockholders’ equity

6-32 LO 3
Balance Sheet Effects

Effect of inventory errors on the balance sheet is determined

by using the basic accounting equation: Assets = Liabilities +
Stockholders’ Equity.

Errors in the ending inventory have the following effects.

Illustration 6-18
Effects of ending inventory
errors on balance sheet

6-33 LO 3
DO IT! 3 Inventory Errors

Visual Company overstated its 2016 ending inventory by

$22,000. Determine the impact this error has on ending
inventory, cost of goods sold, and stockholders’ equity in 2016
and 2017.

Solution
2016 2017
Ending inventory $22,000 overstated No effect
Cost of goods sold $22,000 understated $22,000 overstated
Stockholders’ equity $22,000 overstated No effect

6-34 LO 3
LEARNING Explain the statement presentation and
OBJECTIVE
4
analysis of inventory.

Presentation
Balance Sheet - Inventory classified as current asset.

Income Statement - Cost of goods sold is subtracted from

sales.

There also should be disclosure of the

1) major inventory classifications,

2) basis of accounting (cost or LCM), and

3) costing method (FIFO, LIFO, or average-cost).

6-35 LO 4
Lower-of-Cost-or-Net Realizable Value

When the value of inventory is lower than its cost

◆ Companies must “write down” the inventory to its net

realizable value.

◆ Net realizable value: Amount that a company expects to

realize (receive from the sale of inventory).

◆ Example of conservatism.

6-36 LO 4
Lower-of-Cost-or-Net Realizable Value

Illustration: Assume that Ken Tuckie TV has the following

lines of merchandise with costs and market values as
indicated.

Illustration 6-20
Computation of lower-of-
cost-or-net realizable value

6-37 LO 4
Statement Presentation and Analysis

Analysis
Inventory management is a double-edged sword
1. High Inventory Levels - may incur high carrying costs
(e.g., investment, storage, insurance, obsolescence, and
damage).

2. Low Inventory Levels – may lead to stock-outs and lost

sales.

6-38 LO 4
Analysis
Illustration: Wal-Mart reported in its 2014 annual report a beginning
inventory of $43,803 million, an ending inventory of $44,858 million,
and cost of goods sold for the year ended January 31, 2014, of
$358,069 million. The inventory turnover formula and computation for
Wal-Mart are shown below.
Illustration 6-21

Days in Inventory: Inventory turnover of 8.1 times divided into 365

is approximately 45.1 days. This is the approximate time that it
takes a company to sell the inventory.

6-39 LO 4
Analysis

Inventory turnover measures the number of times on

average the inventory is sold during the period.

Cost of Goods Sold

Inventory
=
Turnover
Average Inventory

Days in inventory measures the average number of days

inventory is held.
Days in Year (365)
Days in
=
Inventory
Inventory Turnover

6-40 LO 4
DO IT! 4 LCNRV and Inventory Turnover

Tracy company sells three different types of home heating stoves

(gas, wood, and pellet). The cost and net realizable value of its
inventory of stoves are as follows.
Cost Net Realizable Value
Gas $ 84,000 $ 79,000
Wood 250,000 280,000
Pellet 112,000 101,000
Determine the value of the company’s inventory under the lower-
of-cost-or-net realizable value approach.
Solution Lowest value for each inventory type is gas $79,000,
wood $250,000, and pellet $101,000. The total
inventory value is the sum of these amounts, $430,000.
6-41 LO 4
LEARNING APPENDIX 6A: Apply the inventory cost flow
OBJECTIVE
5
methods to perpetual inventory records.

Illustration Illustration 6A-1

Inventoriable units and costs

Assuming the Perpetual Inventory System, compute Cost of Goods Sold

and Ending Inventory under FIFO and average-cost.

6-42 LO 5
First-In, First-Out (FIFO)

Perpetual Inventory System Illustration 6A-2

Cost of Goods Ending Inventory

6-43
Sold
LO 5
Average-Cost

Moving Average Method

Illustration 6A-4

Cost of Goods Ending Inventory

Sold

6-44 LO 5