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C8 - 1
Learning Objectives
Power Notes
1. Internal Control of Inventories 2. Effect of Inventory Errors 3. Inventory Cost Flow Assumptions 4. Perpetual Inventory Costing Methods 5. Periodic Inventory Costing Methods 6. Comparing Inventory Costing Methods 7. Inventory Valuation Other Than Cost 8. Balance Sheet Presentation of Merchandise 9. Estimating Inventory Cost10. Financial Analysis and Interpretation
Chapter F8
Inventories Inventories
C8
C8 - 2
• Inventory Control and Relationships• Perpetual Inventory Accounting• LIFO and FIFO Cost Flow Assumptions• Inventory at Lower-of-Cost-or-Market• Retail and Gross Profit Methods• Inventory Turnover Ratio
Slide # Power Note Topics
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Power NotesChapter F8
Inventories Inventories
Note: To select a topic, type the slide # and press Enter.
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Why is Inventory Control Important?Why is Inventory Control Important?
Inventory is a significant asset and for many companies the largest asset.
Inventory is central to the main activity of merchandising and manufacturing companies.
Mistakes in determining inventory cost can cause critical errors in financial statements.
Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.
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LIABILITIES
OWNER’SEQUITY
REVENUES
ASSETS
COSTS & EXPENSES
Inventory Costs and RelationshipsInventory Costs and Relationships
MerchandiseMerchandiseInventoryInventory
Cost ofCost ofMdse. SoldMdse. Sold
If merchandise inventory is . . . . . . . overstated
Cost of merchandise sold is . . . . . .
Gross profit and net income are . . .
Ending owner’s equity is . . . . . . . . .
If merchandise inventory is . . . . . . . overstated
Cost of merchandise sold is . . . . . .
Gross profit and net income are . . .
Ending owner’s equity is . . . . . . . . .
understated
overstated
overstated
Net Income
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LIABILITIES
OWNER’SEQUITY
REVENUES
ASSETS
COSTS & EXPENSES
Inventory Costs and RelationshipsInventory Costs and Relationships
MerchandiseMerchandiseInventoryInventory
Cost ofCost ofMdse. SoldMdse. Sold
If merchandise inventory is . . . . . . . understated
Cost of merchandise sold is . . . . . .
Gross profit and net income are . . .
Ending owner’s equity is . . . . . . . . .
If merchandise inventory is . . . . . . . understated
Cost of merchandise sold is . . . . . .
Gross profit and net income are . . .
Ending owner’s equity is . . . . . . . . .
overstated
understated
understated
Net Income
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Merchandising and InventoryMerchandising and Inventory
Merchandising involves selling inventory.
Inventory is usually an important asset.
Inventory must be accounted for periodically or perpetually.
Traditional periodic method is often being replaced by perpetual inventory accounting.
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Continuous determination of inventory value
Continuous determination of gross profit
Affordable with computers, scanners, and bar codes on most products
Perpetual inventory accounting provides management controls.
Managers know which items are selling fastest and the profit margin on those items.
Advantages of Using Perpetual InventoryAdvantages of Using Perpetual Inventory
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Perpetual Inventory CostsPerpetual Inventory Costs
Inventory cost data to demonstrate Inventory cost data to demonstrate FIFO and LIFO Perpetual SystemsFIFO and LIFO Perpetual Systems
Inventory cost data to demonstrate Inventory cost data to demonstrate FIFO and LIFO Perpetual SystemsFIFO and LIFO Perpetual Systems
Cost ofCost ofMdse. SoldMdse. Sold
Item 127B Units Cost Price
Jan. 1 Inventory 10 $204 Sale 7 $30
10 Purchase 8 2122 Sale 4 3128 Sale 2 3230 Purchase 10 22
Item 127B Units Cost Price
Jan. 1 Inventory 10 $204 Sale 7 $30
10 Purchase 8 2122 Sale 4 3128 Sale 2 3230 Purchase 10 22
Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.
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Jan. 1 10 20 200 4 7 20 140 3 20 60
Item 127B
FIFO Perpetual Inventory AccountFIFO Perpetual Inventory Account
Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
The sale of 7 units leaves a balance of 3 units.
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Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60
8 21 168
Item 127B
FIFO Perpetual Inventory AccountFIFO Perpetual Inventory Account
Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Because the purchase price of $21 is different than the cost of the previous 3 units on hand, the inventory balance of 11 units is accounted for separately.
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Item 127B
FIFO Perpetual Inventory AccountFIFO Perpetual Inventory Account
Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit TotalDate Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Of the 4 units sold, 3 come from the first units in (FIFO) at a cost of $20.
Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60
8 21 168 22 3 20 60
1 21 21 7 21 147
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Item 127B
FIFO Perpetual Inventory AccountFIFO Perpetual Inventory Account
Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit TotalDate Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60
8 21 168 22 3 20 60
1 21 21 7 21 147 28 2 21 42 5 21 105
Sold 2 units from the 7 units on hand. No allocation is necessary.
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Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60
8 21 168 22 3 20 60
1 21 21 7 21 147 28 2 21 42 5 21 105 30 10 22 220 5 21 105
10 22 220
Item 127B
FIFO Perpetual Inventory AccountFIFO Perpetual Inventory Account
Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit TotalDate Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Totals 18 $388 13 $263 15 $325
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Totals 18 $388 13 $263 15 $325
Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60
8 21 168 22 3 20 60
1 21 21 7 21 147 28 2 21 42 5 21 105 30 10 22 220 5 21 105
10 22 220
Item 127B
FIFO Perpetual Inventory AccountFIFO Perpetual Inventory Account
Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
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DateDate DescriptionDescription DebitDebit CreditCredit
FIFO Perpetual Inventory AccountingFIFO Perpetual Inventory Accounting
Accounts Receivable 390Sales 390
Cost of Merchandise Sold 263Merchandise Inventory 263
Gross Profit = Sales ($390) minus Cost of Merchandise Sold ($263) = $127
Jan. 31
To record January sales of item 127B.(7 units@$30, 4 units@$30, 2 units@$30)
To record cost of January sales of item 127B.
Jan. 31
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Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit TotalDate Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Item 127B
LIFO Perpetual Inventory AccountLIFO Perpetual Inventory Account
Jan. 1 10 20 200 4 7 20 140 3 20 60
The sale of 7 units leaves a balance of 3 units.
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Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit TotalDate Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60
8 21 168
Item 127B
LIFO Perpetual Inventory AccountLIFO Perpetual Inventory Account
The purchase price of $21 is different than the cost of the previous 3 units on hand; therefore, the inventory balance of 11 units is accounted for separately.
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Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit TotalDate Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60
8 21 168 22 4 21 84 3 20 60
4 21 84
Item 127B
LIFO Perpetual Inventory AccountLIFO Perpetual Inventory Account
Of the 4 units sold, all come from the last units in (LIFO) at a cost of $21.
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Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit TotalDate Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60
8 21 168 22 4 21 84 3 20 60
4 21 84 28 2 21 42 3 20 60
2 21 42
Item 127B
LIFO Perpetual Inventory AccountLIFO Perpetual Inventory Account
Of the 2 units sold, all come from the last units in (LIFO) at a cost of $21, leaving 2 units from that group.
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Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit TotalDate Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60
8 21 168 22 4 21 84 3 20 60
4 21 84 28 2 21 42 3 20 60
2 21 42 30 10 22 220 3 20 60
2 21 4210 22 220
Item 127B
LIFO Perpetual Inventory AccountLIFO Perpetual Inventory Account
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Purchases Cost of Mdse. Sold Inventory Balance
Unit Total Unit Total Unit TotalDate Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost
Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60
8 21 168 22 4 21 84 3 20 60
4 21 84 28 2 21 42 3 20 60
2 21 42 30 10 22 220 3 20 60
2 21 4210 22 220
Item 127B
Totals 18 $388 13 $266 15 $322
LIFO Perpetual Inventory AccountLIFO Perpetual Inventory Account
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DateDate DescriptionDescription DebitDebit CreditCredit
LIFO Perpetual Inventory AccountingLIFO Perpetual Inventory Accounting
Accounts Receivable 390Sales 390
Cost of Merchandise Sold 266Merchandise Inventory 266
Gross Profit = Sales ($390) minus Cost of Merchandise Sold ($266) = $124
Jan. 31
To record January sales of item 127B.(7 units@$30, 4 units@$30, 2 units@$30)
To record cost of January sales of item 127B.
Jan. 31
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Jan. 1200 units at $9
First-In, First-Out Flow of CostsFirst-In, First-Out Flow of Costs
Mar. 10300 units at $10
Sep. 21400 units at $11
Nov. 18100 units at $12
$1,800
$3,000
$4,400
$1,200
Purchases
MerchandiseAvailablefor Sale
$10,400$10,400
Using FIFO costing, which units are assumed
to be sold first?
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Jan. 1200 units at $9
First-In, First-Out Flow of CostsFirst-In, First-Out Flow of Costs
Mar. 10300 units at $10
Sep. 21400 units at $11
Nov. 18100 units at $12
$1,800
$3,000
$4,400
$1,200
Purchases
MerchandiseAvailablefor Sale
$1,800
$3,000
$2,200
Cost ofMerchandise
Sold
200 units at $9
$10,400$10,400
$7,000$7,000
300 units at $10
200 units at $11
FIFO cost flow assumes merchandise acquired
first is sold first.
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Jan. 1200 units at $9
First-In, First-Out Flow of CostsFirst-In, First-Out Flow of Costs
Mar. 10300 units at $10
Sep. 21400 units at $11
Nov. 18100 units at $12
$1,800
$3,000
$4,400
$1,200
Purchases
MerchandiseAvailablefor Sale
$1,800
$3,000
$2,200
Cost ofMerchandise
Sold
200 units at $9
$10,400$10,400 $2,200
$1,200
$7,000$7,000
MerchandiseInventory
$3,400$3,400
300 units at $10
200 units at $11
200 units at $11
100 units at $12
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Jan. 1200 units at $9
First-In, First-Out Flow of CostsFirst-In, First-Out Flow of Costs
Mar. 10300 units at $10
Sep. 21400 units at $11
Nov. 18100 units at $12
$1,800
$3,000
$4,400
$1,200
Purchases
MerchandiseAvailablefor Sale
$1,800
$3,000
$2,200
Cost ofMerchandise
Sold
200 units at $9
$10,400$10,400 $2,200
$1,200
$7,000$7,000
MerchandiseInventory
$3,400$3,400
300 units at $10
200 units at $11
200 units at $11
100 units at $12
700 units
1,000 units
300 units
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Jan. 1200 units at $9
Last-In, First-Out Flow of CostsLast-In, First-Out Flow of Costs
Mar. 10300 units at $10
Sep. 21400 units at $11
Nov. 18100 units at $12
$1,800
$3,000
$4,400
$1,200
Purchases
MerchandiseAvailablefor Sale
$10,400$10,4001,000 units total
Using LIFO costing, which units are assumed
to be sold first?
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Jan. 1200 units at $9
Last-In, First-Out Flow of CostsLast-In, First-Out Flow of Costs
Mar. 10300 units at $10
Sep. 21400 units at $11
Nov. 18100 units at $12
$1,800
$3,000
$4,400
$1,200
Purchases
MerchandiseAvailablefor Sale
Cost ofMerchandise
Sold
$10,400$10,400
$4,400
$1,200
$7,600$7,600
200 units at $10
400 units at $11
100 units at $12
$2,000
LIFO cost flow assumes merchandise acquired
last is sold first.
1,000 units total
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Jan. 1200 units at $9
Last-In, First-Out Flow of CostsLast-In, First-Out Flow of Costs
Mar. 10300 units at $10
Sep. 21400 units at $11
Nov. 18100 units at $12
$1,800
$3,000
$4,400
$1,200
Purchases
MerchandiseAvailablefor Sale $1,800
$1,000
Cost ofMerchandise
Sold
200 units at $9
$10,400$10,400
$4,400
$1,200
$2,800$2,800
MerchandiseInventory
$7,600$7,600
100 units at $10
200 units at $10
400 units at $11
100 units at $12
$2,000
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Jan. 1200 units at $9
Last-In, First-Out Flow of CostsLast-In, First-Out Flow of Costs
Mar. 10300 units at $10
Sep. 21400 units at $11
Nov. 18100 units at $12
$1,800
$3,000
$4,400
$1,200
Purchases
MerchandiseAvailablefor Sale $1,800
$1,000
Cost ofMerchandise
Sold
200 units at $9
$10,400$10,400
$4,400
$1,200
$2,800$2,800
MerchandiseInventory
$7,600$7,600
100 units at $10
200 units at $10
400 units at $11
100 units at $12
$2,000
700 units
1,000 units
300 units
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$ 3,800
2,700
4,650
3,920
Total $15,520 $15,472 $15,070 The market decline is either: 1. Based on total inventory ($15,520 – $15,472) = $48 2. Based on individual items ($15,520 – $15,070) = $450 The decline is reported on the income statement as a separate item or included in the cost of merchandise sold.
Valuation of Inventory at Lower-of-Cost-or-MarketValuation of Inventory at Lower-of-Cost-or-Market
A 400 $10.25 $ 9.50 $ 4,100 $ 3,800
B 120 22.50 24.10 2,700 2,892
C 600 8.00 7.75 4,800 4,650
D 280 14.00 14.75 3,920 4,130
Unit UnitInventory Cost Market Total Total Lower
Item Quantity Price Price Cost Market C or M
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Assets
Current assets:
Cash $ 19,400
Accounts receivable $80,000
Less allowance 3,000 77,000
Merchandise inventory
at lower of cost (first-in,
first-out method) or market 216,300
Afro-ArtsBalance Sheet
December 31, 2004
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Retail Method of Estimating Inventory CostRetail Method of Estimating Inventory Cost
Retail method is based on relationship between cost of merchandise available for sale and the retail price.
Retail prices of all merchandise must be accumulated.
Inventory at retail is calculated as retail price of merchandise available for sale less sales.
Ratio is calculated as cost divided by retail price.
Inventory at retail price times cost ratio equals estimated cost of inventory.
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$62,000 $100,000
($62,000 / $100,000 = 62%)
$30,000
($30,000 x 62%) $18,600
Retail Inventory Method CalculationRetail Inventory Method Calculation
Cost Retail
Merchandise inventory, January 1 $19,400 $36,000
Purchases in January (net) 42,600 64,000
Merchandise available for sale
Ratio of cost to retail price:
Sales for January (net) 70,000
Merchandise inventory, January 31, at retail
Merchandise inventory, January 31, at est. cost
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Gross Profit Method of Estimating Inventory CostGross Profit Method of Estimating Inventory Cost
1. A gross profit percentage rate is estimated based on previous experience adjusted for known changes.
2. Estimated gross profit is calculated by multiplying the estimated gross profit rate times the actual net sales.
3. Estimated cost of merchandise sold is calculated by subtracting the gross profit from actual sales.
4. The cost of merchandise sold estimate is deducted from actual merchandise available for sale to determine the estimated cost of merchandise inventory.
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Merchandise inventory, January 1 $ 57,000
Purchases in January (net) 180,000
Merchandise available for sale
Sales in January (net) $250,000Less: Estimated gross profit
Estimated cost of merchandise sold
Estimated merchandise inventory, January 31
Gross Profit Method CalculationGross Profit Method Calculation
$237,000
($250,000 x 30%) 75,000
175,000$ 62,000
Many firms generate a surprisingly stable and predictable gross profit as a percentage of sales.
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Inventory Turnover RatiosInventory Turnover Ratios
SUPERVALU ZaleCost of goods sold $15,620,127,000 $ 737,188,000Inventories:
Beginning of year $1,115,529,000 $478,467,000End of year 1,067,837,000 571,669,000Average $1,091,683,000 $525,068,000
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Inventory Turnover RatiosInventory Turnover Ratios
SUPERVALU ZaleCost of goods sold $15,620,127,000 $ 737,188,000Inventories:
Beginning of year $1,115,529,000 $478,467,000End of year 1,067,837,000 571,669,000Average $1,091,683,000 $525,068,000
Inventory turnoverInventory turnover 14.3 times14.3 times 1.4 times1.4 times
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Inventory Turnover RatiosInventory Turnover Ratios
SUPERVALU La-Z-BoyCost of goods sold $15,620,127,000 $ 737,188,000Inventories:
Beginning of year $1,115,529,000 $478,467,000End of year 1,067,837,000 571,669,000Average $1,091,683,000 $525,068,000
Inventory turnoverInventory turnover 14.3 times14.3 times 1.4 times1.4 times
Average selling periodAverage selling period 25 days25 days 283 days283 days
Use: To assess the efficiency in the management of inventory
Use: To assess the efficiency in the management of inventory
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Note: To see the topic slide, type 2 and press Enter.
This is the last slide in Chapter F8. This is the last slide in Chapter F8.
Power Notes Inventories Inventories
Chapter F8