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Chapter 4 1
Cash, Short-term Investments
and Accounts Receivable
Chapter 4
Chapter 5 2
Chapter 5Inventory
Chapter 5 3Chapter 5 3
Chapter 5Learning Objectives
• Account for common inventory transactions.
• Use the four major inventory cost flow methods to calculate ending inventory and cost of goods sold.
• Use the retail inventory method to calculate ending inventory and cost of goods sold.
• Apply the lower-of-cost-or-market rule to inventory.
• Determine the effects of inventory errors on financial statements.
• Use ratios and other analysis techniques to make decisions about inventory.
Chapter 5 4
Comparison of Perpetual and Periodic Inventory Systems
Chapter 5 5
Inventory Accounting Terms
• Sales• Sales Returns and Allowances• Sales Discounts• Purchase Returns and
Allowances • Purchase Discounts• Freight-In• Delivery Expense(Freight-out)• Cost of Goods Sold
Chapter 5 6
Shipping Terms
FOB Shipping Point: BuyerBuyer payspays to get the goods to the destination.
FOB Destination: Seller paysSeller pays to get the goods to the destination.
Chapter 5 7
Accounting for Common Inventory Transactions
Six common transactions are related to accounting for inventory:a. Purchasing inventory from a supplierb. Paying for freight on purchasesc. Returning inventory to a supplierd. Selling inventory to a customere. Accepting returns of inventory from a customerf. Paying on account for purchases of inventory
The next few slides will show examples of journal entries for the above transactions.
Chapter 5 8
Purchasing Inventory From a Supplier
On August 1, Marcia’s Boutique purchased 12 dresses at $50 each from a supplier, Kwon, Inc. The credit terms are 2/10, n/30 and the shipping terms are FOB shipping point.
Chapter 5 9
Paying for Freight-In on Purchases
On August 3, Marcia receives and pays the $22 freight bill on the dresses purchased on August 1.
Chapter 5 10
Returning Inventory to a Supplier
On August 5, Marcia’s Boutique returned a dress to Kwon because the dress had a fabric flaw.
Chapter 5 11
Selling Inventory to a Customer
Marcia’s Boutique sells three dresses for cash ($110 per dress) on August 7. Because the company uses a perpetual inventory system, two journal entries are required.
Chapter 5 12
Accepting Returns of Inventory from a Customer
On August 8, one customer who bought a dress on August 7 decided to return it. Marcia’s Boutique will prepare two journal entries to record the return.
Chapter 5 13
Paying on Account for Purchases of Inventory
On August 11, Marcia’s paid for the dresses purchased from Kwon. The credit terms allow Marcia’s Boutique to deduct 2% from the total amount owed if payment is made by August 11.
Chapter 5 14
Summary of Perpetual Inventory Transactions
Chapter 5 15Chapter 5 15
The entry to purchase merchandise under a perpetual inventory system includes a debit to:
a. purchases.
b. accounts payable.
c. inventory.
d. accounts receivable.
Chapter 5 16Chapter 5 16
The entry to purchase merchandise under a perpetual inventory system includes a debit to:
a. purchases.
b. accounts payable.
c. inventory.
d. accounts receivable.
Chapter 5 17Chapter 5 17
The entry under a perpetual inventory system for the seller to record the cost of merchandise returned includes a credit to:
a. purchases.
b. accounts payable.
c. inventory.
d. cost of goods sold.
Chapter 5 18Chapter 5 18
The entry under a perpetual inventory system for the seller to record the cost of merchandise returned includes a credit to:
a. purchases.
b. accounts payable.
c. inventory.
d. cost of goods sold.
Chapter 5 19Chapter 5 19
The entry under a perpetual inventory system to record the cost of merchandise sold includes a debit to:
a. accounts receivable.
b. inventory.
c. cost of goods sold.
d. sales.
Chapter 5 20Chapter 5 20
The entry under a perpetual inventory system to record the cost of merchandise sold includes a debit to:
a. accounts receivable.
b. inventory.
c. cost of goods sold.
d. sales.
Chapter 5 21
Inventory Cost Flow Methods
•Specific Identification•First In First Out•Last In First Out
•Weighted Average
Chapter 5 22
Cost Flow Example
The operations of University Bookstore are used to explore the topic of inventory costing. Following are inventory data for January for a Principles of Marketing textbook. The text is a paperback version and, thus, there are no used copies of the text available for sale. To simplify the example, it is assumed that University Bookstore is only open two days in January; all sales, therefore, occur on those two days.
1/ 1 Beginning inventory 100 copies @ $30 each $ 3,0001/ 8 Purchased 400 copies @ $35 each 14,0001/14 Sold 360 copies1/18 Purchased 70 copies @ $39 each 2,7301/22 Sold 180 copies
Chapter 523
Item: Principles of Marketing, Perpetual Inventory Record, FIFO Method
Purchases Sold Balance
Date #
UnitCost
Total
#
UnitCost
Total
#
Unit Cost
Balance
Jan. 1 100 $30 $3,000
Jan. 8 400 $35 14,000 100400500
$30 35
$ 3,000 14,000$17,000
Jan. 17
100260
$30 35
$3,000
$9,100
140
$35
$4,900
Jan. 18
70 $39 $2,730 140 70210
$35 39
$4,900 2,730 $7,630
Jan. 22
140 40
$35 39
$4,900 $1,560
30
$39
$1,170
Chapter 524
Item: Principles of Marketing, Perpetual Inventory Record, Perpetual LIFO
Purchases Sold Balance
Date #
UnitCost
Total
#
UnitCost
Total
#
Unit Cost
Balance
Jan. 1 100 $30 $3,000
Jan. 8 400 $35 $14,000 100400500
$30 35
$ 3,000 14,000$17,000
Jan. 17
360 $35 $12,600 100 40
$30 35
$ 3,000 1,400 $4,400
Jan. 18
70 $39 $2,730 100 40 70210
$30 35 39
$3,000 1,400 2,730 $7,130
Jan. 22
70 40 70
$39 35 30
$2,730 1,400 2,100
30
$30
$ 900
Chapter 525
Item: Principles of Marketing, Perpetual Inventory Record, Moving Average Method
Purchases Sold Balance
Date #
UnitCost
Total
#
UnitCost
Total
#
Unit Cost
Balance
Jan. 1 100 $30 $ 3,000
Jan. 8 400 $35 $14,000
500
$17,000
Jan. 17
360 $34 $12,240 140
$34
$ 4,760
Jan. 18
70 $39 $2,730 210
$ 7,490
Jan. 22
180
$35.67
$6,421 30
$35.67
$ 1,069
Chapter 5 26
Cost of Goods Sold, Gross Profit and Inventory Amounts
Chapter 5 27
Cost Flow
Chapter 5 28Chapter 5 28
Compute the ending inventory for Rayborn Company using the LIFO perpetual method based on the following information. On January 1 Rayborn Company had 25 units at a cost of $50 each.
Date Purchases Sales
Feb. 10 20 units @ $56
April 5 32 units
June 19 26 units @ $60
Aug. 29 15 units
Nov. 10 10 units @ $63
Chapter 5 29
Date Purchases Sales Balance
Jan. 1 25 @ $50 = $1,250
Feb. 10 20 @ $56 = $1,120 25 @ $50 = $1,250
20 @ $56 = $1,120
April 5 20 @ $56 = $1,120
12 @ $50 = $600 13 @ $50 = $650
June 19 26 @ $60 = $1,560 13 @ $50 = $650
26 @ $60 = $1,560
Aug. 29 15 @ $60 = $900 13 @ $50 = $650
11 @ $60 =$660
Nov. 10 10 @ $63 = $630 13 @ $50 = $650
11 @ $60 = $660
10 @ $63 = $630
Total ending inventory = $1,940
Chapter 5 30
Retail Inventory Method
• Often used in small businesses to estimate the amount of inventory on hand.
• Should be a consistent relationship between the costs and selling prices of a company’s products.
• Can be used with FIFO, LIFO, or average cost flow assumptions.
Chapter 5 31
Retail Inventory Method Illustrated
Chapter 5 32Chapter 5 32
Compute estimated ending inventory using the retail inventory method for the King Company on December 31, 2011.
Cost Retail
Jan. 1 inventory $50,000 $ 90,000
Purchases during 2011 70,000 150,000
Sales during 2011 200,000
Chapter 5 33Chapter 5 33
Compute estimated ending inventory using the retail inventory method for the King Company on Dec. 31, 2011.
Cost Retail
Jan. 1 inventory $ 50,000 $ 90,000
Purchases during 2011 70,000
150,000
Goods available for sale 120,000 240,000
Sales during 2011 (200,000)
Ending inventory at retail $ 40,000
Cost to retail % (120,000/240,000 = 50%
Ending inventory at cost ($40,000 X 50%) $ 20,000
Chapter 5 34
Lower of Cost or Market
ITEM727 Jeans757 JeansTank tops Pullovers
Quantity30205040
Unit Cost14241518
ReplacementCost
18172014
Total Cost 420 480 750 7202,370*
Total Market 540 3401000 5602440
LCM 420 340 750 5602,070**
*Applying LCM on a total inventory basis
**Applying LCM on an Item by Item basis
Chapter 5 35Chapter 5 35
John Company has 200 units of inventory on hand at December 31. John’s cost under FIFO is $52 per unit. The Dec. 31 current cost is $55 per unit. Using lower-of-cost-or-market, John should show an ending inventory balance of
a. $10,400.
b. $11,000.
c. $10,700.
d. $10,500.
Chapter 5 36Chapter 5 36
John Company has 200 units of inventory on hand at December 31. John’s cost under FIFO is $52 per unit. The Dec. 31 current cost is $55 per unit. Using lower-of-cost-or-market, John should show an ending inventory balance of
a. $10,400.
b. $11,000.
c. $10,700.
d. $10,500.
Chapter 5 37
Effects of Inventory Errors
Inventory
Cost of Goods Sold
Current Year Next Year
Ending - overstated
Overstated
Understated
Net Income
Beginning - overstated
Overstated
Understated
Ending - understated
Overstated
Overstated
Understated
Understated
Beginning - overstated
Chapter 5 38Chapter 5 38
John Company overstated 2010 ending inventory by $25,000. What effect will this error have on 2010 and 2011 net income, respectively?
a. overstate and understate
b. overstate and overstate
c. understate and understate
d. understate and overstate
Chapter 5 39Chapter 5 39
John Company overstated 2010 ending inventory by $25,000. What effect will this error have on 2010 and 2011 net income, respectively?
a. overstate and understate
b. overstate and overstate
c. understate and understate
d. understate and overstate
Chapter 5 40
Relevant RatiosInventory Turnover Ratio = Cost of Goods Sold ÷ Average Inventory
Age of Inventory = 360 days ÷ Inventory Turnover Ratio
The inventory turnover ratio indicates the number of times that a company sells or "turns over" its inventory each year.
Inventory age indicates the average period required to sell an item of inventory.
Chapter 5 41Chapter 5 41
THE END!
