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Inventories – Part II
Chapter 8
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Using FIFO, the earliest batch purchased is considered the first batch of merchandise sold. The physical flow does not have to match the accounting method chosen.
First-In, First-Out Method
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= $2,000
= 1,680
= 2,200
Cost of merchandise available for sale
100 units @ $20100 units @ $20
80 units @ $2180 units @ $21
100 units @ $22100 units @ $22
280 units available for sale during year
Jan. 1
Jan. 10
Jan. 30
$5,880
FIFO Method
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The physical count on January 31 shows that 150 units are on hand (conclusion: 130 units were sold). What is the cost of the ending inventory?
= $ 0
= 1,050
= 2,200
100 units @ $20100 units @ $20
80 units @ $2180 units @ $21
100 units @ $22100 units @ $22
Jan. 1
Jan. 10
Jan. 30
Sold these
Sold 30 of the 80
50 units @ $2150 units @ $21
100 units @ $22100 units @ $22
Ending inventory
$3,2504
Now we can calculate the cost of goods sold as follows:
Beginning inventory, January 1 $2,000Purchases ($1,680 + $2,200) 3,880Cost of merchandise available for sale $5,880Ending inventory, January 31 3,250Cost of merchandise sold $2,630
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Exhibit 5 First-In, First-Out Flow of Costs
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Using LIFO, the most recent batch purchased is considered the first batch of merchandise sold. The actual flow of goods does not have to be LIFO. For example, a store selling fresh fish would want to sell the oldest fish first (which is FIFO) even though LIFO is used for accounting purposes.
Last-In, First-Out Method
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= $2,000
= 1,680
= 2,200
Cost of merchandise available for sale
100 units @ $20100 units @ $20
80 units @ $2180 units @ $21
100 units @ $22100 units @ $22
280 units available for sale during year
Jan. 1
Jan. 10
Jan. 30
$5,880
LIFO Method
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Assume again that the physical count on January 31 is 150 units (and that 130 units were sold). What is the cost of the ending inventory?
= $2,000
= 1, 680
= 2,200
100 units @ $20100 units @ $20
80 units @ $2180 units @ $21
100 units @ $22100 units @ $22
Jan. 1
Jan. 10
Jan. 30 Sold these
Sold 30 of the 80
50 units @ $2150 units @ $21
= 0
= 1,050
Ending inventory
$3,050
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Now we can calculate the cost of goods sold as follows:
Beginning inventory, January 1 $2,000Purchases ($1,680 + $2,200) 3,880Cost of merchandise available for sale $5,880Ending inventory, January 31 3,050Cost of merchandise sold $2,830
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Exhibit 5
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The average cost method is sometimes called the weighted average method. It uses the average unit cost for determining cost of merchandise sold and the ending merchandise inventory.
Average Cost Method
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The weighted average unit cost is determined as follows:
Average Unit Cost =
Total Cost of Units Available for Sale
Units Available for Sale
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$5,880
= $2,000
= 1,680
= 2,200
100 units @ $20100 units @ $20
80 units @ $2180 units @ $21
100 units @ $22100 units @ $22
280
Jan. 1
Jan. 10
Jan. 30
Average unit cost: $5,880 ÷ 280 = $21Cost of merchandise sold: 130 units at $21 = $2,730Ending merchandise inventory: 150 units at $21= $3,150
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Now we can calculate the cost of goods sold as follows:
Beginning inventory, January 1 $2,000Purchases ($1,680 + $2,200) 3,880Cost of merchandise available for sale $5,880Ending inventory, January 31 3,150Cost of merchandise sold $2,730
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Example Exercise 7-4
Periodic Inventory Using FIFO, LIFO, Average Cost Methods
The units of an item available for sale during the year were as follows:
Jan. 1 Inventory 6 units @ $50 $ 300Mar. 20Purchase 14 units @ $55 770Oct. 30 Purchase 20 units @ $62 1,240 Available for sale 40 units $2,310
There are 16 units of the item in the physical inventory at December 31. The periodic inventory system is used. Determine the inventory cost by (a) the first-in, first-out (FIFO) method, (b) the last-in, first-out (LIFO) method, and (c) the average cost method.
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Example Exercise 7-4 (continued)
a) First-in, first-out (FIFO) method: $992 (16 units × $62)
c) Average method: $924 (16 units × $57.75) where average cost = $57.75 ($2,310 ÷ 40 units)
b) Last-in, first-out (LIFO) method: $850 (6 units × $50) + (10 units × $55)
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Partial Income Statements
Net sales $3,900Cost of merchandise sold:
Beginning inventory $2,000Purchases 3,880Merchandise available for sale $5,880Less ending inventory 3,250 Cost of merchandise sold 2,630
Gross profit $1,270
First-In, First-Out
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Partial Income Statements
Net sales $3,900Cost of merchandise sold:
Beginning inventory $2,000Purchases 3,880Merchandise available for sale $5,880Less ending inventory 3,150 Cost of merchandise sold 2,730
Gross profit $1,170
Average Cost
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Net sales $3,900Cost of merchandise sold:
Beginning inventory $2,000Purchases 3,880Merchandise available for sale $5,880Less ending inventory 3,050 Cost of merchandise sold 2,830
Gross profit $1,070
Last-In, First-Out
Partial Income Statements
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Effects of Changing Costs (Prices): FIFO and LIFO Cost MethodsExhibit 7
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Weighted FIFO Average LIFO
Ending inventory $3,250 $3,150 $3,050
Cost of merchandise sold $2,630 $2,730 $2,830
Gross profit $1,270 $1,170 $1,070
Recap
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Cost is the primary basis for valuing and reporting inventories in the financial statements. However, inventory may be valued at other than cost in the following cases:
Cost
(continued)
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1. The cost of replacing items in inventory is below the recorded cost.
2. The inventory cannot be sold at normal prices due to imperfections, style changes, or other causes.
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Market, as used in lower of cost or market, is the cost to replace the merchandise on the inventory date.
Market
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Cost and replacement cost can be determined for the following:1. Each item in the inventory.
2. Each major class or category of inventory.
3. Total inventory as a whole.
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Determining Inventory at Lower of Cost or MarketExhibit 8
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Example Exercise 7-5
Lower-of-Cost-or-Market Method
On the basis of the following data, determine the value of the inventory at the lower of cost or market. Apply lower of cost or market to each inventory item as shown in Exhibit 8.
Inventory Unit UnitCommodity Quantity Cost Price Market Price
C17Y 10 $ 39 $40B563 7 110 98
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Example Exercise 7-5 (continued)
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Merchandise that is out of date, spoiled, or damaged should be written down to its net realizable value. This is the estimated selling price less any direct cost of disposal, such as sales commissions.
Net Realizable Value
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Merchandise inventory is usually presented in the Current Assets section of the balance sheet, following receivables.
Merchandise Inventory on the Balance Sheet
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The method of determining the cost of inventory (FIFO, LIFO, or weighted average) and the method of valuing the inventory (cost or the lower of cost or market) should be shown.
Merchandise Inventory on the Balance Sheet
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Effect of Inventory Errors on the Financial Statements
Some reasons causing inventory errors to occur include the following:1. Physical inventory on hand was miscounted.2. Costs were incorrectly assigned to
inventory.3. Inventory in transit was incorrectly
included or excluded from inventory.4. Consigned inventory was incorrectly
included or excluded from inventory.
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Effect of Inventory Errors on Current Period’s Income StatementExhibit 9
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Effect of Inventory Errors on Two Years’ Income Statements
7-91
Exhibit 10
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Effect of Inventory Errors on Current Period’s Balance Sheet
Exhibit 11
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Example Exercise 7-6
Effect of Inventory Errors
Zula Repair Shop incorrectly counted its December 31, 2010 inventory as $250,000 instead of the correct amount of $220,000. Indicate the effect of the misstatement on Zula’s December 31, 2010 balance sheet and income statement for the year ended December 31, 2010.
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Example Exercise 7-6 (continued)
Amount of Misstatement Overstatement (Understatement)
Balance Sheet:Merchandise inventory overstated $30,000Current assets overstated 30,000Total assets overstated 30,000Owner’s equity overstated 30,000
Income Statement:Cost of merchandise sold understated $(30,000)Gross profit overstated 30,000Net income overstated 30,000
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