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Reporting and Interpreting Cost of Goods Sold and Inventory
Chapter 7
McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.
Inventory Costing Methods
Total Dollar Amount of Goods Available for Sale
Total Dollar Amount of Goods Available for Sale
Ending InventoryEnding Inventory Cost of Goods SoldCost of Goods Sold
Inventory Costing Method
Inventory Costing Methods1. Specific Identification2. First-in, First-out3. Last-in, First-out4. Weighted Average
Specific Identification
When units are sold, the
specific cost of the unit sold is added to cost of goods sold.
When units are sold, the
specific cost of the unit sold is added to cost of goods sold.
Cost Flow AssumptionsThe choice of an inventory
costing method is not based on the physical flow of goods on and
off the shelves.
LIFO
FIFOWeightedAverage
First-In, First-Out Method
Cost of Goods Sold
Cost of Goods SoldOldest CostsOldest Costs
Ending Inventory
Ending Inventory
Recent CostsRecent Costs
First-In, First-OutRemember: The
costs of most recent purchases
are in ending inventory. Start with 11/29 and
add units purchased until you reach the
number in ending inventory.
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 ?
Cost of Goods Sold 1,050 ?
First-In, First-Out
Now, we have allocated the cost to all 1,200 units in ending inventory.
Now, we have allocated the cost to all 1,200 units in ending inventory.
Beg. Inv. 1,000 @ 5.25$ Jan. 3 500 @ 5.30 450 @ $5.30June 20 300 @ 5.60 300 @ $5.60Sept. 15 250 @ 5.80 250 @ $5.80Nov. 29 200 @ 5.90 200 @ $5.90
1,200 Units Units
6,695$ Cost
Ending InventoryCost of Goods
SoldGiven Information
First-In, First-Out
Now, we have allocated the cost to all 1,050 units sold.
Now, we have allocated the cost to all 1,050 units sold.
Beg. Inv. 1,000 @ 5.25$ 1,000 @ 5.25$ Jan. 3 500 @ 5.30 450 @ $5.30 50 @ 5.30 June 20 300 @ 5.60 300 @ $5.60Sept. 15 250 @ 5.80 250 @ $5.80Nov. 29 200 @ 5.90 200 @ $5.90
1,200 Units 1,050 Units
6,695$ Cost 5,515$ Cost
Ending InventoryCost of Goods
SoldGiven Information
First-In, First-Out
Here is the cost of ending
inventory and cost of goods sold using FIFO.
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 6,695.00$
Cost of Goods Sold 1,050 5,515.00$
Last-In, First-Out Method
Ending Inventory
Ending Inventory
Cost of Goods Sold
Cost of Goods Sold
Oldest CostsOldest Costs
Recent CostsRecent Costs
Last-In, First-OutRemember: The
costs of the oldest purchases are in
ending inventory. Start with beginning
inventory and add units purchased
until you reach the number in ending
inventory.
Remember: The costs of the oldest purchases are in
ending inventory. Start with beginning
inventory and add units purchased
until you reach the number in ending
inventory.
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 ?
Cost of Goods Sold 1,050 ?
Last-In, First-Out
Now, we have allocated the cost to all 1,200 units in ending inventory.
Now, we have allocated the cost to all 1,200 units in ending inventory.
Beg. Inv. 1,000 @ 5.25$ 1,000 @ $5.25Jan. 3 500 @ 5.30 200 @ 5.30 June 20 300 @ 5.60 Sept. 15 250 @ 5.80 Nov. 29 200 @ 5.90
1,200 Units Units
6,310$ Cost
Ending InventoryCost of Goods
SoldGiven Information
Last-In, First-Out
Now, we have allocated the cost to all 1,050 units sold.
Now, we have allocated the cost to all 1,050 units sold.
Beg. Inv. 1,000 @ 5.25$ 1,000 @ $5.25Jan. 3 500 @ 5.30 200 @ 5.30 300 @ 5.30$ June 20 300 @ 5.60 300 @ 5.60 Sept. 15 250 @ 5.80 250 @ 5.80 Nov. 29 200 @ 5.90 200 @ 5.90
1,200 Units 1,050 Units
6,310$ Cost 5,900$ Cost
Ending InventoryCost of Goods
SoldGiven Information
Last-In, First-Out
Here is the cost of ending
inventory and cost of goods sold using LIFO.
Here is the cost of ending
inventory and cost of goods sold using LIFO.
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 6,310.00$
Cost of Goods Sold 1,050 5,900.00$
Average Cost Method
When a unit is sold, the average cost of each unit in inventory is assigned to cost
of goods sold.
When a unit is sold, the average cost of each unit in inventory is assigned to cost
of goods sold. Cost of Goods Available for
Sale
Number of Units Available
for Sale÷
Average Cost Method
12,210$ 2,250
= $5.42667
Weighted Average Cost
1,200 × 5.42667$
1,050 × 5.42667$
Computers, Inc.Mouse Pad Inventory
Date Units $/Unit TotalBeginning Inventory 1,000 5.25$ 5,250.00$ Purchases:Jan. 3 500 5.30 2,650.00 June 20 300 5.60 1,680.00 Sept. 15 250 5.80 1,450.00 Nov. 29 200 5.90 1,180.00 Goods Available for Sale 2,250 12,210.00$
Ending Inventory 1,200 6,512.00$
Cost of Goods Sold 1,050 5,698.00$
Comparison of Methods
FIFO LIFO
Weighted Average
Net sales 25,000$ 25,000$ 25,000$ Cost of goods sold:Merchandise inventory, beginning 5,250$ 5,250$ 5,250$ Net purchases 6,960 6,960 6,960 Goods available for sale 12,210$ 12,210$ 12,210$ Merchandise inventory, ending 6,695 6,310 6,512 Cost of goods sold 5,515$ 5,900$ 5,698$ Gross profit 19,485$ 19,100$ 19,302$ Operating expenses 750 750 750 Income before taxes 18,735$ 18,350$ 18,552$ Income taxes expense (30%)* 5,621 5,505 5,566 Net income 13,114$ 12,845$ 12,986$
* Tax expense amounts were rounded.
Computers, Inc.Income Statement
For Year Ended December 31, 2009
Financial Statement Effects of Costing Methods
Advantages of MethodsAdvantages of Methods
Better matches current costs in cost of goods sold with
revenues.
Better matches current costs in cost of goods sold with
revenues.
Ending inventory approximates
current replacement cost.
Ending inventory approximates
current replacement cost.
First-In, First-Out
First-In, First-Out
Last-In, First-Out
Last-In, First-Out
Smoothes out price changes.Smoothes out price changes.
Weighted Average
Weighted Average
Managers Choice of Inventory Methods
Net Income EffectsManagers prefer to report higher earnings for their
companies.
Net Income EffectsManagers prefer to report higher earnings for their
companies.
Income Tax EffectsManagers prefer to pay the
least amount of taxes allowed by law as late as possible.
Income Tax EffectsManagers prefer to pay the
least amount of taxes allowed by law as late as possible.
LIFO Conformity RuleIf last-in, first-out is used on the
income tax return, it must also be used to calculate inventory and cost of
goods sold for financial statements.
LIFO and International Comparisons
LIFO Permitted?
YesYesNoNo
ChinaSingapore
Canada
Great Britain
Australia
IFRS also Prohibits the use of LIFO
• Work AP7-1 (page 389)
