ACCT 201

REPORTING AND
ANALYZING
6
INVENTORY
Tuba Toksoz
Office: CAS 276
E-Mail: [email protected]
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Learning Objectives

After studying this chapter, you should be able to:

1. Determine how to classify inventory and inventory quantities.

2. Explain the basis of accounting for inventories and apply the inventory
cost flow methods under a perpetual inventory system.

3. Explain the financial statement and tax effects of each of the inventory
cost flow assumptions.

4. Explain the lower-of-cost-or-market basis of accounting for

inventories.

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 Classifying Inventory

Merchandising Manufacturing
Company Company

One Classification: Three Classifications:

 Inventory  Raw Materials

 Work in Process

 Finished Goods

Regardless of the classification, companies report all inventories under

Current Assets on the balance sheet.

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Determining Inventory Quantities

Physical Inventory taken for two reasons:

Perpetual System
1. Check accuracy of inventory records.
2. Determine amount of inventory lost (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.

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 Determining Inventory Quantities

Goods in Transit
 Purchased goods not yet received.
 Sold goods not yet delivered.

Goods in transit should be included in the inventory of the

company that has legal title to the goods. Legal title is
determined by the terms of sale.

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Determining Inventory Quantities

Goods in Transit

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.

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 Determining Inventory Quantities

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.

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Determining Inventory Quantities

Columbia Bank and Trust is considering giving Gallup Company a loan. Before doing so, it
decides that further discussions with Gallup's accountant may be desirable. One area of particular
concern is the Inventory account, which has a year-end balance of $275,000. Discussions with
the accountant reveal the following.
1. Gallup sold goods costing $55,000 to Bazil Company FOB shipping point on December
28. The goods are not expected to reach Bazil until January 12. The goods were not
included in the physical inventory because they were not in the warehouse.
2. The physical count of the inventory did not include goods costing $95,000 that were
shipped to Gallup FOB destination on December 27 and were still in transit at year-end.
3. Gallup received goods costing $25,000 on January 2. The goods were shipped FOB
shipping point on December 26 by Lynch Co. The goods were not included in the physical
count.
4. Gallup sold goods costing $51,000 to Lamey of Canada FOB destination on December 30.
The goods were received in Canada on January 8. They were not included in Gallup's
physical inventory.
5. Gallup received goods costing $42,000 on January 2 that were shipped FOB destination on
December 29. The shipment was a rush order that was supposed to arrive December 31.
This purchase was included in the ending inventory of $275,000.
Instructions
Determine the correct inventory amount on December 31.

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 Ending inventoryphysical count $275,000
1. No effecttitle passes to purchaser upon shipment
when terms are FOB shipping point 0
2. No effecttitle does not transfer to Gallup until
goods are received 0
3. Add to inventory: Title passed to Gallup when
goods were shipped 25,000
4. Add to inventory: Title remains with Gallup until
purchaser receives goods 51,000
5. Subtract from inventory: The goods did not arrive
prior
to year-end. The goods,therefore, cannot be included in
the inventory (42,000)
Correct inventory $309,000

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Determining Inventory Quantities

Consigned Goods
 Goods held for sale by one party.
 Ownership of the goods is retained by another
party.
 The party who owns the goods includes them in
their inventory.

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 Inventory Costing

Unit costs can be applied to quantities on hand using

the following costing methods:

 Specific Identification

 First-in, first-out (FIFO)

Cost Flow
 Last-in, first-out (LIFO)
Assumptions
 Average-cost

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Inventory Costing

Cost Flow
Assumption
does not need to be
consistent with the
physical movement of
goods
Illustration 6-12
Use of cost flow methods in
major U.S. companies

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 Inventory Costing

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.

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Inventory Costing

Illustration: Assume that 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 6-2

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 Inventory Costing

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.

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Inventory Costing

First-In-First-Out (FIFO)
 Earliest goods purchased are first to be sold.

 Often parallels actual physical flow of merchandise.

 Generally good business practice to sell oldest units

first.

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Inventory Costing

Last-In-First-Out (LIFO)
 Latest goods purchased are first to be sold.

 Seldom coincides with actual physical flow of

merchandise.

 Includes goods stored in piles, such as coal or hay.

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Inventory Costing

Average Cost
 Allocates cost of goods available for sale on the basis
of weighted-average unit cost incurred.

 Assumes goods are similar in nature.

 Applies weighted-average unit cost to the units on

hand to determine cost of the ending inventory.

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 APPENDIX6A
Inventory Costing - Perpetual Inventory Systems
Illustration 6A-1

Assuming the Perpetual Inventory System, compute Cost of Goods Sold

and Ending Inventory under FIFO, LIFO, and Average cost.

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Perpetual Inventory System

First-In-First-Out (FIFO) Illustration 6A-2

Cost of Goods
Ending Inventory
Sold
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6-21

Perpetual Inventory System

Last-In-First-Out (LIFO) Illustration 6A-3

Cost of Goods
Ending Inventory
Sold
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6-23

Perpetual Inventory System

Average-Cost
Illustration 6A-4

Cost of Goods Ending Inventory

Sold

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6-25

Inventory Costing

Question
Given equal circumstances, which inventory
method would probably be the most time
consuming?
a. FIFO
b. LIFO
c. Average cost
d. Specific identification.

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 Inventory Costing

Question
Which of the following statements is correct with
respect to inventories?
a. The FIFO method assumes that the costs of
the earliest goods acquired are the last to be sold.
b. It is generally good business management to
sell the most recently acquired goods first.
c. Under FIFO, the ending inventory is based on
the latest units purchased.
d. FIFO seldom coincides with the actual physical
flow of inventory.

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Inventory Costing

Question
A company just starting in business purchased three
merchandise inventory items at the following prices.
First purchase $80; Second purchase $95; Third
purchase $85. If the company sold two units for a
total of $290 and used FIFO costing, the gross profit
for the period would be
a. $115.
b. $125.
c. $110.
d. $100.

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 Inventory Costing

Question
The LIFO inventory method assumes that the cost of the latest
units purchased are
a. the last to be allocated to cost of goods sold.
b. the first to be allocated to ending inventory.
c. the first to be allocated to cost of goods sold.
d. not allocated to cost of goods sold or ending inventory.

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Inventory Costing

Question
Snug-As-A-Bug Blankets has the following inventory data:
July 1 Beginning inventory 15 units at $60
5 Purchases 90 units at $56
14 Sale 60 units
21 Purchases 45 units at $58
30 Sale 42 units

Assuming that a perpetual inventory system is used, what is ending

inventory (rounded) under the average cost method for July?
a. $2,750
b. $2,784
c. $2,406.
d. $2,772

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 Inventory Costing

Question
Classic Floors has the following inventory data:
July 1 Beginning inventory 15 units at $6.00
5 Purchases 60 units at $6.60
14 Sale 40 units
21 Purchases 30 units at $7.20
30 Sale 28 units
Assuming that a perpetual inventory system is used, what is the
cost of goods sold on a LIFO basis for July?
a. $465.60
b. $236.40
c. $702.00
d. $348.00

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Perpetual Inventory System

Financial Statement and Tax Effects

Houston Electronics
Condensed Income Statements

FIFO LIFO Average-Cost

Sales revenue $11,500 $11,500 $11,500
Beginning inventory 1,000 1,000 1,000
Purchases 11,000 11,000 11,000
Cost of goods available for sale 12,000 12,000 12,000
Ending inventory 5,800 5,700 5,767
Cost of goods sold 6,200 6,300 6,233
Gross profit 5,300 5,200 5,267
Operating expenses 2,000 2,000 2,000
Income before income taxes2 3,300 3,200 3,267
Income tax expense (30%) 990 960 980
Net income $2,310 $2,240 $2,287

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 Inventory Costing

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.

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Inventory Costing

Question
In a period of inflation, the cost flow method that results
in the lowest income taxes is the:

a. FIFO method.

b. LIFO method.

c. average cost method.

d. gross profit method.

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 Inventory Costing

Using Cost Flow Methods Consistently

 Method should be used consistently, enhances
comparability.
 Although consistency is preferred, a company may
change its inventory costing method.
Illustration 6-14
Disclosure of change in
cost flow method

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Inventory Costing

Lower-of-Cost-or-Market
When the value of inventory is lower than its cost

 Companies can “write down” the inventory to its market

value in the period in which the price decline occurs.

 Market value = Replacement Cost

 Example of conservatism.

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 Inventory Costing

Question
When applying the lower of cost or market rule to each item, what will
Nelson's total ending inventory balance be?
Inventory Item Units Cost per unit Market value per unit
X 150 $4.00 $3.50
Y 300 $2.00 $1.50
Z 750 $3.00 $4.00

a. $3,450
b. $3,225
c. $3,975
d. $3,300

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Key Points
 A major difference between IFRS and GAAP relates to the
LIFO cost flow assumption. GAAP permits the use of LIFO
for inventory valuation. IFRS prohibits its use. FIFO and
average-cost are the only two acceptable cost flow
assumptions permitted under IFRS.

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 IFRS Self-Test Questions

Which method of inventory costing is prohibited under

IFRS?

a) Specific identification.

b) FIFO.

c) LIFO.

d) Average-cost.

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Inventory Costing

Question
In periods of rising prices, which is an advantage of using the LIFO
inventory costing method?
a. Ending inventory will include latest (most recent) costs
and thus be more realistic.
b. Cost of goods sold will include latest (most recent) costs
and thus will be more realistic.
c. Net income will be the highest and thus reflect the
prosperity of the company.
d. Phantom profits are reported.

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 Inventory Costing

Question
The managers of Hong Company receive performance bonuses based
on the net income of the firm. Which inventory costing method are they
likely to favor in periods of declining prices?
a. LIFO
b. Average Cost
c. FIFO
d. Physical inventory method

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Inventory Costing

Question
Ace Company is a retailer operating in an industry that experiences
inflation (rising prices). Ace wants the most realistic cost of goods sold.
Which inventory costing method should Ace consider using?
a. Average because all inventory costs will then represent an
average amount.
b. Specific identification is the most realistic method because it
involves the actual costs.
c. LIFO because cost of goods sold represents the latest costs.
d. FIFO because cost of goods sold represents the earliest costs.

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 Inventory Costing

Question
Which of the following should not be included in the physical
inventory of a company?
a. Goods held on consignment from another company.
b. Goods in transit from another company shipped FOB
shipping point.
c. Goods shipped on consignment to another company.
d. All of these answer choices should be included.

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Inventory Costing

Question
Echo Sound Company just began business and made the following four
inventory purchases in June:
June 1 150 units $ 780
June 10 200 units 1,170
June 15 200 units 1,260
June 28 150 units 990
$4,200
A physical count of merchandise inventory on June 30 reveals that there are 210
units on hand. The inventory method which results in the highest gross profit for
June is
a. the FIFO method.
b. the LIFO method.
c. the average cost method.
d. not determinable.

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