3. Inventories are assets held:
1. For sale in the ordinary course of business
2. In the process of production for such sale
3. In the form of materials or supplies to be
consumed in the production process or in the
rendering of services
4. Types of Inventory
Inventory comes in many
shapes and sizes such
as:
◦ Raw materials –
purchased items or
extracted materials
transformed into
components or products
◦ Components – parts or
subassemblies used in
final product
◦ Work-in-process – items
in process throughout the
plant
◦ Finished goods –
products sold to
customers
◦ Distribution inventory –
finished goods in the
distribution system
5. Accounting Principles Related to Inventory
Consistency
Companies should use same inventory
method from period to period
Disclosure
Companies should disclose inventory
method used
Conservatism
Companies should “write down” inventory if
market price falls below cost
6. COST OF INVENTORY
All expenditures incurred to
bring the item to its
existing condition and
location
7. Purchase price
+ Freight-in
- Purchase returns
- Purchase Discounts
= Net cost of purchases
- Purchase allowances
Transportation costs
Unsuitable goods
returned to seller
Reduction in
amount owed
For early payment
8. Sales revenue
- Sales returns
- Sales Discounts
= Net Sales
- Sales allowances
Unsuitable goods
returned to company
Reduction in
amount owed
For early payment
10. HOW TO ACCOUNT FOR INVENTORY
PURCHASES, SALES AND REPORTING?
Applying either the periodic inventory
system or the perpetual inventory system
and select a cost flow assumption to
determine the value of inventories.
Both inventory systems require a physical
count of inventory at the end of a period to
determine the units which can be included
in the inventory count.
11. Inventory Systems -
Periodic
Compute inventory balance at end of
each accounting period
Compute cost of goods sold at the
end of accounting period
12. Compute cost of goods sold at each
sale
Compute new inventory balance at
each sale
13. Perpetual system Periodic System
At purchase
Inventory xxx Purchases xxx
A/P xxx A/P xxx
At sale:
CGS xxx None
Inventory xxx
A/R xxx A/R xxx
Sales xxx Sales xxx
13
14. Cost Flow Assumptions
Only with specific identification do we
attempt to match the actual movement of
product through the business with the
movement of costs through the accounting
system
With other inventory cost methods, we make
an assumption of the movement of costs
through the accounting system.
15. Cost Flow Assumptions(Contd.)
This "flow" of costs through the system need
not match the movement of product through
the business
16. COST FLOW ASSUMPTIONS
FIRST-IN, FIRST-OUT(FIFO)
Earliest goods assumed to be first units
sold
Inventory made up of latest goods
acquired
18. First-in, First-out (FIFO) Method
Step 1: Assign the cost of the beginning
inventory to cost of goods sold.
1st
in
19. First-in, First-out (FIFO) Method
ALLOCATE TO
Ending Cost of
Units Cost Inventory Goods Sold
1/1 500 $10 $5,000
1/20 300 $11
4/8 400 $12
9/5 200 $13
12/12 100 $14
20. First-in, First-out (FIFO) Method
Step 2: Continue to work forward until you
assign the total number of units sold
during the period to cost of goods sold.
Allocate the remaining costs to ending
inventory.
2nd
3rd etc.
24. Last-in, First-out (LIFO) Method
Step 1: Assign the cost of the last units
purchased to cost of goods sold.
1st
in
25. Last-in, First-out (LIFO) Method
ALLOCATE TO
Ending Cost of
Units Cost Inventory Goods Sold
1/1 500 $10
1/20 300 $11
4/8 400 $12
9/5 200 $13
12/12 100 $14 $1,400
26. 1st
in
Step 2: Work backwards until you assign the
total number of units sold during the
period to cost of goods sold (allocate
the remaining costs to ending
inventory).
Last-in, First-out (LIFO) Method
28. COST FLOW ASSUMPTIONS
AVERAGE COST
Cost of items sold is the weighted average
of costs incurred
Inventory is the weighted average of costs
incurred
31. Weighted Average Method
Date purchased Units Cost Total cost
Beg. inventory 500 $10 $ 5,000
1/20 300 11 3,300
4/8 400 12 4,800
9/5 200 13 2,600
12/12 100 14 1,400
Cost of goods
available for sale 1,500 $17,100
32. Weighted Average Method
Step 2: Divide the cost of goods available
for sale by the total units to
determine the weighted average
cost per unit.
34. Weighted Average Method
Step 3: Calculate ending inventory and
cost of goods sold by multiplying
the weighted average cost per unit
by the number of units in ending
inventory and the number of units
sold.
Avg.
Cost
No. of
Units
35. Weighted Average Method
ALLOCATE TO
Ending Cost of
Inventory Goods Sold
Units on hand 600
Units sold 900
Weighted average cost $11.40 $ 11.40
Total cost of goods
available of $17,100 allocated: $6,840 $10,260
36. Comparison of Costing Methods
Cost of
Goods
Sold
Ending
Inventory
11,000
6,840
7,600
10,260
9,500
17,100
17,000
17,100
Weighted
Average
FIFO
LIFO
Goods
Available
for Sale
6,100