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Learning Objectives

Power Notes. Week 9 & 10. Inventories. 1. Internal Control of Inventories 2. Effect of Inventory Errors 3. Inventory Cost Flow Assumptions 4. Perpetual Inventory Costing Methods 5. Periodic Inventory Costing Methods 6. Comparing Inventory Costing Methods

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Learning Objectives

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  1. Power Notes Week9 & 10 Inventories 1. Internal Control of Inventories 2. Effect of Inventory Errors 3. Inventory Cost Flow Assumptions 4. Perpetual Inventory Costing Methods 5. Periodic Inventory Costing Methods 6. Comparing Inventory Costing Methods 7. Inventory Valuation Other Than Cost 8. Balance Sheet Presentation of Merchandise 9. Estimating Inventory Cost 10. Financial Analysis and Interpretation Learning Objectives C9

  2. Why is Inventory Control Important? • Inventory is a significant asset and for many companies the largest asset. • Inventory is central to the main activity of merchandising and manufacturing companies. • Mistakes in determining inventory cost can cause critical errors in financial statements. • Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.

  3. Inventory Costs and Relationships LIABILITIES Merchandise Inventory OWNER’S EQUITY ASSETS understated overstated overstated Net Income Cost of Mdse. Sold REVENUES COSTS & EXPENSES If merchandise inventory is . . . . . . . overstated Cost of merchandise sold is . . . . . . Gross profit and net income are . . . Ending owner’s equity is . . . . . . . . .

  4. Inventory Costs and Relationships LIABILITIES Merchandise Inventory OWNER’S EQUITY ASSETS overstated understated understated Net Income Cost of Mdse. Sold REVENUES COSTS & EXPENSES If merchandise inventory is . . . . . . . understated Cost of merchandise sold is . . . . . . Gross profit and net income are . . . Ending owner’s equity is . . . . . . . . .

  5. Merchandising and Inventory • Merchandising involves selling inventory. • Inventory is usually an important asset. • Inventory must be accounted for periodically or perpetually. • Traditional periodic method is often being replaced by perpetual inventory accounting.

  6. Advantages of Using Perpetual Inventory • Continuous determination of inventory value • Continuous determination of gross profit • Affordable with computers, scanners, and bar codes on most products • Perpetual inventory accounting provides management controls. • Managers know which items are selling fastest and the profit margin on those items.

  7. Perpetual Inventory Costs Inventory cost data to demonstrate FIFO and LIFO Perpetual Systems Item 127B Units Cost Price Jan. 1 Inventory 10 $20 4 Sale 7 $30 10 Purchase 8 21 22 Sale 4 31 28 Sale 2 32 30 Purchase 10 22 Cost of Mdse. Sold Sale price assumptions are added to demonstrate journal entries and ease of calculating gross profit.

  8. FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 The sale of 7 units leaves a balance of 3 units.

  9. FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 Because the purchase price of $21 is different than the cost of the previous 3 units on hand, the inventory balance of 11 units is accounted for separately.

  10. FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 3 20 60 1 21 21 7 21 147 Of the 4 units sold, 3 come from the first units in (FIFO) at a cost of $20.

  11. FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 3 20 60 1 21 21 7 21 147 28 2 21 42 5 21 105 Sold 2 units from the 7 units on hand. No allocation is necessary.

  12. FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 3 20 60 1 21 21 7 21 147 28 2 21 42 5 21 105 30 10 22 220 5 21 105 10 22 220 Totals 18 $388 13 $263 15 $325

  13. FIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 3 20 60 1 21 21 7 21 147 28 2 21 42 5 21 105 30 10 22 220 5 21 105 10 22 220 Totals 18 $388 13 $263 15 $325

  14. FIFO Perpetual Inventory Accounting Date Description Debit Credit Jan. 31 Accounts Receivable 390 Sales 390 Cost of Merchandise Sold 263 Merchandise Inventory 263 Gross Profit = Sales ($390) minus Cost of Merchandise Sold ($263) = $127 To record January sales of item 127B. (7 units@$30, 4 units@$30, 2 units@$30) Jan. 31 To record cost of January sales of item 127B.

  15. LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 The sale of 7 units leaves a balance of 3 units.

  16. LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 The purchase price of $21 is different than the cost of the previous 3 units on hand; therefore, the inventory balance of 11 units is accounted for separately.

  17. LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 4 21 84 3 20 60 4 21 84 Of the 4 units sold, all come from the last units in (LIFO) at a cost of $21.

  18. LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 4 21 84 3 20 60 4 21 84 28 2 21 42 3 20 60 2 21 42 Of the 2 units sold, all come from the last units in (LIFO) at a cost of $21, leaving 2 units from that group.

  19. LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 4 21 84 3 20 60 4 21 84 28 2 21 42 3 20 60 2 21 42 30 10 22 220 3 20 60 2 21 42 10 22 220

  20. LIFO Perpetual Inventory Account Item 127B Purchases Cost of Mdse. Sold Inventory Balance Unit Total Unit Total Unit Total Date Qty. Cost Cost Qty. Cost Cost Qty. Cost Cost Jan. 1 10 20 200 4 7 20 140 3 20 60 10 8 21 168 3 20 60 8 21 168 22 4 21 84 3 20 60 4 21 84 28 2 21 42 3 20 60 2 21 42 30 10 22 220 3 20 60 2 21 42 10 22 220 Totals 18 $388 13 $266 15 $322

  21. LIFO Perpetual Inventory Accounting Date Description Debit Credit Jan. 31 Accounts Receivable 390 Sales 390 Cost of Merchandise Sold 266 Merchandise Inventory 266 Gross Profit = Sales ($390) minus Cost of Merchandise Sold ($266) = $124 To record January sales of item 127B. (7 units@$30, 4 units@$30, 2 units@$30) Jan. 31 To record cost of January sales of item 127B.

  22. First-In, First-Out Flow of Costs Merchandise Available for Sale Purchases Jan. 1 200 units at $9 $1,800 Mar. 10 300 units at $10 $3,000 Sep. 21 400 units at $11 $4,400 Nov. 18 100 units at $12 Using FIFO costing, which units are assumed to be sold first? $1,200 $10,400

  23. First-In, First-Out Flow of Costs Cost of Merchandise Sold Merchandise Available for Sale Purchases 200 units at $9 $1,800 Jan. 1 200 units at $9 $1,800 $3,000 300 units at $10 Mar. 10 300 units at $10 $3,000 200 units at $11 $2,200 Sep. 21 400 units at $11 $7,000 $4,400 Nov. 18 100 units at $12 FIFO cost flow assumes merchandise acquired first is sold first. $1,200 $10,400

  24. First-In, First-Out Flow of Costs Cost of Merchandise Sold Merchandise Available for Sale Purchases 200 units at $9 $1,800 Jan. 1 200 units at $9 $1,800 $3,000 300 units at $10 Mar. 10 300 units at $10 $3,000 200 units at $11 $2,200 Sep. 21 400 units at $11 $7,000 $4,400 Merchandise Inventory Nov. 18 100 units at $12 $1,200 $2,200 200 units at $11 $10,400 100 units at $12 $1,200 $3,400

  25. First-In, First-Out Flow of Costs Cost of Merchandise Sold Merchandise Available for Sale Purchases 200 units at $9 $1,800 Jan. 1 200 units at $9 $1,800 $3,000 300 units at $10 Mar. 10 300 units at $10 $3,000 200 units at $11 $2,200 Sep. 21 400 units at $11 $7,000 700 units $4,400 Merchandise Inventory Nov. 18 100 units at $12 $1,200 $2,200 200 units at $11 $10,400 1,000 units 100 units at $12 $1,200 $3,400 300 units

  26. Last-In, First-Out Flow of Costs Merchandise Available for Sale Purchases Using LIFO costing, which units are assumed to be sold first? Jan. 1 200 units at $9 $1,800 Mar. 10 300 units at $10 $3,000 Sep. 21 400 units at $11 $4,400 Nov. 18 100 units at $12 $1,200 $10,400 1,000 units total

  27. Last-In, First-Out Flow of Costs Merchandise Available for Sale Purchases LIFO cost flow assumes merchandise acquired last is sold first. Jan. 1 200 units at $9 $1,800 Mar. 10 300 units at $10 $3,000 Cost of Merchandise Sold Sep. 21 400 units at $11 $4,400 $2,000 200 units at $10 Nov. 18 100 units at $12 $1,200 $4,400 400 units at $11 $10,400 1,000 units total $1,200 100 units at $12 $7,600

  28. Last-In, First-Out Flow of Costs Merchandise Inventory Merchandise Available for Sale 200 units at $9 Purchases $1,800 Jan. 1 200 units at $9 $1,000 100 units at $10 $1,800 $2,800 Mar. 10 300 units at $10 $3,000 Cost of Merchandise Sold Sep. 21 400 units at $11 $4,400 $2,000 200 units at $10 Nov. 18 100 units at $12 $1,200 $4,400 400 units at $11 $10,400 $1,200 100 units at $12 $7,600

  29. Last-In, First-Out Flow of Costs Merchandise Inventory Merchandise Available for Sale 200 units at $9 Purchases $1,800 Jan. 1 200 units at $9 $1,000 100 units at $10 $1,800 $2,800 300 units Mar. 10 300 units at $10 $3,000 Cost of Merchandise Sold Sep. 21 400 units at $11 $4,400 $2,000 200 units at $10 Nov. 18 100 units at $12 $1,200 $4,400 400 units at $11 $10,400 1,000 units $1,200 100 units at $12 $7,600 700 units

  30. Valuation of Inventory at Lower-of-Cost-or-Market Unit Unit Inventory Cost Market Total Total Lower Item Quantity Price Price Cost Market C or M $ 3,800 2,700 4,650 3,920 Total $15,520 $15,472 $15,070 The market decline is either: 1. Based on total inventory($15,520 – $15,472) = $48 2. Based on individual items($15,520 – $15,070) = $450 The decline is reported on the income statement as a separate item or included in the cost of merchandise sold. A 400 $10.25 $ 9.50 $ 4,100 $ 3,800 B 120 22.50 24.10 2,700 2,892 C 600 8.00 7.75 4,800 4,650 D 280 14.00 14.75 3,920 4,130

  31. Afro-ArtsBalance SheetDecember 31, 2004 Assets Current assets: Cash $ 19,400 Accounts receivable $80,000 Less allowance 3,000 77,000 Merchandise inventory at lower of cost (first-in, first-out method) or market 216,300

  32. Retail Method of Estimating Inventory Cost • Retail method is based on relationship between cost of merchandise available for sale and the retail price. • Retail prices of all merchandise must be accumulated. • Inventory at retail is calculated as retail price of merchandise available for sale less sales. • Ratio is calculated as cost divided by retail price. • Inventory at retail price times cost ratio equals estimated cost of inventory.

  33. Retail Inventory Method Calculation Cost Retail Merchandise inventory, January 1 $19,400 $36,000 Purchases in January (net) 42,600 64,000 Merchandise available for sale Ratio of cost to retail price: Sales for January (net) 70,000 Merchandise inventory, January 31, at retail Merchandise inventory, January 31, at est. cost $62,000 $100,000 ($62,000 / $100,000 = 62%) $30,000 ($30,000 x 62%) $18,600

  34. Gross Profit Method of Estimating Inventory Cost 1. A gross profit percentage rate is estimated based on previous experience adjusted for known changes. 2. Estimated gross profit is calculated by multiplying the estimated gross profit rate times the actual net sales. 3. Estimated cost of merchandise sold is calculated by subtracting the gross profit from actual sales. 4. The cost of merchandise sold estimate is deducted from actual merchandise available for sale to determine the estimated cost of merchandise inventory.

  35. Gross Profit Method Calculation Merchandise inventory, January 1 $ 57,000 Purchases in January (net) 180,000 Merchandise available for sale Sales in January (net) $250,000 Less: Estimated gross profit Estimated cost of merchandise sold Estimated merchandise inventory, January 31 $237,000 ($250,000 x 30%) 75,000 175,000 $ 62,000 Many firms generate a surprisingly stable and predictable gross profit as a percentage of sales.

  36. Inventory Turnover Ratios SUPERVALU Zale Cost of goods sold $15,620,127,000 $ 737,188,000 Inventories: Beginning of year $1,115,529,000 $478,467,000 End of year 1,067,837,000 571,669,000 Average $1,091,683,000 $525,068,000

  37. Inventory Turnover Ratios SUPERVALU Zale Cost of goods sold $15,620,127,000 $ 737,188,000 Inventories: Beginning of year $1,115,529,000 $478,467,000 End of year 1,067,837,000 571,669,000 Average $1,091,683,000 $525,068,000 Inventory turnover 14.3 times 1.4 times

  38. Inventory Turnover Ratios SUPERVALU La-Z-Boy Cost of goods sold $15,620,127,000 $ 737,188,000 Inventories: Beginning of year $1,115,529,000 $478,467,000 End of year 1,067,837,000 571,669,000 Average $1,091,683,000 $525,068,000 Inventory turnover 14.3 times 1.4 times Average selling period 25 days 283 days Use: To assess the efficiency in the management of inventory

  39. Note: To see the topic slide, type 2 and press Enter. Power Notes Week9 & 10 Inventories This is the last slide in Week 9 & 10

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