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Reporting and Interpreting Cost of Goods Sold and Inventory. Chapter 7. McGraw-Hill/Irwin. © 2009 The McGraw-Hill Companies, Inc. Merchandiser. Merchandise Purchases. Merchandise Inventory. Cost of Goods Sold. Manufacturer. Raw Materials. Raw Materials Inventory.

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reporting and interpreting cost of goods sold and inventory

Reporting and Interpreting Cost of Goods Sold and Inventory

Chapter 7


© 2009 The McGraw-Hill Companies, Inc.

flow of inventory costs




Cost ofGoods Sold



Raw MaterialsInventory

Work in ProcessInventory

Finished GoodsInventory


Cost ofGoods Sold


Flow of Inventory Costs
nature of cost of goods sold
Nature of Cost of Goods Sold


Purchasesfor the Period

Goods availablefor Sale

Cost of Goods Sold(Income Statement)

Ending Inventory(Balance Sheet)

Beginning inventory + Purchases = Goods Available for Sale

Goods Available for Sale – Ending inventory = Cost of goods sold

inventory costing methods
Inventory Costing Methods

Inventory Costing Methods

Specific Identification

First-in, First-out

Last-in, First-out

Weighted Average

Total Dollar Amount of Goods Available for Sale

Inventory Costing Method

Ending Inventory

Cost of Goods Sold

first in first out method
First-In, First-Out Method

Cost of Goods Sold

Oldest Costs

Ending Inventory

Recent Costs

last in first out method
Last-In, First-Out Method

Ending Inventory

Oldest Costs

Cost of Goods Sold

Recent Costs

average cost method
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
financial statement effects of costing methods

Smoothes out price changes.

Ending inventory approximates current replacement cost.

Better matches current costs in cost of goods sold with revenues.

Financial Statement Effects of Costing Methods

Advantages of Methods

First-In, First-Out

Last-In, First-Out

Weighted Average

valuation at lower of cost or market
Valuation at Lower of Cost or Market

Ending inventory is reported at the lower of cost or market (LCM).

Replacement CostThe current purchase price for identical goods.

The company will recognize a “holding” loss in the current period rather than the period in which the item is sold.This practice is conservative.

internal control of inventory
Internal Control of Inventory

Separation of inventory accounting and physical handling of inventory.

Storage in a manner that protects from theft and damage.

Limiting access to authorized employees.

Maintaining perpetual inventory records.

Comparing perpetual records to periodic physical counts.

perpetual and periodic inventory systems
Perpetual and Periodic Inventory Systems

Provides up-to-date inventory records.



Provides up-to-date cost of sales records.

In a periodic inventory system, ending inventory and cost of goods sold are determined at the end of the accounting period based on a physical count.