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  1. 7 Inventories Principles of Financial Accounting, 11e Reeve • Warren • Duchac

  2. Describe the importance of control over inventories. 1 Describe three inventory cost flow assumptions and how they impact the income statement and balance sheet. 2 Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and average cost methods. 3 Inventories After studying this chapter, you should be able to: 7-2

  3. Describe the cost of inventory under the periodic inventory system, using the FIFO, LIFO, and average cost methods. After studying this chapter, you should be able to: 4 Compare and contrast the use of the three inventory costing methods. 5 Describe and illustrate the reporting of merchandise inventory in the financial statements. 6 Inventories (continued) 7-3

  4. 1 Describe the importance of control over inventory. 7-4

  5. 1 Two primary objectives of control over inventory are: • Safeguarding the inventory, and • Properly reporting it in the financial statements.

  6. 1 • The purchase order authorizes the purchase of the inventory from an approved vendor. • The receiving report establishes an initial record of the receipt of the inventory. • The amount of inventory is always available in the subsidiary inventory ledger.

  7. 1 Controls for safeguarding inventory should include security measures to prevent damage and customer or employee theft. Some examples of security measures include the following: • Storing inventory in areas that are restricted to only authorized employees.

  8. 1 • Locking high-priced inventory in cabinets. • Using two-way mirrors, cameras, security tags, and guards.

  9. 1 A physical inventory or count of inventory should be taken near year-end to make sure that the quantity of inventory reported in the financial statements is accurate.

  10. 2 Describe the three inventory cost flow assumptions and how they impact the income statement and balance sheet. 7-10

  11. 2 Inventory Costing Methods

  12. 2 May 10 Purchase 1 $ 9 18 Purchase 1 13 24 Purchase 1 14 Total 3 $36 Average cost per unit $12 ($36 ÷ 3 units)

  13. 2 Assume that one unit is sold on May 30 for $20. Depending upon which unit was sold, the gross profit varies from $11 to $6 as shown below:

  14. 2 Under the specific identificationinventory cost flow method, the unit sold is identified with a specific purchase. Not practical unless each inventory unit can be separately identified.

  15. 2 Under the first-in, first out (FIFO)inventory cost flow method, the first units purchased are assumed to be sold and the ending inventory is made up of the most recent purchases.

  16. 2 Under the last-in, first out (LIFO)inventory cost flow method, the last units purchased are assumed to be sold first and the ending inventory is made up of the first units purchased.

  17. 2 Under the average inventory cost flow method, the cost of the units sold and in ending inventory is an average of the purchase costs.

  18. Exhibit 1 2 Effect of Inventory Costing Methods on Financial Statements FIFO Method Income Statement Sales $20 Cost of merchan- dise sold 9 Gross profit $11 (continued)

  19. Exhibit 1 2 Effect of Inventory Costing Methods on Financial Statements (continued) LIFO Method Income Statement Sales $20 Cost of merchan- dise sold 14 Gross profit $ 6 (continued)

  20. Exhibit 1 2 Effect of Inventory Costing Methods on Financial Statements (continued) Average Cost Method Income Statement Sales $20 Cost of merchan- dise sold 12 Gross profit $ 8 $36 ÷ 3 = $12 $12 × 2 = $24

  21. Exhibit 2 2 Inventory Costing Methods* *Firms may be counted more than once for using multiple methods

  22. 2 Example Exercise 7-1 Cost Flow Methods The three identical units of Item QBM are purchased during February, as shown below. Item QBMUnitsCost Feb. 8 Purchase 1 $ 45 15 Purchase 1 48 26 Purchase 1 51 Total 3 $144 Average cost per unit $48 ($144 ÷ 3 units) Assume that one unit is sold on February 27 for $70. Determine the gross profit for February and ending inventory on February 28 using (a) first-in, first-out (FIFO); (b) last-in, first-out (LIFO); and (c) average cost methods. 7-22

  23. For Practice: PE 7-1A, PE 7-1B Follow My Example 7-1 2 Example Exercise 7-1 (continued) Gross ProfitEnding Inventory • First-in, first-out (FIFO): $25 ($70 – $45) $99 ($48 + $51) • Last-in, first-out (LIFO): $19 ($70 – $51) $93 ($45 + $48) • Average cost: $22 ($70 – $48) $96 ($48 × 2) 7-23

  24. 3 Determine the cost of inventory under the perpetual inventory system, using the FIFO, LIFO, and average cost methods. 7-24

  25. 3 First-In, First-Out Method On January 1, the firm had 100 units of Item 127B that cost $20 per unit. Item 127B Units Cost Jan. 1 Inventory 100 $20

  26. 3 First-In, First-Out Method On January 4, the firm sold 70 units of 127B at $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70

  27. Exhibit 3 3 Entries and Perpetual Inventory Account (FIFO)

  28. 3 First-In, First-Out Method On January 10, the firm purchased 80 units at $21 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21

  29. Exhibit 3 3 Entries and Perpetual Inventory Account (FIFO) (continued) 10 Merchandise Inventory 1,680 Accounts Payable 1,680 Date Jan. 1

  30. 3 First-In, First-Out Method On January 22, the firm sold 40 units for $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40

  31. Exhibit 3 Date Jan. 1 3 Entries and Perpetual Inventory Account (FIFO) (continued)

  32. 3 First-In, First-Out Method On January 28, the firm sold 20 units at $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40 28 Sale 20

  33. Exhibit 3 3 Entries and Perpetual Inventory Account (FIFO) (continued) Date Jan. 1

  34. 3 First-In, First-Out Method On January 30, purchased one hundred additional units of Item 127B at $22 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40 28 Sale 20 30 Purchase 100 22

  35. Exhibit 3 3 Entries and Perpetual Inventory Account (FIFO) (continued)

  36. Exhibit 3 3 Entries and Perpetual Inventory Account (FIFO) (concluded) January 31 inventory Cost of merchandise sold

  37. 3 Example Exercise 7-2 Perpetual Inventory Using FIFO Beginning inventory, purchases, and sales for Item ER27 are as follows: Nov. 1 Inventory 40 units at $5 5 Sale 32 units 11 Purchase 60 units at $7 21 Sale 45 units Assuming a perpetual inventory system and the first-in, first-out (FIFO) method, determine (a) the cost of the merchandise sold for the November 21 sale and (b) the inventory on November 30. 7-37

  38. For Practice: PE 7-2A, PE 7-2B Follow My Example 7-2 3 Example Exercise 7-2 (continued) • Cost of merchandise sold (November 21): • 8 units @ $5 $40 • 37 units @ $7 259 • 45 units $299 • Inventory, November 30: • $161 = (23 units × $7) 7-38

  39. 3 Last-In, First-Out Method On January 1, the firm had 100 units of Item 127B that cost $20 per unit. Item 127B Units Cost Jan. 1 Inventory 100 $20

  40. 3 Last-In, First-Out Method On January 4, the firm sold 70 units of 127B at $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70

  41. Exhibit 4 3 Entries and Perpetual Inventory Account (LIFO)

  42. 3 Last-In, First-Out Method On January 10, the firm purchased 80 units at $21 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21

  43. Exhibit 4 3 Entries and Perpetual Inventory Account (LIFO) (continued) 10 Merchandise Inventory 1,680 Accounts Payable 1,680 Date Jan. 1 4

  44. 3 Last-In, First-Out Method On January 22, the firm sold 40 units for $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40

  45. Exhibit 4 3 Entries and Perpetual Inventory Account (LIFO) (continued) Date Jan. 1 4

  46. 3 Last-In, First-Out Method On January 28, the firm sold 20 units at $30 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40 28 Sale 20

  47. Exhibit 4 3 Entries and Perpetual Inventory Account (LIFO) (continued) Date Jan. 1 4

  48. 3 Last-In, First-Out Method On January 30, the firm purchased one hundred additional units of Item 127B at $22 each. Item 127B Units Cost Jan. 1 Inventory 100 $20 4 Sale 70 10 Purchase 80 21 22 Sale 40 28 Sale 20 30 Purchase 100 22

  49. Exhibit 4 3 Entries and Perpetual Inventory Account (LIFO) (continued) Date Jan. 1 4 10

  50. Exhibit 4 3 Entries and Perpetual Inventory Account (LIFO) (concluded) Cost of Merchandise Sold January 31 Inventory