Accounting for Merchandise Inventory Chapter 6 Perpetual systems maintain a running record to show the inventory on hand at all times. Periodic systems.

Accounting for Merchandise Inventory

Chapter 6

Perpetual systems maintain a running recordto show the inventory on hand at all times.

Periodic systems do not keep acontinuous record of inventory on hand.

Inventory Accounting Systems

Compute and record journal entries for perpetual

inventory amounts under FIFO, LIFO, and average

cost.

Objectives 1 and 2

Debit Cash or Accounts ReceivableCredit Sales Revenue

Debit Cost of Goods SoldCredit Inventory

Perpetual System

Debit Inventory Credit Cash or Accounts Payable

Cost of inventory on hand = Quantity × unit cost

Computing the Cost of Inventory

• Physical count is made at least once a year, even with a perpetual system.

• Consigned goods are excluded.

Perpetual System Examples

• Assume the following:

Nov. 1 Beg. Inventory 1 @ $40

15 Purchase 6 @ $45

15 Sale 4

26 Purchase 7 @ $50

30 Sale 8

Perpetual System FIFO Example

• Many companies keep their perpetual inventory records in quantities only.

• Other companies keep perpetual records in both quantities and dollar cost.

Perpetual FIFO

• Consistent with the physical flow of inventory

• Oldest inventory sold first

• Most recent purchases make-up ending inventory


Item: Ski Parka Received Sold Balance on Hand

Unit Unit UnitDate Qty. Cost Total Qty. Cost Total Qty. Cost TotalNov. 1 1 $40 $40

5 6 $45 $270 1 40 40 6 45 270

15 1 40 40 3 45 135 3 45 135

Columbia Sportswear



Unit Unit UnitDate Qty. Cost Total Qty. Cost Total Qty. Cost TotalNov. 26 7 $50 $ 350 3 $45 $135

7 50 350 30 3 $45 135

5 50 250 2 50 100Totals 13 $ 620 12 $560 2 $100

Columbia Sportswear


Nov. 5 Inventory………….…270Accounts Payable……270

15 Accounts receivable…320Sales Revenue……….350

15 Cost of Goods Sold…175Inventory…………….175





Perpetual LIFO

• Is not consistent with the physical flow of inventory

• Oldest inventory costs make-up ending inventory

• Cost of goods sold is assumed to be from the most recent purchases

Perpetual System LIFO Example


Unit Unit UnitDate Qty. Cost Total Qty. Cost Total Qty. Cost TotalNov. 1 1 $40 $40

5 6 $45 $270 1 40 40 6 45 270

15 4 45 180 1 40 40 2 45 90

Columbia Sportswear



Unit Unit UnitDate Qty. Cost Total Qty. Cost Total Qty. Cost TotalNov. 26 7 $50 $ 350 1 $40 $135

2 45 90 7 50 350

30 7 $50 350 1 45 45 1 40 40

1 45 45 Totals 13 $ 620 12 $575 2 90

Columbia Sportswear







30 Accounts receivable…640

Sales Revenue……….640


Perpetual System Average Cost

• Ending inventory and cost of goods sold are based on the average cost per unit.

• A new average cost per unit is computed after each purchase.

Perpetual System Average Cost Example


Unit Unit UnitDate Qty. Cost Total Qty. Cost Total Qty. Cost TotalNov. 1 1 40.00 40

5 6 $45 $270 7 44.29 310

15 4 44.29 177 3 44.29 133

Columbia Sportswear



Unit Unit UnitDate Qty. Cost Total Qty. Cost Total Qty. Cost TotalNov. 26 7 $50 $ 350 10 48.30 483

30 8 48.30 386 2 48.30 97

Totals 13 $ 620 12 $563 2 $ 97

Columbia Sportswear






Nov.26 Inventory………….…350Accounts Payable……350



Objective 3

Compare the effects of FIFO, LIFO, and average cost

Ending InventoryFIFO $100.00LIFO $ 90.00Weighted-average $ 97.00

Comparison of Methods

Cost of Goods SoldFIFO $560.00LIFO $575.00Weighted-average $563.00


When prices are rising LIFO producesthe lowest income and lowest income tax.


• Gross Margin from Sales:

FIFO $400.00

LIFO $ 385.00

Weighted-average $ 397.00

Compute periodic inventory amounts under

weighted-average cost,FIFO, and LIFO.

Objective 4

Cost-of-Goods-Sold Model

Budgeted Cost of Goods Sold

Budgeted Ending Inventory+

=

Actual Beginning Inventory

= Purchases

–

Budgeted Cost of Goods Available for Sale

Cost of Goods Sold under a periodic

BeginningInventory$100,000

NetPurchases$560,000

Cost of GoodsAvailable forSale $660,000

+ =

EndingInventory$120,000

=Cost of Goods

Sold$540,000

–

Accounts Payable

Inventory

120,000Ending

Balance

Purchases

560,000Purchases

100,000BeginningBalance

Cost of Goods Sold100,000560,000540,000

120,000EndingBalance560,000

Purchases

560,000Purchases

100,000Beginning

Balance

Periodic System

Periodic System

• At the end of the period make a physical count and apply unit cost to determine ending inventory.

• Inventory purchases are debited to the purchases account.

• The inventory account carries the beginning inventory balance until adjusted at period end.

January 8 20 units @ $20 = $ 400May 19 55 units @ $30 = $1,650October 23 25 units @ $31 = $ 775Total units 100 Units sold 70Units left 30

Units Purchased in 20xx

Units sold by date:Jan 5 17May 19 33Oct 23 20Total sales 70

30 units left in inventory

Units Sold and in Ending Inventory

Cost of Goods SoldOct 23 $ 620May 19 990Jan 5 340Total $1,950

Specific Identification

20 Units @ $31

5 Units @ $31

20 Units @ $31

5 Units @ $31

33 Units @ $30

22 Units @ $30

33 Units @ $30

22 Units @ $30

17 Units @ $20

3 Units @ $20

17 Units @ $20

3 Units @ $20

Ending InventoryOct 23 $155May 660Jan 60Total $875

Specific Identification

20 Units @ $31

5 Units @ $31

33 Units @ $30

22 Units @ $30

17 Units @ $20

3 Units @ $20

Weighted Average

25 Units @ $31 (Oct)

55 Units @ $30 (May)

20 Units @ $20 (Jan)

= $ 775

= 1,650

= 400

= $2,825 Total Cost100 Total Units

Weighted Average

$2,825 total cost/100 units = $28.25/unit

Cost of goods sold = 70 × $28.25 = $1977.50

Ending inventory = 30 × $28.25 = $847.50

Cost of Goods SoldJan $ 400May 1,500Total $1,900

First-In, First-Out


5 Units @ $30 (May)

50 Units @ $30


Ending InventoryOct $775May 150Total $925

First-In, First-Out


5 Units @ $30 (May)

50 Units @ $30


Cost of Goods SoldOct $ 775May 1,350Total $2,125

Last-In, First-Out



10 Units @ $30


Ending InventoryOct $300May 400Total $700

Last-In, First-Out



10 Units @ $30


Ending InventorySpecific identification $875.00FIFO $925.00LIFO $700.00Weighted-average $847.50


Cost of Goods SoldSpecific identification $1,965.00FIFO $1,900.00LIFO $2,125.00Weighted-average $1,977.50


When prices are rising LIFO producesthe lowest income and lowest income tax.


• Gross Margin from Sales:• Specific identification $1,035.00• FIFO $1,100.00• LIFO $ 875.00• Weighted-average $1,022.50

The Income Tax Advantage of LIFO

• During periods of inflation, LIFO’s income is the lowest.

• The most attractive feature of LIFO is reduced income tax payments.

Use of the Various Inventory Costing Methods

LIFO32%

FIFO44%

Average20%

Other4%

LIFO Liquidation

• When prices are rising...

• the company draws down inventory quantities below the level of the previous period which releases older costs to the income statement.

The business should use the same accountingmethods and procedures from one period to the next.

A company may change inventory methods, but itmust disclose the effects of the change on net income.

Accounting Principles: Consistency

The financial statementsshould report enoughinformation to enablean outsider to make

knowledgeable decisionsabout the company.

Accounting Principles: Disclosure

Accounting Principles: Materiality

An item is material if it has the potentialto alter a statement user’s decision.

Materiality is specific tothe entity being evaluated.

Err on the sideof caution when

reporting any item inthe financial statements.

Accounting Principles: Conservatism

Apply the lower-of-cost-or-market rule to

inventory.

Objective 5

Lower-of-Cost-or-Market

• An asset is reported at the lower of its historical cost or market (replacement) value.

• If the replacement cost falls below its historical cost, the business must write down the value of its inventory.

December 31Cost of Goods Sold 800

Inventory 800Write down inventory to LCM

Lower-of-Cost-or-Market Example

• Cost of inventory: $3,000

• Market value at balance sheet date: $2,200

• What is the journal entry?

Determine the effects of

inventory errors.

Objective 6

Inventory Errors

• If inventory is computed incorrectly, how many years of financial statements will it affect?

• Two years

• The current year’s ending inventory is next year’s beginning inventory.

Estimate ending inventoryby the gross profit

method.

Objective 7

Sales revenues – Cost of goods sold =Gross margin (before operating expenses)

Gross margin – Operating expenses =Net income

Gross Profit

Net Sales $150,000Gross Profit Margin 31.5%Beginning Inventory $ 18,500Net Purchases $110,500

Gross Profit Method Example

Net Sales $150,000– Gross Profit of 31.5% 47,250= Cost of Goods Sold $102,750

Gross Profit Method Example

BeginningInventory$18,500

NetPurchases$110,500

Cost of GoodsAvailable forSale $129,000

+ =

EndingInventory$26,250

=Cost of Goods

Sold$102,750

–

End of Chapter 6

Accounting for Merchandise Inventory Chapter 6 Perpetual systems maintain a running record to show the inventory on hand at all times. Periodic systems.

Documents

cost totalnov

cost totalqty

dollar cost

cost of goods sold180inventory

cost of goods sold175inventory

cost of goods sold395inventory

cost of goods sold385inventory

new average cost