Chapter 5 Accounting for Inventories: (OMIT pgs 276- 277 & page 282) McGraw-Hill/Irwin McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Jan 04, 2016
Chapter 5
Accounting for Inventories:
(OMIT pgs 276-277 & page 282)
McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
LO 1
Determine the amount of cost of goods sold and
ending inventory using the FIFO, LIFO, weighted average,
and specific identification cost
flow methods.5-2
Inventory Cost Flow Methods
Four Acceptabl
e Inventory
“Cost Flow”
Methods
Specific Identificatio
n
First-in, First-Out
(FIFO)
Last-in, First-Out
(LIFO)
Weighted Average
5-3
Specific Identification
When a company’s inventory consists
of many high-priced, low-
turnover goods the record keeping
necessary to use specific
identification is more practical.
5-4
Specific Identification
Assume TMBC Company purchased two identical inventory items: the first for $100 and the second
for $110.
Using specific identification, when the first item is sold, cost of
goods sold would be $100. When the second item is sold, cost of goods sold
would be $110. 5-5
First-in, First-out
The first-in, first-out cost flow
method requires that the cost of the
items purchased first be assigned to Cost of Goods Sold.
5-6
First-in, First-out
Assume TMBC Company purchased two identical inventory items: the first for $100 and the second
for $110.
Using first-in, first-out, the cost assigned to the first item sold would be $100
(the first cost in). The cost of goods sold assigned to
the second item sold would be $110.
5-7
Last-in, First-out
The last-in, first-out cost flow
method requires that the cost of the
items purchased last be assigned to Cost of Goods Sold.
5-8
Last-in, First-out
Assume TMBC Company purchased two identical inventory items: the first for $100 and the second
for $110.
Using last-in, first-out, the cost assigned to the first item sold would be $110
(the last cost in). The cost of goods sold assigned to
the second item sold would be $100.
5-9
Weighted Average
The weighted average cost flow
method assigns the average cost of the items available to
Cost of Goods Sold.
5-10
Weighted Average
Assume TMBC Company purchased two identical inventory items: the first for $100 and the second
for $110. Using weighted average, the cost assigned to the first item sold would be $105 (the average cost).
Total CostTotal
Number
=$210
2= $105
5-11
Physical Flow
Note: Our discussions about inventory cost flow methods pertain to the flow of costs
through the accounting records,
NOT the actual physical flow of goods!
Cost flows can be done on a different basis than physical flow.
5-12
Effect of Cost Flow on Income Statement
FIFO LIFOWeighted Average
Sales 120$ 120$ 120$ Cost of Goods Sold 100 110 105 Gross Margin 20$ 10$ 15$
The cost flow method a company uses can significantly affect the gross margin reported in the income
statement.
5-13
Effect of Cost Flow on Balance Sheet
FIFO LIFOWeighted Average
Ending Inventory 110$ 100$ 105$
Since total product costs are allocated between costs of goods sold and
ending inventory, the cost flow method used affects its balance sheet as well.
5-14
5-15
Inventory Cost Flow Under a Perpetual System
Jan. 1 Beginning Inventory 10 units at $200 = $2,000
Mar. 18 First purchase 20 units @ $220 =
$4,400
Aug. 21 Second purchase 25 units @ $250 =
$6,250
$12,650
TMBC Inventory
Total cost of 55 bikes (goods) available for sale
Goods Available for Sale
First-in, First-Out
(FIFO)
Last-in, First-Out
(LIFO)
Weighted Average
Sold 43 bikes for $350 each
5-16
Inventory Cost Flow Under a Perpetual System
Goods Available for Sale must be allocated between the Cost of Goods Sold and Ending Inventory
We use one of these three methods:
5-17
First-in, First-Out
(FIFO)
Last-in, First-Out
(LIFO)
Weighted Average
First-in, First-out Inventory Cost Flow (FIFO)
Jan. 1 Beginning inventory 10 units @ 200$ = 2,000$ Mar. 18 First purchase 20 units @ 220$ = 4,400 Aug. 21 Second purchase 13 units @ 250$ = 3,250 Total cost of the 43 bikes sold 9,650$
FIFO Cost of Goods Sold
5-18
Last-in, First-out Inventory Cost Flow (LIFO)
Aug. 21 Second purchase 25 units @ 250$ = 6,250$ Mar. 18 First purchase 18 units @ 220$ = 3,960 Total cost of the 43 bikes sold 10,210$
LIFO Cost of Goods Sold
5-19
Weighted Average Inventory Cost Flow (WAVG)
Total cost of the 43 bikes sold 43 units @ 230$ = 9,890$ Weighted Average Cost of Goods Sold
Total CostTotal
Number
=$12,650
55= $230
5-20
Comparative Financial Statements and the Impact of Income Taxes
5-21
LO 2
Apply the lower-of-cost-or-
market rule to inventory valuation.
5-22
Lower of Cost or Market (LCM)
Inventory must be reported at lower of cost or market.
Inventory must be reported at lower of cost or market.
Applied three ways:(1) separately to each individual item.(2) to major classes or categories of assets.(3) to the whole
inventory.
Applied three ways:(1) separately to each individual item.(2) to major classes or categories of assets.(3) to the whole
inventory.
Market is defined as current
replacement cost (not sales price).Consistent with
the conservatismprinciple.
Market is defined as current
replacement cost (not sales price).Consistent with
the conservatismprinciple.
5-23
Lower of Cost or Market (LCM)
To illustrate lower of cost or market, assume The Mountain Bike Company has in ending
inventory 100 t-shirts purchased at a cost of $14 each.
To illustrate lower of cost or market, assume The Mountain Bike Company has in ending
inventory 100 t-shirts purchased at a cost of $14 each.
Cost Market LCMSituation 1 14$ 18$ 14$ Situation 2 14$ 11$ 11$
5-24
5-25
LO 3
Explain how fraud can be
avoided through
inventory control.
5-26
Fraud Avoidance in Merchandising Businesses
Because inventory and cost of goods sold accounts are so significant, they are
attractive targets for concealing fraud.
Because of this, auditors and financial analysts carefully examine them for signs of
fraud. 5-27
If Ending Inventory is overstated then Cost of Goods Sold will be understated.
5-28
If Cost of Goods Sold is understated, then Gross Margin is overstated.
Resulting in overstatement of Net Income.
5-29
Then, on the balance sheet Inventory is overstated and Retained Earnings is overstated.
5-30
LO 5
Explain the importance of
inventory turnover to a company’s profitability.
5-31
Inventory Turnover
Cost of Goods SoldInventory
This measures how quickly a company
sells its merchandise inventory.
This is the first step in calculating the average number of days to sell
inventory.
5-32
Average Number of Days to Sell Inventory
365Inventory Turnover
This measures how many days, on average, it takes to sell inventory.
Other things being equal, the company with the lower average
number of days to sell inventory is doing better.
5-33
5-34
End of Chapter Five
5-35