merchandise inventory and cost of sales powerpoint slides to accompany fundamental accounting...
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Merchandise Merchandise Inventory and Inventory and Cost of SalesCost of Sales
PowerPoint Slides to accompanyFundamental Accounting Principles, 14ce
Prepared byJoe Pidutti, Durham College
CHAPTER
6
1. Identify the components and costs included in merchandise inventory. (LO1)
2. Calculate cost of goods sold and merchandise inventory using specific identification, moving weighted average, and FIFO-perpetual. (LO2)
3. Analyze the effects of the costing methods on financial reporting. (LO3)
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Learning ObjectivesLearning Objectives
2
4. Calculate the lower of cost and net realizable value of inventory. (LO4)
5. Analyze the effects of merchandise inventory errors on current and future financial
statements-perpetual. (LO5)6. Apply both the gross profit and retail methods
to estimate inventory. (LO6)
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Learning ObjectivesLearning Objectives
3
7. Calculate cost of goods sold and merchandise inventory using FIFO –periodic, weighted average ,
and specific identification (Appendix 6A). (LO7)8. Analyze the effects of merchandise inventory errors
on current and future financial statements-periodic.
(Appendix 6A). (LO8)9. Assess merchandise inventory management using
both merchandise turnover and days’ sales in
inventory. (Appendix 6B) (LO9)
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Learning ObjectivesLearning Objectives
4
Accounting for merchandise inventory requires several decisions which include:
Assigning Costs to Merchandise Assigning Costs to Merchandise InventoryInventory
• Items included and their costs. • Costing Method. (specific identification, moving
weighted average or FIFO)• Merchandise Inventory System. (perpetual or
periodic)• Use of net realizable value or other estimates.
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Merchandise inventory includes all goods owned by a company and held for sale.
Items requiring special attention:• Goods in Transit• Goods on Consignment• Goods Damaged or Obsolete
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Items in Merchandise InventoryItems in Merchandise Inventory
LO LO 116
All expenditures necessary to bring an item to a saleable condition and location.
This includes:• Invoice price less discounts• Import duties• Transportation-in• Storage• Insurance
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Costs of Merchandise InventoryCosts of Merchandise Inventory
LO LO 117
Assigning Costs to Merchandise Assigning Costs to Merchandise InventoryInventory
• Management must decide on method of determining unit cost.
• This will affect both the income statement and the balance sheet.
Methods:1. First-in, first-out (FIFO)2. Moving weighted average3. Specific identification
© 2013 McGraw-Hill Ryerson Limited. LO LO 228
© 2013 McGraw-Hill Ryerson Limited.
Based on the assumption that the items are sold in the order acquired.
When a sale occurs:• The earliest units purchased are
charged to Cost of Goods Sold.• The cost of the most recent purchases
remain in merchandise inventory.
First-In, First-Out (FIFO)First-In, First-Out (FIFO)
LO LO 229
FIFO — Example
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Purchases Sales (at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold Units
Unit Cost Total Cost
8/1 Beginning Inventory10 91$ 910$ 10 91$ 910$
10 91$ 910$ 8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 10 91$ 910$
10 106$ 1,060$ 5 106$ 530$ 5 106$ 530$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,830$ 8/28 5 106$ 530$
9 115$ 1,035$ 11 115$ 1,265$
FIFO Computations - Perpetual Merchandise Inventory System
The opening inventory consists of 10 units @ $91/unit.
LO LO 2210
FIFO — Example
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Additional units re purchased @ $106/unit.
Purchases Sales (at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold Units
Unit Cost
Total Cost
8/1 Beginning inventory10 91$ 910$ 10 91$ 910$
10 91$ 910$ 8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 10 91$ 910$
10 106$ 1,060$ 5 106$ 530$ 5 106$ 530$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,830$ 8/28 5 106$ 530$
9 115$ 1,035$ 11 115$ 1,265$
FIFO Computations - Perpetual Merchandise Inventory System
This results in two layers of merchandise inventory.
Additional units are purchased @ $106/unit.
LO LO 2211
FIFO — Example
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Purchases Sales (at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold Units
Unit Cost
Total Cost
8/1 Beginning Inventory 910$ 10 91$ 910$ 10 91$
10 91$ 910$ 8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 10 91$ 910$
10 106$ 1,060$ 5 106$ 530$ 5 106$ 530$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,830$ 8/28 5 106$ 530$
9 115$ 1,035$ 11 115$ 1,265$
FIFO Computations - Perpetual Inventory System
Under FIFO, units are assumed to be sold in the order acquired. Therefore, of the 20 units sold on August 14, the first 10 units come
from beginning inventory. Therefore, those 10 units are removed from the inventory record based on the cost of those units of $91.
LO LO 2212
FIFO — Example
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Purchases Sales (at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold Units
Unit Cost
Total Cost
8/1 Beginning inventory10 91$ 910$ 10 91$ 910$
10 91$ 910$ 8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 10 91$ 910$
10 106$ 1,060$ 5 106$ 530$ 5 106$ 530$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,830$ 8/28 5 106$ 530$
9 115$ 1,035$ 11 115$ 1,265$
FIFO Computations - Perpetual Merchandise Inventory System
The remaining 10 units sold on August 14th come from the next purchase, made on August 3rd. Therefore, these units are removed
from the inventory record based on their cost of $106.
LO LO 2213
FIFO — Example
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Purchases Sales (at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold Units
Unit Cost
Total Cost
8/1 Beginning Inventory10 91$ 910$ 10 91$ 910$
10 91$ 910$ 8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 10 91$ 910$
10 106$ 1,060$ 5 106$ 530$ 5 106$ 530$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,830$ 8/28 5 106$ 530$
9 115$ 1,035$ 11 115$ 1,265$
FIFO Computations - Perpetual Merchandise Inventory System
The ending inventory consists of the 5 remaining units from the August 3 purchase.
LO LO 2214
Mini-QuizMini-QuizA company that uses a perpetual merchandise inventory system made the following cash purchases and sales:
Jan. 1-Purchased 100 units at $10 per unit.
Feb. 5-Purchased 60 units at $12 per unit.
Mar.16-Sold for cash 40 units for $16 per unit.
Prepare journal entries to record the sale assuming a FIFO system is used.
Cash 640 Sales (40x $16) 640
Cost of goods sold 400 Merchandise Inventory (40x $10 ) 400
© 2013 McGraw-Hill Ryerson Limited.LO LO 2215
Moving Weighted Average Moving Weighted Average MethodMethod
Under this method, the cost of all units are averaged together.
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Cost of goods available for sale
Number of units available for sale
Average cost per unit
=
LO LO 2216
Moving Weighted Average - Example
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Purchases Sales (at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold
(b) Units
(a)+(b) Average
Cost/Unit
(a) Total Cost
8/1 Beginning inventory10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 25 100$ 2,500$
8/14 20 100$ 2,000$ 5 100$ 500$
8/17 20 115$ 2,300$ 25 112$ 2,800$
8/28 14 112$ 1,568$ 11 112$ 1,232$
Moving Weighted Average Computations - Perpetual Merchandise Inventory System
The opening inventory consists of 10 units @ $91/unit.
LO LO 2217
Moving Weighted Average- Example
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Purchases Sales (at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold
(b) Units
(a)+(b) Average
Cost/Unit
(a) Total Cost
8/1 Beginning inventory10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 25 100$ 2,500$
8/14 20 100$ 2,000$ 5 100$ 500$
8/17 20 115$ 2,300$ 25 112$ 2,800$
8/28 14 112$ 1,568$ 11 112$ 1,232$
Moving Weighted Average Computations - Perpetual Merchandise Inventory System
15 additional units are purchased @ $106/unit.
This results in an average cost of $100/unit.
(10 x $91) + (15 x $106) 25 units
LO LO 2218
Moving Weighted Average- Example
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Purchases Sales ( at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold
(b) Units
(a)+(b) Average
Cost /Unit
(a) Total Cost
8/1 Beginning inventory10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 25 100$ 2,500$
8/14 20 100$ 2,000$ 5 100$ 500$
8/17 20 115$ 2,300$ 25 112$ 2,800$
8/28 14 112$ 1,568$ 11 112$ 1,232$
Moving Weighted Average Computations - Perpetual Merchandise Inventory System
These 20 units are sold at the average cost of $100/unit.
LO LO 2219
Moving Weighted Average- Example
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Purchases Sales (at cost) Inventory Balance
Date Units Unit Cost Total Cost Units
Unit Cost Total
(b) Units
(a)+(b) Average
Cost/Unit
(a) Total Cost
8/1 Beginning inventory10 91$ 910$ 10 91$ 910$
8/3 15 106$ 1,590$ 25 100$ 2,500$
8/14 20 100$ 2,000$ 5 100$ 500$
8/17 20 115$ 2,300$ 25 112$ 2,800$
8/28 14 112$ 1,568$ 11 112$ 1,232$
Moving Weighted Average Computations - Perpetual Merchandise Inventory System
This leaves 5 units remaining at an average cost of $100/unit.
LO LO 2220
Mini-QuizMini-QuizA company that uses a perpetual merchandise inventory system made the following cash purchases and sales:
Jan. 1-Purchased 100 units at $10 per unit.
Feb. 5-Purchased 60 units at $12 per unit.
Mar.16-Sold for cash 40 units for $16 per unit.
Prepare journal entries to record the sale assuming a Moving Weighted Average system is used.
Cash 640 Sales (40x $16) 640
Cost of goods sold 430 Merchandise Inventory 430 (100x$10 + 60x$12)/160 x 40
© 2013 McGraw-Hill Ryerson Limited. LO LO 2221
Specific IdentificationSpecific Identification
This method is used when items:• Can be directly identified.• Can be directly identified with a specific
purchase and its invoice.
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Examples: Automobiles, art, custom furniture.
LO LO 2222
Specific Identification - Example
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Purchases Sales (at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold Units
Unit Cost
Total Cost
8/1 Beginning inventory10 91$ 910$ 10 91$ 910$
10 91$ 910$ 8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 8 91$ 728$ 2 91$ 182$
12 106$ 1,272$ 3 106$ 318$
5 500$ 2 91$ 182$ 3 106$ 318$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,800$ 8/28 2 91$ 182$ 3 106$ 318$
12 115$ 1,380$ 8 115$ 920$
Specific Identificaton Computations - Perpetual Merchandise Inventory System
The opening inventory consists of 10 units @ $91/unit.
LO LO 2223
Specific Identification - Example
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Purchases Sales (at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold Units
Unit Cost
Total Cost
8/1 Beginning inventory10 91$ 910$ 10 91$ 910$
10 91$ 910$ 8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$
8/14 8 91$ 728$ 2 91$ 182$ 12 106$ 1,272$ 3 106$ 318$
5 500$ 2 91$ 182$ 3 106$ 318$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,800$ 8/28 2 91$ 182$ 3 106$ 318$
12 115$ 1,380$ 8 115$ 920$
Specific Identificaton Computations - Perpetual Merchandise Inventory System
This results in two layers of merchandise inventory.
15 additional units are purchased @ $106/unit.
LO LO 2224
Specific Identification - Example
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Purchases Sales ( at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold Units
Unit Cost
Total Cost
8/1 Beginning inventory10 91$ 910$ 10 91$ 910$
10 91$ 910$ 8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 8 91$ 728$ 2 91$ 182$
12 106$ 1,272$ 3 106$ 318$
5 500$ 2 91$ 182$ 3 106$ 318$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,800$ 8/28 2 91$ 182$ 3 106$ 318$
12 115$ 1,380$ 8 115$ 920$
Specific Identificaton Computations - Perpetual Merchandise Inventory System
On August 14, 20 units are sold. Eight of these units came from the opening merchandise inventory and the remaining 12 units came from the August 3 purchase.
LO LO 2225
Specific Identification - Example
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Purchases Sales (at cost) Inventory Balance
Date Units Unit Cost
Total Cost Units
Unit Cost
Cost of Goods Sold Units
Unit Cost
Total Cost
8/1 Beginning Inventory10 91$ 910$ 10 91$ 910$
10 91$ 910$ 8/3 15 106$ 1,590$ 15 106$ 1,590$
25 2,500$ 8/14 8 91$ 728$ 2 91$ 182$
12 106$ 1,272$ 3 106$ 318$
5 500$ 2 91$ 182$ 3 106$ 318$
8/17 20 115$ 2,300$ 20 115$ 2,300$
25 2,800$ 8/28 2 91$ 182$ 3 106$ 318$
12 115$ 1,380$ 8 115$ 920$
Specific Identificaton Computations - Perpetual Merchandise Inventory System
This leaves 2 units remaining from the original mercandise inventory and 3 units remaining from the August 3 purchase.
LO LO 2226
Because prices change, the choice of an merchandise inventory method is important.
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Units FIFO
Moving Weighted Average
Specific Identification
Cost of Goods Sold 34 3,535$ 3,568$ 3,562$
Ending Merchandise Inv. 11 1,265$ 1,232$ 1,238$
Goods Available for Sale 45 4,800$ 4,800$ 4,800$
Comparison of MethodsComparison of Methods
LO LO 3327
Advantages of Each Method
First-In, First-Out
First-In, First-Out
Ending inventory approximates
current replacement cost.
Ending inventory approximates
current replacement cost.
Moving Weighted Average
Moving Weighted Average
Smoothes out purchase price
changes
Smoothes out purchase price
changes
Specific Identification
Specific Identification
Exactly matches costs and revenues
Exactly matches costs and revenues
Financial ReportingFinancial Reporting
First-In, First-Out
First-In, First-Out
Most current values are on the balance
sheet as ending inventory
Most current values are on the balance
sheet as ending inventory
© 2013 McGraw-Hill Ryerson Limited. LO LO 3328
Disadvantages of Each Method
First-In, First-Out
First-In, First-Out
Ending inventory approximates
current replacement cost.
Ending inventory approximates
current replacement cost.
Moving Weighted Average
Moving Weighted Average
Does not accurately match
revenues to expenses
Does not accurately match
revenues to expenses
Specific Identification
Specific Identification
Relatively more costly to implement and
maintain
Relatively more costly to implement and
maintain
Financial ReportingFinancial Reporting
First-In, First-Out
First-In, First-Out
CGS does not reflect current costs
CGS does not reflect current costs
© 2013 McGraw-Hill Ryerson Limited. LO LO 3329
• A company is required to use the same accounting methods from period to period (consistency principle).
• A change is only acceptable when it improves financial reporting.
• The costing method used must be disclosed in the notes to the financial statements (full-disclosure principle).
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Financial ReportingFinancial Reporting
LO LO 3330
Merchandise Inventory must be reported at net realizable value (NRV) when NRV is lower than cost (principle of faithful representation).
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Lower of Cost and Net Realizable Lower of Cost and Net Realizable Value (LCNRV)Value (LCNRV)
LO LO 4431
May be applied in one of two ways:
1. Separately to each item.
2. To groups of similar or related items.
© 2013 McGraw-Hill Ryerson Limited.
Lower of Cost and Net Realizable Lower of Cost and Net Realizable Value (LCNRV)Value (LCNRV)
LO LO 4432
Errors in the computation of or physical count of merchandise inventory will cause a misstatement of:
• Cost of goods sold• Gross profit• Net income• Current assets• Equity
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Merchandise Inventory ErrorsMerchandise Inventory Errors
LO LO 5533
Inventory Errors- Effect on This Inventory Errors- Effect on This PeriodPeriod’’s Income Statements Income Statement
© 2013 McGraw-Hill Ryerson Limited. LO LO 5534
© 2013 McGraw-Hill Ryerson Limited.
Inventory Errors- Effect on This Inventory Errors- Effect on This PeriodPeriod’’s Balance Sheets Balance Sheet
LO LO 5535
Ending merchandise inventory is estimated by applying the gross profit ratio to net sales.
It is used:• When merchandise inventory has been
destroyed, lost, or stolen.• For testing the reasonableness of the physical
merchandise inventory count.
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Gross Profit MethodGross Profit Method
LO LO 6636
Occasionally used for interim period reporting.
Information required:1. Beginning inventory at cost and retail.
2. Net purchases at cost and retail.
3. Net sales.
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Retail Inventory MethodRetail Inventory Method
LO LO 6637
Q Describe how management’s decisions can affect the determination of the cost of merchandise inventory.
A Choice of method –FIFO, moving weighted average, specific identification.
Choice of application of LCNRV -separate item or categories.
Choice of periodic or perpetual system.
Items to include in cost.
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ReviewReview
38
• The periodic system also uses FIFO, specific identification, and weighted average methods to assign costs to merchandise inventory and cost of goods sold.
• The results may be the same or different under both systems.
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Periodic System-Appendix 6APeriodic System-Appendix 6A
LO LO 7739
Yields same results as perpetual system since most recent purchases are in ending merchandise inventory under both systems.
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FIFO-Appendix 6AFIFO-Appendix 6A
LO LO 7740
Steps:
1. Calculate weighted average unit cost.
(# units beg. Inv. X unit cost) + (#units purchased x unit cost) # units available for sale
= weighted average unit cost
2. Use weighted average unit cost to assign costs to cost of goods sold and ending merchandise inventory.
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Weighted Average-Appendix 6AWeighted Average-Appendix 6A
LO LO 7741
• Applied in same manner as periodic system.
• Yields same results as perpetual system since units are specifically identified.
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Specific Identification- Specific Identification- Appendix 6AAppendix 6A
LO LO 7742
• An error in the ending merchandise inventory affects the assets, net income, and equity of that period.
• The ending merchandise inventory of one period becomes the opening merchandise inventory of the next period. The cost of goods sold and net income of the next period are affected as well.
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Merchandise Inventory Errors in Merchandise Inventory Errors in a Periodic System-Appendix 6Aa Periodic System-Appendix 6A
LO LO 8843
Merchandise Inventory ratios may be used to assess:
1. Short-term liquidity.
2. Merchandise Inventory management.
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Ratios-Appendix 6BRatios-Appendix 6B
LO LO 9944
Merchandise Turnover Ratio• Measures how many times a company
turns its merchandise inventory over each period.
• The ratio will vary from industry to industry.
Merchandise turnover Cost of goods sold
Average merchandise inventory
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Ratios-Appendix 6BRatios-Appendix 6B
LO LO 9945
=
Days’ Sales in Inventory • Used to estimate how many days it will take to
convert merchandise inventory to cash or receivables.
• Used to assess if merchandise inventory levels can meet sales demand.
Days’ sales in inventory Ending inventory x 365
Cost of goods sold
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Ratios-Appendix 6BRatios-Appendix 6B
LO LO 9946
=
End of ChapterEnd of Chapter
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