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Chapter 5
Inventory
Chapter 5 1
Chapter 5: Objectives
• Account for common inventory transactions.
• Use the four major inventory costing methods to
calculate ending inventory and cost of goods sold.
• Apply the lower-of-cost-or-market rule to
inventory.
• Determine the effects of inventory errors on the
financial statements.
• Use ratios and other analysis techniques to make
decisions about inventory.
Chapter 5 2
Comparison of Methods
Periodic Perpetual
• Uses Temporary • Uses the inventory
accounts for purchases, account for all
freight, etc. transactions.
• Does not keep track of • Keeps a running balance
the Cost of Goods Sold in the Cost of Goods Sold
during the period. account.
• Inventory levels are • Inventory balance is kept
determined solely by current throughout the
ending physical count. period and adjusted based
on a physical count.
Chapter 5 3
Inventory Accounting Terms
•Sales
•Sales Returns and Allowances
•Sales Discounts
•Purchase Returns and Allowances
•Purchase Discounts
•Freight-In
•Delivery Expense(Freight-out)
•Cost of Goods Sold
Chapter 5 4
Shipping Terms
FOB Shipping Point: Buyer pays to get
the goods to the destination.
FOB Destination: Seller pays to get the
goods to the destination.
Chapter 5 5
Inventory Cost Flow Methods
•Specific Identification
•First In First Out
•Last In First Out
•Weighted Average
Chapter 5 6
Cost Flow Example
The operations of University Bookstore are used to explore the topic of inventory costing. Following
are inventory data for January for a Principles of Marketing textbook. The text is a paperback version and,
thus, there are no used copies of the text available for sale. To simplify the example, it is assumed that
University Bookstore is only open two days in January; all sales, therefore, occur on those two days.
1/ 1 Beginning inventory 100 copies @ $30 each $ 3,000
1/ 8 Purchased 400 copies @ $35 each 14,000
1/14 Sold 360 copies
1/18 Purchased 70 copies @ $39 each 2,730
1/22 Sold 180 copies
Chapter 5 7
Item: Principles of Marketing, Perpetual Inventory Record, FIFO Method
Purchases Sold Balance
Unit Unit Unit
Date # Cost Total # Cost Total # Cost Balance
Jan. 1 100 $30 $3,000
Jan. 8 400 $35 14,000
100 $30 $ 3,000
400 35 14,000
500 $17,000
Jan. 100 $30 $3,000
17 260 35
140 $35 $4,900
Jan. 70 $39 $2,730 $9,100
18 140 $35 $4,900
70 39 2,730
210 $7,630
Jan. 140 $35 $4,900
22 40 39 $1,560
30 $39 $1,170
Chapter 5 8
Item: Principles of Marketing, Perpetual LIFO
Purchases Sold Balance
Unit Unit Unit
Date # Cost Total # Cost Total # Cost Balance
Jan. 1 100 $30 $3,000
Jan. 8 400 $35 $14,000 100 $ 3,000
400 $30 14,000
500 35 $17,000
Jan. 360 $35 $12,600 $ 3,000
17 100 $30 1,400
40 35 $4,400
Jan. 70 $39 $2,730 100 $30 $3,000
18 40 35 1,400
70 39 2,730
210 $7,130
Jan. 70 $39 $2,730
22 40 35 1,400 30 $ 900
70 30 2,100 $30
Chapter 5 9
Item: Principles of Marketing, Perpetual Inventory Record, Moving Average Method
Purchases Sold Balance
Unit Unit Unit
Date # Cost Total # Cost Total # Cost Balance
Jan. 1 100 $30 $ 3,000
Jan. 8 400 $35 $14,000
500 $17,000
Jan. 360 $34 $12,240
17 140 $34 $ 4,760
Jan. 70 $39 $2,730
18 210 $ 7,490
Jan. 180 $35.67 $6,420
22 30 $35.67 $ 1,070
Chapter 5 10
Cost Flow Gross Profit and Inventory Amounts
EXHIBIT 5-6
Specific Weighted
Identification FIFO LIFO Average
Sales ($540 @ $50) $27,000 $27,000 $27,000 $27,000
Cost of Goods Sold 18,690 18,560 18,830 18,860
Gross Profit $ 8,310 $ 8,440 8,170 8,140
Inventory, 1/31 $ 1,040 $ 1,170 $ 900 $ 1,070
Chapter 5 11
Lower of Cost or Market
Total
Replacement Total Cost Market LCM
ITEM Quantity Unit Cost Cost 420 540 420
727 Jeans 30 14 18 480 340 340
757 Jeans 20 24 17 750 1000 750
Tank tops 50 15 20 720 560 560
Pullovers 40 18 14 2370* 2440 2070**
*Applying LCM on a total inventory basis
**Applying LCM on an Item by Item basis
Chapter 5 12
Effects of Inventory Errors
Current Year Next Year
Ending - overstated Beginning - overstated
Inventory
Ending - understated Beginning - overstated
Cost of Understated Overstated
Goods Sold Overstated Understated
Net Overstated Understated
Income Understated Overstated
Chapter 5 13
Relevant Ratios
Inventory Turnover Ratio =
Cost of Goods Sold ÷ Average Inventory
The inventory turnover ratio indicates the number of times that a
company sells or "turns over" its inventory each year.
Age of Inventory =
360 days ÷ Inventory Turnover Ratio
Inventory age indicates the average period required to sell an
item of inventory.
Chapter 5 14
