Reporting and Interpreting Cost

of Goods Sold and Inventory

Chapter 7

McGraw-Hill/Irwin

2008 The McGraw-Hill Companies, Inc.

Flow of Inventory Costs

Merchandiser
Merchandise
Merchandise
Purchases
Purchases

Manufacturer
Raw
Raw
Materials
Materials
Direct
Direct
Labor
Labor
Factory
Factory
Overhead
Overhead
McGraw-Hill/Irwin

Merchandise
Merchandise
Inventory
Inventory

Raw
Raw Materials
Materials
Inventory
Inventory

Work
Work in
in Process
Process
Inventory
Inventory

Cost
Cost of
of
Goods
Goods Sold
Sold

Finished
Finished Goods
Goods
Inventory
Inventory

Cost
Cost of
of
Goods
Goods Sold
Sold
Slide 2

Nature of Cost of Goods Sold

Beginning
Beginning
Inventory
Inventory

Purchases
Purchases
for
for the
the Period
Period

Goods
Goods available
available
for
for Sale
Sale
Ending
Ending Inventory
Inventory
(Balance
(Balance Sheet)
Sheet)

Cost
Cost of
of Goods
Goods Sold
Sold
(Income
(Income Statement)
Statement)

Beginning
Beginning inventory
inventory ++ Purchases
Purchases == Goods
Goods Available
Available for
for Sale
Sale
Goods
Goods Available
Available for
for Sale
Sale Ending
Ending inventory
inventory == Cost
Cost of
of goods
goods sold
sold
McGraw-Hill/Irwin

Slide 3

Inventory Costing
Methods
Inventory
Costing
Methods
1.Specific
Identification
2.First-in, First-out
3.Last-in, First-out
4.Weighted
Average
Total Dollar Amount of Goods

Total Dollar Amount of Goods

Available
Available for
for Sale
Sale

Inventory Costing
Method

Ending
Ending Inventory
Inventory
McGraw-Hill/Irwin

Cost
Cost of
of Goods
Goods Sold
Sold
Slide 4

Specific Identification

When
When units
units
are
are sold,
sold, the
the
specific
specific cost
cost
of
of the
the unit
unit
sold
sold is
is added
added
to
to cost
cost of
of
goods
goods sold.
sold.
McGraw-Hill/Irwin

Slide 5

First-In, First-Out Method

Oldest
Oldest Costs
Costs

Cost
Cost of
of
Goods
Goods Sold
Sold

Recent
Recent Costs
Costs

Ending
Ending
Inventory
Inventory

McGraw-Hill/Irwin

Slide 6

Last-In, First-Out Method

Oldest
Oldest Costs
Costs

Ending
Ending
Inventory
Inventory

Recent
Recent Costs
Costs

Cost
Cost of
of
Goods
Goods Sold
Sold

McGraw-Hill/Irwin

Slide 7

Average Cost Method

When
When aa unit
unit is
is sold,
sold, the
the
average
average cost
cost of
of each
each
unit
unit in
in inventory
inventory is
is
assigned
assigned to
to cost
cost of
of
Number of
goods
sold.
goods
sold.
Cost of Goods
Units
Available for
Available for
Sale

McGraw-Hill/Irwin

Sale

Slide 8

Financial Statement Effects of Costing

Methods
Advantages
Advantages of
of Methods
Methods
First-In,
First-Out

Last-In,
First-Out

Weighted
Average

Ending
Ending inventory
inventory
approximates
approximates
current
current
replacement
replacement cost.
cost.

Better
Better matches
matches
current
current costs
costs in
in cost
cost
of
of goods
goods sold
sold with
with
revenues.
revenues.

Smoothes
Smoothes out
out
price
price changes.
changes.

McGraw-Hill/Irwin

Slide 9

Valuation at Lower of Cost or Market

Ending
Ending inventory
inventory is
is reported
reported at
at the
the
lower
lower of
of cost
cost or
or market
market (LCM)
(LCM)..
Replacement
Replacement Cost
Cost
The
The current
current purchase
purchase price
price
for
for identical
identical goods.
goods.
The company will recognize a holding loss in the
current period rather than the period in which the
item is sold.
This practice is conservative.
McGraw-Hill/Irwin

Slide 10

Internal Control of Inventory

Separation of inventory
accounting and physical
handling of inventory.

Storage in a manner that

protects from theft and
damage.

Limiting access to
authorized employees.

Maintaining perpetual
inventory records.

Comparing perpetual
records to periodic
physical counts.
McGraw-Hill/Irwin

Slide 11

Perpetual and Periodic Inventory

Systems
Provides
Provides up-to-date
up-to-date
inventory
inventory records.
records.

Perpetual
Perpetual
System
System
Provides
Provides up-to-date
up-to-date
cost
cost of
of sales
sales records.
records.
In a periodic inventory system, ending inventory and cost of
goods sold are determined at the end of the accounting
period based on a physical count.
McGraw-Hill/Irwin

Slide 12

Perpetual and Periodic Inventory

Systems
Inventory System
Periodic System
Carried over
Beginning Inventory
from prior period
Accumulated in
Add: Purchases
the Purchases
account
Measured at end
of period by
Less: Ending Inventory
physical
inventory count
Computed as a
residual amount
Cost of Goods Sold
at end of period
Item

McGraw-Hill/Irwin

Perpetual System
Carried over from
prior period
Accumulated in
the Inventory
account
Perpetual record
updated at every
sale
Measured at
every sale based
on perpetual
record
Slide 13

End of Chapter 7

2008 The McGraw-Hill Companies, Inc.