INVENTOR

Y
SYSTEM

INVENTORY
Inventory

is theraw materials, work-inprocess products and finished goods

that are considered to be the portion of
a business's assets that are ready or
will be ready for sale. Inventory
represents one of the most important
assets of a business because the
turnoverof inventory represents one of
the primary sources of revenue
generation and subsequentearnings
for the company's shareholders.

Learning Objective 1
- Understanding and
journalizing transactions
using the perpetual
inventory system and
explaining the difference
between perpetual and
periodic inventory
systems.

Perpetual Inventory
System

Two key accounts

Merchandise Inventory

Asset
Current balance of Inventory at all times
Entries are recorded for each purchase
and each sale of Inventory
Cost

of Goods Sold

Cumulative total cost of all merchandise

sold to customers during accounting
period
Both

accounts provide current info

to management.

Perpetual vs. Periodic

System

Perpetual system
Value of Inventory is known after every
purchase & sale
Cost of goods sold is known after every sale
Purchases, purchase returns & allowances,
and freight accounts dont exist
Periodic system
Does not give accurate info about
Merchandise Inventory or C.O.G.S. until
ending Inventory is done

Perpetual Inventory
System
We will use Problem 15B-1 to illustrate the journal
entries involved with the perpetual inventory
system.

Transactions for March:

15-Purchased merchandise on acct. totaling $1,800, terms n/30.
16- Sold merchandise costing $71 on acct. for $92 to B. Hackett.
18Returned $120 of defective merchandise purchased Mar. 15.
19- Sold $230 of merchandise for cash. It costs $175.
19- Allowed merchandise sold on Mar. 16 return for credit -$14. It
costs $11.
20- Bought $900 merchandise on acct. from JT Supply; terms
n/30.
22- Received pmt from B. Hackett for Mar. 16 sale less return.
23- Sold $410 of merchandise costing $320 for cash.

Problem 15B-1

Problem 15B-1

Problem 15B-1

Problem 15B-1

Learning Objective
2
Maintaining a
subsidiary ledger
for inventory.

Inventory Subsidiary
Ledger

business with a variety of

products in Inventory will
use Inventory subsidiary
ledger.
Maintain an individual
record for each different
product.
Companies like Wal-Mart and
Target use this ledger.

Merchandise Inventory
Subsidiary Accounts
Controlling Account
Merchandise Inventory
Bal. 292

Merchandise Inventory
Controlling Account
Merchandise Inventory
Bal. 292

Sep. 4 150
Bal. 442

Bal. 442

Purchased 5 units of
Product A for $30 on Sep. 4.

Subsidiary Accounts

Merchandise Inventory
Controlling Account
Merchandise Inventory
Bal. 292

210 Sep. 8

Sep. 4 150
Bal. 232
Sold 7 units of
Product A on Sep. 8.

Bal. 232

Subsidiary Accounts

Learning Objective
3
Understanding
periodic methods
of determining
the value of the
ending inventory.

Inventory Valuation
Methods-Periodic
Inventory System
Specific

Invoice
First In, First Out
(FIFO)
Last In, First Out
(LIFO)
Weighted Average

Inventory Valuation
Methods-Periodic Inventory
System
Method used will have effect on
Ending Inventory
Cost of goods sold
Gross profit

Specific Invoice
Method

Identify

each item in
ending Inventory by a
specific purchase price
and invoice number
Also known as specific
identification method
Would be used with cars,
boats, and antiques.

Specific Invoice Method

Pros
Simple if small
amounts of highcost goods
Flow of goods
and flow of cost
are same
Costs are exactly
matched with
Sales

Cons
Difficult if large
unit volume and
small unit prices

First In, First Out

Method

Assume

that the oldest

goods are sold first
Ending Inventory
valued at costs shown
on most recent invoices
Refer to Problem 15B-4

First In, First Out

Method

At end of year, 400 units unsold

First In, First Out

Method

Cost of Goods Available for Sale

Less Cost of Ending Inventory
Cost of Goods Sold

$43,800
22,000
$21,800

First In, First Out

Method
Pros
Cost flow tends
to follow physical
flow
Ending Inventory
valuation is made
up of current costs
on balance sheet

Cons
During
inflationary
periods, FIFO
produces higher
net income, thus
more taxes to be
paid
Recent costs are
not matched
with recent Sales

Last In, First Out

Method

Assume

that the goods

most recently acquired
are sold first
Ending Inventory
valued at earliest
invoice costs
Refer again to Problem
15B-4

Last In, First Out

Method

At end of year, 400 units unsold

Last In, First Out

Method

Cost of Goods Available for Sale

Less Cost of Ending Inventory
Cost of Goods Sold

$43,800
11,300
$32,500

Last In, First Out

Method
Pros
Cost

Cons

of goods sold is Ending

near current costs
Inventory is
Matches current
valued at old
costs with current
prices
selling price
Does not match
During inflationary
physical flow of
periods, LIFO
goods
produces lowest net
income, a tax
advantage.

Weighted-Average
Method

Average unit cost =

Total cost of goods available for
sale
Total units of goods available for
sale
Usually falls between FIFO & LIFO
amounts

Weighted-Average
Method

Average Unit Cost = $43,800 / 1,010 = $43.37

Ending Inventory = 400 units x $43.37 = $17,348

Weighted-Average
Method

Cost of Goods Available for Sale

Less Cost of Ending Inventory
Cost of Goods Sold

$43,800
17,348
$26,452

Weighted Average
Method
Pros
Good for
products sold in
large volume
An equal unit
cost is assigned to
each unit in
Inventory.

Cons
Current prices have
no more
significance than
older prices
Most recent costs
are not matched
with current Sales
Cost of ending
Inventory is not
most recent costs.

Items That Should be

Included in the Cost of
Inventory

Goods in Transit
F.O.B. shipping point buyer
becomes owner when merchandise
is placed on carrier at shipping point
F.O.B. destination seller
maintains ownership until
merchandise reaches the
destination

When Can An Inventory

Method Be Changed?
Consistency

Principle requires
companies to follow the same
accounting methods or procedures
from period to period
Full Disclosure Principle requires
companies to disclose on their
financial reports changes in
accounting procedures and methods
along with effect of the change as
well as justification for change.

Items That Should Not be

Included in the Cost of
Inventory
Merchandise

on consignment merchandise sold through agent

(consignee) who does not own it,
but has possession
Damaged or obsolete merchandise
- if not saleable, should not be
added to cost of Inventory.
If saleable at lower cost, value
should be conservatively
estimated & added to Inventory

Items That Should be

Included in the Cost of
Inventory
Goods

in Transit - When inventory is

taken, add only if ownership of
inventory has been transferred to
buyer.
Only use with F.O.B. - shipping point

Damaged

or Obsolete
Merchandise - only if saleable,
estimate value at conservative
cost.

Learning Objective 4
Estimating ending
inventory using the
retail method and gross
profit method and
understanding how the
ending inventory
amount affects financial
reports.

Methods of Estimating
Ending Inventory
Retail

Method

Gross

Profit Method

Retail Method
Must

know

Beginning Inventory at
cost and at retail
Cost of net purchases at
cost and at retail
Net Sales at retail

Retail MethodProblem
15B-5

Retail Method
Problem 15B-5

Retail Method
Problem 15B-5

Retail Method
Problem 15B-5

Gross Profit Method

Develops

relationship among Sales,

Cost of Goods Sold, and gross profit

Can

also be used to determine amount

of Inventory on hand at time of a fire

Can

verify accuracy of physical

Inventory at years end

Gross Profit Method

Helps

prepare financial
statements

Must

know

Average gross profit rate

Net Sales, beginning Inventory,
net purchases

Gross Profit Method

Step 1: Compute cost of goods
available for sale
Step 2: Estimate Cost of Goods
Sold by multiplying cost
percentage times Net Sales
Step 3: Subtract Cost of Goods Sold
from cost of goods available
for sale

Problem 15B-6

Effects of Inventory
Errors

Error

in ending Inventory
in Year 1 affects income
statement for two years
Year 1 ending Inventory
becomes Year 2 beginning
Inventory.

Effects of Inventory
Errors
If the item is:

Overstated

Understated

Beginning
Inventory

Profit is
understated

Profit is
overstated

Ending
Inventory

Profit is
overstated

Profit is
understated

THANK
YOU :D